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, 2001

COMMISSION FILE NUMBER: 1-13011

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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 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 S-K 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. [ ]

As of March 4, 2002, the aggregate market value of the 35,701,439 shares of
the registrant's common stock held by non-affiliates of the registrant was
$142,091,727, based on the $3.98 last sale price of the registrant's common
stock on the New York Stock Exchange on that date.

As of March 4, 2002, 37,492,678 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, 2001.
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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, a national downturn or one or more regional downturns in
construction, shortages of labor and specialty building materials, difficulty in
obtaining or increased costs associated with debt financing or bonding, 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 ("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 services such as electrical and plumbing.
Approximately 97% of the Company's consolidated 2001 revenues were derived from
commercial and industrial customers with approximately 54% of the revenues
attributable to installation services and 46% attributable to maintenance,
repair and replacement services. The Company's consolidated 2001 revenues
related to the following service activities: HVAC -- 62%, plumbing -- 15%,
electrical -- 5%, building automation control systems -- 5%, fire
protection -- 5% and other -- 8%. These service activities are within the
mechanical services industry which is the single industry segment served by
Comfort Systems.

On July 2, 1997, Comfort Systems completed the initial public offering (the
"IPO") of its common stock (the "Common Stock") and simultaneously acquired 12
companies (collectively referred to as the "Founding Companies") engaged in
providing HVAC services. The Founding Companies had 18 operating locations in 10
states. Subsequent to the IPO, and through December 31, 1999, the Company
acquired 107 HVAC and complementary businesses (collectively with the Founding
Companies, the "Acquired Companies"). These acquisitions included 26 "tuck-in"
operations that have been integrated with existing Company operations. Since the
suspension of the acquisition program in the fourth quarter of 1999, Comfort
Systems has sold or ceased operations at nine locations through 2001. The
Company had 120 operating locations in 90 cities at December 31, 2001.

On March 1, 2002, the Company completed the sale of 19 of its operations
("the Divested Operations") which were predominantly located in the Midwest and
in the New York metropolitan area. Excluding these 19 operations, the Company
currently operates 84 locations in 57 cities which had revenues of approximately
$888 million for 2001.

INDUSTRY OVERVIEW

Comfort Systems believes the HVAC industry as a whole is estimated to
generate annual revenues in excess of $75 billion, over $40 billion of which is
in the commercial and industrial markets. HVAC systems are a necessity in
virtually all commercial and industrial buildings as well as homes. Because most
commercial
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buildings are sealed, HVAC systems provide the primary method of circulating
fresh air in such buildings. 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. In
many instances, the replacement of an aging system with a modern,
energy-efficient system will significantly reduce a building's operating costs
while also improving air quality and the effectiveness of the HVAC system. These
factors cause many facility owners to consider early replacement of older
systems.

Growth in the HVAC industry is positively affected by a number of factors,
particularly (i) the aging of the installed base, (ii) the increasing
efficiency, sophistication and complexity of HVAC systems, (iii) the increasing
opportunities associated with utility deregulation, (iv) the emphasis on indoor
air quality, and (v) the reduction or elimination of the refrigerants commonly
used in older HVAC systems. These factors are expected to increase demand for
the reconfiguration or replacement of existing HVAC systems. The Company
believes that these factors 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 installation services and
maintenance, repair and replacement services.

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 which
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 utilize 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." The Company believes that "plan and spec" projects usually take longer to
complete than "design and build" projects because the preparation of the system
design by a third party and resulting bid process may often take months to
complete. Furthermore, in "plan and spec" projects, the HVAC firm is not
responsible for project design and any changes must be approved by other
parties, thereby increasing overall project time and cost. Approximately 54% of
the Company's consolidated 2001 revenues and 54% of consolidated 2001 revenues
excluding the Divested Operations related to installation services and the
majority of the revenues from installation projects was performed on a "design
and build/negotiated" basis.

Maintenance, Repair and Replacement Services. These services include the
maintenance, repair, replacement, reconfiguration and monitoring of previously
installed HVAC systems and building automation controls. The growth and aging of
the installed base of HVAC systems and the increasing 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, increasing restrictions are being 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. Approximately 46% of the Company's consolidated 2001
revenues and 46% of consolidated 2001 revenues excluding the Divested Operations
related to maintenance, repair and replacement services.

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STRATEGY

Beginning in 2000, Comfort Systems shifted from a strategy focused on
growth through acquisitions to an operating strategy designed to strengthen
operating competencies, increase operating income and cash flow as well as
enhance its comprehensive mechanical services in the HVAC industry. The key
elements of the Company's operating strategy are:

Achieve Excellence in Core Competencies. The Company has identified six
core competencies, which it believes 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. The Company believes there are
opportunities to achieve operating efficiencies and cost savings through
purchasing economies, the adoption of "best practices" operating programs and a
focus on job management to deliver services in a cost-effective and efficient
manner. The Company uses its 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. The Company seeks to attract and
retain quality employees by providing them (i) an enhanced career path from
working for a larger public 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. The Company primarily focuses
on the commercial and industrial markets with particular emphasis on "design and
build" installation services and maintenance, repair and replacement services.
The Company believes that the commercial and industrial HVAC markets are
attractive because of their growth opportunities, 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 97% of the Company's
consolidated 2001 revenues and 95% of consolidated 2001 revenues excluding the
Divested Operations were derived from commercial and industrial customers.

Expand National Service Capabilities. The Company believes that
significant demand exists from large regional and national companies to utilize
the services of a single HVAC service company capable of providing commercial
and industrial services on a regional or national basis. The Company has
increased its ability to handle multi-location service opportunities by
internally developing a National Service Group to facilitate these activities
including an Internet based technology platform and call center designed to
manage HVAC and related service along with the information needs of
multi-location customers. The Company believes its growing ability to add value
in these areas will lead to improved profitability.

Capitalize on Specialized Technical and Marketing Strengths. The Company
believes it will be able to continue to expand the services it offers in its
markets by leveraging the specialized technical and marketing strengths of
individual companies. The Company also believes its size and geographical
coverage will enable it to serve existing customers' needs in new regions that
may have been beyond the service area of the Company's operations that
originated the existing customer relationship.

Increase Emphasis on Facility Automation Services. The Company believes
that through coordination and leadership it will be able to expand the Company's
technical capabilities related to building automation control systems including
HVAC lighting, building access control and fire alarms. In 2001, the Company
established its Facility Automation Services Group in order to coordinate
automation engineering practices, manage national account opportunities and
implement business development strategies at operating locations with existing
building automation capability and at or through operating locations that have
not offered such services.

Benefit from Integrated Energy Services. The Company believes that energy
deregulation has and will increase the demand for mechanical contractors that
provide consultative energy-based solutions. Comfort

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Systems provides energy auditing, energy management and energy master planning
along with real-time energy pricing and usage data. The Company is currently
working with various companies in the utility industry through cooperative
marketing of the Company's services and is seeking to provide utilities the
opportunity to profit and to benefit from the Company's own customer
relationships.

Leveraging Resources. The Company believes that there are significant
operating efficiencies that can be achieved in the leveraging of resources
between its operating locations. The Company has shifted certain prefabrication
activities into centralized locations increasing asset utilization in these
centralized locations and redirecting prefabrication employees into other
operational areas. The Company has also transferred its engineering, field and
supervisory labor from one operation to another in order to more fully utilize
the employee base to meet the customers' needs and share expertise.

OPERATIONS SERVICES PROVIDED

The Company provides a wide range of installation, maintenance, repair and
replacement services for HVAC and related systems in commercial and industrial
properties. The Company manages its locations on a decentralized basis, with
local management maintaining responsibility for day-to-day operating decisions.
Local management is augmented by regional leadership that focuses its efforts on
core business competencies, cooperation and coordination between locations,
implementation of best practices and focus 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. The Company has centralized certain administrative
functions such as insurance, employee benefits, training, safety programs,
marketing and cash management to enable the management of its locations to focus
on pursuing new business opportunities and improving operating efficiencies. The
Company is continuing to expand its national service, facility automation and
energy efficiency services.

Installation Services. The Company's installation business, which
comprised approximately 54% of the Company's 2001 consolidated revenues and 54%
of consolidated 2001 revenues excluding the Divested Operations, involves the
design, engineering, integration, installation and start-up of HVAC, building
automation controls and related systems. The commercial and industrial
installation services performed by the Company consist of "design and build" and
"plan and spec" 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" project, the customer typically has an overall design for the facility
prepared by an architect or a consulting engineer who then enlists the Company's
engineering personnel to participate in or assume responsibility for design of
the HVAC system. Working with the customer, the Company can determine the needed
capacity, energy efficiency and type of building automation controls that best
suit the proposed facility. The Company's 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, the Company participates 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, the Company orders the necessary
materials and equipment for delivery to meet the project schedule. In many
instances, the Company fabricates in its own facilities the ductwork and piping
and assembles certain components for the system based on the mechanical drawing
specifications, eliminating the need to subcontract ductwork or piping
fabrication. The Company installs the system at the project site, working
closely with the general contractor. Most commercial and industrial 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% commonly held
back until completion and successful start-up of the HVAC system.

The Company also installs process cooling systems, building automation
controls and monitoring systems and industrial process piping. Process cooling
systems are utilized primarily in industrial facilities to provide

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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 will communicate an exception when an operating 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. Industrial process piping is utilized in manufacturing
facilities to convey required raw material, support utilities and finished
products.

Maintenance, Repair and Replacement Services. The Company's maintenance,
repair and replacement services comprised approximately 46% of the Company's
2001 consolidated revenues and 46% of consolidated 2001 revenues excluding the
Divested Operations, and include the maintenance, repair, replacement,
reconfiguration and monitoring of HVAC systems and industrial process piping.
Over two-thirds of the Company's maintenance, repair and replacement revenues
were derived from reconfiguring existing HVAC systems for commercial and
industrial customers. Reconfiguration often utilizes consultative expertise
similar to that provided in the "design and build" installation market. The
Company believes that the reconfiguration of an existing system results in a
more cost-effective, energy-efficient system that better meets the specific
needs of the building owner. The reconfiguration also enables the Company to
utilize its design and engineering personnel as well as its sheet metal and
pre-fabrication facilities.

Maintenance and repair services are provided either in response to service
calls or pursuant to 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. The Company also provides 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 used by the Company 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
("York"), Carrier Corporation and Trane Air Conditioning Company. The major
suppliers of building automation control systems are Honeywell, Inc., Johnson
Controls, Inc., York, Automated Logic, Novar and Andover Control Corporation.
The Company does not have any significant contracts guaranteeing the Company a
supply of raw materials or components.

SALES AND MARKETING

The Company has a diverse customer base, with no single customer accounting
for more than 4% of consolidated 2001 revenues and not more than 2% of
consolidated 2001 revenues excluding the Divested Operations. 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. The

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Company intends to continue its emphasis on developing and maintaining long-term
relationships with its customers by providing superior, high-quality service in
a professional manner.

The Company has a national sales team to capitalize on cross-marketing and
business development opportunities that management believes are available to the
Company as a regional or national provider of comprehensive commercial and
industrial HVAC and related services. Management believes that it can
increasingly leverage the diverse technical and marketing strengths at
individual locations to expand the services offered in other local markets.

EMPLOYEES

As of December 31, 2001, the Company had 10,098 employees, including 548
management personnel, 8,181 engineers, service and installation technicians, 361
sales personnel and 1,008 administrative personnel across its 120 operating
locations. Certain of the Company's subsidiaries have collective bargaining
agreements that cover, in the aggregate, approximately 2,726 employees. The
Company has not experienced any significant strikes or work stoppages and
believes its relations with employees covered by collective bargaining
agreements are good. At December 31, 2001, the Divested Operations had 3,692
employees, including 2,663 employees covered by collective bargaining
agreements.

RECRUITING, TRAINING AND SAFETY

The Company's continued future success will depend, in part, on its ability
to continue to attract, retain and motivate qualified engineers, service
technicians, field supervisors and project managers. The Company believes that
its success in retaining qualified employees will be based on the quality of its
recruiting, training, compensation, employee benefits programs and opportunities
for advancement. The Company coordinates its recruiting efforts via the Internet
and at local technical schools and community colleges where students focus on
learning basic industry skills. Additionally, Comfort Systems provides
on-the-job training, technical training, apprenticeship programs, attractive
benefit packages and career advancement opportunities within the Company.

The Company is working to establish comprehensive safety programs
throughout its operations to ensure that all technicians comply with safety
standards established by the Company and federal, state and local laws and
regulations. Additionally, the Company has implemented a "best practices" safety
program throughout its 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. The Company's 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 the Company's operations are bodily injury, property
damage and injured workers' compensation. The Company retains 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 the Company's known claims incurred and an estimate of claims
incurred but not reported.

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

The Company's subsidiaries typically warrant labor for the first year after
installation on new HVAC systems and pass through to the customer manufacturers'
warranties on equipment. The Company's

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subsidiaries generally warrant labor for 30 days after servicing of existing
HVAC systems. The Company does not expect warranty claims to have a material
adverse effect on its financial position or results of operations.

COMPETITION

Comfort Systems believes the HVAC industry is highly competitive and
consists of thousands of small companies. The Company believes 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. The Company's strategy of focusing on both the highly consultative
"design and build" installation market and the maintenance, repair and
replacement market promotes the development and strengthening of long-term
customer relationships. In addition, the Company's ability to provide
multi-location coverage, access to project financing and specialized technical
skills for facilities owners gives it a strategic advantage over smaller
competitors who may be unable to provide these services to customers at a
competitive price.

Many of the Company's competitors are small, owner-operated companies that
typically operate in a limited geographic area. There are also public companies,
divisions of utility companies and equipment manufacturers that are focused on
providing HVAC services in some of the same service lines and geographic
locations served by the Company. Certain of the Company's competitors and
potential competitors may have greater financial resources than the Company to
finance development opportunities and support their operations.

FACILITIES AND VEHICLES

The Company leases the majority of its facilities. In most instances these
leases are with the former owners of the Acquired Companies. Leased premises
range in size from approximately 1,000 square feet to 130,000 square feet. The
Company believes that its facilities are sufficient for its current needs.

The Company operates a fleet of various owned or leased service trucks,
vans and support vehicles. The Company believes that these vehicles generally
are well maintained and adequate for its current operations.

GOVERNMENTAL REGULATION AND ENVIRONMENTAL MATTERS

The Company's 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. The Company
believes it has all required licenses to conduct its operations and is in
substantial compliance with applicable regulatory requirements. Failure of the
Company to comply with applicable regulations could result in substantial fines
or revocation of the Company's operating licenses.

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

The Company's operations are subject to the federal Clean Air Act, as
amended (the "Clean Air Act"), which governs air emissions and imposes specific
requirements on the use and handling of chlorofluorocarbons ("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 the Company's 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.

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EXECUTIVE OFFICERS

The Company has five executive officers.

William F. Murdy, age 60, has served as Chairman of the Board and Chief
Executive Officer of Comfort Systems 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 the organization of 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.

Gary E. Hess, age 54, has served as President and Chief Operating Officer
since September 2000 and Executive Vice President and Chief Operating Officer of
Comfort Systems since June 1999. From March 2000 to February 2002, Mr. Hess
served as a director of Comfort Systems. Prior to this he was the Senior Vice
President-Operations from February 1999 to May 1999. He served Comfort Systems
as regional director of its Northeast region from August 1998 to January 1999.
Prior to that, he was employed by Hess Mechanical Corporation, a wholly-owned
subsidiary of the Company, since 1980, serving as Chairman and Chief Executive
Officer. Mr. Hess was President of Associated Builders and Contractors during
1996 and was selected as their 1997 Contractor of the Year. Effective April 1,
2002, Mr. Hess will retire from the Company.

J. Gordon Beittenmiller, age 42, has served as Executive Vice President,
Chief Financial Officer and a director of Comfort Systems since May 1998, and
was Senior Vice President, Chief Financial Officer and a director of Comfort
Systems from February 1997 to April 1998. From 1994 to February 1997, Mr.
Beittenmiller was Corporate Controller of Keystone International, Inc.
("Keystone"), 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 37, has served as Senior Vice President, General
Counsel and Secretary of Comfort Systems since May 1998, and was Vice President,
General Counsel and Secretary of Comfort Systems 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 38, has served as Vice President and Corporate
Controller of Comfort Systems since February 1997. 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

Most of the Company's subsidiaries lease the real property and buildings
from which they operate. The Company's facilities consist of offices, shops,
maintenance and warehouse facilities. Generally, leases range from five to ten
years and are on terms the Company believes to be commercially reasonable.
Certain of these facilities are leased from related parties. In order to
maximize available capital, the Company generally

8

intends to continue to lease the majority of its properties. The Company
believes that its facilities are adequate for its current needs.

The Company leases its executive and administrative offices in Houston,
Texas.

ITEM 3. LEGAL PROCEEDINGS

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

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

None.

9

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
the Common Stock for the quarters indicated as traded at the New York Stock
Exchange. The Common Stock is traded under the symbol FIX:

As of March 4, 2002, there were approximately 635 stockholders of record of
the Company's Common Stock, and the last reported sale price on that date was
$3.98 per share.

The Company has never declared or paid a dividend on its Common Stock. The
Company currently expects to retain future earnings in order to repay debt and
finance growth and, consequently, does not intend to declare any dividend on the
Common Stock for the foreseeable future. In addition, the Company's revolving
credit agreement restricts the ability of the Company to pay dividends without
the lenders' consent. The Company's Restricted Voting Common Stock converts to
Common Stock upon sale and under certain other conditions.

RECENT SALES OF UNREGISTERED SECURITIES

During 2001, the Company did not issue any unregistered shares of its
Common Stock.

10

ITEM 6. SELECTED FINANCIAL DATA

Comfort Systems acquired the 12 Founding Companies in connection with the
IPO on July 2, 1997. Subsequent to the IPO and through December 31, 1999, the
Company completed 107 acquisitions, 17 of which were accounted for as
poolings-of-interests (the "Pooled Companies") and 90 of which were accounted
for as purchases (the "Purchased Companies"). Since the suspension of the
acquisition program in the fourth quarter of 1999, Comfort Systems has sold or
ceased operations at nine locations through 2001. 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 the Founding Companies and Purchased Companies as of their
respective acquisition dates and reflects 15 of the Pooled Companies (the
"Restated Companies") for all periods presented. Two of the Pooled Companies are
considered immaterial poolings based upon criteria set forth by the Securities
and Exchange Commission and have not been restated for all periods presented.
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

INTRODUCTION

The following discussion should be read in conjunction with the historical
Consolidated Financial Statements of Comfort Systems USA, Inc. ("Comfort
Systems" and collectively with its subsidiaries, the "Company") and related
notes thereto included elsewhere in this Form 10-K. This discussion contains
forward-looking statements regarding the business and industry of Comfort
Systems within the meaning of the Private Securities Litigation Reform Act of
1995. These statements are based on the current plans and expectations of the
Company and involve risks and uncertainties that could cause actual future
activities and results of operations to be materially different from those set
forth in the forward-looking statements. 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."

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
services such as electrical and plumbing. Approximately 54% of the Company's
consolidated 2001 revenues were attributable to installation services, with the
remaining 46% attributable to maintenance, repair and replacement services. The
Company's consolidated 2001 revenues related to the following service
activities: HVAC -- 62%, plumbing -- 15%, electrical -- 5%, building automation
control systems -- 5%, fire protection -- 5% and other -- 8%.
11

These service activities are within the mechanical services industry which is
the single industry segment served by Comfort Systems.

In response to the Securities and Exchange Commission's Release No.
33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting
Policies", the Company identified its critical accounting policies based upon
the significance of the accounting policy to the Company's overall financial
statement presentation, as well as the complexity of the accounting policy and
its use of estimates and subjective assessments. The Company concluded that its
critical accounting policy is its revenue recognition policy. This accounting
policy, as well as others, are described in Note 2 to the Consolidated Financial
Statements included elsewhere in the Form 10-K.

The Company enters into construction contracts with general contractors or
end-use customers based upon negotiated contracts and competitive bids. As part
of the negotiation and bidding processes, the Company estimates its 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. Revenues from
construction contracts are recognized on the percentage-of-completion method in
accordance with the American Institute of Certified Public Accountants Statement
of Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts." Under this method, the amount of total contract
revenue recognizable at any given time during a contract is determined by
multiplying total contract revenue by the percentage of contract costs incurred
at any given time to total estimated contract costs. Accordingly, 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 given 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 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 what stage of completion the contract has reached.
Depending on the size of a particular 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.

Approximately 54% of the Company's consolidated 2001 revenues were
attributable to installation of systems in newly constructed buildings. As a
result, if general economic activity in the U.S. slows significantly from
current levels, and leads to a corresponding decrease in new nonresidential
building construction, the Company's operating results could suffer.

Effective January 1, 2002, the Company is required to adopt Statement of
Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible
Assets." Under this new standard, which is discussed in "New Accounting
Pronouncements" below, the new requirements for assessing whether goodwill
assets have been impaired involve market-based information. This information,
and its use in assessing goodwill, will entail some degree of subjective
assessments.

12

RESULTS OF OPERATIONS - HISTORICAL

2001 Compared to 2000

Revenues -- Revenues decreased $44.8 million, or 2.8%, to $1.5 billion in
2001 compared to 2000. The 2.8% decline in revenue for 2001 was comprised of a
2.3% decline in revenues related to operations that were sold or shut down
during late 2000 or in 2001 and a 0.5% reduction in revenues from ongoing
operations.

The Company's ongoing revenues declined slightly in 2001. This results in
part from a general slowing in the U.S. economy. The Company's revenue decline
is also consistent with management's decreased emphasis on revenue growth in
favor of improvement in profit margins, operating efficiency, and cash flow. In
view of these factors, the Company may continue to experience revenue declines
or only modest revenue growth in upcoming periods. There can be no assurance,
however, that this strategy will continue to lead to improved profit margins in
the near term. In addition, if general economic activity in the U.S. slows
significantly from current levels, the Company may realize further decreases in
revenue and lower operating margins.

Gross Profit -- Gross profit decreased $8.1 million, or 2.8%, to $276.2
million in 2001 compared to 2000. As a percentage of revenues, gross profit
remained at 17.9% in 2001 as compared to 2000. Excluding operations that were
sold or shut down during late 2000 or in 2001, gross profit decreased $11.1
million, or 3.8%, to $276.8 million and gross profit as a percentage of revenues
decreased from 18.7% in 2000 to 18.0% in 2001.

The Company's 2001 gross profit margin was hurt by subpar gross profit
performance from certain ongoing operations that are 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 that performed poorly in 2000 and by the improvement in four of the
Company's larger operations.

Selling, General and Administrative Expenses ("SG&A") -- SG&A decreased
$12.9 million, or 5.7%, to $213.0 million in 2001 compared to 2000. As a
percentage of revenues, SG&A decreased from 14.2% in 2000 to 13.8% in 2001.
Excluding operations that were sold or shut down during late 2000 or in 2001,
SG&A decreased $1.6 million, or 0.8%, to $211.0 million in 2001 compared to 2000
and SG&A as a percentage of revenues decreased from 13.8% in 2000 to 13.7% in
2001. During the fourth quarter of 2001, the Company estimated and recorded bad
debt expense of approximately $3.5 million related to the Company's receivables

13

with Kmart, in light of that company's recent bankruptcy filing in January 2002.
Excluding both the Kmart receivables reserve as well as operations sold or shut
down in late 2000 or in 2001, SG&A declined $5.1 million, or 2.4%, to $207.5
million, and as a percentage of revenue, from 13.8% in 2000 to 13.5% in 2001.
The decreases in SG&A primarily related to operations that were sold or shut
down as well as to a concerted effort to reduce SG&A throughout the Company.

Restructuring Charges -- 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 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 by the Company in the third quarter of 2000, management
performed an extensive review of its 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,
the Company estimated and 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. 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 are substantially complete.

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.

Other Expense, Net -- Other expense, net, decreased $4.4 million, or 17.3%,
to $21.2 million in 2001 compared to 2000. This decrease was primarily due to a
reduction in interest expense as a result of the decline in the Company's
average debt levels throughout 2001 as compared to 2000.

Reductions in Non-Operating Assets and Liabilities, Net -- During 2000, the
Company recorded a non-cash charge of approximately $5.9 million primarily
related to the impairment of certain non-operating assets, principally notes
receivable from former owners of businesses acquired by the Company. This charge
also 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. 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.

Income Tax Expense -- The Company's effective tax rates for 2001 and 2000
were 55.7% and (52.3%), respectively. The Company's 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. In 2000, the Company reported
income tax expense of $5.8 million even though it reported a pre-tax loss of
$11.1 million. This occurred primarily because large restructuring-related
writedowns of goodwill that contributed to its 2000 book loss were not
deductible for tax purposes. Excluding these writedowns for tax purposes
resulted in positive taxable income and, therefore, tax expense in 2000.

2000 Compared to 1999

Revenues -- Revenues increased $221.0 million, or 16.1%, to $1.6 billion in
2000 compared to 1999. The 16.1% revenue growth was comprised of approximately
12.0% internal growth and 4.1% for 1999 acquisitions that are included in the
Company's results for the full year of 2000. Revenue growth of approximately 3%

14

(included in the total growth of 16.1%) resulted from the Company's ability to
increase volume by subcontracting portions of projects to other contractors.

Approximately one-half of the 12% internal growth was attributable to the
Company's largest single operation. This growth represented substantial
increases in volume at this operation, which did not result in commensurate
increases in profitability due to scarce technical and skilled labor and
customer scheduling and site restrictions related to strong business conditions.
The Company has experienced these kinds of challenges at numerous other
operations as well, and believes they reflected high levels of activity and
capacity constraints for the construction industry in general during 2000. As a
result, management placed less emphasis on revenue growth and more on
operations, cash flow, efficiency and profit margin improvements in 2000 and
2001 across all operations. It is likely, therefore, that the Company will
continue to experience revenue declines or only modest revenue growth in
upcoming periods. There can be no assurance, however, that this strategy will
lead to improved profit margins in the near term.

Gross Profit -- Gross profit decreased $8.5 million, or 2.9%, to $284.3
million in 2000 compared to 1999. As a percentage of revenues, gross profit
decreased from 21.4% in 1999 to 17.9% in 2000.

During 2000, the Company experienced significant execution shortfalls on
certain projects at its largest operation, and at an operating location on the
West Coast, and at a location in the Southeast. These execution shortfalls
resulted from difficulty in obtaining quality skilled and technical labor in
certain markets, scheduling changes imposed by customers, and from poor pricing
and estimating by two previous operating managers. The Company also experienced
weak operating performance at several locations relating to ongoing turnaround
efforts and execution difficulties. As part of the restructuring review during
2000 discussed below, the Company decided to cease operating at or sell eight of
these locations. These units reported a combined negative gross profit of $2.7
million during 2000.

Gross profit in 2000 was also reduced, to a lesser extent, by the Company's
e-commerce activities which were discontinued in the fourth quarter of 2000. The
costs associated with these decisions are included in the restructuring charges
as discussed below.

The remaining decrease in gross profit as a percentage of revenues resulted
from increased labor costs, pricing pressures in certain markets and scheduling
and efficiency challenges associated with labor availability and productivity at
the high levels of activity that most of the Company's operations experienced in
2000. The Company has also increased the amount of activity it subcontracts to
third parties. Pricing to the Company's customers of such subcontracted work
generally carries lower margins than the Company's self-performed work.

Selling, General and Administrative Expenses -- SG&A increased $38.1
million, or 20.3%, to $225.9 million in 2000 compared to 1999. As a percentage
of revenues, SG&A increased from 13.7% in 1999 to 14.2% in 2000. This increase
in SG&A as a percentage of revenues resulted primarily from the inclusion in
2000 of results of companies acquired in 1999 that had higher SG&A as a
percentage of revenues than the rest of the Company's operations. These
acquisitions included Outbound Services where the Company incurred significantly
higher SG&A to support expansion of its e-commerce activities. During the 4th
quarter of 2000, the Company decided to cease its e-commerce activities at
Outbound, and costs associated with this decision are included in restructuring
charges as discussed below.

The Company also increased corporate and regional office spending in 2000
to support the requirements of a larger organization, and to increase its
efforts to obtain more national account and energy project business. In
addition, as discussed above, the Company experienced weak performance in 2000
at several locations related to turnaround efforts and execution difficulties.
In connection with these challenges, these companies incurred a disproportionate
amount of SG&A in 2000 as compared to their revenues.

During the latter part of 2000, the Company identified and wrote off
certain accounts receivable that were deemed uncollectible. This resulted in the
need for increased provisions for bad debt in SG&A, which also contributed to
the Company's higher SG&A as a percentage of revenues.

Restructuring Charges -- During the second half of 2000, management
performed an extensive review of its operations. As part of this review,
management decided to cease operating at three locations, sell five

15

operations (including two smaller satellite operations), and merge two companies
into other operations. As a result of these decisions, the Company estimated and
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. 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. The
aggregate results for 2000 related to the operations and activities included in
the restructuring charges were revenues of $46.1 million and operating losses of
$17.1 million.

Other Expense, Net -- Other expense, net, increased $6.5 million, or 33.9%,
to $25.6 million in 2000 compared to 1999. This increase was primarily due to
higher interest expense related to additional borrowings and consideration paid
for companies acquired in 1999.

Reductions in Non-Operating Assets and Liabilities, Net -- During 2000, the
Company recorded a non-cash charge of approximately $5.9 million primarily
related to the impairment of certain non-operating assets, principally notes
receivable from former owners of business acquired by the Company. This charge
also 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. 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.

Income Tax Expense -- The Company's effective tax rate for 2000 was (52.3%)
as compared to 42.9% for 1999. The Company's provision for income taxes differs
from the federal statutory rate due to state income taxes (net of federal income
tax benefit) and the non-deductibility of the amortization of goodwill
attributable to certain acquisitions. In 2000, the Company reported income tax
expense of $5.8 million even though it reported a pre-tax loss of $11.1 million.
This occurred primarily because large restructuring-related writedowns of
goodwill that contributed to its 2000 book loss were not deductible for tax
purposes. Excluding these writedowns for tax purposes resulted in positive
taxable income and, therefore, tax expense in 2000.

RESULTS OF OPERATIONS -- RESTATED FINANCIAL INFORMATION DUE TO SUBSEQUENT
DIVESTITURE OF CERTAIN OPERATIONS

On February 11, 2002, the Company entered into an agreement with EMCOR
Group, Inc. ("EMCOR") to sell 19 operations. Under the terms of the agreement,
the total purchase price is approximately $186.25 million, including debt
assumed by EMCOR of approximately $22.1 million of subordinated notes to former
owners of certain of the divested companies. This transaction closed on March 1,
2002. The Company expects that net of taxes, transaction costs, and escrows,
approximately $160 million of this amount will be used to reduce debt. In
addition, the Company expects that it will take certain steps to reduce its
costs in light of the smaller size of the Company following the EMCOR
transaction. As a result, the Company currently expects it will record
restructuring charges of not less than $1 million, before taxes, in the first
quarter of 2002.

Under SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived
Assets" which takes effect for the Company on January 1, 2002, the operating
results of units being sold as well as any gain or loss on the sale of these
operations will be presented as discontinued operations in the Company's
statement of operations for the first quarter of 2002. This reporting will be
separate from income statement items for ongoing operations. Based on estimates
of the net assets of these operations and on estimates of transaction costs, the
Company expects to realize an estimated loss on the sale of these operations of
approximately $27 million in the first quarter of 2002, exclusive of tax
liabilities. Approximately $67 million of this loss will be included in the
cumulative effect of a change in accounting principle as a result of the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." See "New
Accounting Pronouncements" below for further discussion.

The following supplemental financial information reflects restated
financial information for 2001 and 2000 in light of this transaction. These
restated financial statements do not consider any allocation of corporate
16

overhead to the discontinued operations, and therefore, SG&A does not reflect
any potential reductions in corporate costs in response to this major change in
the Company. A portion of the Company's interest expense, which is included in
other expense, net, has been allocated to the discontinued operations based upon
the Company's 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 any earlier periods.

Revenues -- Revenues decreased $19.2 million, or 2.1%, to $888.4 million in
2001 compared to 2000. The 2.1% decline in revenue for 2001 was comprised of a
4.0% 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.

The Company's internal revenue growth for 2001 is lower than the growth it
experienced throughout 2000. This results in part from a general slowing in the
U.S. economy. The Company's lower revenue growth in 2001 is also consistent with
management's decreased emphasis on revenue growth in favor of improvement in
profit margins, operating efficiency, and cash flow. In view of these factors,
the Company may continue to experience only modest revenue growth or even
revenue declines in upcoming periods. There can be no assurance, however, that
this strategy will continue to lead to improved profit margins in the near term.
In addition, if general economic activity in the U.S. slows significantly from
current levels, the Company may realize further decreases in revenue and lower
operating margins.

Gross Profit -- Gross profit decreased $0.3 million, or 0.2%, to $165.9
million in 2001 compared to 2000. As a percentage of revenues, gross profit
increased from 18.3% in 2000 to 18.7% in 2001. Excluding operations that were
sold or shut down during late 2000 or in 2001, gross profit decreased $3.3
million, or 1.9%, to $166.5 million and gross profit as a percentage of revenues
decreased from 19.8% in 2000 to 18.9% in 2001.

The Company's 2001 gross profit margin was hurt by subpar gross profit
performance from certain ongoing operations that are 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 that performed poorly in 2000 and by the improvement in two of the
Company's larger operations.

Selling, General and Administrative Expenses -- SG&A decreased $10.1
million, or 6.5%, to $144.1 million in 2001 as compared to 2000. As a percentage
of revenues, SG&A decreased from 17.0% in 2000 to 16.2%

17

in 2001. Excluding operations that were sold or shut down during late 2000 or in
2001, SG&A increased $1.2 million, or 0.8%, to $142.1 million in 2001 compared
to 2000 and SG&A as a percentage of revenues decreased from 16.4% in 2000 to
16.1% in 2001. During the fourth quarter of 2001, the Company estimated and
recorded bad debt expense of approximately $3.5 million related to the Company's
receivables with Kmart, in light of that company's recent bankruptcy filing in
January 2002. Substantially all of the Kmart charge relates to ongoing
operations of the Company not being divested. Excluding both the Kmart charge as
well as operations sold or shut down in late 2000 or in 2001, SG&A declined $2.3
million, or 1.7%, to $138.6 million, and as a percentage of revenue, from 16.4%
in 2000 to 15.7% in 2001.

SG&A as a percentage of revenues is higher than historical levels because
this restated financial information does not allocate any corporate overhead to
the discontinued operations, and therefore, SG&A does not reflect any potential
reductions in corporate costs in response to this major change in the 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 the Company.

Restructuring Charges -- 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 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 by the Company in the third quarter of 2000, management
performed an extensive review of its 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,
the Company estimated and 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. 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 are substantially complete.

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.

Other Expense, Net -- Other expense, net, decreased $3.0 million, or 28.3%,
to $7.5 million in 2001 compared to 2000. This decrease was primarily due to a
reduction in interest expense as a result of the decline in the Company's
average debt levels throughout 2001 as compared to 2000. A portion of the
Company's interest expense has been allocated to the discontinued operations
based upon the Company's 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 any earlier periods.

Reductions in Non-Operating Assets and Liabilities, Net -- During 2000, the
Company recorded a non-cash charge of $1.1 million primarily related to the
impairment of certain non-operating assets. This charge 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 $0.2 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.

18

Income Tax Expense -- The Company's effective tax rates for 2001 and 2000
were 120.3% and 10.1%, respectively. The Company's 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 120.3%
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, the Company reported income tax benefit of
$3.4 million on a pre-tax loss from continuing operations of $33.7 million. This
is primarily because of large restructuring-related writedowns of non-deductible
goodwill that contributed to the 2000 book loss. The effective tax rate is
expected to decrease significantly in future periods as compared to 2001 due to
the elimination of goodwill amortization for book purposes in 2002 as a result
of the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets."

LIQUIDITY AND CAPITAL RESOURCES

Cash Flow -- Cash provided by operating activities less customary capital
expenditures plus the proceeds from asset sales is generally called free cash
flow and, if positive, 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, 2001, the Company had free cash flow of
$61.9 million, an increase of $19.8 million as compared to free cash flow of
$42.1 million in 2000. This improvement primarily resulted from faster billing
by the Company for its project work coupled with modest improvement in the
average days to collect receivables once billed, as well as from a decrease in
net capital expenditures versus the prior year. Free cash flow in 1999 was $3.9
million.

Cash used in financing activities for the year ended December 31, 2001 was
$68.2 million. This primarily reflects a net reduction of long-term debt of
$69.1 million. In 2000, $30.4 million was used in financing activities. This
primarily reflects a net reduction of long-term debt of $30.7 million. In 1999,
financing activities provided $24.7 million primarily from net borrowings of
long-term debt used to fund acquisitions.

Revolving Credit Facility -- The Company's principal debt financing is a
revolving credit facility (the "Credit Facility" or the "Facility") provided by
Bank One, Texas, N.A. ("Bank One") and other banks (including Bank One, the
"Bank Group"). As of December 31, 2001, the Credit Facility provided the Company
with a revolving line of credit of up to the lesser of $250 million or 80% of
accounts receivable, net of reserves ("Net Receivables"). Borrowings outstanding
under the Facility as of December 31, 2001 were $163.7 million.

In connection with the Company's sale of operations to EMCOR as discussed
in Note 16 to the Consolidated Financial Statements included elsewhere in the
Form 10-K and in "Results of Operations" above, the Company agreed in February
2002 to pay down debt under the Facility by at least $130 million, and to reduce
the size of the Facility to the lesser of $100 million or 80% of Net
Receivables. This transaction closed on March 1, 2002. The Company expects that
net of taxes, transaction costs, and escrows, approximately $138 million of the
cash proceeds will be used to reduce its bank debt.

Borrowings under the Facility are secured by accounts receivable,
inventory, fixed assets other than real estate, and the shares of capital stock
of the Company's subsidiaries. The Credit Facility expires on January 1, 2003,
at which time all amounts outstanding are due.

The Company has a choice of two interest rate options under the Facility.
Under one option, the interest rate is determined based on the higher of the
Federal Funds Rate plus 0.5% or Bank One's prime rate. An additional margin of
1% to 2% is then added to the higher of these two rates. Under the other
interest rate option, borrowings bear interest based on designated short-term
Eurodollar rates (which generally approximate London Interbank Offered Rates or
"LIBOR") plus 2.5% to 3.5%. The additional margin for both options depends on
the ratio of the Company's debt to earnings before interest, taxes, depreciation
and amortization ("EBITDA"), as defined. Commitment fees of 0.375% to 0.5% per
annum, also depending on the ratio of debt to EBITDA, are payable on the unused
portion of the Facility.

19

The Credit Facility prohibits payment of dividends and the repurchase of
shares by the Company, limits certain non-Bank Group debt, and restricts outlays
of cash by the Company relating to certain investments, capital expenditures,
vehicle leases, acquisitions and subordinate debt. The Credit Facility also
provides for the maintenance of certain levels of shareholder equity and EBITDA,
and for the maintenance of certain ratios of the Company's EBITDA to interest
expense and debt to EBITDA.

As noted above in "Results of Operations," the Company estimated and
recorded an allowance of $3.5 million in the fourth quarter of 2001 against its
receivables with the Kmart Corporation based on Kmart's bankruptcy filing in
January 2002. Including this reserve, the Company's fourth quarter EBITDA did
not meet the Facility's minimum EBITDA covenant. The Bank Group agreed to
exclude the Kmart reserve from covenant calculations. As a result, the Company
has no unresolved covenant violations under the Facility.

As a result of the substantial reduction in debt following the EMCOR
transaction, the Company believes that it currently complies with the Facility's
debt to EBITDA and EBITDA to interest expense covenants by comfortable margins.
The Bank Group has agreed to adjust the Facility's minimum EBITDA covenants to
reflect the Company's reduced size following the EMCOR transaction. While the
Company expects to be in compliance with these new EBITDA requirements, the
minimum EBITDA covenant allows less room for variance than the Facility's other
financial covenants. If the Company violates this or any other covenant, it may
have to negotiate new borrowing terms under the Facility. While the Company
believes that its improved creditworthiness following the EMCOR transaction
would result in a successful negotiation of new terms if necessary, there can be
no assurance that it could obtain terms acceptable to the Company. In view of
these restrictions, the Facility's January 2003 maturity, and the Company's
improved creditworthiness, the Company has started the process of seeking more
flexible borrowing arrangements.

As of December 31, 2001, the Company had $163.7 million in borrowings
outstanding under the Credit Facility and had incurred interest expense at an
average rate of approximately 8.7% for the year ended December 31, 2001. The
Company also had $2.4 million in letters of credit outstanding under the
Facility at yearend. While not actual borrowings, letters of credit do reflect
potential liabilities under the Facility and therefore are treated by the Bank
Group as a use of borrowing capacity under the Facility. Letters of credit are
discussed below under "Other Commitments." Unused borrowing capacity under the
Facility based upon the most restrictive covenant was $30.7 million as of
December 31, 2001.

As of March 4, 2002, the Company had $24.7 million outstanding under the
Facility as a result of using proceeds from the EMCOR transaction to reduce its
borrowings, and unused borrowing capacity of approximately $50.1 million under
the Facility. The Company expects to make payments of taxes and other costs
related to the EMCOR transaction of approximately $19 million in early second
quarter of 2002. This would have resulted in $43.7 million outstanding under the
Facility as of March 4, 2002, if these payments had been made contemporaneously
with the closing of the EMCOR transaction. The Company estimates its current
all-in floating interest rate under the Facility to be approximately 6.1%.

In connection with the reduction of the Facility's size as well as the
Company's expectation of obtaining new debt arrangements as noted above, the
Company expects to write off in the first quarter of 2002 as much as $1.2
million, before tax benefits, of deferred arrangement fees associated with its
current Facility.

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. These notes had an outstanding balance of $41.0
million as of December 31, 2001. These notes bear interest, payable quarterly,
at a weighted average interest rate of 9.7%. In addition, $0.6 million of these
notes are convertible by the holders into shares of the Company's common stock
("Common Stock") at a weighted average price of $24.25 per share.

In connection with the Company's sale of operations to EMCOR as discussed
in Note 16 to the Consolidated Financial Statements included elsewhere in the
Form 10-K and in "Results of Operations" above, $22.1 million of subordinate
debt was assumed by EMCOR. As a result of this assumption as well as scheduled
principal payments that have already occurred in 2002, the outstanding balance
of subordinate debt

20

as of March 4, 2002 was $18.4 million. The maturities on this remaining debt are
$2.9 million in 2002 and $15.5 million in 2003. Substantially all of the 2003
maturities are due on April 10, 2003.

Other Commitments -- As is common in the Company's industry, the Company
has entered into certain off- balance sheet arrangements in the ordinary course
of business that result in risks not directly reflected in the Company's balance
sheets. The Company's significant off-balance sheet transactions include
liabilities associated with noncancelable operating leases, letter of credit
obligations and surety guarantees.

The Company enters into noncancelable operating leases for many of its
facility, vehicle and equipment needs. These leases allow the Company 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, the
Company has no further obligation to the lessor. The Company may decide to
cancel or terminate a lease before the end of its term. Typically the Company is
liable to the lessor for the remaining lease payments under the term of the
lease.

Some customers require the Company to post letters of credit to guarantee
performance under the Company's contracts and to ensure payment to the Company's
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 behalf of the Company, such as to beneficiaries under the
Company's 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 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.

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.

The Company's future contractual obligations include (in thousands):

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 Credit
Facility, the Company is prohibited from purchasing additional shares of its
Common Stock.

Outlook -- The Company anticipates that cash flow from operations as well
as borrowings under lending facilities will be sufficient to meet the Company's
normal cash needs. As noted above, the Company has certain relatively tight
restrictions under the Credit Facility. If the Company violates these or certain
other restrictions under the Facility, it may be required to negotiate new terms
with its banks. While the Company believes that its improved creditworthiness
following the EMCOR transaction would result in a successful negotiation of new
terms if necessary, there can be no assurance that it could obtain terms
acceptable to the Company. In view of these restrictions, the Facility's January
2003 maturity, and the Company's improved creditworthiness, the Company has
started the process of seeking more flexible borrowing arrangements.

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 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, the Company expects its 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, the Company's 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. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations initiated after June 30, 2001. SFAS No.
141 also specifies criteria for recording intangible assets other than goodwill
in connection with business combinations. SFAS No. 142 requires companies to
assess goodwill assets for impairment each year, and more frequently if
circumstances suggest an impairment may have occurred. SFAS No. 142 also
introduces a more stringent framework for assessing goodwill impairment than the
approach required under existing rules. In addition, SFAS No. 142 discontinues
the regular charge, or amortization, of goodwill assets against income.

SFAS No. 141 took effect upon issuance in July 2001. SFAS No. 142 is
effective for the Company beginning January 1, 2002 and early adoption is not
allowed for calendar year companies. Under SFAS No. 142, any impairment loss
recognized in accordance with the initial adoption will be shown as a cumulative
effect of a change in accounting principle in the Company's statement of
operations. Under this treatment, the Company's statement of operations would
show after-tax results of operations both with and without the cumulative effect
of a change in accounting principle recognizing an impairment.

Under previous standards, the Company recognized a non-cash charge of
approximately $12 million per year in its statement of operations through
December 31, 2001 to amortize its goodwill assets over 40-year lives. This
amortization was discontinued beginning January 1, 2002 under the new standard.

22

The new requirements for assessing whether goodwill assets have been
impaired involve market-based information. Based on a preliminary review of the
new standards, the Company believes that it will record a non-cash, pre-tax
goodwill impairment charge of between $240 million and $260 million. The Company
anticipates that this charge will be recorded in the first quarter of 2002 when
the new standard becomes effective. As noted above, this charge will be
reflected as a cumulative effect of a change in accounting principle.

The Company has specifically provided for the possibility of a non-cash
goodwill impairment charge in its lending agreements with its banks and
accordingly, expects no impact on its current bank credit facility as a result
of this charge.

In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets." This Statement supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions of APB 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." Under SFAS No. 144, the operating results of the
companies being sold to EMCOR (as discussed in Note 16 to the Consolidated
Financial Statements included elsewhere in the Form 10-K and in "Results of
Operations" above), as well as any gain or loss on the sale of these operations
will be presented as discontinued operations in the Company's statement of
operations for 2002. The Company believes that the adoption of SFAS No. 144 will
not have a material impact on its results of operations, financial position or
cash flows.

FACTORS WHICH MAY AFFECT FUTURE RESULTS

The Company's 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, a national downturn or one or more regional
downturns in construction, shortages of labor and specialty building materials,
difficulty in obtaining or increased costs associated with debt financing or
bonding, 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 the Company will not experience
material fluctuations in future operating results or cash flows on a quarterly
or annual basis.

The Company's success depends in part on its ability to integrate and
further consolidate the companies it has acquired. These businesses operated as
separate, independent entities prior to their affiliation with the Company, and
there can be no assurance that the Company 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 future results of the Company because,
among other reasons, the Company's 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.

The existing senior management at many of the Company's subsidiary
operations is generally comprised of former owners who committed to stay with
their operations after acquisition. Certain of these individuals have suffered
losses in the Company 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 the Company 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 the Company's strategy are to both maintain and improve the
profitability and cash flow of the individual businesses. The Company's 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 the Company's control, such as the level of new construction or the
potential for slower replacement based upon
23

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 the Company's services.

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

The Company's ability to generate positive cash flow at its historical
levels in the future could be adversely impacted by a reduction in its 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 the Company's
faster billing for its project work in the past year because the Company 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 the Company's debt instruments, could limit its
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 the Company operates
will not change significantly in the future. The Company's failure to comply, or
the costs of compliance, with such laws and regulations could adversely affect
the Company's 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 the Company's 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

The Company is 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. The Company is 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.

The Company's exposure to changes in interest rates primarily results from
its short-term and long-term debt with both fixed and floating interest rates.
The Company's debt with fixed interest rates consists of capital leases,
convertible subordinated notes, subordinated notes and various other notes
payable. The Company's debt with variable interest rates consists entirely of
its revolving Credit Facility. The following table presents principal amounts
(stated in thousands) and related average interest rates by year of maturity for
the Company's debt obligations and their indicated fair market value at December
31, 2001:

24

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA

INDEX TO FINANCIAL STATEMENTS

25

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Comfort Systems USA, Inc.:

We have audited the accompanying consolidated balance sheets of Comfort
Systems USA, Inc. (a Delaware corporation) and subsidiaries as of December 31,
2000 and 2001, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Comfort Systems USA, Inc., and subsidiaries as of December 31, 2000 and 2001,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 2001, in conformity with
accounting principles generally accepted in the United States.

ARTHUR ANDERSEN LLP

Houston, Texas
March 5, 2002

26

COMFORT SYSTEMS USA, INC.

CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

The accompanying notes are an integral part of these consolidated financial
statements.
27

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these consolidated financial
statements.
28

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

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

COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

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

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001

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 services such as electrical and plumbing.
Approximately 54% of the Company's consolidated 2001 revenues were attributable
to installation services, with the remaining 46% attributable to maintenance,
repair and replacement services. The Company's consolidated 2001 revenues
related to the following service activities: HVAC -- 62%, plumbing -- 15%,
electrical -- 5%, building automation control systems -- 5%, fire
protection -- 5% and other -- 8%. These service activities are within the
mechanical services industry which is the single industry segment served by
Comfort Systems.

On March 1, 2002, the Company sold 19 operations to EMCOR Group, Inc.
("EMCOR"). See Note 16 for further discussion.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

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 in 1999, 2000 and 2001 was approximately $17.8
million, $25.8 million and $20.7 million, respectively. Cash paid for income
taxes in 1999, 2000 and 2001 was approximately $33.6 million, $13.1 million and
$10.1 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 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 the
statement of operations.

31

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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. Goodwill is amortized on a straight-line basis
over 40 years. In addition, see discussion of new accounting standards related
to goodwill below in this note under "Accounting Pronouncements."

As of December 31, 2000 and 2001, accumulated amortization of goodwill was
approximately $32.9 million and $44.7 million, respectively.

LONG-LIVED ASSETS

Long-lived assets are comprised principally of goodwill and property and
equipment. 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

The Company enters into construction contracts with general contractors or
end-use customers based upon negotiated contracts and competitive bids. As part
of the negotiation and bidding processes, the Company estimates its 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. Revenues from
construction contracts are recognized on the percentage-of-completion method in
accordance with the American Institute of Certified Public Accountants Statement
of Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts." Under this method, the amount of total contract
revenue recognizable at any given time during a contract is determined by
multiplying total contract revenue by the percentage of contract costs incurred
at any given time to total estimated contract costs. Accordingly, 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 given 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 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 what stage of completion the contract has reached.
Depending on the size of a particular 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 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, the retention
balance at each balance sheet date is billed and collected within the subsequent
year. The retainage balances at December 31, 2000 and 2001 are $67.7 million and
$60.5 million, respectively, and are included in accounts receivable.

32

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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.

WARRANTY COSTS

The Company typically warrants labor for the first year after installation
on new air conditioning and heating systems. The Company generally warrants
labor for 30 days after servicing of existing air conditioning and heating
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
Statement of Financial Accounting Standards ("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.

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
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 as deemed necessary.
33

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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.

ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that the purchase method of accounting
be used for all business combinations initiated after June 30, 2001. SFAS No.
141 also specifies criteria for recording intangible assets other than goodwill
in connection with business combinations. SFAS No. 142 requires companies to
assess goodwill assets for impairment each year, and more frequently if
circumstances suggest an impairment may have occurred. SFAS No. 142 also
introduces a more stringent framework for assessing goodwill impairment than the
approach required under existing rules. In addition, SFAS No. 142 discontinues
the regular charge, or amortization, of goodwill assets against income.

SFAS No. 141 took effect upon issuance in July 2001. SFAS No. 142 is
effective for the Company beginning January 1, 2002 and early adoption is not
allowed for calendar year companies. Under SFAS No. 142, any impairment loss
recognized in accordance with the initial adoption will be shown as a cumulative
effect of a change in accounting principle in the Company's statement of
operations. Under this treatment, the Company's statement of operations would
show after-tax results of operations both with and without the cumulative effect
of a change in accounting principle recognizing an impairment.

Under previous standards, the Company recognized a non-cash charge of
approximately $12 million per year in its statement of operations through
December 31, 2001 to amortize its goodwill assets over 40-year lives. This
amortization was discontinued beginning January 1, 2002 under the new standard.

The new requirements for assessing whether goodwill assets have been
impaired involve market-based information. Based on a preliminary review of the
new standards, the Company believes that it will record a non-cash, pre-tax
goodwill impairment charge of between $240 million and $260 million. The Company
anticipates that this charge will be recorded in the first quarter of 2002 when
the new standard becomes effective. As noted above, this charge will be
reflected as a cumulative effect of a change in accounting principle.

The Company has specifically provided for the possibility of a non-cash
goodwill impairment charge in its lending agreements with its banks and
accordingly, expects no impact on its current bank credit facility as a result
of this charge.

In August 2001, the FASB issued SFAS No. 144 "Accounting for the Impairment
or Disposal of Long-Lived Assets." This statement supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and the accounting and reporting provisions of APB 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions." Under SFAS No. 144, the operating results of the
companies being sold to EMCOR (as discussed in Note 16) as well as any gain or
loss on the sale of these operations will be presented as discontinued
operations in the Company's statement of operations for 2002. The Company
believes that the adoption of SFAS No. 144 will not have a material impact on
its results of operations, financial position or cash flows.

34

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

3. RESTRUCTURING CHARGES:

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 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 by the Company in the third quarter of 2000, management
performed an extensive review of its 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,
the Company estimated and 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. 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 are substantially complete.

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.

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

Aggregated financial information related to the operations addressed by
restructuring is as follows (in thousands):

35

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

As of December 31, 2000, net assets held for sale were comprised of the
following (in thousands):

Current assets (primarily accounts receivable).............. $5,789
Long-term assets............................................ 6
Current liabilities (primarily accounts payable)............ (2,577)
Long-term liabilities....................................... (21)
------
Total............................................. $3,197
======

The restructuring charges associated with the operations that were held for
sale at December 31, 2000 were $3.7 million and primarily related to impairments
of goodwill and other long-lived assets based upon the estimated proceeds from
the anticipated sale of these operations.

4. REDUCTIONS IN NON-OPERATING ASSETS AND LIABILITIES, NET:

During 2000, the Company recorded a non-cash charge of approximately $5.9
million primarily related to the impairment of certain non-operating assets,
principally notes receivable from former owners of businesses acquired by the
Company. This charge also 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. 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.

5. BUSINESS COMBINATIONS:

During 1999, the Company acquired 25 businesses which were accounted for as
purchases. These companies provide HVAC and related services. The aggregate
consideration paid in these transactions was $38.0 million in cash, 1,151,907
shares of the Company's common stock ("Common Stock") with a fair value at the
date of acquisition totaling $8.5 million, $2.2 million in the form of
convertible subordinated notes and $21.3 million in the form of subordinated
notes. In addition, the Company received 68,177 shares from a former owner
related to a prior year acquisition. Subsequent to the issuance of certain of
the convertible subordinated notes, the Company entered into agreements with
certain of the convertible noteholders to modify the terms of $2.1 million of
these notes to eliminate the provisions relating to convertibility into Common
Stock. The remaining convertible subordinated notes are convertible into 5,133
shares of Common Stock. There were no acquisitions in 2000 or 2001.

The unaudited pro forma data presented below consists of the income
statement data presented in these consolidated financial statements plus income
statement data for the purchased companies as if the acquisitions had occurred
on January 1, 1999 (in thousands, except per share data):

Pro forma adjustments included in the preceding table relate to (a) certain
reductions in salaries and benefits to the former owners of the purchased
companies which the former owners agreed would take effect as of the acquisition
date, (b) amortization of goodwill related to the purchased companies, (c)
interest expense on borrowings used in the acquisition of the purchased
companies and (d) interest expense related to

36

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

subordinated notes issued in the acquisition of certain of the purchased
companies. In addition, an incremental tax provision has been recorded as if all
applicable purchased companies had been subject to federal and state income
taxes.

The pro forma results presented above are not necessarily indicative of
actual results which might have occurred had the operations and management teams
of the Company and the purchased companies been combined at the beginning of the
period presented.

6. PROPERTY AND EQUIPMENT:

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

Depreciation expense for the years ended December 31, 1999, 2000 and 2001
was $11.3 million, $12.3 million and $12.4 million, respectively.

7. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS:

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

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COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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

Contracts in progress are as follows (in thousands):

8. LONG-TERM DEBT OBLIGATIONS:

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

38

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

At December 31, 2001, future principal payments of long-term debt are as
follows (in thousands):

Year Ending December 31 --
2002...................................................... $ 3,709
2003...................................................... 201,171
2004...................................................... 63
2005...................................................... 44
2006...................................................... 34
Thereafter................................................ 111
--------
$205,132
========

REVOLVING CREDIT FACILITY

The Company's principal debt financing is a revolving credit facility (the
"Credit Facility" or the "Facility") provided by Bank One, Texas, N.A. ("Bank
One") and other banks (including Bank One, the "Bank Group"). As of December 31,
2001, the Credit Facility provided the Company with a revolving line of credit
of up to the lesser of $250 million or 80% of accounts receivable, net of
reserves ("Net Receivables"). Borrowings outstanding under the Facility as of
December 31, 2001 were $163.7 million.

In connection with the Company's sale of operations to EMCOR as discussed
in Note 16, the Company agreed in February 2002 to pay down debt under the
Facility by at least $130 million, and to reduce the size of the Facility to the
lesser of $100 million or 80% of Net Receivables. This transaction closed on
March 1, 2002. The Company expects that net of taxes, transaction costs, and
escrows, approximately $138 million of the cash proceeds will be used to reduce
its bank debt.

Borrowings under the Facility are secured by accounts receivable,
inventory, fixed assets other than real estate, and the shares of capital stock
of the Company's subsidiaries. The Credit Facility expires on January 1, 2003,
at which time all amounts outstanding are due.

The Company has a choice of two interest rate options under the Facility.
Under one option, the interest rate is determined based on the higher of the
Federal Funds Rate plus 0.5% or Bank One's prime rate. An additional margin of
1% to 2% is then added to the higher of these two rates. Under the other
interest rate option, borrowings bear interest based on designated short-term
Eurodollar rates (which generally approximate London Interbank Offered Rates or
"LIBOR") plus 2.5% to 3.5%. The additional margin for both options depends on
the ratio of the Company's debt to earnings before interest, taxes, depreciation
and amortization ("EBITDA"), as defined. Commitment fees of 0.375% to 0.5% per
annum, also depending on the ratio of debt to EBITDA, are payable on the unused
portion of the Facility.

The Credit Facility prohibits payment of dividends and the repurchase of
shares by the Company, limits certain non-Bank Group debt, and restricts outlays
of cash by the Company relating to certain investments, capital expenditures,
vehicle leases, acquisitions and subordinate debt. The Credit Facility also
provides for the maintenance of certain levels of shareholder equity and EBITDA,
and for the maintenance of certain ratios of the Company's EBITDA to interest
expense and debt to EBITDA.

The Company estimated and recorded an allowance of $3.5 million in the
fourth quarter of 2001 against its receivables with the Kmart Corporation based
on Kmart's bankruptcy filing in January 2002. Including this reserve, the
Company's fourth quarter EBITDA did not meet the Facility's minimum EBITDA
covenant. The Bank Group agreed to exclude the Kmart reserve from covenant
calculations. As a result, the Company has no unresolved covenant violations
under the Facility.

39

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

As a result of the substantial reduction in debt following the EMCOR
transaction, the Company believes that it currently complies with the Facility's
debt to EBITDA and EBITDA to interest expense covenants by comfortable margins.
The Bank Group has agreed to adjust the Facility's minimum EBITDA covenants to
reflect the Company's reduced size following the EMCOR transaction. While the
Company expects to be in compliance with these new EBITDA requirements, the
minimum EBITDA covenant allows less room for variance than the Facility's other
financial covenants. If the Company violates this or any other covenant, it may
have to negotiate new borrowing terms under the Facility. While the Company
believes that its improved creditworthiness following the EMCOR transaction
would result in a successful negotiation of new terms if necessary, there can be
no assurance it could obtain terms acceptable to the Company. In view of these
restrictions, the Facility's January 2003 maturity, and the Company's improved
creditworthiness, the Company has started the process of seeking more flexible
borrowing arrangements.

As of December 31, 2001, the Company had $163.7 million in borrowings
outstanding under the Credit Facility and had incurred interest expense at an
average rate of approximately 8.7% for the year ended December 31, 2001. The
Company also had $2.4 million in letters of credit outstanding under the
Facility at yearend. While not actual borrowings, letters of credit do reflect
potential liabilities under the Facility and therefore are treated by the Bank
Group as a use of borrowing capacity under the Facility. Unused borrowing
capacity under the Facility based upon the most restrictive covenant was $30.7
million as of December 31, 2001.

As of March 4, 2002, the Company had $24.7 million outstanding under the
Facility as a result of using proceeds from the EMCOR transaction to reduce its
borrowings, and unused borrowing capacity of approximately $50.1 million under
the Facility. The Company expects to make payments of taxes and other costs
related to the EMCOR transaction of approximately $19 million in early second
quarter of 2002. This would have resulted in $43.7 million outstanding under the
Facility as of March 4, 2002, if these payments had been made contemporaneously
with the closing of the EMCOR transaction. The Company estimates its current
all-in floating interest rate under the Facility to be approximately 6.1%.

In connection with the reduction of the Facility's size as well as the
Company's expectation of obtaining new debt arrangements as noted above, the
Company expects to write off in the first quarter of 2002 as much as $1.2
million, before tax benefits, of deferred arrangement fees associated with its
current Facility.

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. These
notes had an outstanding balance of $41.0 million as of December 31, 2001. These
notes bear interest, payable quarterly, at a weighted average interest rate of
9.7%. In addition, $0.6 million of these notes are convertible by the holders
into shares of the Company's Common Stock at a weighted average price of $24.25
per share.

In connection with the Company's sale of operations to EMCOR as discussed
in Note 16, $22.1 million of subordinate debt was assumed by EMCOR. As a result
of this assumption as well as scheduled principal payments that have already
occurred in 2002, the outstanding balance of subordinate debt as of March 4,
2002 was $18.4 million. The maturities on this remaining debt are $2.9 million
in 2002 and $15.5 million in 2003. Substantially all of the 2003 maturities are
due on April 10, 2003.

OTHER LONG-TERM OBLIGATIONS DISCLOSURES

The Company estimates the fair value of long-term debt as of December 31,
2000 and 2001 to be approximately the same as the recorded value.

The Company anticipates that cash flow from operations as well as
borrowings under lending facilities will be sufficient to meet the Company's
normal cash needs. As noted above, the Company has certain
40

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

relatively tight restrictions under the Credit Facility. If the Company violates
these or certain other restrictions under the Facility, it may be required to
negotiate new terms with its banks. While the Company believes that its improved
creditworthiness following the EMCOR transaction would result in a successful
negotiation of new terms if necessary, there can be no assurance that it could
obtain terms acceptable to the Company. In view of these restrictions, the
Facility's January 2003 maturity, and the Company's improved creditworthiness,
the Company has started the process of seeking more flexible borrowing
arrangements.

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

41

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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

At December 31, 2001, the Company had $5.9 million of available state net
operating loss carry forwards for income tax purposes which expire 2013-2021.

At December 31, 2001, 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.

10. 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 ranging from 1% to 6% of
covered employees' salaries or wages and totaled $5.4 million for 1999, $5.9
million for 2000 and $6.0 million for 2001. Of these amounts,

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COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

approximately $2.9 million and $2.4 million was payable to the plans at December
31, 2000 and 2001, 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 $14.6 million
for 1999, $17.7 million for 2000 and $19.7 million for 2001. 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.

11. COMMITMENTS AND CONTINGENCIES:

LEASES

The Company leases certain facilities and equipment under noncancelable
operating leases. Rent expense for the years ended December 31, 1999, 2000 and
2001 was $17.5 million, $25.0 million and $26.8 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 1999, 2000 and 2001 rent expense above is approximately $6.1
million, $8.0 million and $9.4 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 --
2002...................................................... $15,969
2003...................................................... 13,193
2004...................................................... 10,632
2005...................................................... 8,230
2006...................................................... 6,053
Thereafter................................................ 21,112
-------
$75,189
=======

Excluding the operations that were sold to EMCOR, operating lease
commitments would have been as follows at December 31, 2001 (in thousands): Less
than one year -- $10,466, 2003 -- $8,924, 2004 -- $6,912, 2005 -- $5,036,
2006 -- $3,747, Thereafter -- $15,759, for a total commitment of $50,844.

CLAIMS AND LAWSUITS

The Company is party to litigation in the ordinary course of business.
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. The Company has estimated and provided accruals for
probable losses and legal fees associated with certain of these actions in the
accompanying consolidated financial statements.

SELF-INSURANCE

The Company retains 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 the Company's known
claims incurred and an estimate of claims incurred but not reported. The
accruals are based upon known facts and historical trends, and management
believes such accruals to be adequate. A wholly-owned insurance company
subsidiary reinsures a portion of the risk associated with surety bonds issued
by a third party insurance

43

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

company. Because no claims have been made against these financial instruments in
the past, management does not expect these instruments will have a material
effect on the Company's consolidated financial statements.

12. STOCKHOLDERS' EQUITY:

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 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, 2001, there
are 1,240,412 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 and
convertible subordinated notes. Options to purchase 4.0 million shares of Common
Stock at prices ranging from $3.63 to $21.438 per share were outstanding as of
December 31, 2001, 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
year ended December 31, 2000 because the Company reported a net loss during this
period, 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 if it were not for the net
loss during the period. 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 after-tax interest expense related to the assumed conversion of
the convertible subordinated notes in 1999 was $0.8 million.

44

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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):

13. 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.

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

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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, 2001:

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.

The Company accounts for its stock-based compensation 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 grant was recorded as an expense in the

46

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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

Long-Term Incentive Plan -- 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 -- The effects of applying SFAS No. 123 in the
pro forma disclosure may not be indicative of future amounts as the granting of
additional purchase rights is anticipated. 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 1999,
2000 and 2001 were $4.88 per share, $1.65 per share, and $0.88 per share,
respectively.

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 250,000 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 5,000 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.

47

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

Either at the time of the initial public offering or upon election as a
director, options were granted to four 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 an option for 5,000 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, 2001, 105,000 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,
2001.

14. RELATED PARTY TRANSACTIONS:

One of the Company's subsidiaries performs contracting services for an
entity partially owned by a director of the Company. Total revenues from this
related party were $6.8 million, $10.0 million and $4.9 million during 1999,
2000 and 2001, respectively. The balance included in accounts receivable at
December 31, 2000 and 2001 was $1.1 million and $1.9 million, respectively.

One of the Company's subsidiaries subcontracts sheet metal services from an
entity owned by a director of the Company. Total purchases from this related
party were $3.8 million, $9.6 million and $5.6 million during 1999, 2000 and
2001, respectively. The balance due included in accounts payable at December 31,
2000 and 2001 was $1.5 million and $0.9 million, respectively.

15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):

Quarterly financial information for the years ended December 31, 2000 and
2001 is summarized as follows (in thousands, except per share data):

48

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 in each quarter.

(a) During the second quarter of 2000, the Company recorded a non-cash, pre-tax
charge of approximately $5.2 million primarily related to the impairment of
certain non-operating assets (see Note 4).

(b) During the third quarter of 2000, the Company recorded pre-tax
restructuring charges of approximately $10.0 million associated primarily
with restructuring efforts at certain underperforming operations (see Note
3).

(c) During the fourth quarter of 2000, the Company recorded an additional
pre-tax charge of $0.7 million related to the impairment of certain
non-operating assets. In addition, during the fourth quarter of 2000, the
Company recorded additional pre-tax restructuring charges of approximately
$15.0 million primarily related to restructuring efforts at certain
underperforming operations and its decision to cease its e-commerce
activities at Outbound Services (see Notes 3 and 4).

16. SUBSEQUENT EVENT:

On February 11, 2002, the Company entered into an agreement with EMCOR to
sell 19 operations. Under the terms of the agreement, the total purchase price
is approximately $186.25 million, including debt assumed by EMCOR of
approximately $22.1 million of subordinated notes to former owners of certain of
the divested companies. This transaction closed on March 1, 2002. The Company
expects that net of taxes, transaction costs, and escrows, approximately $160
million of this amount will be used to reduce debt. In addition, the Company
expects that it will take certain steps to reduce its costs in light of the
smaller size of the Company following the EMCOR transaction. As a result, the
Company currently expects it will record restructuring charges of not less than
$1 million, before taxes, in the first quarter of 2002.

Under SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," which takes effect for the Company on January 1, 2002, the
operating results of units being sold as well as any gain or loss on the sale of
these operations will be presented as discontinued operations in the Company's
statement of operations for the first quarter of 2002. This reporting will be
separate from income statement items for ongoing operations. Based on estimates
of the net assets of these operations and on estimates of transaction costs, the
Company expects to realize an estimated loss on the sale of these operations of
approximately $27 million in the first quarter of 2002, exclusive of tax
liabilities. Approximately $67 million of this loss will be included in the
cumulative effect of a change in accounting principle as a result of the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." See Note 2 for
further discussion.

49

COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

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

None.

PART III

ITEMS 10 TO 13 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, 2001.

PART IV

ITEM 14. 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 25 of this report
and is incorporated herein by reference.

(2) Financial Statement Schedules:

None.

(b) Reports on Form 8-K

The Company filed a report on Form 8-K with the Securities and Exchange
Commission on February 15, 2002. Under Item 5 of that report, the Company
disclosed that it had entered into a Purchase Agreement with EMCOR-CSI Holding
Co. ("EMCOR Holding"), a Delaware corporation and wholly-owned subsidiary of
EMCOR Group, Inc., pursuant to which the Company agreed to sell to EMCOR Holding
all of the outstanding capital stock of and ownership interests in 19 of the
Company's subsidiary operations.

(c) Exhibits

Reference is made to the Index of Exhibits beginning on page 52 which index
is incorporated herein by reference.

50

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company 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
Chief Executive Officer

Date: March 5, 2002

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, this report has been signed by the following persons in
the capacities and on the date indicated.

51

INDEX OF EXHIBITS