COMFORT SYSTEMS USA INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002

COMMISSION FILE NUMBER: 1-13011

COMFORT SYSTEMS USA, INC.
(Exact name of registrant as specified in its charter)

DELAWARE 76-0526487
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)

777 POST OAK BLVD.
SUITE 500
HOUSTON, TEXAS 77056
(713) 830-9600
(Address and telephone number of Principal Executive Offices)

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation SK is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]

Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]

As of March 25, 2003, the aggregate market value of the 36,200,882 shares
of the registrant's common stock held by non-affiliates of the registrant was
$179,918,384, based on the $4.97 last sale price of the registrant's common
stock on the New York Stock Exchange on June 28, 2002.

As of March 25, 2003, 37,923,494 shares of the registrant's common stock
were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III (other than the required information
regarding executive officers) is incorporated by reference from the registrant's
definitive proxy statement, which will be filed with the Commission not later
than 120 days following December 31, 2002.
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FORWARD-LOOKING STATEMENTS

This report contains "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended ("Securities Act") and
Section 21E of the Exchange Act. Such forward-looking statements are made only
as of the date of this report and involve known and unknown risks, uncertainties
and other important factors that could cause the actual results, performance or
achievements of the Company, or industry results, to differ materially from any
future results, performance or achievements expressed or implied by such
forward-looking statements. Such risks, uncertainties and other important
factors include, among others, the lack of a combined operating history and the
difficulty of integrating formerly separate businesses, retention of key
management, national or regional declines in non-residential construction
activity, difficulty in obtaining or increased costs associated with debt
financing or bonding, shortages of labor and specialty building materials,
seasonal fluctuations in the demand for HVAC systems and the use of incorrect
estimates for bidding a fixed price contract. Important factors that could cause
actual results to differ are discussed under "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Factors Which May
Affect Future Results."

PART I

ITEM 1. BUSINESS

Comfort Systems USA, Inc., a Delaware corporation, provides comprehensive
heating, ventilation and air conditioning ("HVAC") installation, maintenance,
repair and replacement services within the mechanical services industry in 57
cities throughout the United States.

We operate primarily in the commercial and industrial HVAC markets, and
perform most of our services within office buildings, retail centers, apartment
complexes, manufacturing plants, and healthcare, education and government
facilities. In addition to standard HVAC services, we provide specialized
applications such as building automation control systems, fire protection,
process cooling, electronic monitoring and process piping. Certain locations
also perform related activities such as electrical service and plumbing.
Approximately 96% of our consolidated 2002 revenues were derived from commercial
and industrial customers with approximately 52% of the revenues attributable to
installation services in newly constructed facilities and 48% attributable to
maintenance, repair and replacement services. Our consolidated 2002 revenues
were derived from the following service activities, all of which are in the
mechanical services industry, the single industry segment we serve:

We were originally formed in 1997 through an initial public offering, or
IPO, and simultaneous acquisition of 12 companies engaged in our business. From
the time we completed our IPO through December 1999, we acquired 107 HVAC and
complementary businesses, of which 26 were "tuck-in" operations that were
integrated with our existing operations. Since we suspended our acquisition
program in late 1999, we have sold or ceased operations at 29 companies through
2002.

Significantly, on March 1, 2002, we sold 19 operations to Emcor Group, Inc.
for $186.25 million, including Emcor's assumption of approximately $22.1 million
of subordinated notes to former owners of certain of the divested companies.
These 19 operations provided $683.4 million and $657.9 million of our revenue in
2000 and 2001, respectively. We used the proceeds from this sale to reduce debt.
We recognized a

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loss of $11.8 million and a goodwill impairment charge prior to the sale of
$32.4 million, net of taxes, related to the sold operations. For a further
discussion of this sale, see "Item 8 -- Financial Statements and Supplemental
Data -- Notes 3 and 4."

Our Internet address is http://www.csusafix.com. We make available free of
charge on or through our website our annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the SEC.

INDUSTRY OVERVIEW

We believe that the HVAC industry as a whole generates annual revenues in
excess of $75 billion, over $40 billion of which is in the commercial and
industrial markets. HVAC systems are necessary to virtually all commercial and
industrial buildings as well as homes. Because most commercial buildings are
sealed, HVAC systems provide the primary method of circulating fresh air in such
buildings. In many instances, replacing an aging system with a modern,
energy-efficient HVAC system significantly reduces a building's operating costs
and improves air quality and the HVAC system effectiveness. Older commercial and
industrial facilities often have poor air quality as well as inadequate air
conditioning, and older HVAC systems result in significantly higher energy costs
than do modern systems. These factors cause many facility owners to consider
replacing older systems early.

Many factors positively affect HVAC industry growth, particularly (i) an
aging installed base, (ii) increasing efficiency, sophistication and complexity
of HVAC systems, (iii) opportunities associated with utility deregulation, (iv)
increasing emphasis on indoor air quality, and (v) reduction or elimination of
the refrigerants commonly used in older HVAC systems. We believe these factors
should increase demand for the reconfiguration or replacement of existing HVAC
systems and may also mitigate, to some extent, the effect on the HVAC industry
of the cyclicality inherent in the traditional construction industry.

The HVAC industry can be broadly divided into two service functions:

- installation in newly constructed facilities, which provided
approximately 52% of our revenues in 2002, and

- maintenance, repair and replacement, which provided the remaining 48% of
our 2002 revenues.

Installation Services. Installation services consist of "design and build"
and "plan and spec" projects. In "design and build" projects, the commercial
HVAC firm is responsible for designing, engineering and installing a
cost-effective, energy-efficient system customized to the specific needs of the
building owner. Costs and other project terms are normally negotiated between
the building owner or its representative and the HVAC firm. Firms that
specialize in "design and build" projects generally have specially-trained HVAC
engineers, CAD/CAM design systems and in-house sheet metal and prefabrication
capabilities. These firms use a consultative approach with customers and tend to
develop long-term relationships with building owners and developers, general
contractors, architects and property managers. "Plan and spec" installation
refers to projects where a third-party architect or consulting engineer designs
the HVAC systems and the installation project is "put out for bid." We believe
that "plan and spec" projects usually take longer to complete than "design and
build" projects because the system design and installation process generally are
not integrated and because the resulting bid process often takes months to
complete. Furthermore, in "plan and spec" projects, the HVAC firm is not
responsible for project design and other parties must also approve any changes,
thereby increasing overall project time and cost.

Maintenance, Repair and Replacement Services. These services include
maintaining, repairing, replacing, reconfiguring and monitoring previously
installed HVAC systems and building automation controls. The growth and aging of
the installed base of HVAC systems and the demand for more efficient,
sophisticated and complex systems and building automation controls have fueled
growth in this service line. The increasing sophistication and complexity of
these HVAC systems is leading many commercial and industrial building owners and
property managers to increase attention to maintenance and to outsource
maintenance and repair, often through service agreements with HVAC service
providers. In addition, further restrictions have been
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placed on the use of certain types of refrigerants used in HVAC systems, which,
along with indoor air quality concerns, may increase demand for the
reconfiguration and replacement of existing HVAC systems. State-of-the-art
control and monitoring systems feature electronic sensors and microprocessors.
These systems require specialized training to install, maintain and repair, and
the typical building engineer has not received this training. Increasingly, HVAC
systems in commercial and industrial buildings are being remotely monitored
through PC-based communications systems to improve energy efficiency and
expedite problem diagnosis and correction, thereby allowing us to provide
maintenance and repair services at a lower cost.

STRATEGY

We are focusing on strengthening operating competencies and increasing
operating margins. The key elements of our operating strategy are:

Achieve Excellence in Core Competencies. We have identified six core
competencies, which we believe are critical to attracting and retaining
customers, increasing operating income and cash flow and creating
additional employment opportunities. The six core competencies are: (i)
customer cultivation and intimacy, (ii) design and build expertise, (iii)
estimating, (iv) job costing and job measurements, (v) safety, and (vi)
service capability.

Achieve Operating Efficiencies. We think we can achieve operating
efficiencies and cost savings through purchasing economies, adopting "best
practices" operating programs, and focusing on job management to deliver
services in a cost-effective and efficient manner. For example, we use our
combined purchasing to gain volume discounts on products and services such
as HVAC components, raw materials, services, vehicles, advertising,
bonding, insurance and employee benefits.

Attract and Retain Quality Employees. We seek to attract and retain
quality employees by providing them (i) an enhanced career path from
working for a larger company, (ii) additional training, education and
apprenticeships to allow talented employees to advance to higher-paying
positions, (iii) the opportunity to realize a more stable income, and (iv)
attractive benefits packages.

Focus on Commercial and Industrial Markets. We primarily focus on the
commercial and industrial markets with particular emphasis on "design and
build" installation services and maintenance, repair and replacement
services. We believe that the commercial and industrial HVAC markets are
attractive because of their growth opportunities, large and diverse
customer base, reduced weather exposure as compared to residential markets,
attractive margins and potential for long-term relationships with building
owners, property managers, general contractors and architects.
Approximately 96% of our consolidated 2002 revenues were derived from
commercial and industrial customers.

Expand National Service Capabilities. We believe larger regional and
national commercial and industrial companies can benefit from consolidating
their HVAC needs with fewer HVAC service companies that are capable of
providing those services regionally or nationally. In response to this
opportunity, we have developed a National Accounts Group with an
interactive website and a call center to increase our ability to handle
these types of customers. We are devoting increased marketing resources to
expanding our customer base in regional and national service coverage.

Increase Emphasis on Facility Automation Services. We believe we can
expand our technical capabilities related to building automation control
systems including HVAC lighting, building access control and fire alarms.
We coordinate these services, manage national account opportunities and
implement business development strategies across operating locations with
expertise in providing these services.

Leveraging Resources. We believe significant operating efficiencies
can be achieved by leveraging resources among our operating locations. For
example, we have shifted certain prefabrication activities into centralized
locations thereby increasing asset utilization in these centralized
locations and redirecting prefabrication employees into other operational
areas. We have also transferred our engineering, field and supervisory
labor from one operation to another to more fully use our employee base,
meet our customers' needs, and share expertise.
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OPERATIONS SERVICES PROVIDED

We provide a wide range of installation, maintenance, repair and
replacement services for HVAC and related systems in commercial and industrial
properties. We manage our locations on a decentralized basis, with local
management maintaining responsibility for day-to-day operating decisions. Our
local management is augmented by regional leadership that focuses its efforts on
core business competencies, cooperation and coordination between locations,
implementing best practices and focusing on major corporate initiatives. In
addition to senior management, local personnel generally include design
engineers, sales personnel, customer service personnel, installation and service
technicians, sheet metal and prefabrication technicians, estimators and
administrative personnel. We have centralized certain administrative functions
such as insurance, employee benefits, training, safety programs, marketing and
cash management to enable our local operating management to focus on pursuing
new business opportunities and improving operating efficiencies. We also take
advantage of best practices by opportunistically combining certain back office
and administrative functions at various locations.

Installation Services. Our installation business related to newly
constructed facilities, which comprised approximately 52% of our consolidated
2002 revenues involves the design, engineering, integration, installation and
start-up of HVAC, building automation controls and related systems. We provide
"design and build" and "plan and spec" installation services for office
buildings, retail centers, apartment complexes, manufacturing plants, health
care, education and government facilities and other commercial and industrial
facilities. In a "design and build" installation, working with the customer, we
determine the needed capacity, energy efficiency and type of building automation
controls that best suit the proposed facility. Our engineer then estimates the
amount of time, labor, materials and equipment needed to build the specified
system. The final design, terms, price and timing of the project are then
negotiated with the customer or its representatives, after which any necessary
modifications are made to the system. In "plan and spec" installation, we
participate in a bid process to provide labor, equipment, materials and
installation based on plans and engineering provided by a customer or a general
contractor.

Once an agreement has been reached, we order the necessary materials and
equipment for delivery to meet the project schedule. In many instances, we
fabricate the ductwork and piping and assemble certain components for the system
based on the mechanical drawing specifications, eliminating the need to
subcontract ductwork or piping fabrication. Then we install the system at the
project site, working closely with the general contractor. Most of our
installation projects last from two weeks to one year and generate revenues from
$50,000 to $3,000,000 per project. These projects are generally billed
periodically as costs are incurred and, in most cases, with retainage of 5% to
10% that is held back until completion and successful start-up of the HVAC
system.

We also install process cooling systems and building automation controls
and monitoring systems. Process cooling systems are used primarily in industrial
facilities to provide heating and/or cooling to precise temperature and climate
standards for products being manufactured and for the manufacturing equipment.
Building automation control systems are used in HVAC and process cooling systems
to maintain pre-established temperature or climate standards for commercial or
industrial facilities. Building automation control systems are capable not only
of controlling a facility's entire HVAC system, often on a room-by-room basis,
but can be programmed to integrate energy management, security, fire, card key
access, lighting and overall facility monitoring. This monitoring can be
performed on-site or remotely through a PC-based communications system. The
monitoring system communicates an exception when a system is operating outside
pre-established parameters. Diagnosis of potential problems can be performed
from the computer terminal which often can remotely adjust the control system.

Maintenance, Repair and Replacement Services. Our maintenance, repair and
replacement services comprised approximately 48% of our consolidated 2002
revenues and include the maintenance, repair, replacement, reconfiguration and
monitoring of HVAC systems and industrial process piping. Over two-thirds of our
maintenance, repair and replacement revenues were derived from reconfiguring
existing HVAC systems for commercial and industrial customers. Reconfiguration
often uses consultative expertise similar to that provided in the "design and
build" installation market.

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Maintenance and repair services are provided either in response to service
calls or under a service agreement. Service calls are coordinated by customer
service representatives or dispatchers that use computer and communication
technology to process orders, arrange service calls, communicate with customers,
dispatch technicians and invoice customers. Service technicians work from
service vehicles equipped with commonly used parts, supplies and tools to
complete a variety of jobs. Commercial and industrial service agreements usually
have terms of one to three years, with automatic annual renewals. We also
provide remote monitoring of temperature, pressure, humidity and air flow for
HVAC systems. If the system is not operating within the specifications set forth
by the customer and cannot be remotely adjusted, a service crew is dispatched to
analyze and repair the system.

SOURCES OF SUPPLY

The raw materials and components we use include HVAC system components,
ductwork, steel, sheet metal and copper tubing and piping. These raw materials
and components are generally available from a variety of domestic or foreign
suppliers at competitive prices. Delivery times are typically short for most raw
materials and standard components, but during periods of peak demand, may extend
to a month or more. Chillers for large units typically have the longest delivery
time and generally have lead times of up to six months. The major components of
commercial HVAC systems are compressors and chillers that are manufactured
primarily by York Heating and Air Conditioning Corporation, Carrier Corporation,
Trane Air Conditioning Company and Lennox International. The major suppliers of
building automation control systems are Honeywell, Johnson Controls, Siemens,
York, Automated Logic, Novar and Andover Control Corporation. We do not have any
significant contracts guaranteeing us a supply of raw materials or components.

SALES AND MARKETING

We have a diverse customer base, with no single customer accounting for
more than 2% of consolidated 2002 revenues. Management and a dedicated sales
force have been responsible for developing and maintaining successful long-term
relationships with key customers. Customers generally include building owners
and developers and property managers, as well as general contractors, architects
and consulting engineers. We intend to continue our emphasis on developing and
maintaining long-term relationships with our customers by providing superior,
high-quality service in a professional manner.

We have a national sales team focusing on cross-marketing and business
development opportunities that we believe are available to us as a regional or
national provider of comprehensive commercial and industrial HVAC and related
services. We believe we can continue to leverage the diverse technical and
marketing strengths at individual locations to expand the services offered in
other local markets.

EMPLOYEES

As of December 31, 2002, we had 6,088 employees, including 331 management
personnel, 4,853 engineers, service and installation technicians, 253 sales
personnel and 651 administrative personnel across our 84 operating locations. We
have collective bargaining agreements covering approximately 108 employees. We
have not experienced and do not expect any significant strikes or work stoppages
and believe our relations with employees covered by collective bargaining
agreements are good.

RECRUITING, TRAINING AND SAFETY

Our continued success depends, in part, on our ability to continue to
attract, retain and motivate qualified engineers, service technicians, field
supervisors and project managers. We believe our success in retaining qualified
employees will be based on the quality of our recruiting, training,
compensation, employee benefits programs and opportunities for advancement. We
coordinate our recruiting efforts via the Internet and at local technical
schools and community colleges where students focus on learning basic industry
skills. Additionally, we provide on-the-job training, technical training,
apprenticeship programs, attractive benefit packages and career advancement
opportunities within our company.

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We have established comprehensive safety programs throughout our operations
to ensure that all technicians comply with safety standards we have established
and that are established under federal, state and local laws and regulations.
Additionally, we have implemented a "best practices" safety program throughout
our operations, which provides employees with incentives to improve safety
performance and decrease workplace accidents. Regional safety directors
establish safety programs and benchmarking to improve safety within their
region. Finally, our employment screening process seeks to determine that
prospective employees have the requisite skills, sufficient background
references and acceptable driving records, if applicable.

RISK MANAGEMENT, INSURANCE AND LITIGATION

The primary risks in our operations are bodily injury, property damage and
injured workers' compensation. We retain the risk for worker's compensation,
employer's liability, auto liability, general liability and employee group
health claims resulting from uninsured deductibles per accident or occurrence.
Losses up to the deductible amounts are estimated and accrued based upon known
facts, historical trends and industry averages utilizing the assistance of an
actuary to determine the best estimate of these obligations.

We are subject to certain claims and lawsuits arising in the normal course
of business and maintain various insurance coverages to minimize financial risk
associated with these claims. We have estimated and provided accruals for
probable losses and legal fees associated with certain of these actions in our
consolidated financial statements. We do not believe uninsured losses, if any,
resulting from the ultimate resolution of these matters will have a material
adverse effect on our financial position or results of operations.

We typically warrant labor for the first year after installation on new
HVAC systems and pass through to the customer manufacturers' warranties on
equipment. We generally warrant labor for 30 days after servicing of existing
HVAC systems. We do not expect warranty claims to have a material adverse effect
on our financial position or results of operations.

COMPETITION

The HVAC industry is highly competitive and consists of thousands of local
and regional companies. We believe that purchasing decisions in the commercial
and industrial markets are based on (i) long-term customer relationships, (ii)
quality, timeliness and reliability of services provided, (iii) competitive
price, (iv) range of services provided and (v) scale of operation. To improve
our competitive position we focus on both the highly consultative "design and
build" installation market and the maintenance, repair and replacement market to
promote first the development and then the strengthening of long-term customer
relationships. In addition, we believe our ability to provide multi-location
coverage, access to project financing and specialized technical skills for
facilities owners gives us a strategic advantage over smaller competitors who
may be unable to provide these services to customers at a competitive price, if
at all.

We believe that we are larger than most of our competitors which are
generally small, owner-operated companies that typically operate in a limited
geographic area. However, there are larger companies, divisions of utility
companies and equipment manufacturers that provide HVAC services in some of the
same service lines and geographic locations we serve. Some of these competitors
and potential competitors have greater financial resources than we do to finance
development opportunities and support their operations. We believe our smaller
competitors generally compete with us based on price and their long-term
relationships with local customers. Our larger competitors compete with us on
those factors but may also provide attractive financing and comprehensive
service and product packages.

VEHICLES

We operate a fleet of various owned or leased service trucks, vans and
support vehicles. We believe these vehicles generally are well maintained and
sufficient for our current operations.

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GOVERNMENTAL REGULATION AND ENVIRONMENTAL MATTERS

Our operations are subject to various federal, state and local laws and
regulations, including: (i) licensing requirements applicable to engineering,
construction and service technicians, (ii) building and HVAC codes and zoning
ordinances, (iii) regulations relating to consumer protection, including those
governing residential service agreements and (iv) regulations relating to worker
safety and protection of the environment. We believe we have all required
licenses to conduct our operations and are in substantial compliance with
applicable regulatory requirements. If we fail to comply with applicable
regulations we could be subject to substantial fines or revocation of our
operating licenses.

Many state and local regulations governing the HVAC services trades require
individuals to hold permits and licenses. In some cases, a required permit or
license held by a single individual may be sufficient to authorize specified
activities for all of our service technicians who work in the state or county
that issued the permit or license. We are implementing a policy to ensure that,
where possible, we have two employees who hold any such permits or licenses that
may be material to our operations in a particular geographic region.

Our operations are subject to the federal Clean Air Act, as amended, which
governs air emissions and imposes specific requirements on the use and handling
of chlorofluorocarbons, or CFCs, and certain other refrigerants. Clean Air Act
regulations require the certification of service technicians involved in the
service or repair of equipment containing these refrigerants and also regulate
the containment and recycling of these refrigerants. These requirements have
increased our training expenses and expenditures for containment and recycling
equipment. The Clean Air Act is intended ultimately to eliminate the use of CFCs
in the United States and to require alternative refrigerants to be used in
replacement HVAC systems. We do not believe these regulations on CFCs will
materially affect our business on the whole because although they require us to
incur modest ongoing training costs, they also encourage our potential customers
to update their HVAC systems.

EXECUTIVE OFFICERS

We have five executive officers.

William F. Murdy, age 61, has served as our Chairman of the Board and Chief
Executive Officer since June 2000. Prior to this he was Interim President and
Chief Executive Officer of Club Quarters, a privately-owned chain of membership
hotels. From January 1998 through July 1999, Mr. Murdy served as President,
Chief Executive Officer and Chairman of the Board of LandCare USA, a
publicly-traded commercial landscape and tree services company. He was primarily
responsible for organizing LandCare USA and its listing as a publicly-traded
company on the New York Stock Exchange in July 1998. LandCare USA was acquired
in July 1999 by another publicly-traded company specializing in services to
homeowners and commercial facilities. From 1989 through December 1997, Mr. Murdy
was President and Chief Executive Officer of General Investment and Development
Company, a privately-held real estate operating company. From 1981 to 1989, Mr.
Murdy served as the Managing General Partner of the Morgan Stanley Venture
Capital Fund. From 1974 to 1981, Mr. Murdy served as the Senior Vice President
and Chief Operating Officer, among other positions, of Pacific Resources, Inc.,
a publicly-traded company involved primarily in petroleum refining and
marketing.

Norman C. Chambers, age 53, has served as our President and as a director
since November 2002. Prior to this, Mr. Chambers was Chief Operating Officer of
Capstone Turbine Corporation, a small cap distributive generation technology
company. From April 2000 to September 2001, Mr. Chambers served as President and
Chief Executive Officer of Petrocosm Corporation, a privately held e-commerce
business serving as a procurement portal for the energy industry. From June 1985
to April 2000, Mr. Chambers served in various positions with the Halliburton
Companies. His responsibilities included construction, service, and business
development at the Halliburton Company, including President of Halliburton
Energy Development, Senior Vice President of the Halliburton Company and
Managing Director of Brown & Root.

J. Gordon Beittenmiller, age 44, has served as our Executive Vice
President, Chief Financial Officer and a director since May 1998, and was our
Senior Vice President, Chief Financial Officer and a director from

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February 1997 to April 1998. From 1994 to February 1997, Mr. Beittenmiller was
Corporate Controller of Keystone International, Inc., a publicly-traded
multi-national manufacturer of industrial valves and actuators, and served
Keystone in other financial positions from 1991 to 1994. From 1987 to 1991, he
was Vice President-Finance of Critical Industries, Inc., a publicly-traded
manufacturer and distributor of specialized safety equipment. From 1982 to 1987,
he held various positions with Arthur Andersen LLP. Mr. Beittenmiller is a
Certified Public Accountant.

William George III, age 38, has served as our Senior Vice President,
General Counsel and Secretary since May 1998, and was our Vice President,
General Counsel and Secretary from March 1997 to April 1998. From October 1995
to February 1997, Mr. George was Vice President and General Counsel of American
Medical Response, Inc., a publicly-traded healthcare transportation company.
From September 1992 to September 1995, Mr. George practiced corporate and
antitrust law at Ropes & Gray, a Boston, Massachusetts law firm.

Milburn Honeycutt, age 39, has served as our Senior Vice President-Finance
since March 2002, and was our Vice President and Corporate Controller from
February 1997 to February 2002. He was promoted to Senior Vice President in
September 2000. From 1994 to January 1997, Mr. Honeycutt was Financial
Accounting Manager -- Corporate Controllers Group for Browning-Ferris
Industries, Inc., a publicly-traded multi-national waste services company. From
1986 to 1994, he held various positions with Arthur Andersen LLP and was a
Certified Public Accountant.

ITEM 2. PROPERTIES

We lease the real property and buildings from which we operate. Our
facilities consist of offices, shops, maintenance and warehouse facilities.
Generally, leases range from five to ten years and are on terms we believe to be
commercially reasonable. In many instances these leases are with the former
owners (some of whom continue to work for us) of companies we purchased from
1997 through 1999. These leases were entered into in connection with the
acquisition of the companies these individuals owned. To the extent we renew
these leases or otherwise change them, we enter into such agreements on an
arm's-length basis. Leased premises range in size from approximately 1,000
square feet to 130,000 square feet. To maximize available capital, we generally
intend to continue to lease the majority of our properties. We believe that our
facilities are sufficient for our current needs.

We lease our executive and administrative offices in Houston, Texas.

ITEM 3. LEGAL PROCEEDINGS

We are subject to certain claims and lawsuits arising in the ordinary
course of business and maintain various insurance coverages to minimize
financial risk associated with these claims. We have estimated and provided
accruals for probable losses and legal fees associated with certain of these
actions in our consolidated financial statements. In the opinion of our
management, uninsured losses, if any, resulting from the ultimate resolution of
these matters will not have a material adverse effect on our financial position
or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The following table sets forth the reported high and low sales prices of
our Common Stock for the quarters indicated as traded at the New York Stock
Exchange. Our Common Stock is traded under the symbol FIX:

As of March 25, 2003, there were approximately 542 stockholders of record
of our Common Stock, and the last reported sale price on that date was $2.63 per
share.

We have never declared or paid a dividend on our Common Stock. We currently
expect to retain future earnings to repay debt and finance growth and,
consequently, do not intend to declare any dividend on our Common Stock for the
foreseeable future. In addition, our revolving credit agreement restricts our
ability to pay dividends without the lenders' consent. Our Restricted Voting
Common Stock converts to Common Stock upon sale and under certain other
conditions.

RECENT SALES OF UNREGISTERED SECURITIES

During 2002, we did not issue any unregistered shares of our Common Stock.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected historical financial data has been derived from the
audited financial statements of the Company. The historical financial statement
data reflects the acquisitions of businesses accounted for as purchases as of
their respective acquisition dates. The selected historical financial data below
should be read in conjunction with the historical Consolidated Financial
Statements and related notes.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis should be read in conjunction with
the consolidated financial statements and related notes included elsewhere in
this Form 10-K. Also see "Forward-Looking Statements" discussion.

10

INTRODUCTION

We are a national provider of comprehensive heating, ventilation and air
conditioning ("HVAC") installation, maintenance, repair and replacement services
within the mechanical services industry. We operate primarily in the commercial
and industrial HVAC markets and perform most of our services within office
buildings, retail centers, apartment complexes, manufacturing plants, and
healthcare, education and government facilities. In addition to standard HVAC
services, we provide specialized applications such as building automation
control systems, fire protection, process cooling, electronic monitoring and
process piping. Certain locations also perform related activities such as
electrical service and plumbing. The segment of the HVAC industry we serve can
be broadly divided into two service functions: installation in newly constructed
facilities, which provided approximately 52% of our revenues in 2002, and
maintenance, repair and replacement, which provided the remaining 48% of our
2002 revenues.

Our company was originally formed in 1997 through an initial public
offering, or IPO, and simultaneous acquisition of 12 companies engaged in our
business. From the time we completed our IPO through December 1999, we acquired
107 HVAC and complementary businesses, of which 26 were "tuck-in" operations
that were integrated with our existing operations.

Beginning in the fourth quarter of 1999, we shifted our strategy from an
acquisition-based growth strategy to an operating strategy that increased
emphasis on improving our operating performance. Since then, we have sold or
ceased operations at 29 locations through December 31, 2002. Significantly, on
March 1, 2002, we sold 19 operations to Emcor Group, Inc. for $186.25 million,
including Emcor's assumption of approximately $22.1 million of subordinated
notes to former owners of certain of the divested companies. These 19 operations
provided $683.4 million and $657.9 million of our revenue in 2000 and 2001,
respectively. We used the proceeds from this sale to reduce debt. The operating
results of companies sold to Emcor have been reported as discontinued operations
in the accompanying consolidated statements of operations. We recognized a loss
of $11.8 million and a goodwill impairment charge prior to the sale of $32.4
million, net of taxes, related to the sold operations. For a further discussion
of this sale, see "Item 8 -- Financial Statements and Supplemental Data -- Notes
3 and 4."

In response to the Securities and Exchange Commission's Release No.
33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting
Policies", we identified our critical accounting policies based upon the
significance of the accounting policy to our overall financial statement
presentation, as well as the complexity of the accounting policy and our use of
estimates and subjective assessments. We have concluded that our most critical
accounting policy is our revenue recognition policy. As discussed elsewhere in
this annual report, our business has two service functions: (i) installation,
which we account for under the percentage of completion method, and (ii)
maintenance, repair and replacement, which we account for as the services are
performed, or in the case of replacement, under the percentage completion
method. In addition, we identified other critical accounting policies related to
our allowance for doubtful accounts receivable, the recording of our
self-insurance liabilities and the assessment of goodwill impairment. These
accounting policies, as well as others, are described in Note 2 to the
Consolidated Financial Statements included elsewhere in the Form 10-K.

PERCENTAGE OF COMPLETION METHOD OF ACCOUNTING

Under the percentage of completion method of accounting as provided by
American Institute of Certified Public Accountants Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts," contract revenue recognizable at any time during the life of a
contract is determined by multiplying expected total contract revenue by the
percentage of contract costs incurred at any time to total estimated contract
costs. More specifically, as part of the negotiation and bidding process in
which we engage in connection with obtaining installation contracts, we estimate
our contract costs, which include all direct materials (net of estimated
rebates), labor and subcontract costs and indirect costs related to contract
performance, such as indirect labor, supplies, tools, repairs and depreciation
costs. Then, as we perform under those contracts, we measure such costs
incurred, compare them to total estimated costs to complete the contract, and
recognize a corresponding proportion of contract revenue. As a result, contract

11

revenues recognized in the statement of operations can and usually do differ
from amounts that can be billed or invoiced to the customer at any point during
the contract.

An added complexity to the percentage of completion method of accounting is
that changes in job performance, job conditions, estimated profitability and
final contract settlements may result in revisions to estimated costs and,
therefore, revenues. Such revisions are frequently based on further estimates
and subjective assessments, and we recognize these revisions in the period in
which they are determined. If such revisions lead us to conclude that we will
recognize a loss on a contract, the full amount of the estimated ultimate loss
is recognized in the period we reach that conclusion, regardless of the
percentage of completion of the contract. Depending on the size of a project,
variations from estimated project costs could have a significant impact on our
operating results.

ACCOUNTING FOR ALLOWANCE FOR DOUBTFUL ACCOUNTS

We are required to estimate the collectibility of accounts receivable.
Inherent in the assessment of the allowance for doubtful accounts are certain
judgments and estimates including, among others, the creditworthiness of the
customer, our prior collection history with the customer, the ongoing
relationships with our customers, the aging of past due balances, our lien
rights, if any, in the property where we performed the work, and the
availability, if any, of payment bonds applicable to our contract. The estimate
of the allowance is based upon the best facts available and estimates are
re-evaluated and adjusted as additional information is received.

ACCOUNTING FOR SELF-INSURANCE LIABILITIES

We are self-insured for worker's compensation, employer's liability, auto
liability, general liability and employee group health claims resulting from
uninsured deductibles per accident or occurrence. Losses up to the deductible
amounts are estimated and accrued based upon known facts, historical trends and
industry averages utilizing the assistance of an actuary to determine the best
estimate of these obligations. We believe such accruals to be adequate. However,
insurance liabilities are difficult to assess and estimate due to unknown
factors, including the severity of an injury, the determination of our liability
in proportion to other parties, timely reporting of occurrences and the
effectiveness of safety and risk management programs. Therefore, if actual
experience differs from the assumptions and estimates used for recording the
liabilities, adjustments may be required and would be recorded in the period
that the experience becomes known.

ACCOUNTING FOR GOODWILL AND OTHER INTANGIBLE ASSETS

Effective January 1, 2002, we adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." This new
standard has two effects. First, we are no longer required to amortize goodwill
against our operating results on a recurring basis. Second, we are required to
regularly test the goodwill on our books to determine whether its value has been
impaired, and if it has, immediately write off, as a component of operating
income, the amount of the goodwill that is impaired.

More specifically, we are required to assess our goodwill asset amounts for
impairment each year, and more frequently if circumstances suggest an impairment
may have occurred. The new requirements for assessing whether goodwill assets
have been impaired involve market-based information. This information, and its
use in assessing goodwill, entails some degree of subjective assessments.

As part of the adoption of SFAS No. 142, we were required to make a
one-time determination of any transitional impairment loss by applying the
standard's new, more rigorous valuation methodology. The result of this
transitional analysis was a $202.5 million charge net of taxes reflected as a
cumulative effect of a change in accounting principle in our statement of
operations in the first quarter of 2002. We recorded an additional impairment
charge of $0.2 million as a component of operating results during the fourth
quarter of 2002.

12

RESULTS OF OPERATIONS

2002 COMPARED TO 2001

Revenues -- Revenues decreased $63.6 million, or 7.2%, to $819.3 million in
2002 compared to 2001. The 7.2% decline in revenues was comprised of a 6.5%
decline in revenues at ongoing operations and a 0.7% decline in revenues related
to operations that were sold or shut down during 2001.

The decline in revenues at ongoing operations in 2002 resulted primarily
from the lagged effect of the general economic slowdown that began in 2001. This
slowdown led to widespread delays in facility owners' decisions to proceed on
both new and replacement projects, and has also resulted in a more competitive
pricing environment. The decline in revenue is also consistent with management's
decreased emphasis on revenue growth in favor of improvement in profit margins,
operating efficiency, and cash flow. There can be no assurance, however, that
this strategy will lead to improved profit margins in the near term. In view of
these factors, particularly the decreased economic activity and increased price
competition affecting our industry, we may continue to experience only modest
revenue growth or revenue declines in upcoming periods. In addition, if general
economic activity in the U.S. slows significantly from current levels, we may
realize further decreases in revenue and lower operating margins.

Backlog primarily contains installation and replacement project work, and
maintenance agreements. These projects generally last less than a year. Service
work and short duration projects are generally billed as performed and therefore
do not flow through backlog. Accordingly, backlog represents only a portion of
our revenues for any given future period, and it represents revenues that are
likely to be reflected in our operating results over the next six to twelve
months. As a result, we believe the predictive value of backlog information is
limited to indications of general revenue direction over the near term, and
should not be interpreted as indicative of ongoing revenue performance over
several quarters.

13

Backlog associated with continuing operations as of December 31, 2002 was
$444.5 million, a 6.9% increase from December 31, 2001 backlog of $415.7
million. During the fourth quarter, we removed $16.0 million from backlog that
related to a project that we now believe will not proceed. This project was
first reflected in backlog in the third quarter of 2001. If this project is
excluded from all applicable periods, our backlog reflected an increase of 11.2%
from an adjusted December 31, 2001 backlog of $399.7 million.

Gross Profit -- Gross profit decreased $22.6 million, or 13.6%, to $143.0
million in 2002 compared to 2001. As a percentage of revenues, gross profit
decreased from 18.8% in 2001 to 17.5% in 2002.

The decline in gross profit for the year as a whole is primarily due to a
more competitive pricing environment as a result of the general economic
slowdown which began in 2001. This slowdown also resulted in project delays at a
number of our operations as decisions to start new construction activities as
well as retrofit projects were delayed in the fourth quarter of 2001. These
delays significantly affected our revenue volume and profitability during the
first part of 2002.

In the fourth quarter of 2002, we began experiencing cost overruns in
certain operations as well as reduced activity levels in connection with renewed
uncertainty about the economy and international events. These developments
continued into the first quarter of 2003. We also undertook restructuring steps
at our energy efficiency and national account operations in the first quarter of
2003. With the occurrence of these developments during what is traditionally a
period of reduced seasonal activity, we expect we will report a net loss for the
first quarter of 2003 that is comparable to the net loss from continuing
operations that we reported in the first quarter of 2002. We do expect to be
profitable in the second quarter and for 2003 as a whole.

Selling, General and Administrative Expenses ("SG&A") -- SG&A decreased
$16.6 million, or 11.6%, to $127.1 million in 2002 compared to 2001. As a
percentage of revenues, SG&A decreased from 16.3% in 2001 to 15.5% in 2002.
During the fourth quarter of 2001, we estimated and recorded bad debt expense of
approximately $3.5 million related to our receivables with Kmart, in light of
that company's bankruptcy filing in January 2002. During the second quarter of
2002, we reversed $0.8 million of the bad debt reserves that were established in
the fourth quarter of 2001 related to the Kmart receivables as a result of a
settlement with Kmart. Excluding the Kmart charge in 2001 and reversal in 2002,
SG&A declined $12.3 million, or 8.8%, to $127.9 million, and as a percentage of
revenue, from 15.9% in 2001 to 15.6% in 2002. The decrease in SG&A is primarily
due to a concerted effort to reduce SG&A throughout our Company. This effort
included a reduction in corporate overhead at the end of the first quarter of
2002 in response to our smaller size following the sale of 19 units to Emcor as
discussed further below under "Discontinued Operations." Nonrecurring costs
associated with this particular reduction were reflected as restructuring
charges in March 2002.

SG&A as a percentage of revenues for periods prior to the Emcor transaction
is higher than historical levels because the financial statements do not
allocate any corporate overhead to the discontinued operations. As a result,
SG&A for continuing operations in those periods includes substantially the full
amount of corporate office overhead that was in place to support our larger size
prior to the sale of operations to Emcor.

Goodwill Amortization and Impairment -- As discussed above, we no longer
amortize goodwill via regular charges to our income statement due to our
adoption of SFAS 142. See "Cumulative Effect of Change in Accounting Principle"
for further discussion. We recorded an additional goodwill impairment charge of
$0.2 million during the fourth quarter of 2002.

Restructuring Charges -- During the first quarter of 2002, we recorded
restructuring charges of approximately $1.9 million. These charges included
approximately $0.8 million for severance costs primarily associated with the
reduction in corporate overhead in light of our smaller size following the Emcor
transaction. The severance costs related to the termination of 33 employees, all
of whom were terminated as of March 31, 2002. In addition, these charges include
approximately $0.7 million for costs associated with decisions to merge or close
three smaller divisions and realign regional operating management. These
restructuring charges are primarily cash obligations but did include
approximately $0.3 million of non-cash writedowns associated with long-lived
assets.

During the first quarter of 2001, we recorded restructuring charges of
approximately $0.2 million, primarily related to contractual severance
obligations of two operating presidents in connection with our
14

significant restructuring program in the second half of 2000. These
restructuring charges are net of a gain of approximately $0.1 million related to
management's decision to sell a small operation during the first quarter of
2001.

Other Expense, Net -- Other expense, net, primarily includes interest
expense, and decreased $4.1 million, or 53.9%, to $3.5 million in 2002 compared
to 2001. A portion of our actual interest expense in both years has been
allocated to the discontinued operations caption based upon our net investment
in these operations. Therefore, interest expense relating to continuing
operations does not reflect the pro forma reduction of interest expense from
applying the proceeds from the sale of these operations to reduce debt in any
earlier period. Interest expense allocated to the discontinued operations in
2001 and 2002 was $13.8 million and $1.5 million, respectively. In addition,
first quarter 2002 interest expense in continuing operations includes a non-cash
writedown of $0.6 million, before taxes, of loan arrangement costs in connection
with the reduction in our borrowing capacity following the Emcor transaction.
Other expense, net, for the second quarter of 2002 also includes a gain of $0.6
million on the sale of the residential portion of one of our operations. In
addition, a gain of $0.7 million was recorded in the fourth quarter of 2002
related to the extinguishment of subordinated debt which was partially offset by
the acceleration of the amortization of deferred debt costs of $0.4 million in
October 2002 when we replaced our existing credit facility.

Income Tax Expense -- Our effective tax rates associated with results from
continuing operations for 2001 and 2002 were 117.6% and 47.2%, respectively. As
a result of the discontinuation of goodwill amortization in connection with the
adoption of SFAS No. 142 effective January 1, 2002, our 2002 effective tax rate
no longer reflects a permanent difference between book income and tax income for
goodwill amortization that is not deductible for tax purposes.

Discontinued Operations -- On March 1, 2002, we sold 19 operations to Emcor
Group. The total purchase price was $186.25 million, including the assumption by
Emcor of approximately $22.1 million of subordinated notes to former owners of
certain of the divested companies.

The transaction with Emcor provided for a post-closing adjustment based on
a final accounting, done after the closing of the transaction, of the net assets
of the operations that were sold to Emcor. That accounting indicated that the
net assets transferred to Emcor were approximately $7 million greater than a
target amount that had been agreed to with Emcor. In the second quarter of 2002,
Emcor paid us that amount, and released $2.5 million that had been escrowed in
connection with this element of the transaction.

Of Emcor's purchase price, $5 million was deposited into an escrow account
to secure potential obligations on our part to indemnify Emcor for future claims
and contingencies arising from events and circumstances prior to closing, all as
specified in the transaction documents. Of this escrow, $4 million has been
applied in determining the Company's liability to Emcor in connection with the
settlement of certain claims as described subsequently in this section. The
remaining $1 million of escrow is available for book purposes to apply to any
future claims and contingencies in connection with this transaction, and has not
been recognized as part of the Emcor transaction purchase price.

The net cash proceeds of approximately $164 million received to date from
the Emcor transaction have been used to reduce our debt. We paid $7.3 million of
federal taxes related to this transaction in March 2003.

In the fourth quarter of 2002, we recognized a charge of $1.2 million, net
of tax benefits of $2.7 million, in "Estimated loss on disposition, including
tax" in our results of operations in connection with the Emcor transaction. This
charge primarily relates to a preliminary agreement to settle claims from Emcor
for reimbursement of impaired assets and additional liabilities associated with
the operations acquired from us. Under this settlement, we also agreed to
partially reimburse Emcor for any loss on the eventual resolution of certain
claims involving a project at one of the operations Emcor acquired from us, and
we were released from liability on all other outstanding receivables and issues
relating to the profitability of projects that were in process at the time Emcor
acquired these operations from us. The settlement agreement also includes the
use of $2.5 million of the $5 million escrow described above to fund settled
claims. We further estimated that an additional $1.5 million of the remaining
escrow would be applied against elements of the settlement that will not be
fully resolved until a later date, principally the one open project referred to
above. Accordingly, for book

15

purposes, $1.0 million of escrow remains available to apply against future
claims that may arise from Emcor in connection with this transaction. We
recorded a tax benefit of $1.4 million related to this additional charge. In
addition, the $1.2 million charge recognized during the fourth quarter is also
net of a tax credit of $1.3 million as a result of lower final tax liabilities
in connection with the overall Emcor transaction than we originally estimated in
the first quarter.

Under SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which took effect for us on January 1, 2002, the operating
results of the companies sold to Emcor for all periods presented through the
sale, as well as the loss on the sale of these operations, have been presented
as discontinued operations in our results of operations. We realized a total
loss of $11.8 million, including related tax expense, in connection with the
sale of these operations. As a result of the adoption of SFAS No. 142 "Goodwill
and Other Intangible Assets," we also recognized a goodwill impairment charge
related to these operations of $32.4 million, net of taxes, as of January 1,
2002. The reporting of our aggregate initial goodwill impairment charge in
connection with adopting SFAS No. 142 is discussed further below under
"Cumulative Effect of Change in Accounting Principle."

In March 2002, we also decided to divest of an additional operating
company. In the first quarter of 2002, we recorded an estimated loss of $0.6
million from this planned disposition in "Estimated loss on disposition,
including tax" in our results of operations. In the fourth quarter of 2002, we
reversed this estimated loss because we decided not to sell this unit.

During the second quarter of 2002, we sold a division of one of our
operations. The operating loss for this division for the first two quarters of
2002 of $0.3 million, net of taxes, has been reported in discontinued operations
under "Operating results, net of tax" in our results of operations. We realized
a loss of $0.3 million on the sale of this division. This loss is included in
"Estimated loss on disposition, including tax" during the second quarter of 2002
in our results of operations.

Cumulative Effect of Change in Accounting Principle -- Effective January 1,
2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets," which
required a transitional assessment of our goodwill assets.

To perform the transitional impairment testing required by SFAS No. 142
under its new, more rigorous impairment criteria, we broke our operations into
"reporting units," as prescribed by the new standard, and tested each of these
reporting units for impairment by comparing the unit's fair value to its
carrying value. The fair value of each reporting unit was estimated using a
discounted cash flow model combined with market valuation approaches.
Significant estimates and assumptions were used in assessing the fair value of
reporting units. These estimates and assumptions involved future cash flows,
growth rates, discount rates, weighted average cost of capital and estimates of
market valuations for each of the reporting units.

As provided by SFAS No. 142, the transitional impairment loss identified by
applying the standard's new, more rigorous valuation methodology upon initial
adoption of the standard was reflected as a cumulative effect of a change in
accounting principle in our results of operations. The resulting non-cash charge
was $202.5 million, net of taxes.

2001 COMPARED TO 2000

Revenues -- Revenues decreased $19.4 million, or 2.2%, to $882.9 million in
2001 compared to 2000. The 2.2% decline in revenue for 2001 was comprised of a
4.1% decline in revenues related to operations that were sold or shut down
during late 2000 or in 2001, which was partially offset by 1.9% of internal
growth.

This low revenue growth resulted in part from a general slowing in the U.S.
economy as well as management's decreased emphasis on revenue growth in favor of
improvement in profit margins, operating efficiency, and cash flow.

Gross Profit -- Gross profit decreased $0.5 million, or 0.3%, to $165.6
million in 2001 compared to 2000. As a percentage of revenues, gross profit
increased from 18.4% in 2000 to 18.8% in 2001. Excluding operations

16

that were sold or shut down during late 2000 or in 2001, gross profit decreased
$3.5 million, or 2.1%, to $166.2 million and gross profit as a percentage of
revenues decreased from 19.9% in 2000 to 19.0% in 2001.

Our gross profit margin was hurt by sub par gross profit performance from
certain ongoing operations that were undergoing operational and management
changes. The results of these operations generally improved in the second half
of 2001 as compared to the first half. The negative effect on gross profit
percentages of these operations was offset by the divestiture of certain
operations in 2001 that performed poorly in 2000 and by the improvement in two
of our larger operations.

Selling, General and Administrative Expenses -- SG&A decreased $9.9
million, or 6.4%, to $143.7 million in 2001 as compared to 2000. As a percentage
of revenues, SG&A decreased from 17.0% in 2000 to 16.3% in 2001. Excluding
operations that were sold or shut down during late 2000 or in 2001, SG&A
increased $1.4 million, or 1.0%, to $141.7 million in 2001 compared to 2000 and
SG&A as a percentage of revenues decreased from 16.4% in 2000 to 16.2% in 2001.
During the fourth quarter of 2001, we estimated and recorded bad debt expense of
approximately $3.5 million related to our receivables with Kmart, in light of
that company's bankruptcy filing in January 2002. Substantially all of the Kmart
charge related to our ongoing operations that were not divested. Excluding both
the Kmart charge as well as operations sold or shut down in late 2000 or in
2001, SG&A declined $2.1 million, or 1.5%, to $138.2 million, and as a
percentage of revenue, from 16.4% in 2000 to 15.8% in 2001.

SG&A as a percentage of revenues during these periods was higher than
historical levels because the financial statements do not allocate any corporate
overhead to the discontinued operations sold to Emcor, and therefore, SG&A does
not reflect any potential reductions in corporate costs in response to this
major change in our company. Excluding the Kmart charge, the decrease in SG&A is
primarily related to operations that were sold or shut down as well as to a
concerted effort to reduce SG&A throughout our company.

Restructuring Charges -- During the first quarter of 2001, we recorded
restructuring charges of approximately $0.2 million, primarily related to
contractual severance obligations of two operating presidents in connection with
our significant restructuring program undertaken in the second half of 2000.
These restructuring charges are net of a gain of approximately $0.1 million
related to management's decision to sell a small operation during the first
quarter of 2001.

As announced in the third quarter of 2000, management performed an
extensive review of our operations during the second half of 2000. As part of
this review, management decided to cease operating at three locations, sell five
operations (including two smaller satellite operations), and merge two companies
into other operations. As a result of these decisions, we estimated and recorded
restructuring charges of approximately $25.3 million, primarily associated with
restructuring efforts at certain underperforming operations and our decision to
cease our e-commerce activities at Outbound Services, a subsidiary of our
company. The restructuring charges were primarily non-cash and included goodwill
impairments of approximately $11.5 million and the writedown of other long-lived
assets of approximately $8.5 million. The remaining restructuring items
primarily include severance and lease termination costs. These restructuring
actions were substantially completed in 2001.

During the third quarter of 2001, we decided to retain one of the
operations that was previously held for sale and reversed approximately $0.3
million of non-cash charges related to the anticipated loss on the sale of this
operation. This amount was offset by an additional loss on the sale in late
September 2001 of the final operation that was identified as part of this
restructuring program. The losses associated with the other operations that were
sold were consistent with the amounts recorded as restructuring charges in 2000.

Other Expense, Net -- Other expense, net, decreased $3.0 million, or 28.1%,
to $7.6 million in 2001 compared to 2000. This decrease was primarily due to a
reduction in interest expense as a result of the decline in our average debt
levels throughout 2001 as compared to 2000. A portion of our actual interest
expense in both years has been allocated to the discontinued operations caption
based upon our net investment in these operations. Therefore, interest expense
related to continuing operations does not reflect the pro forma reduction of
interest expense from applying the proceeds from the sale of these operations to
reduce debt in

17

any earlier periods. Interest expense allocated to the discontinued operations
in 2000 and 2001 was $15.5 million and $13.8 million, respectively.

Reductions in Non-Operating Assets and Liabilities, Net -- During 2000, we
recorded a non-cash charge of approximately $1.1 million primarily related to
the impairment of certain non-operating assets. This charge included an
impairment of approximately $1.4 million to our minority investment in two
entities associated with the distribution and implementation of high-end
engineering and design software. These entities have ceased operations. This
charge also included an impairment of approximately $0.3 million related to
notes receivable from former owners of businesses acquired. Offsetting these
items was a gain of approximately $0.6 million on the reduction of a
subordinated note payable to a former owner in connection with the settlement of
claims with this former owner.

Income Tax Expense -- Our effective tax rates associated with results from
continuing operations for 2000 and 2001 were 9.6% and 117.6%, respectively. Our
provision for income taxes differs from the federal statutory rate primarily due
to state income taxes (net of federal income tax benefit) and the
non-deductibility of the amortization of goodwill attributable to certain
acquisitions. The effective tax rate of 117.6% for 2001 is primarily due to the
high level of permanent differences (primarily non-deductible goodwill
amortization) as compared to the level of pre-tax income from continuing
operations. In 2000, we reported income tax benefit of $3.2 million on a pre-tax
loss from continuing operations of $33.1 million. This is primarily because of
large restructuring-related writedowns of non-deductible goodwill that
contributed to the 2000 book loss.

LIQUIDITY AND CAPITAL RESOURCES

Free cash flow:
Cash provided by operating activities............. $ 58,172 $ 66,829 $ 14,090
Purchases of property and equipment............... (18,037) (5,978) (5,322)
Proceeds from sales of property and equipment..... 1,937 1,011 1,551
-------- -------- ---------
Free cash flow...................................... $ 42,072 $ 61,862 $ 10,319

Cash Flow -- Cash provided by operating activities less customary capital
expenditures plus the proceeds from asset sales is generally called free cash
flow. Positive free cash flow represents funds available to invest in
significant operating initiatives, to acquire other companies or to reduce a
company's outstanding debt or equity. If free cash flow is negative, additional
debt or equity is generally required to fund the outflow of cash.

For the year ended December 31, 2002, we had positive free cash flow of
$10.3 million as compared to $61.9 million for the same period in 2001. Free
cash flow in 2000 was $42.1 million. The 2001 and 2000 cash flow amounts include
the 19 operations we sold to Emcor in 2002. This sale primarily accounts for the
lower cash flow amounts in 2002.

The proceeds received at the closing of the Emcor transaction, the
post-closing adjustment and related escrow received from Emcor, and free cash
flow from our operations were all used to reduce our debt.

Credit Facility -- Our primary current debt financing capacity consists of
a $55 million senior credit facility, or the Facility, provided by a syndicate
of three financial institutions led by General Electric Capital Corporation, or
GE. The Facility includes a $20 million sublimit for letters of credit. The
Facility is secured by substantially all of our assets. The Facility was entered
into on October 11, 2002 and replaces our previous revolving credit facility.
The Facility consists of two parts: a term loan and a revolving credit facility.

18

The term loan under the Facility, or the Term Loan, is $15 million, which
we borrowed upon the closing of the Facility on October 11, 2002. The Term Loan
must be repaid in quarterly installments over five years beginning December 31,
2002. The amount of each quarterly installment increases annually. These
scheduled payments are recapped below under Amounts Outstanding, Capacity and
Maturities.

The Facility requires certain prepayments of the Term Loan. Approximately
half of any free cash flow (primarily cash from operations less capital
expenditures) in excess of scheduled principal payments and voluntary
prepayments must be used to pay down the Term Loan. This requirement is measured
annually based on full-year results. We do not have any prepayments of the Term
Loan due as of December 31, 2002 under this requirement primarily as a result of
our significant amount of voluntary prepayments of debt during 2002. In
addition, proceeds in excess of $250,000 from any individual asset sales, or in
excess of $1 million for a full year's asset sales, must be used to pay down the
Term Loan. Proceeds from asset sales that are less than these individual
transaction or annual aggregate levels must also be used to pay down the Term
Loan unless they are reinvested in long-term assets within six months of the
receipt of such proceeds.

All prepayments under the Term Loan, whether required or voluntary, are
applied to scheduled principal payments in inverse order, i.e. to the last
scheduled principal payment first, followed by the second-to-last, etc. All
principal payments under the Term Loan permanently reduce the original $15
million capacity under this portion of the Facility.

The Facility also includes a three-year $40 million revolving credit
facility. Under this revolving credit facility, through July 31, 2003 we can
borrow up to $25 million, with the difference between actual borrowings and $40
million available for letter of credit issuance up to a maximum of $20 million
in letters of credit. After July 31, 2003, we can borrow up to $20 million under
the revolving credit facility, with a maximum of $20 million available for
letters of credit.

Interest Rates and Fees -- We have a choice of two interest rate options
for borrowings under the Facility. Under one option, the interest rate is
determined based on the higher of the Federal Funds Rate plus 0.5% or the prime
rate of at least 75% of the U.S.'s 30 largest banks, as published each business
day by the Wall Street Journal. An additional margin of 2.25% is then added to
the higher of these two rates for borrowings under the Revolving Loan, while an
additional margin of 2.75% is added to the higher of these two rates for
borrowings under the Term Loan.

Under the other interest rate option, borrowings bear interest based on
designated rates that are described in various general business media sources as
the London Interbank Offered Rate or "LIBOR." Revolving Loan borrowings using
this interest rate option then have 3.25% added to LIBOR, while Term Loan
borrowings have 3.75% added to LIBOR.

The rates underlying these interest rate options are floating interest
rates determined by the broad financial markets, meaning they can and do move up
and down from time to time. The Facility required that we convert these floating
interest rate terms on at least half of the Term Loan to fixed rates for at
least a one-year term. In January 2003, we converted $10 million of principal
value to a fixed LIBOR-based interest rate of 5.62% for an eighteen-month term.
This was done via a transaction known as a "swap" under which we agreed to pay
fixed interest rate payments on $10 million for eighteen months to a bank in
exchange for receiving from the bank floating LIBOR interest rate payments on
$10 million for the same term. This transaction is a derivative and qualifies
for hedge accounting treatment. As such, interest expense related to the hedged
portion of this debt will be recorded at the fixed rate of 5.62% in our results
of operations. Changes in market interest rates in any given period may increase
or decrease the valuation of our obligations to the bank under this swap versus
the bank's obligations to us. Such changes in market valuation will be reflected
in stockholders' equity as other comprehensive income (loss) for that period,
even though these obligations may not have been terminated and settled in cash
during the period. Such adjustments are known as mark-to-market adjustments.

Commitment fees of 0.5% per annum are payable on the unused portion of the
Revolving Loan.

We also incurred certain financing and professional costs in connection
with the arrangement and the closing of the Facility. These costs will be
amortized to interest expense over the term of the Facility in the
19

amount of approximately $0.4 million per quarter. To the extent prepayments of
the Term Loan are made, we may have to accelerate amortization of these deferred
financing and professional costs. Additionally, we expect to charge
approximately $0.5 million of deferred financing costs to interest expense in
the first quarter of 2003 that were associated with higher levels of capacity
under the Facility than the current total of $55 million.

In connection with the Facility, we granted GE a warrant to purchase
409,051 shares of our common stock for nominal consideration. In addition, GE
may "put," or require us to repurchase, these shares at the higher of market
price, appraised price or book value per share, during the fifth and final year
of the Facility -- October 11, 2006 to October 11, 2007. This put may be
accelerated under certain circumstances including a change of control of our
company, full repayments of amounts owing under the Facility, or a public
offering of shares by us. This warrant and put are discussed in greater detail
in Note 13, "Stockholders' Equity," to the Consolidated Financial Statements.
The value of this warrant and put as of the start of the Facility of $2.9
million is reflected as a discount of our obligation under the Facility and is
being amortized over the term of the Facility, as described above. This warrant
and put obligation is also recorded as a liability in the Company's balance
sheet. The value of this warrant and put will change over time, principally in
response to changes in the market price of our common stock. The warrant and the
put qualify as a derivative for financial reporting purposes. Accordingly, such
changes in the value of the warrant and put in any given period will be
reflected in interest expense for that period, even though the warrant and put
may not have been terminated and settled in cash during the period. Such
adjustments are known as mark-to-market adjustments. The after-tax loss related
to the warrant's mark-to-market obligation in 2002 was $0.1 million.

The weighted average interest rate that we currently pay on borrowings
under the Facility is 5.6% per annum. This reflects a combination of borrowings
under both interest rate options described above, as well as the swap of
floating rates to a fixed rate described above. This rate does not include
amortization of debt financing and arrangement costs, or mark-to-market
adjustments for derivatives.

Restrictions and Covenants -- Borrowings under the Facility are
specifically limited by our ratio of total debt to earnings before interest,
taxes, depreciation, and amortization ("EBITDA") and by our ratio of EBITDA less
taxes and capital expenditures to interest expense and scheduled principal
payments, also known as the fixed charge coverage ratio. The Facility's
definition of debt for purposes of the ratio of total debt to EBITDA includes
aggregate letters of credit outstanding less $10 million.

The definition of EBITDA under the Facility excludes certain items,
generally non-cash amounts and transactions reported in Other Income and
Expense, that are otherwise included in the determination of earnings under
generally accepted accounting principles in our financial statements. As such,
EBITDA as determined under the Facility's definition could be less than EBITDA
as derived from our financial statements in the future.

20

The financial covenants under the Facility are summarized below. Covenant
compliance is measured on a monthly basis. Intra-quarter monthly covenants are
at either the same or very similar levels to the quarter-end covenants shown
below. EBITDA amounts are in thousands:

Our trailing twelve months EBITDA as of December 31, 2002 as determined
under the Facility did not comply with the covenant. Our lenders waived this
violation. In addition, based on expectations of reduced operating results, at
least through the first quarter of 2003 as described above under 2002 Compared
to 2001 -- Gross Profit, our lenders agreed to reduce our minimum EBITDA,
leverage and fixed charge covenants for 2003. Even at these reduced levels,
these covenants leave only moderate room for variance based on our recent
performance. If we again violate a covenant under the Facility, we may have to
negotiate new borrowing terms under the Facility or obtain new financing. While
we believe that our levels of debt in comparison to our EBITDA would enable us
to negotiate new borrowing terms under the Facility or to obtain new financing
from other sources if necessary, there can be no assurance that we would be
successful in doing so.

The Facility prohibits us from paying dividends and repurchasing shares,
limits annual lease expense and non-Facility debt, and restricts outlays of cash
by us relating to certain investments, acquisitions and subordinate debt.

Notes to Affiliates and Former Owners -- Subordinated notes were issued to
former owners of certain purchased companies as part of the consideration used
to acquire their companies. As of December 31, 2002, these notes had been paid
off. A gain of approximately $0.7 million was recognized in 2002 related to
agreements with former owners for early repayment of certain of these notes, or
other settlement of claims.

Other Commitments -- As is common in our industry, we have entered into
certain off-balance sheet arrangements in the ordinary course of business that
result in risks not directly reflected in our balance sheets. Our most
significant off-balance sheet transactions include liabilities associated with
noncancelable operating leases. We also have other off-balance sheet obligations
involving letters of credit and surety guarantees.

We enter into noncancelable operating leases for many of our facility,
vehicle and equipment needs. These leases allow us to conserve cash by paying a
monthly lease rental fee for use of facilities, vehicles and equipment rather
than purchasing them. At the end of the lease, we have no further obligation to
the lessor. We may decide to cancel or terminate a lease before the end of its
term. Typically we are liable to the lessor for the remaining lease payments
under the term of the lease.

Some customers require us to post letters of credit to guarantee
performance under our contracts and to ensure payment to our subcontractors and
vendors under those contracts. Certain of our vendors also require
21

letters of credit to ensure reimbursement for amounts they are disbursing on our
behalf, such as to beneficiaries under our self-funded insurance programs. Such
letters of credit are generally issued by a bank or similar financial
institution. The letter of credit commits the issuer to pay specified amounts to
the holder of the letter of credit if the holder demonstrates that we have
failed to perform specified actions. If this were to occur, we would be required
to reimburse the issuer of the letter of credit. Depending on the circumstances
of such a reimbursement, we may also have to record a charge to earnings for the
reimbursement. To date we have not had a claim made against a letter of credit
that resulted in payments by the issuer of the letter of credit or by us. We
believe that it is unlikely that we will have to fund claims under a letter of
credit in the foreseeable future.

Many customers, particularly in connection with new construction, require
us to post performance and payment bonds issued by a financial institution known
as a surety. These bonds provide a guarantee to the customer that we will
perform under the terms of a contract and that we will pay subcontractors and
vendors. If we fail to perform under a contract or to pay subcontractors and
vendors, the customer may demand that the surety make payments or provide
services under the bond. We must reimburse the surety for any expenses or
outlays it incurs. To date, we have not had any significant reimbursements to
our surety for bond-related costs. We believe that it is unlikely that we will
have to fund claims under our surety arrangements in the foreseeable future.

We have reached a preliminary agreement with our surety and GE to grant the
surety a secured interest in assets such as receivables, costs incurred in
excess of billings, and equipment related to projects for which bonds are
outstanding as collateral for potential obligations under bonds. As of December
31, 2002, the amount of these assets is approximately $41.9 million. We have
also posted a $5 million letter of credit as collateral for potential
obligations under bonds.

Surety market conditions are currently difficult as a result of significant
losses incurred by many sureties in recent periods, both in the construction
industry as well as in certain larger corporate bankruptcies. As a result, less
bonding capacity is available in the market and terms have become more
restrictive. Further, under standard terms in the surety market, sureties issue
bonds on a project by project basis, and can decline to issue bonds at any time.
Historically, approximately 25% of our business has required bonds. While we
have enjoyed a longstanding relationship with our surety, current market
conditions as well as changes in our surety's assessment of our operating and
financial risk could cause our surety to decline to issue bonds for our work. If
that were to occur, our alternatives include doing more business that does not
require bonds, posting other forms of collateral for project performance such as
letters of credit or cash, and seeking bonding capacity from other sureties.
There can be no assurance that we could easily achieve these alternatives.
Accordingly, if we were to experience an interruption in the availability of
bonding capacity, our revenues and profits could decline.

Amounts Outstanding, Capacity and Maturities -- The following recaps our
debt amounts outstanding and capacity (in thousands):

As of December 31, 2002, we also have $9.8 million of letter of credit
commitments, all of which will expire in 2003.

Outlook -- As noted above, we have generated positive free cash flow in
most recent periods, and we currently have a moderate level of debt. We
anticipate that free cash flow from operations and borrowing capacity under the
Facility will provide us with sufficient liquidity to fund our operations for
the foreseeable future. However, we do not have a significant amount of excess
borrowing capacity in comparison to expected working capital requirements over
the balance of 2003. We believe that our levels of debt in comparison to our
EBITDA and our cash flows would enable us to obtain new financing if necessary,
but there can be no assurance that we would be successful in doing so.

We currently have $12.8 million in letters of credit outstanding. We
self-insure a significant portion of our workers compensation, auto liability
and general liability risks. We use third parties to manage this self-insurance
and to retain some of these risks. As is customary under such arrangements,
these third parties can require letters of credit as security for amounts they
fund or risks they might potentially absorb on our behalf. Under our current
self-insurance arrangements, we expect that we will be required to post
approximately $3.0 million per quarter during the first three quarters of 2003.
In addition, we may receive other letter of credit requests in the ordinary
course of business, and we may have a net increase in the amount of insurance-
related letters of credit we must post when we renew our insurance arrangements
in the fourth quarter of next year. Accordingly, our letter of credit
requirements over the next year may exceed the current letter of credit sublimit
of $20 million under our credit facility. If so, we may have to seek additional
letter of credit capacity or post different forms of security such as bonds or
cash in lieu of letters of credit. We believe that our levels of debt in
comparison to our EBITDA and free cash flows would enable us to obtain
additional letter of credit capacity or to otherwise meet financial security
requirements of third parties if necessary, but there can be no assurance that
we would be successful in doing so.

As described above, we must comply with a number of financial covenants in
connection with the Facility. Our trailing twelve months EBITDA as of December
31, 2002 as determined under the Facility did not comply with covenant. Our
lenders waived this violation. In addition, based on expectations of lower
operating results at least through the first quarter of 2003 as described above
under 2002 Compared to 2001 -- Gross Profit, our lenders agreed to modify our
minimum EBITDA, leverage and fixed charge covenants for 2003. Even at these
modified levels, these covenants leave only moderate room for variance based on
our recent performance. If we again violate a covenant under the Facility, we
may have to negotiate new borrowing terms under the Facility or obtain new
financing. While we believe that our levels of debt in comparison to our EBITDA
and our cash flows would enable us to negotiate new borrowing terms under the

23

Facility or to obtain new financing from other sources if necessary, there can
be no assurance that we would be successful in doing so.

SEASONALITY AND CYCLICALITY

The HVAC industry is subject to seasonal variations. Specifically, the
demand for new installation and replacement is generally lower during the winter
months (the first quarter of the year) due to reduced construction activity
during inclement weather and less use of air conditioning during the colder
months. Demand for HVAC services is generally higher in the second and third
calendar quarters due to increased construction activity and increased use of
air conditioning during the warmer months. Accordingly, we expect our revenues
and operating results generally will be lower in the first and fourth calendar
quarters.

Historically, the construction industry has been highly cyclical. As a
result, our volume of business may be adversely affected by declines in new
installation projects in various geographic regions of the United States.

NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 establishes new
accounting and reporting requirements for goodwill and other intangible assets.
We adopted this new standard effective January 1, 2002. See Note 4 of the
Consolidated Financial Statements for further discussion.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." We adopted SFAS No. 144 effective
January 1, 2002. Under SFAS No. 144, the operating results of companies sold or
held for sale meeting certain criteria, as well as any gain or loss on the sale
of these operations, are presented as discontinued operations in our statements
of operations. See Note 3 of the Consolidated Financial Statements for a
discussion of our discontinued operations. The operating results for companies
which were sold or shut down during 2001 are presented as continuing operations
through the date of disposition. The adoption of SFAS No. 144 did affect the
presentation of discontinued operations in the consolidated financial
statements; however, it did not have any overall financial impact on our results
of operations, financial position or cash flows.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
("SFAS No. 145"). SFAS No. 145 requires that gains and losses from
extinguishment of debt be classified as extraordinary items only if they meet
the criteria in Accounting Principles Board Opinion No. 30 ("Opinion No. 30").
Applying the provisions of Opinion No. 30 will distinguish transactions that are
part of an entity's recurring operations from those that are unusual and
infrequent and meet the criteria for classification as an extraordinary item. In
connection with our new credit facility, we fully amortized $0.4 million of
deferred debt costs and recognized a $0.7 million gain on the extinguishment of
subordinated debt in 2002. These amounts are recorded in "Other Expense, net" in
our results of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities, such as restructurings, involuntarily terminating employees, and
consolidating facilities initiated after December 31, 2002. The implementation
of SFAS No. 146 will not require the restatement of previously issued financial
statements. Implementation of the pronouncement will therefore have no impact on
our current year financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"). It clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee, including its
ongoing obligation to stand ready to perform over the term of the guarantee in
the event that the specified triggering events or conditions occur. The
objective of the initial measurement of the liability is the fair value of the
guarantee at its inception. The initial

24

recognition and initial measurement provisions of FIN 45 are effective for us on
a prospective basis for guarantees issued after December 31, 2002. Although we
from time to time guarantee the performance of systems or designs we provide, we
currently have no material guarantees.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS 148 amends FASB Statement No.
123, "Accounting for Transition for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
148 amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS 148 is effective for fiscal years ending after
December 15, 2002 and was adopted by us for all periods presented.

FACTORS WHICH MAY AFFECT FUTURE RESULTS

Our future operating results are difficult to predict and may be affected
by a number of factors, including the lack of a combined operating history and
the difficulty of integrating formerly separate businesses, retention of key
management, national or regional declines in non-residential construction
activity, difficulty in obtaining or increased costs associated with debt
financing or bonding, shortages of labor and specialty building materials,
seasonal fluctuations in the demand for HVAC systems and the use of incorrect
estimates for bidding a fixed price contract. As a result of these and other
factors, there can be no assurance that we will not experience material
fluctuations in future operating results or cash flows on a quarterly or annual
basis.

Our success depends in part on our ability to integrate and further
consolidate the companies we have acquired. These businesses operated as
separate, independent entities prior to their affiliation with us, and there can
be no assurance that we will be able to integrate the operations of these
businesses successfully or institute the necessary systems and procedures,
including accounting and financial reporting systems, to effectively manage the
combined enterprise on a profitable basis. The historical results are not
necessarily indicative of our future results because, among other reasons, our
subsidiary operations were not under common control or management prior to their
acquisition. There are also risks associated with unanticipated events or
liabilities resulting from the acquired businesses' operations prior to the
acquisition.

Many customers, particularly in connection with new construction, require
us to post performance and payment bonds issued by a financial institution known
as a surety. These bonds provide a guarantee to the customer that we will
perform under the terms of a contract and that we will pay subcontractors and
vendors. If we fail to perform under a contract or to pay subcontractors and
vendors, the customer may demand that the surety make payments or provide
services under the bond. We must reimburse the surety for any expenses or
outlays it incurs. To date, we have not had any significant reimbursements to
our surety for bond-related costs. We believe that it is unlikely that we will
have to fund claims under our surety arrangements in the foreseeable future.

Surety market conditions are currently difficult as a result of significant
losses incurred by many sureties in recent periods, both in the construction
industry as well as in certain larger corporate bankruptcies. As a result, less
bonding capacity is available in the market and terms have become more
restrictive. Further, under standard terms in the surety market, sureties issue
bonds on a project by project basis, and can decline to issue bonds at any time.
Historically, approximately 25% of our business has required bonds. While we
have enjoyed a longstanding relationship with our surety, current market
conditions as well as changes in our surety's assessment of our operating and
financial risk could cause our surety to decline to issue bonds for our work. If
that were to occur, our alternatives include doing more business that does not
require bonds, posting other forms of collateral for project performance such as
letters of credit or cash, and seeking bonding capacity from other sureties.
There can be no assurance that we could easily achieve these alternatives.
Accordingly, if we were to experience an interruption in the availability of
bonding capacity, our revenues and profits could decline.

The existing senior management at many of our subsidiary operations is
generally comprised of former owners who committed to stay with their operations
after acquisition. Certain of these individuals have
25

suffered losses in the value of our common stock or have lower incomes than they
averaged when they owned their former businesses. Further, former owners
generally have noncompetition obligations that expire on the fifth anniversary
of their date of acquisition, and thus these obligations expire from July 2002
through 2004. There is no assurance that we will be able to retain these
individuals or find suitable replacements if such individuals leave the Company.
The failure to retain or replace such management on a timely basis could
negatively impact results from operations at such locations.

Key elements of our strategy are to both maintain and improve the
profitability and cash flow of the individual businesses. Our level of success
in this strategy, if any, will be affected by demand for new or replacement HVAC
systems. In part, such demand will be contingent upon factors outside our
control, such as the level of new construction or the potential for slower
replacement based upon the overall level of activity in the economy. The HVAC
industry is subject to both seasonal and cyclical variations, meaning that
temperate weather and downturns in the domestic or regional economies will
negatively affect overall demand for our services.

The timely provision of high-quality installation service and maintenance,
repair and replacement of HVAC systems requires an adequate supply of skilled
HVAC technicians. In addition, we depend on the senior management of the
businesses we acquire and regional and corporate management to remain committed
to our success. Accordingly, our ability to maintain and increase our
productivity and profitability is also affected by our ability to employ, train
and retain the skilled technicians necessary to meet our service requirements,
and to retain senior management at the corporate, regional and local level.

Our ability to generate positive cash flow at our historical levels in the
future could be adversely impacted by a reduction in our billings and
collections as a result of a decline in new projects. The risk associated with a
decline in new projects could be further perpetuated by our accelerated billing
for our project work because we will continue to incur costs on older projects
where payment may have already been received from the customer. Such
indebtedness, together with the financial and other restrictive covenants in our
debt instruments, could limit our ability to borrow additional funds.
Additionally, failing to comply with those covenants could result in an event of
default, which, if not cured or waived, could have a material adverse effect on
the Company.

HVAC systems are subject to various environmental statutes and regulations,
including the Clean Air Act and those regulating the production, servicing and
disposal of certain ozone depleting refrigerants used in HVAC systems. There can
be no assurance that the regulatory environment in which we operate will not
change significantly in the future. Our failure to comply, or the costs of
compliance, with such laws and regulations could adversely affect our future
results.

Because of these and other factors, past financial performance should not
necessarily be considered an indicator of future performance. Investors should
not rely solely on historical trends to anticipate future results and should be
aware that the trading price of our Common Stock may be subject to wide
fluctuations in response to quarter-to-quarter variations in operating results,
general conditions in the HVAC industry, the increasing supply of tradable
stock, changes in analysts' earnings estimates, recommendations by analysts, or
other events.

ITEM 7-A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk primarily related to potential adverse
changes in interest rates as discussed below. Management is actively involved in
monitoring exposure to market risk and continues to develop and utilize
appropriate risk management techniques. In January 2003, we converted $10
million of our Term Loan to a fixed rate of 5.62% for an eighteen-month term.
This was done via a transaction known as a "swap" under which we agree to pay
fixed LIBOR-based interest rate payments on $10 million for eighteen months to a
bank in exchange for receiving from the bank floating LIBOR-based interest rate
payments on $10 million for the same term. This transaction is a derivative and
qualifies for hedge accounting treatment. We are not exposed to any other
significant financial market risks including commodity price risk, foreign
currency exchange risk or interest rate risks from the use of derivative
financial instruments. Management does not use derivative financial instruments
for trading or to speculate on changes in interest rates or commodity prices.
26

Our exposure to changes in interest rates primarily results from our
short-term and long-term debt with both fixed and floating interest rates. Our
debt with fixed interest rates consists of capital leases and various notes
payable. This differs from the exposure for the fiscal year ended December 31,
2001 due to the elimination of convertible subordinated notes and subordinated
notes as exposures. Our debt with variable interest rates consists entirely of
our Facility. The following table presents principal amounts (stated in
thousands) and related weighted average interest rates by year of maturity for
our debt obligations and their indicated fair market value at December 31, 2002:

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

INDEX TO FINANCIAL STATEMENTS

27

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
Comfort Systems USA, Inc.

We have audited the accompanying consolidated balance sheets of Comfort Systems
USA, Inc. (the "Company") as of December 31, 2001 and 2002, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 2002. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Comfort Systems
USA, Inc. as of December 31, 2001 and 2002, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2002, in conformity with accounting principles generally
accepted in the United States.

As discussed in Note 4 to the consolidated financial statements, on January 1,
2002, the Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," which changed the method of accounting
for goodwill and other intangible assets.

ERNST & YOUNG LLP

Houston, Texas
March 28, 2003

28

COMFORT SYSTEMS USA, INC.

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial
statements.
29

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial
statements.
30

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

The accompanying notes are an integral part of these consolidated financial
statements.
31

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial
statements.
32

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2002

1. BUSINESS AND ORGANIZATION

Comfort Systems USA, Inc., a Delaware corporation ("Comfort Systems" and
collectively with its subsidiaries, the "Company"), is a national provider of
comprehensive heating, ventilation and air conditioning ("HVAC") installation,
maintenance, repair and replacement services within the mechanical services
industry. The Company operates primarily in the commercial and industrial HVAC
markets, and performs most of its services within office buildings, retail
centers, apartment complexes, manufacturing plants, and healthcare, education
and government facilities. In addition to standard HVAC services, the Company
provides specialized applications such as building automation control systems,
fire protection, process cooling, electronic monitoring and process piping.
Certain locations also perform related activities such as electrical service and
plumbing. Approximately 52% of the Company's consolidated 2002 revenues were
attributable to installation of systems in newly constructed facilities, with
the remaining 48% attributable to maintenance, repair and replacement services.
The Company's consolidated 2002 revenues related to the following service
activities: HVAC -- 73%, plumbing -- 10%, building automation control
systems -- 5%, electrical -- 3%, fire protection -- 2% and other -- 7%. These
service activities are within the mechanical services industry which is the
single industry segment served by Comfort Systems.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company adopted Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," which is discussed in Note 4
and SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," which is discussed in Note 3 during the first quarter of 2002. There
were no other significant changes in the accounting policies of the Company
during the period.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
Comfort Systems and its wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated.

CASH FLOW INFORMATION

The Company considers all highly liquid investments purchased with an
original maturity of three months or less to be cash equivalents.

Cash paid for interest for continuing and discontinued operations in 2000,
2001 and 2002 was approximately $25.8 million, $20.7 million and $5.3 million,
respectively. Cash paid for income taxes for continuing and discontinued
operations in 2000, 2001 and 2002 was approximately $13.1 million, $10.1 million
and $10.7 million, respectively.

INVENTORIES

Inventories consist of parts and supplies held for use in the ordinary
course of business and are stated at the lower of cost or market using the
first-in, first-out method.

PROPERTY AND EQUIPMENT

Property and equipment are stated at cost, and depreciation is computed
using the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are capitalized and amortized over the lesser of the
expected life of the lease or the estimated useful life of the asset.

Expenditures for repairs and maintenance are charged to expense when
incurred. Expenditures for major renewals and betterments, which extend the
useful lives of existing equipment, are capitalized and depreciated

33

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

over the remaining useful life of the equipment. Upon retirement or disposition
of property and equipment, the cost and related accumulated depreciation are
removed from the accounts and any resulting gain or loss is recognized in "Other
income (expense)" in the statement of operations.

GOODWILL

Goodwill represents the excess of the aggregate purchase price paid by the
Company in acquisitions accounted for as purchases over the fair value of the
net tangible assets acquired. Prior to 2002, goodwill was amortized on a
straight-line basis over 40 years. As further discussed in Note 4, effective
January 1, 2002, goodwill is no longer subject to scheduled amortization, but is
subjected to an annual impairment test.

LONG-LIVED ASSETS

Long-lived assets are comprised principally of goodwill, property and
equipment, and deferred income tax assets. The Company periodically evaluates
whether events and circumstances have occurred that indicate that the remaining
balances of these assets may not be recoverable. The Company uses an estimate of
future income from operations and cash flows, as well as other economic and
business factors as a measure of recoverability of these assets.

REVENUE RECOGNITION

Under the percentage of completion method of accounting as provided by
American Institute of Certified Public Accountants Statement of Position 81-1,
"Accounting for Performance of Construction-Type and Certain Production-Type
Contracts," contract revenue recognizable at any time during the life of a
contract is determined by multiplying expected total contract revenue by the
percentage of contract costs incurred at any time to total estimated contract
costs. More specifically, as part of the negotiation and bidding process in
which the Company engages in connection with obtaining installation contracts,
the Company estimates contract costs, which include all direct materials (net of
estimated rebates), labor and subcontract costs and indirect costs related to
contract performance, such as indirect labor, supplies, tools, repairs and
depreciation costs. Then, as the Company performs under those contracts, such
costs are measured as incurred, compared to total estimated costs to complete
the contract, and a corresponding proportion of contract revenue is recognized.
As a result, contract revenues recognized in the statement of operations can and
usually do differ from amounts that can be billed or invoiced to the customer at
any point during the contract.

Changes in job performance, job conditions, estimated profitability and
final contract settlements may result in revisions to estimated costs and,
therefore, revenues. Such revisions are frequently based on further estimates
and subjective assessments. The effects of these revisions are recognized in the
period in which the revisions are determined. When such revisions lead to a
conclusion that a loss will be recognized on a contract, the full amount of the
estimated ultimate loss is recognized in the period such a conclusion is
reached, regardless of the percentage of completion of the contract. Depending
on the size of a project, variations from estimated project costs could have a
significant impact on the Company's operating results.

Revenues associated with maintenance, repair and monitoring services and
related contracts are recognized as services are performed.

ACCOUNTS RECEIVABLE

Accounts receivable include amounts billed to but not paid by customers
pursuant to retainage provisions in construction contracts. These amounts are
due upon completion of the contracts and acceptance by the customer. Based on
the Company's experience with similar contracts in recent years, billings for
such retention balances at each balance sheet date are finalized and collected
within the subsequent year. The retainage balances at December 31, 2001 and 2002
are $33.1 million, and are included in accounts receivable.

34

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The carrying value of the Company's receivables, net of the allowance for
doubtful accounts, represents their estimated net realizable value. The Company
estimates its allowance for doubtful accounts based upon the creditworthiness of
its customer, prior collection history, the ongoing relationship with its
customers, the aging of past due balances, the Company's lien rights, if any, in
the property where the Company performed the work, and the availability, if any,
of payment bonds applicable to the contract. The estimate of the allowance is
based upon the best facts available and is re-evaluated and adjusted as
additional information is received.

COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS

The current asset "Costs and estimated earnings in excess of billings"
represents revenues recognized in excess of amounts billed under the terms of
the contract. These amounts are billable upon completion of contract performance
milestones or other specified conditions of the contract.

Claims or unapproved change orders represent amounts to be recovered from
the customer or other third parties for errors, changes in specifications or
design or other unanticipated customer-related changes resulting in additional
contract costs. These amounts are recorded as "Costs and estimated earnings in
excess of billings" at their estimated net realizable amounts when realization
is probable and such amounts can be reasonably estimated. These claims and
unapproved change orders involve estimates which will be revised as additional
information becomes known. The amounts for such claims and unapproved change
orders that are currently included in costs and estimated earnings in excess of
billings are not material.

SELF-INSURANCE LIABILITIES

The Company retains the risk of worker's compensation, employer's
liability, auto liability, general liability and employee group health claims
resulting from uninsured deductibles per accident or occurrence. Losses up to
the deductible amounts are estimated and accrued based upon known facts,
historical trends and industry averages utilizing the assistance of an actuary
to determine the best estimate of these obligations.

WARRANTY COSTS

The Company typically warrants labor for the first year after installation
on new HVAC systems. The Company generally warrants labor for 30 days after
servicing of existing HVAC systems. A reserve for warranty costs is estimated
and recorded based upon the historical level of warranty claims and management's
estimate of future costs.

INCOME TAXES

The Company files a consolidated return for federal income tax purposes.
Income taxes are provided for under the liability method in accordance with SFAS
No. 109, "Accounting for Income Taxes," which takes into account differences
between financial statement treatment and tax treatment of certain transactions.
Deferred tax assets represent the tax effect of activity that has been reflected
in the financial statements but which will not be deductible for tax purposes
until future periods. Deferred tax liabilities represent the tax effect of
activity that has been reflected in the financial statements but which will not
be taxable until future periods.

NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards board ("FASB") issued SFAS
No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 establishes new
accounting and reporting requirements for goodwill and other intangible assets.
The Company adopted this new standard effective January 1, 2002. See Note 4 for
further discussion.

35

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets." The Company adopted SFAS No. 144 effective
January 1, 2002. Under SFAS No. 144, the operating results of companies sold or
held for sale meeting certain criteria, as well as any gain or loss on the sale
of these operations, are presented as discontinued operations in the Company's
statements of operations. See Note 3 for a discussion of the Company's
discontinued operations. The operating results for companies which were sold or
shut down during 2001 are presented as continuing operations through the date of
disposition. The adoption of SFAS No. 144 did affect the presentation of
discontinued operations in the consolidated financial statements; however, it
did not have any overall financial impact on the Company's results of
operations, financial position or cash flows.

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections
("SFAS No. 145"). SFAS No. 145 requires that gains and losses from
extinguishment of debt be classified as extraordinary items only if they meet
the criteria in Accounting Principles Board Opinion No. 30 ("Opinion No. 30").
Applying the provisions of Opinion No. 30 will distinguish transactions that are
part of an entity's recurring operations from those that are unusual and
infrequent and meet the criteria for classification as an extraordinary item. In
connection with the Company's new credit facility, the Company fully amortized
$0.4 million of deferred debt costs and recognized a $0.7 million gain on the
extinguishment of subordinated debt in 2002. These amounts are recorded in
"Other Expense, net" in the Company's statement of operations.

In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities ("SFAS No. 146"). SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities, such as restructurings, involuntarily terminating employees, and
consolidating facilities initiated after December 31, 2002. The implementation
of SFAS No. 146 will not require the restatement of previously issued financial
statements. Implementation of the pronouncement will therefore have no impact on
the Company's current year financial statements.

In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others ("FIN 45"). It clarifies that a guarantor
is required to recognize, at the inception of a guarantee, a liability for the
fair value of the obligation undertaken in issuing the guarantee, including its
ongoing obligation to stand ready to perform over the term of the guarantee in
the event that the specified triggering events or conditions occur. The
objective of the initial measurement of the liability is the fair value of the
guarantee at its inception. The initial recognition and initial measurement
provisions of FIN 45 are effective for the Company on a prospective basis for
guarantees issued after December 31, 2002. Although the Company from time to
time guarantees the performance of systems or designs it provides, the Company
does not currently have any material guarantees.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure." SFAS 148 amends FASB Statement No.
123, "Accounting for Transition for Stock-Based Compensation" to provide
alternative methods of transition for a voluntary change to the fair value based
method of accounting for stock-based employee compensation. In addition, SFAS
148 amends the disclosure requirements of SFAS 123 to require prominent
disclosures in both annual and interim financial statements of the method of
accounting for stock-based employee compensation and the effect of the method
used on reported results. SFAS 148 is effective for fiscal years ending after
December 15, 2002 and was adopted by the Company for all periods presented.

SEGMENT DISCLOSURE

Comfort Systems' activities are within the mechanical services industry
which is the single industry segment served by the Company. Under SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," each
operating subsidiary represents an operating segment and these segments have

36

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

been aggregated, as no individual operating unit is material and the operating
units meet a majority of the aggregation criteria.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of assets and liabilities,
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. The most
significant estimates used in the Company's financial statements include revenue
and cost recognition for construction contracts, allowance for doubtful accounts
and self-insurance accruals.

CONCENTRATIONS OF CREDIT RISK

The Company provides services to a broad range of geographical regions. The
Company's credit risk primarily consists of receivables from a variety of
customers including general contractors, property owners and developers, and
commercial and industrial companies. The Company reviews its accounts receivable
and provides estimates of allowances regularly.

FINANCIAL INSTRUMENTS

The Company's financial instruments consist of cash and cash equivalents,
accounts receivable, receivables from related parties, other receivables,
accounts payable, a line of credit, notes payable, notes payable to related
parties and long-term debt. The Company believes that the carrying values of
these instruments on the accompanying balance sheets approximate their fair
values.

STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation using the intrinsic
value method under Accounting Principles Board Statement No. 25, "Accounting for
Stock Issued to Employees" ("APB 25"). Under this accounting method, no expense
in connection with the stock option plan or the stock purchase plan is
recognized in the consolidated statements of operations when the exercise price
of the stock options is greater than or equal to the value of the Common Stock
on the date of grant. In October 1995, the FASB issued SFAS No. 123, "Accounting
for Stock-Based Compensation," which requires that if a company accounts for
stock-based compensation in accordance with APB 25, the company must also
disclose the effects on its results of operations as if an estimate of the value
of stock-based compensation at the date of

37

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

grant was recorded as an expense in the company's statement of operations. These
effects for the Company are as follows (in thousands, except per share data):

Stock Option Plans -- The effects of applying SFAS No. 123 in the pro forma
disclosure may not be indicative of future amounts as additional option awards
in future years are anticipated. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:

Employee Stock Purchase Plan -- Compensation cost associated with the stock
purchase plan is recognized for the fair value of the employees' purchase
rights, which is estimated using the Black-Scholes model with the following
assumptions:

The weighted average fair values of the purchase rights granted in 2000 and
2001 were $1.65 per share and $0.88 per share, respectively. No purchase rights
were granted in 2002.

RECLASSIFICATIONS

Certain reclassifications have been made in prior period financial
statements to conform to current period presentation. These reclassifications
have not resulted in any changes to previously reported net income for any
periods.

38

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. DISCONTINUED OPERATIONS

On March 1, 2002, the Company sold 19 operations to Emcor Group, Inc.
("Emcor"). The total purchase price was $186.25 million, including the
assumption by Emcor of approximately $22.1 million of subordinated notes to
former owners of certain of the divested companies.

The transaction with Emcor provided for a post-closing adjustment based on
a final accounting, done after the closing of the transaction, of the net assets
of the operations that were sold to Emcor. That accounting indicated that the
net assets transferred to Emcor were approximately $7 million greater than a
target amount that had been agreed to with Emcor. In the second quarter of 2002,
Emcor paid the Company that amount, and released $2.5 million that had been
escrowed in connection with this element of the transaction.

Of Emcor's purchase price, $5 million was deposited into an escrow account
to secure potential obligations on the Company's part to indemnify Emcor for
future claims and contingencies arising from events and circumstances prior to
closing, all as specified in the transaction documents. Of this escrow, $4
million has been applied in determining the Company's liability to Emcor in
connection with the settlement of certain claims as described subsequently in
this section. The remaining $1 million of escrow is available for book purposes
to apply to any future claims and contingencies in connection with this
transaction, and has not been recognized as part of the Emcor transaction
purchase price.

The net cash proceeds of approximately $164 million received to date from
the Emcor transaction have been used to reduce the Company's debt. The Company
paid $7.3 million of federal taxes related to this transaction in March 2003.

In the fourth quarter of 2002, the Company recognized a charge of $1.2
million, net of tax benefits of $2.7 million, in "Estimated loss on disposition,
including income tax" in the Company's statement of operations in connection
with the Emcor transaction. This charge primarily relates to a preliminary
agreement to settle claims from Emcor for reimbursement of impaired assets and
additional liabilities associated with the operations acquired from the Company.
Under this settlement, the Company also agreed to partially reimburse Emcor for
any loss on the eventual resolution of certain claims involving a project at one
of the operations Emcor acquired from the Company, and the Company was released
from liability on all other outstanding receivables and issues relating to the
profitability of projects that were in process at the time Emcor acquired these
operations. The settlement agreement also includes the use of $2.5 million of
the $5 million escrow described above to fund settled claims. The Company
further estimated that an additional $1.5 million of the remaining escrow would
be applied against elements of the settlement that will not be fully resolved
until a later date, principally the one open project referred to above.
Accordingly, for book purposes, $1.0 million of escrow remains available to
apply against future claims that may arise from Emcor in connection with this
transaction. The Company recorded a tax benefit of $1.4 million related to this
additional charge. In addition, the $1.2 million charge recognized during the
fourth quarter is also net of a tax credit of $1.3 million as a result of lower
final tax liabilities in connection with the overall Emcor transaction than we
originally estimated in the first quarter.

Under SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which took effect for the Company on January 1, 2002, the
operating results of the companies sold to Emcor for all periods presented
through the sale, as well as the loss on the sale of these operations, have been
presented as discontinued operations in the Company's statements of operations.
The Company realized a total loss of $11.8 million, including related tax
expense, in connection with the sale of these operations. As a result of the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," the Company
also recognized a goodwill impairment charge related to these operations of
$32.4 million, net of taxes, as of January 1, 2002. The reporting of the
Company's aggregate initial goodwill impairment charge in connection with
adopting SFAS No. 142 is discussed further in Note 4.

39

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In March 2002, the Company also decided to divest of an additional
operating company. In the first quarter of 2002, the Company recorded an
estimated loss of $0.6 million from this planned disposition in "Estimated loss
on disposition, including income tax" in the Company's statement of operations.
In the fourth quarter of 2002, the Company reversed this estimated loss because
the Company decided not to sell this unit.

During the second quarter of 2002, the Company sold a division of one of
its operations. The operating loss for this division for the first two quarters
of 2002 of $0.3 million, net of taxes, has been reported in discontinued
operations under "Operating income (loss), net of applicable income taxes" in
the Company's statement of operations. The Company realized a loss of $0.3
million on the sale of this division. This loss is included in "Estimated loss
on disposition, including income tax" during the second quarter of 2002 in the
Company's statement of operations.

Assets and liabilities related to discontinued operations were as follows
(in thousands):

Revenues and pre-tax income (loss) related to discontinued operations were
as follows (in thousands):

Interest expense allocated to the discontinued operations in 2000, 2001 and
2002 was $15.5 million, $13.8 million and $1.5 million, respectively. These
amounts have been allocated based upon the Company's net investment in these
operations.

4. GOODWILL

Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and
Other Intangible Assets." SFAS No. 142 requires companies to assess goodwill
asset amounts for impairment each year, and more frequently if circumstances
suggest an impairment may have occurred. In addition to discontinuing the
regular charge, or amortization, of goodwill against income, the new standard
also introduces more rigorous criteria for determining how much goodwill should
be reflected as an asset in a company's balance sheet.

To perform the transitional impairment testing required by SFAS No. 142
under its new, more rigorous impairment criteria, the Company broke its
operations into "reporting units," as prescribed by the new

40

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

standard, and tested each of these reporting units for impairment by comparing
the unit's fair value to its carrying value. The fair value of each reporting
unit was estimated using a discounted cash flow model combined with market
valuation approaches. Significant estimates and assumptions were used in
assessing the fair value of reporting units. These estimates and assumptions
involved future cash flows, growth rates, discount rates, weighted average cost
of capital and estimates of market valuations for each of the reporting units.

As provided by SFAS No. 142, the transitional impairment loss identified by
applying the standard's new, more rigorous valuation methodology upon initial
adoption of the standard was reflected as a cumulative effect of a change in
accounting principle in the Company's statement of operations. The resulting
non-cash charge was $202.5 million, net of taxes. Impairment charges recognized
after the initial adoption, if any, generally are to be reported as a component
of operating income. An additional impairment charge of $0.2 million was
recorded during the fourth quarter of 2002.

The changes in the carrying amount of goodwill for the year ended December
31, 2002 are as follows (in thousands):

Goodwill balance as of January 1, 2002(a)................... $ 438,448
Impairment adjustments...................................... (229,056)
Goodwill related to sale of operations...................... (95,965)
---------
Goodwill balance as of December 31, 2002.................... $ 113,427
=========

- ---------------

(a) A portion of this goodwill balance is included in assets related to
discontinued operations in the Company's consolidated balance sheet.

The unaudited results of operations presented below (in thousands) for the
years ended December 31, 2000, 2001 and 2002 reflect the adoption of the
non-amortization provisions of SFAS No. 142 effective January 1, 2000 and
exclude the impact of the cumulative effect of change in accounting principle
recorded in the first quarter of 2002. Therefore, the component of the
cumulative effect of change in accounting principle related to the operations
sold to Emcor is included in the estimated loss on disposition for purposes of
this table.

41

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. RESTRUCTURING CHARGES

During the first quarter of 2002, the Company recorded restructuring
charges of approximately $1.9 million. These charges included approximately $0.8
million for severance costs primarily associated with the reduction in corporate
overhead in light of the Company's smaller size following the Emcor transaction.
The severance costs related to the termination of 33 employees, all of whom were
terminated as of March 31, 2002. In addition, these charges include
approximately $0.7 million for costs associated with decisions to merge or close
three smaller divisions and realign regional operating management. These
restructuring charges are primarily cash obligations but did include
approximately $0.3 million of non-cash writedowns associated with long-lived
assets.

During the first quarter of 2001, the Company recorded restructuring
charges of approximately $0.2 million, primarily related to contractual
severance obligations of two operating presidents in connection with the
Company's significant restructuring program in the second half of 2000. These
restructuring charges are net of a gain of approximately $0.1 million related to
management's decision to sell a small operation during the first quarter of
2001.

During the second half of 2000, the Company recorded restructuring charges
of approximately $25.3 million primarily associated with restructuring efforts
at certain underperforming operations and its decision to cease its e-commerce
activities at Outbound Services, a subsidiary of the Company. Management
performed an extensive review of its operations during the second half of 2000
and as part of this review management decided to cease operating at three
locations, sell five operations (including two smaller satellite operations),
and merge two companies into other operations. The restructuring charges were
primarily non-cash and included goodwill impairments of approximately $11.5
million and the writedown of other long-lived assets of approximately $8.5
million. The remaining items in these restructuring charges primarily included
severance and lease termination costs.

During the third quarter of 2001, the Company decided to retain one of the
operations that was previously held for sale and reversed approximately $0.3
million of non-cash charges related to the anticipated loss on the sale of this
operation. This amount was offset by an additional loss on the sale in late
September 2001 of the final operation that was identified as part of this
restructuring program. The losses associated with the other operations that were
sold were consistent with the amounts recorded as restructuring charges in 2000.

42

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Severance costs recorded in 2000 and 2001 relate to the termination of 147
employees (all of whom had been terminated by June 30, 2001) including certain
corporate personnel and the management and employees of certain underperforming
locations, and to the departure of the Company's former chief executive officer.

Aggregated financial information for 2000 and 2001 related to the
operations addressed by the 2000 and 2001 restructuring charges is as follows
(in thousands):

The following table shows the remaining liabilities associated with the
cash portion of the restructuring charges as of December 31, 2000, 2001 and 2002
(in thousands):

6. REDUCTIONS IN NON-OPERATING ASSETS AND LIABILITIES, NET

During 2000, the Company recorded a non-cash charge of approximately $1.1
million primarily related to the impairment of certain non-operating assets.
This charge principally included an impairment of approximately $1.4 million to
the Company's minority investment in two entities associated with the
distribution and implementation of high-end engineering and design software.
These entities have ceased operations. This charge also included an impairment
of approximately $0.3 million related to notes receivable from former owners of
businesses acquired by the Company. Offsetting these items was a gain of
approximately $0.6 million on the reduction of the Company's subordinated note
payable to a former owner in connection with the settlement of claims with this
former owner.

43

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. PROPERTY AND EQUIPMENT

Property and equipment consist of the following (dollars in thousands):

Depreciation expense for the years ended December 31, 2000, 2001 and 2002
was $8.1 million, $8.0 million and $6.4 million, respectively.

8. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS

Activity in the Company's allowance for doubtful accounts consists of the
following (in thousands):

Other current liabilities consist of the following (in thousands):

44

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Contracts in progress are as follows (in thousands):

Other long-term liabilities consist of the following (in thousands):

9. LONG-TERM DEBT OBLIGATIONS

Long-term debt obligations consist of the following (in thousands):

45

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

At December 31, 2002, future principal payments of long-term debt are as
follows (in thousands):

Year Ending December 31 --
2003...................................................... $ 1,780
2004...................................................... 2,550
2005...................................................... 3,351
2006...................................................... 3,996
2007...................................................... 3,433
Thereafter................................................ 124
-------
$15,234
=======

CREDIT FACILITY

The Company's primary current debt financing capacity consists of a $55
million senior credit facility (the "Facility") provided by a syndicate of three
financial institutions led by General Electric Capital Corporation ("GE"). The
Facility includes a $20 million sublimit for letters of credit. The Facility is
secured by substantially all the assets of the Company. The Facility was entered
into on October 11, 2002 and replaces the Company's previous revolving credit
facility. The Facility consists of two parts: a term loan and a revolving credit
facility.

The term loan under the Facility (the "Term Loan") is $15 million, which
the Company borrowed upon the closing of Facility on October 11, 2002. The Term
Loan must be repaid in quarterly installments over five years beginning December
31, 2002. The amount of each quarterly installment increases annually.

The Facility requires certain prepayments of the Term Loan. Approximately
half of any free cash flow (primarily cash from operations less capital
expenditures) in excess of scheduled principal payments and voluntary
prepayments must be used to pay down the Term Loan. This requirement is measured
annually based on full-year results. We do not have any prepayments of the Term
Loan due as of December 31, 2002 under this requirement primarily as a result of
the significant amount of voluntary prepayments of debt made by the Company
during 2002. In addition, proceeds in excess of $250,000 from any individual
asset sales, or in excess of $1 million for a full year's asset sales, must be
used to pay down the Term Loan. Proceeds from asset sales that are less than
these individual transaction or annual aggregate levels must also be used to pay
down the Term Loan unless they are reinvested in long-term assets within six
months of the receipt of such proceeds.

All prepayments under the Term Loan, whether required or voluntary, are
applied to scheduled principal payments in inverse order, i.e. to the last
scheduled principal payment first, followed by the second-to-last, etc. All
principal payments under the Term Loan permanently reduce the original $15
million capacity under this portion of the Facility.

The Facility also includes a three-year $40 million revolving credit
facility (the "Revolving Loan"). Under this revolving credit facility, through
July 31, 2003, the Company can borrow up to $25 million, with the difference
between actual borrowings and $40 million available for letter of credit
issuance up to a maximum of $20 million in letters of credit. After July 31,
2003, the Company can borrow up to $20 million under the revolving credit
facility, with a maximum of $20 million available for letters of credit.

The Company has reached a preliminary agreement with its surety and GE to
grant the surety a secured interest in assets such as receivables, costs
incurred in excess of billings, and equipment related to projects for which
bonds are outstanding as collateral for potential obligations under bonds. As of
December 31, 2002 the amount of these assets is approximately $41.9 million. The
Company has also posted a $5 million letter of credit as collateral for
potential obligations under bonds.

46

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

INTEREST RATES AND FEES

The Company has a choice of two interest rate options for borrowings under
the Facility. Under one option, the interest rate is determined based on the
higher of the Federal Funds Rate plus 0.5% or the prime rate of at least 75% of
the US's 30 largest banks, as published each business day by the Wall Street
Journal. An additional margin of 2.25% is then added to the higher of these two
rates for borrowings under the Revolving Loan, while an additional margin of
2.75% is added to the higher of these two rates for borrowings under the Term
Loan.

Under the other interest rate option, borrowings bear interest based on
designated rates that are described in various general business media sources as
the London Interbank Offered Rate or "LIBOR." Revolving Loan borrowings using
this interest rate option then have 3.25% added to LIBOR, while Term Loan
borrowings have 3.75% added to LIBOR.

The rates underlying these interest rate options are floating interest
rates determined by the broad financial markets, meaning they can and do move up
and down from time to time. The Facility required that the Company convert these
floating interest rate terms on at least half of the Term Loan to fixed rates
for at least a one-year term. In January 2003, the Company converted $10 million
of principal value to a fixed LIBOR-based interest rate of 5.62% for an
eighteen-month term. This was done via a swap transaction under which the
Company agreed to pay fixed interest rate payments on $10 million for eighteen
months to a bank in exchange for receiving from the bank floating LIBOR interest
rate payments on $10 million for the same term. This transaction is a derivative
and qualifies for hedge accounting treatment. As such, interest expense related
to the hedged portion of this debt will be recorded at the fixed rate of 5.62%
in the Company's statement of operations. Changes in market interest rates in
any given period may increase or decrease the market valuation of the Company's
obligations to the bank under this swap versus the bank's obligations to the
Company. Such changes in market valuation will be reflected in stockholders'
equity as other comprehensive income (loss) for that period, even though these
obligations may not have been terminated and settled in cash during the period.
Such adjustments are known as mark-to-market adjustments.

Commitment fees of 0.5% per annum are payable on the unused portion of the
Revolving Loan.

The Company also incurred certain financing and professional costs in
connection with the arrangement and the closing of the Facility. These costs
will be amortized to interest expense over the term of the Facility in the
amount of approximately $0.4 million per quarter. To the extent prepayments of
the Term Loan are made, the Company may have to accelerate amortization of these
deferred financing and professional costs. Additionally, the Company expects to
charge approximately $0.5 million of deferred financing costs to interest
expense in the first quarter of 2003 that were associated with higher levels of
capacity under the Facility than the current total of $55 million.

In connection with the Facility, the Company granted GE a warrant to
purchase 409,051 shares of Company common stock for nominal consideration. In
addition, GE may "put," or require the Company to repurchase, these shares at
the higher of market price, appraised price or book value per share, during the
fifth and final year of the Facility -- October 11, 2006 to October 11, 2007.
This put may be accelerated under certain circumstances including a change of
control of the Company, full repayment of amounts owing under the Facility, or a
public offering of shares by the Company. This warrant and put are discussed in
greater detail in Note 13, "Stockholders' Equity." The value of this warrant and
put as of the start of the Facility of $2.9 million is reflected as a discount
of the Company's obligation under the Facility and is being amortized over the
term of the Facility, as described above. This warrant and put obligation is
also recorded as a liability in the Company's balance sheet. The value of this
warrant and put will change over time, principally in response to changes in the
market price of the Company's common stock. The warrant and the put qualify as a
derivative for financial reporting purposes. Accordingly, such changes in the
value of the warrant and put in any given period will be reflected in interest
expense for that period, even though the warrant and put may not

47

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

have been terminated and settled in cash during the period. Such adjustments are
known as mark-to-market adjustments. The after-tax loss related to the warrant's
mark-to-market obligation in 2002 was $0.1 million.

The weighted average interest rate that the Company currently pays on
borrowings under the Facility is 5.6% per annum. This reflects a combination of
borrowings under both interest rate options described above, as well as the swap
of floating rates to a fixed rate described above. This rate does not include
amortization of debt financing and arrangement costs, or mark-to-market
adjustments for derivatives.

RESTRICTIONS AND COVENANTS

Borrowings under the Facility are specifically limited by the Company's
ratio of total debt to earnings before interest, taxes, depreciation, and
amortization ("EBITDA") and by the Company's ratio of EBITDA less taxes and
capital expenditures to interest expense and scheduled principal payments, also
known as the fixed charge coverage ratio. The Facility's definition of debt for
purposes of the ratio of total debt to EBITDA includes aggregate letters of
credit outstanding less $10 million.

The definition of EBITDA under the Facility excludes certain items,
generally non-cash amounts and transactions reported in Other Income and
Expense, that are otherwise included in the determination of earnings under
generally accepted accounting principles in the Company's financial statements.
As such, EBITDA as determined under the Facility's definition could be less than
EBITDA as derived from the Company's financial statements in the future.

The financial covenants under the Facility are summarized below. Covenant
compliance is measured on a monthly basis. Intra-quarter monthly covenants are
at either the same or very similar levels to the quarter-end covenants shown
below. EBITDA amounts are in thousands.

The Company's trailing twelve months EBITDA as of December 31, 2002 as
determined under the Facility did not comply with the covenant. Our lenders
waived this violation. In addition, based on expectations of lower operating
results at least through the first quarter of 2003, the Company's lenders agreed
to modify the minimum EBITDA, leverage and fixed charge covenants for 2003. Even
at these modified levels, these covenants leave only moderate room for variance
based on the Company's recent performance. If the Company again violates a
covenant under the Facility, the Company may have to negotiate new borrowing
terms under the Facility or obtain new financing. While the Company believes
that its levels of debt in
48

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

comparison to its EBITDA and its cash flows would enable the Company to
negotiate new borrowing terms under the Facility or to obtain new financing from
other sources if necessary, there can be no assurance that the Company would be
successful in doing so.

The Facility prohibits payment of dividends and the repurchase of shares by
the Company, limits annual lease expense and non-Facility debt, and restricts
outlays of cash by the Company relating to certain investments, acquisitions and
subordinate debt.

NOTES TO AFFILIATES AND FORMER OWNERS

Subordinated notes were issued to former owners of certain purchased
companies as part of the consideration used to acquire their companies. As of
December 31, 2002, these notes had been paid off. A gain of approximately $0.7
million was recognized in 2002 related to agreements with former owners for
early repayment of certain of these notes, or other settlement of claims.

AMOUNTS OUTSTANDING AND CAPACITY

The following recaps the Company's debt amounts outstanding and capacity
(in thousands):

- ---------------

(a) This amount reflects combined revolving loan capacity and letter of credit
capacity and therefore includes letter of credit capacity shown above of
$7,156.
(b) This amount is included in revolving loan capacity of $8,055 shown above.

The increase in the Company's borrowings outstanding under the revolving
loan during the first quarter of 2003 primarily results from the payment of a
$7.3 million tax liability relating to the Emcor transaction that was due in
March 2003.

OTHER LONG-TERM OBLIGATIONS DISCLOSURES

The Company estimates the fair value of long-term debt as of December 31,
2001 and 2002 to be approximately the same as the recorded value.

The Company has generated positive operating cash flow in most recent
periods, and it currently has a moderate level of debt. The Company anticipates
that cash flow from operations and borrowing capacity under the Facility will
provide the Company with sufficient liquidity to fund its operations for the
foreseeable future. However, the Company does not have a significant amount of
excess borrowing capacity in comparison to expected working capital requirements
over the balance of 2003. The Company believes that its levels of debt in
comparison to its EBITDA and its cash flows would enable it to obtain new
financing if necessary, but there can be no assurance that it would be
successful in doing so.

49

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Some customers require the Company to post letters of credit to guarantee
performance under its contracts and to ensure payment to its subcontractors and
vendors under those contracts. Certain of the Company's vendors also require
letters of credit to ensure reimbursement for amounts they are disbursing on the
Company's behalf, such as to beneficiaries under its self-funded insurance
program. Such letters of credit are generally issued by a bank or similar
financial institution. The letter of credit commits the issuer to pay specified
amounts to the holder of the letter of credit if the holder demonstrates that
the Company has failed to perform specified actions. If this were to occur, the
Company would be required to reimburse the issuer of the letter of credit.
Depending on the circumstances of such a reimbursement, the Company may also
have to record a charge to earnings for the reimbursement. To date the Company
has not had a claim made against a letter of credit that resulted in payments by
the issuer of the letter of credit or by the Company. The Company believes that
it is unlikely that it will have to fund claims under a letter of credit in the
foreseeable future.

The Company currently has $12.8 million in letters of credit outstanding.
The Company self-insures a significant portion of its worker's compensation,
auto liability and general liability risks. The Company uses third parties to
manage this self-insurance and to retain some of these risks. As is customary
under such arrangements, these third parties can require letters of credit as
security for amounts they fund or risks they might potentially absorb on the
Company's behalf. Under its current self-insurance arrangements, the Company
expects that it will be required to post approximately $3.0 million per quarter
during the first three quarters of 2003. In addition, the Company may receive
other letter of credit requests in the ordinary course of business, and it may
have a net increase in the amount of insurance-related letters of credit it must
post when it renews its insurance arrangements in the fourth quarter of next
year. Accordingly, the Company's letter of credit requirements over the next
year may exceed the current letter of credit sublimit of $20 million under the
Company's credit facility. If so, the Company may have to seek additional letter
of credit capacity or post different forms of security such as bonds or cash in
lieu of letters of credit. The Company believes that its levels of debt in
comparison to its EBITDA and its cash flows would enable it to obtain additional
letter of credit capacity or to otherwise meet financial security requirements
of third parties if necessary, but there can be no assurance that the Company
would be successful in doing so.

As described above, the Company must comply with a number of financial
covenants in connection with the Facility. The Company's trailing twelve months
EBITDA as of December 31, 2002 as determined under the Facility did not comply
with covenant. The Company's lenders waived this violation. In addition, based
on expectations of lower operating results at least through the first quarter of
2003, the Company's lenders agreed to modify the minimum EBITDA, leverage and
fixed charge covenants for 2003. Even at these modified levels, these covenants
leave only moderate room for variance based on the Company's recent performance.
If the Company again violates a covenant under the Facility, the Company may
have to negotiate new borrowing terms under the Facility or obtain new
financing. While the Company believes that its levels of debt in comparison to
its EBITDA and its cash flows would enable the Company to negotiate new
borrowing terms under the Facility or to obtain new financing from other sources
if necessary, there can be no assurance that the Company would be successful in
doing so.

50

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

10. INCOME TAXES

The provision for income taxes consists of the following (in thousands):

The difference in income taxes provided for and the amounts determined by
applying the federal statutory tax rate to income before income taxes results
from the following (in thousands):

Deferred income tax provisions result from current period activity that has
been reflected in the financial statements but which is not includable in
determining the Company's tax liabilities until future periods. Deferred tax
assets and liabilities reflect the tax effect in future periods of all such
activity to date that has

51

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

been reflected in the financial statements but which is not includable in
determining the Company's tax liabilities until future periods.

The deferred income tax assets and liabilities reflected above are included
in the consolidated balance sheets as follows (in thousands):

At December 31, 2002 the Company had $4.1 million of available state net
operating loss carry forwards for income tax purposes which expire 2013-2022.

At December 31, 2002, the Company's net deferred tax assets are partially
offset by a valuation allowance. The Company will continue to assess the
valuation allowance and to the extent it is determined that such allowance is no
longer required, the tax benefit of the remaining net deferred tax assets will
be recognized in the future.

52

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. EMPLOYEE BENEFIT PLANS

The Company and certain of the Company's subsidiaries sponsor various
retirement plans for most full-time and some part-time employees. These plans
consist of defined contribution plans and multi-employer pension plans and cover
employees at substantially all of the Company's operating locations. The defined
contribution plans generally provide for contributions up to 2.5% of covered
employees' salaries or wages in 2002 and up to 6% of covered employees' salaries
or wages in previous periods and totaled $4.5 million for 2000, $4.5 million for
2001 and $3.3 million for 2002. Of these amounts, approximately $1.8 million and
$0.8 million was payable to the plans at December 31, 2001 and 2002,
respectively.

Certain of the Company's subsidiaries also participate in various
multi-employer pension plans for the benefit of their employees who are union
members. Company contributions to these plans were approximately $0.3 million
for 2000, $0.2 million for 2001 and $0.3 million for 2002. The data available
from administrators of the multi-employer pension plans is not sufficient to
determine the accumulated benefit obligations, nor the net assets attributable
to the multi-employer plans in which Company employees participate.

12. COMMITMENTS AND CONTINGENCIES

LEASES

The Company leases certain facilities and equipment under noncancelable
operating leases. Rent expense for the years ended December 31, 2000, 2001 and
2002 was $15.5 million, $16.2 million and $16.6 million, respectively.
Concurrent with the acquisitions of certain acquired companies, the Company
entered into various agreements with previous owners to lease land and buildings
used in the Company's operations. The terms of these leases range from three to
ten years and provide for certain escalations in the rental expenses each year.
Included in the 2000, 2001 and 2002 rent expense above is approximately $4.5
million, $5.8 million and $4.7 million of rent paid to these related parties,
respectively. The following represents future minimum rental payments under
noncancelable operating leases (in thousands):

Year ending December 31 --
2003...................................................... $10,265
2004...................................................... 8,260
2005...................................................... 6,041
2006...................................................... 4,789
2007...................................................... 4,202
Thereafter................................................ 15,425
-------
$48,982
=======

CLAIMS AND LAWSUITS

The Company is party to litigation in the ordinary course of business. The
Company has estimated and provided accruals for probable losses and related
legal fees associated with certain of these actions in the accompanying
consolidated financial statements. There are currently no pending legal
proceedings that, in management's opinion, would have a material adverse effect
on the Company's operating results or financial condition.

SELF-INSURANCE

The Company retains the risk of worker's compensation, employer's
liability, auto liability, general liability and employee group health claims
resulting from uninsured deductibles per accident or occurrence. Losses up to
the deductible amounts are estimated and accrued based upon known facts,
historical trends and

53

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

industry averages utilizing the assistance of an actuary to determine the best
estimate of these obligations. A wholly owned insurance company subsidiary
reinsures a portion of the risk associated with surety bonds issued by a third
party insurance company. Because no claims have been made against these
financial instruments in the past, management does not expect that these
instruments will have a material effect on the Company's consolidated financial
statements.

SURETY

Many customers, particularly in connection with new construction, require
the Company to post performance and payment bonds issued by a financial
institution known as a surety. These bonds provide a guarantee to the customer
that the Company will perform under the terms of a contract and that the Company
will pay subcontractors and vendors. If the Company fails to perform under a
contract or to pay subcontractors and vendors, the customer may demand that the
surety make payments or provide services under the bond. The Company must
reimburse the surety for any expenses or outlays it incurs. To date, the Company
has not had any significant reimbursements to its surety for bond-related costs.
The Company believes that it is unlikely that it will have to fund claims under
its surety arrangements in the foreseeable future.

Surety market conditions are currently difficult as a result of significant
losses incurred by many sureties in recent periods, both in the construction
industry as well as in certain larger corporate bankruptcies. As a result, less
bonding capacity is available in the market and terms have become more
restrictive. Further, under standard terms in the surety market, sureties issue
bonds on a project by project basis, and can decline to issue bonds at any time.
Historically, approximately 25% of the Company's business has required bonds.
While the Company has enjoyed a longstanding relationship with its surety,
current market conditions as well as changes in the surety's assessment of the
Company's operating and financial risk could cause the surety to decline to
issue bonds for the Company's work. If that were to occur, the alternatives
include doing more business that does not require bonds, posting other forms of
collateral for project performance such as letters of credit or cash, and
seeking bonding capacity from other sureties. There can be no assurance that the
Company could easily achieve these alternatives. Accordingly, if the Company
were to experience an interruption in the availability of bonding capacity, the
Company's revenues and profits could decline.

13. STOCKHOLDERS' EQUITY

RESTRICTED STOCK GRANT

The Company awarded 200,000 shares of restricted stock to its Chief
Executive Officer on March 22, 2002 under its 2000 Equity Incentive Plan. The
shares are subject to forfeiture if the Company does not meet certain
performance measures for the twelve-month period ending March 31, 2003 or if the
executive leaves voluntarily or is terminated for cause. Such forfeiture
provisions lapse upon achievement of the performance measures and pro rata over
a four-year period.

The Company awarded 75,000 shares of restricted stock to its President on
November 1, 2002 under its 2000 Equity Incentive Plan. The shares are subject to
forfeiture if the Company does not meet certain performance measures for the
twelve-month period ending December 31, 2003 or if the executive leaves
voluntarily or is terminated for cause. Such forfeiture provisions lapse upon
achievement of the performance measures and pro rata over a four-year period.

Compensation expense relating to the grants will be charged to earnings
over the four-year period. The initial value of the award was established based
on the market price on the date of grant. The unearned compensation is shown as
a reduction of stockholders' equity in the accompanying consolidated balance
sheet and is being amortized against earnings based upon the market value of the
stock until the achievement of performance measures. The value of the stock
grant remaining after this determination will be amortized ratably over the
remaining three years of the restricted period.

54

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

TREASURY STOCK

On October 5, 1999, the Company announced that its Board of Directors had
approved a share repurchase program authorizing the Company to buy up to 4.0
million shares of its Common Stock. During 1999, the Company purchased
approximately 1.8 million shares at a cost of approximately $12.9 million.
During 2000, the Company purchased approximately 0.2 million shares at a cost of
approximately $1.2 million. Under the current terms of the Company's credit
facility, the Company is prohibited from purchasing additional shares of its
Common Stock.

RESTRICTED COMMON STOCK

In March 1997, Notre Capital Ventures II, L.L.C. ("Notre") exchanged
2,742,912 shares of Common Stock for an equal number of shares of restricted
voting common stock ("Restricted Voting Common Stock"). The holders of
Restricted Voting Common Stock are entitled to elect one member of the Company's
Board of Directors and to 0.55 of one vote for each share on all other matters
on which they are entitled to vote. Holders of Restricted Voting Common Stock
are not entitled to vote on the election of any other directors.

Each share of Restricted Voting Common Stock will automatically convert to
Common Stock on a share-for-share basis (i) in the event of a disposition of
such share of Restricted Voting Common Stock by the holder thereof (other than a
distribution which is a distribution by a holder to its partners or beneficial
owners, or a transfer to a related party of such holders (as defined in Sections
267, 707, 318 and/or 4946 of the Internal Revenue Code of 1986, as amended)),
(ii) in the event any person acquires beneficial ownership of 15% or more of the
total number of outstanding shares of Common Stock of the Company, or (iii) in
the event any person offers to acquire 15% or more of the total number of
outstanding shares of Common Stock of the Company. After July 1, 1998, the Board
of Directors may elect to convert any remaining shares of Restricted Voting
Common Stock into shares of Common Stock in the event 80% or more of the
originally outstanding shares of Restricted Voting Common Stock have been
previously converted into shares of Common Stock. As of December 31, 2002, there
were 1,128,112 shares of Restricted Voting Common Stock remaining.

EARNINGS PER SHARE

Basic earnings per share ("EPS") is computed by dividing net income by the
weighted average number of shares of common stock outstanding during the year.
Diluted EPS is computed considering the dilutive effect of stock options,
convertible subordinated notes, warrants and contingently issuable restricted
stock. Options to purchase 3.2 million shares of Common Stock at prices ranging
from $3.81 to $21.44 per share were outstanding as of December 31, 2002, but
were not included in the computation of diluted EPS because the options'
exercise prices were greater than the respective average market price of the
Common Stock. Options had an anti-dilutive effect for the years ended December
31, 2000 and 2001 because the Company reported a loss from continuing operations
during these periods, and therefore, were not included in the diluted EPS
calculation. The Company would have included 175,767 shares related to the
dilutive impact of stock options for the year ended December 31, 2000 and 62,688
shares related to the dilutive impact of stock options for the year ended
December 31, 2001 if it were not for the loss from continuing operations during
each of these periods.

Diluted EPS is also computed by adjusting both net earnings and shares
outstanding as if the conversion of the convertible subordinated notes occurred
on the first day of the year. The convertible subordinated notes had an
anti-dilutive effect during the years ended December 31, 2000 and 2001, and
therefore, are not included in the diluted EPS calculation. The convertibility
provisions of the remaining convertible subordinated notes expired during the
first quarter of 2002. The dilutive impact of the warrants is computed assuming
the issuance of shares required to fulfill the warrant obligation at the end of
the reporting period. The after-tax
55

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

loss related to the warrant's mark-to-market adjustment was $0.1 million in 2002
and this amount is added to net income for purposes of calculating diluted
earnings per share. The shares associated with contingently issuable restricted
stock are included in diluted earnings per share because it is probable that the
performance requirement for the issuance of these shares will be met.

The following table reconciles the number of shares outstanding with the
number of shares used in computing basic and diluted earnings per share for each
of the periods presented (in thousands):

- ---------------

(a) Excludes 275,000 shares of contingently issuable restricted stock
outstanding as of December 31, 2002 (see "Restricted Stock Grant"
paragraphs above).

WARRANT

In connection with the arrangement of the Company's new debt facility as
described above in Note 9, "Long-Term Debt Obligations," the Company granted GE,
its lender, a warrant to purchase 409,051 shares of Company common stock for
nominal consideration. The warrant agreement also provides for the following:

- In most situations where the Company issues shares, options or warrants,
GE may acquire additional shares or warrants on equivalent terms to
maintain the proportionate interest its warrant shares represent in
comparison to the Company's total shares outstanding.

- GE may require the Company to register its warrant shares.

- GE may include its warrant shares in any public offering of stock by the
Company.

- GE may "put," or require the Company to repurchase, some or all of its
warrant shares at the higher of market price, appraised price or book
value per share, during the fifth and final year of the debt
facility -- October 11, 2006 to October 11, 2007. This put may be
accelerated under certain circumstances including a change of control of
the Company, full repayment of amounts owing under the Facility, or a
public offering of shares by the Company.

The initial value of this warrant and put of $2.9 million is reflected as a
discount of the Company's obligations under its debt facility with GE, net of
amortization of $0.1 million, and as an obligation in long-term liabilities. The
value of this warrant and put will change over time, principally in response to
changes in the market price of the Company's common stock. The warrant and the
put qualify as a derivative for financial reporting purposes. Accordingly, such
changes in the value of the warrant and put in any given period will be
reflected in interest expense for that period and in the Company's long-term
warrant obligation, even though the warrant and put may not have been terminated
and settled in cash during the period. Such adjustments are known as
mark-to-market adjustments. The after-tax loss related to the warrant's
mark-to-market obligation in 2002 was $0.1 million.

56

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

14. STOCK OPTION PLANS

LONG-TERM INCENTIVE PLANS

In March 1997, the Company's stockholders approved the Company's 1997
Long-Term Incentive Plan which provides for the granting or awarding of
incentive or non-qualified stock options, stock appreciation rights, restricted
or deferred stock, dividend equivalents or other incentive awards to directors,
officers, key employees and consultants to the Company.

The Company's 1997 Long-Term Incentive Plan provides for the granting of
options to key employees to purchase an aggregate of not more than 13% of the
total number of shares of the Company's Common Stock outstanding at the time of
grant. Such options have been issued by the Company at fair market value on the
date of grant and become exercisable in five equal annual installments beginning
on the first anniversary of the date of grant. The options expire after seven
years from the date of grant if unexercised. Outstanding options may be canceled
and reissued under terms specified in the plan.

In May 2000, the Company's stockholders approved the Company's 2000
Incentive Plan which provides for the granting or awarding of incentive or
non-qualified stock options, restricted stock or performance awards to
directors, officers, key employees and other persons or entities as approved by
the Board of Directors. Options granted under this plan have been issued by the
Company at fair market value on the date of grant and become exercisable in four
equal annual installments beginning on the first anniversary of the date of
grant. The options expire after ten years from the date of grant if unexercised.

NON-EMPLOYEE DIRECTORS' STOCK PLAN

In March 1997, the Company's stockholders approved the 1997 Non-Employee
Directors' Stock Plan (the "Directors' Plan"), which provides for the granting
or awarding of stock options and stock appreciation rights to non-employees. The
number of shares authorized and reserved for issuance under the Directors' Plan
is 500,000 shares. The Directors' Plan provided for the automatic grant of
options to purchase 10,000 shares to each non-employee director serving at the
commencement of the initial public offering of the Company.

Each non-employee director will be granted options to purchase 10,000
shares at the time of the initial election. In addition, each non-employee
director is automatically granted options to purchase an additional 10,000
shares at each annual meeting of the stockholders that is more than two months
after the date of the director's initial election. All options are granted with
an exercise price equal to the fair market value at the date of grant and are
immediately vested upon grant.

Either at the time of the initial public offering or upon election as a
director, options were granted to six members of the board of directors to
purchase in each case 10,000 shares of Common Stock at the initial public
offering price or at the price in effect at the time of their election. Each of
these directors received options for shares on the dates of the annual meetings
which they have attended. In addition, directors who cease to be employees
become eligible for the annual grant. One former employee received an annual
grant in 2000. These options will expire at the earlier of 10 years from the
date of grant or one year after termination of service as a director. As of
December 31, 2002, 130,000 options were outstanding related to this plan.

The Directors' Plan allows non-employee directors to receive shares
("Deferred Shares") at future settlement dates in lieu of cash. The number of
Deferred Shares will have an aggregate fair market value equal to the fees
payable to the directors. No Deferred Shares have been issued as of December 31,
2002.

The Company has never altered the price of any option after its grant.

57

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes activity under the Company's stock option
plans:

The following table summarizes information about fixed stock options
outstanding at December 31, 2002:

EMPLOYEE STOCK PURCHASE PLAN

In September 1997, the Company's stockholders approved the Company's 1998
Employee Stock Purchase Plan which allows employees to purchase shares from the
Company's authorized but unissued shares of Common Stock or from shares of
Common Stock reacquired by the Company, including shares repurchased on the open
market.

The Company's 1998 Employee Stock Purchase Plan originally provided for the
purchase of up to 300,000 shares, which was increased by an additional 600,000
shares in May 2000, at semi-annual intervals. In March 2001, after all of the
shares were distributed, the Board of Directors of the Company voted to suspend
the Employee Stock Purchase Plan indefinitely. Through the suspension date,
full-time employees were eligible to purchase shares with payroll deductions
ranging from 2% to 8% of compensation with a maximum deduction of $2,000 for any
purchase period for each participant. The purchase price per share is 85% of the
lower of the market price on the first business day of the purchase period or
the purchase date.

58

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

Quarterly financial information for the years ended December 31, 2001 and
2002 is summarized as follows (in thousands, except per share data):

59

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The sum of the individual quarterly earnings per share amounts do not agree
with year-to-date earnings per share as each quarter's computation is based on
the weighted average number of shares outstanding during the quarter, the
weighted average stock price during the quarter and the dilutive effects of the
convertible subordinated notes, warrants, and contingently issuable restricted
stock in each quarter.

60

ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE

For a discussion of a change in the Company's accountants, please see our
Current Report on Form 8-K dated May 24, 2002.

PART III

ITEMS 10 TO 15 INCLUSIVE

These items have been omitted in accordance with the instructions to Form
10-K. The Company will file with the Commission a definitive proxy statement
including the information to be disclosed under the items in the 120 days
following December 31, 2002.

ITEM 14. CONTROLS AND PROCEDURES

Within 90 days before the date of this report on Form 10-K, under the
supervision and with the participation of our management, including our Chairman
of the Board and Chief Executive Officer (our principal executive officer) and
our Chief Financial Officer (our principal financial officer), we evaluated the
effectiveness of our disclosure controls and procedures (as defined under Rule
13a-14(c) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act")). Based on this evaluation, our Chairman of the Board and Chief Executive
Officer and our Chief Financial Officer believe that our disclosure controls and
procedures are effective to ensure that information we are required to disclose
in the reports that we file or submit under the Exchange Act fairly represents,
in all material respects, our financial condition, results of operations and
cash flows.

There were no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the date of
such evaluation.

PART IV

ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this report:

(1) Consolidated Financial Statements (Included Under Item 8): The
Index to the Consolidated Financial Statements is included on page 27 of
this report and is incorporated herein by reference.

(2) Financial Statement Schedules:

None.

(b) Reports on Form 8-K

None.

(c) Exhibits

Reference is made to the Index of Exhibits beginning on page 66 which
index is incorporated herein by reference.

61

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

COMFORT SYSTEMS USA, INC.

By: /s/ WILLIAM F. MURDY
------------------------------------
William F. Murdy
Chairman of the Board and
Chief Executive Officer

By: /s/ J. GORDON BEITTENMILLER
------------------------------------
J. Gordon Beittenmiller
Executive Vice President and
Chief Financial Officer

Date: March 31, 2003

POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that the persons whose signatures
appear below, constitute and appoint J. Gordon Beittenmiller and William George,
and each of them as their true and lawful attorneys-in-fact and agents, with
full power and substitution and resubstitution, for them and in their names,
places and steads, in any and all capacities, to sign any and all amendments to
this Annual Report on Form 10-K, and to file the same, with all exhibits
thereto, and the other documents in connection therewith, with the Securities
and Exchange Commission, granting unto said attorneys-in-fact and agents, and
each of them, full power and authority to do and perform each and every act and
thing requisite and necessary to be done in connection therewith, as fully to
all intents and purposes as they might or could do in person, hereby ratifying
and confirming all that said attorneys-in-fact and agents, or any of them, or
their or his or her substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
date indicated.

63

CERTIFICATION

I, William F. Murdy, Chairman of the Board and Chief Executive Officer, certify
that:

1. I have reviewed this annual report on Form 10-K of Comfort Systems USA,
Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) Presented in this annual report

Our conclusions about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ WILLIAM F. MURDY
--------------------------------------
William F. Murdy
Chairman of the Board and
Chief Executive Officer

Dated: March 31, 2003

64

CERTIFICATION

I, J. Gordon Beittenmiller, Executive Vice President and Chief Financial
Officer, certify that:

1. I have reviewed this annual report on Form 10-K of Comfort Systems USA,
Inc.;

2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;

3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;

(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) Presented in this annual report

Our conclusions about the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

/s/ J. GORDON BEITTENMILLER
--------------------------------------
J. Gordon Beittenmiller
Executive Vice President and
Chief Financial Officer

Dated: March 31, 2003

65

INDEX OF EXHIBITS

- ---------------

* Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this report.

67