10-K 1 h85278e10-k.txt COMFORT SYSTEMS USA, INC. - DATED 12/31/2000 1 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------------- 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, 2000 COMMISSION FILE NUMBER: 1-13011 COMFORT SYSTEMS USA, INC. (Exact name of registrant as specified in its charter) DELAWARE 76-0526487 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.)
777 POST OAK BLVD. SUITE 500 HOUSTON, TEXAS 77056 (713) 830-9600 (Address and telephone number of Principal Executive offices) Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ------------------------ Common Stock, $.01 par value New York Stock Exchange
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 23, 2001, the aggregate market value of the 32,696,669 shares of the registrant's common stock held by non-affiliates of the registrant was $80,106,839, based on the $2.45 last sale price of the registrant's common stock on the New York Stock Exchange on that date. As of March 23, 2001, 37,382,693 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, 2000. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 2 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 acquired 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, 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 leading national provider of comprehensive heating, ventilation and air conditioning ("HVAC") installation, maintenance, repair and replacement services. The Company operates primarily in the commercial and industrial HVAC markets, and performs most of its services within manufacturing plants, office buildings, retail centers, apartment complexes, and healthcare, education and government facilities. In addition to standard HVAC services, the Company provides specialized applications such as process cooling, building automation control systems, electronic monitoring and process piping. Certain locations also perform related services such as electrical and plumbing. Approximately 97% of the Company's consolidated 2000 revenues were derived from commercial and industrial customers with approximately 58% of the revenues attributable to installation services and 42% attributable to maintenance, repair and replacement services. 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, 2000, 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. The Company currently serves its customers with 125 operating locations in 33 states. INDUSTRY OVERVIEW 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 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 and (iv) the increasing standards relating to 1 3 indoor air quality, and 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 58% of the Company's consolidated 2000 revenues 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 42% of the Company's consolidated 2000 revenues related to maintenance, repair and replacement services. STRATEGY The Company has implemented an operating strategy that emphasizes strengthening operating competencies and increasing operating income. OPERATING STRATEGY. After the recent period of sustained growth through acquisitions, the Company is concentrating on the fundamental industry elements needed to increase operating income and cash flow. 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. 2 4 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 has begun and will continue to use its growing purchasing power to gain volume discounts on products and services such as HVAC components, raw materials, service 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 2000 revenues were derived from commercial and industrial customers. GROWTH IN OPERATING INCOME. A key component of the Company's strategy is to nurture growth in operating income and cash flow at the Company's subsidiaries. The key elements of the Company's internal growth strategy are: 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 significantly 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. Expand Alliances with Energy Providers. The Company believes that there is significant potential for mutually beneficial relationships with companies that market energy and energy services. The Company is currently working with several 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. The Company believes it can expand these relationships as it gains experience with successful programs and as its geographic presence increases. 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 that no longer perform these services. 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. 3 5 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 a regional team that focuses its efforts on 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 sales and purchasing programs. Installation Services. The Company's installation business, which comprised approximately 58% of the Company's 2000 consolidated revenues, involves the design, engineering, integration, installation and start-up of HVAC and related systems. The commercial and industrial installation services performed by the Company consist of "design and build" and under some circumstances, "plan and spec" services for manufacturing plants, office buildings, retail centers, apartment complexes, 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 prepare a specific design for the HVAC system. The Company determines 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 most 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 up to 10% 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 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 42% of the Company's 2000 consolidated revenues, and include the maintenance, repair, replacement, reconfiguration and monitoring of HVAC systems and industrial process 4 6 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 2% of consolidated 2000 revenues. Management and a dedicated sales force have been responsible for developing and maintaining successful long-term relationships with key customers. Customers generally include building owners and developers and property managers, as well as general contractors, architects and consulting engineers. The 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. Moreover, the dedicated sales force receives technical and sales training to enhance the comprehensive selling skills necessary to serve the HVAC needs of their customers. 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, 2000, the Company had 10,959 employees, including 599 management personnel, 8,859 engineers, service and installation technicians, 358 sales personnel and 1,143 administrative personnel across its 125 operating locations. Certain of the Company's subsidiaries have collective bargaining agreements that cover, in the aggregate, approximately 2,795 employees. The Company has not experienced any 5 7 significant strikes or work stoppages and believes its relations with employees covered by collective bargaining agreements are good. 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 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 has a national recruiting network and also recruits 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, steady employment 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 maintains liability insurance for bodily injury, third party property damage and workers' compensation which it considers sufficient to insure against these risks, subject to self-insured amounts. 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 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 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 The HVAC industry is highly competitive. 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, 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 provided by the 6 8 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 who are now employed by the Company. Leased premises range in size from approximately 1,000 square feet to over 100,000 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 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. EXECUTIVE OFFICERS The Company has seven executive officers. William F. Murdy, age 59, 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. 7 9 Gary E. Hess, age 53, 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. Prior to this he was the Senior Vice President-Operations from February 1999 to May 1999. In March 2000, the Board of Directors unanimously elected Mr. Hess as a director of Comfort Systems. 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. 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 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. Reagan S. Busbee, age 37, has served as Senior Vice President of Comfort Systems since January 1997. From 1992 through 1996, Mr. Busbee served as Vice President of Chas. P. Young Co., a financial printer and a wholly-owned subsidiary of Consolidated Graphics Inc., a publicly-traded consolidator of the printing industry. From August 1986 to May 1992, he held various positions and was a Certified Public Accountant with Arthur Andersen LLP. William George, III, age 36, 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 consolidator of the healthcare transportation industry. From September 1992 to September 1995, Mr. George practiced corporate and antitrust law at Ropes & Gray, a Boston, Massachusetts law firm. Milburn Honeycutt, age 37, 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 waste services company. From 1986 to 1994, he held various positions with Arthur Andersen LLP and was a Certified Public Accountant. D. F. "Rick" Miller, age 56, has served as Senior Vice President-Organizational Development of Comfort Systems since January 2001. In September 1999, Mr. Miller founded Innovative Leadership Partners LLP, a leadership development consulting partnership serving both individuals and organizations and was a consultant with that entity through December 2000. From January 1999 to August 1999, Mr. Miller was Vice President of Administration with Integrated Electrical Services, a publicly-traded provider of specialty contractor services in the electrical and communications industry. Mr. Miller served as a senior consultant involved with organizational improvement and people development at Mercuri Urval USA from March 1998 to December 1998. Prior to that, Mr. Miller served as a career naval officer and carrier aviator from June 1968 to February 1998, where he held numerous leadership positions in carrier-based squadrons and served in the Pentagon, on the Joint Staff and in the office of the Secretary of the Navy. 8 10 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 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 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 11 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.
HIGH LOW -------- ------- First Quarter, 1999......................................... $ 18.50 $11.375 Second Quarter, 1999........................................ $18.5625 $13.125 Third Quarter, 1999......................................... $ 18.625 $ 11.25 Fourth Quarter, 1999........................................ $ 12.00 $6.4375 First Quarter, 2000......................................... $ 9.375 $ 6.375 Second Quarter, 2000........................................ $ 7.50 $ 3.875 Third Quarter, 2000......................................... $ 5.625 $ 3.375 Fourth Quarter, 2000........................................ $ 5.1875 $ 2.00 January 1 -- March 23, 2001................................. $ 2.80 $2.0625
As of March 23, 2001, there were approximately 657 stockholders of record of the Company's Common Stock, and the last reported sale price on that date was $2.45 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 2000, the Company did not issue any unregistered shares of its Common Stock. 10 12 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, 2000, 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"). 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.
YEAR ENDED DECEMBER 31, -------------------------------------------------------- 1996 1997 1998 1999 2000 -------- -------- -------- ---------- ---------- (IN THOUSANDS) STATEMENT OF OPERATIONS DATA: Revenues................... $161,419 $297,646 $853,961 $1,370,035 $1,591,066 Operating income........... $ 6,575 $ 5,699 $ 68,497 $ 93,204 $ 20,427 Net income (loss).......... $ 4,589 $ (2,064) $ 35,013 $ 42,322 $ (16,853) BALANCE SHEET DATA: Working capital............ $ 13,971 $ 63,137 $133,390 $ 168,341 $ 173,219 Total assets............... $ 50,366 $308,779 $789,293 $ 934,530 $ 926,410 Total debt, including current portion......... $ 8,376 $ 24,726 $236,446 $ 305,833 $ 274,601 Stockholders' equity....... $ 15,429 $217,635 $379,932 $ 418,965 $ 400,239
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 leading national provider of comprehensive HVAC installation, maintenance, repair and replacement services. The Company operates primarily in the commercial and industrial HVAC markets and performs most of its services within manufacturing plants, office buildings, retail centers, apartment complexes, and healthcare, education and government facilities. In addition to standard HVAC services, the Company provides specialized applications such as process cooling, building automation control systems, electronic monitoring and process piping. Certain locations also perform related services such as electrical and plumbing. 11 13 RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ------------------------------------------------------------- 1998 1999 2000 ----------------- ------------------- ------------------- (IN THOUSANDS) Revenues.......................... $853,961 100.0% $1,370,035 100.0% $1,591,066 100.0% Cost of services.................. 647,512 75.8% 1,077,329 78.6% 1,306,816 82.1% -------- ---------- ---------- Gross profit...................... 206,449 24.2% 292,706 21.4% 284,250 17.9% Selling, general and administrative expenses......... 130,820 15.3% 187,771 13.7% 225,894 14.2% Goodwill amortization............. 7,132 0.8% 11,731 0.9% 12,585 0.8% Restructuring charges............. -- -- -- -- 25,344 1.6% -------- ---------- ---------- Operating income.................. 68,497 8.1% 93,204 6.8% 20,427 1.3% Other expense, net................ (6,435) (0.8)% (19,144) (1.4)% (25,628) (1.6)% Reductions in non-operating assets and liabilities, net............ -- -- -- -- (5,867) (0.4)% -------- ---------- ---------- Income (loss) before income taxes........................... 62,062 7.3% 74,060 5.4% (11,068) (0.7)% Income tax expense................ 27,049 31,738 5,785 -------- ---------- ---------- Net income (loss)................. $ 35,013 4.1% $ 42,322 3.1% $ (16,853) (1.1)% ======== ========== ==========
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. Approximately 3% of the revenue growth resulted from the Company's ability to increase volume by subcontracting portions of projects to other contractors. Of the 12.0% internal growth rate compared to last year, approximately one-half of this 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 reflect high levels of activity and capacity constraints for the construction industry in general. As a result, management is placing less emphasis on revenue growth and more on operations, cash flow, efficiency and profit margin improvements for 2001 across all operations. It is likely, therefore, that the Company will experience flat to slower revenue growth in future 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 disappointing results from certain locations due to execution shortfalls on projects and weak performance at several locations relating to ongoing turnaround efforts. 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 the customers and 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. The Company has decided to cease operating at or sell eight of these locations which 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 abandoned in the fourth quarter of 2000. The costs associated with these decisions are included in the 12 14 restructuring charges 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 at most of our operations. 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") -- 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 have 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 has also increased corporate and regional office spending 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 has experienced weak performance at several locations related to turnaround efforts and execution difficulties, and these companies have realized a disproportionate amount of SG&A as compared to their revenues. During the latter part of 2000, the Company identified certain accounts receivable that were deemed uncollectible and written off. This necessitated 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 2000, the Company recorded restructuring charges of approximately $25.3 million primarily associated with restructuring efforts at certain underperforming operations and its decision to cease its e-commerce activities at Outbound Services, a subsidiary of the Company. 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. These actions are substantially complete except that the Company is seeking buyers for two operations it is holding for sale. The Company anticipates that these operations will be sold during the first half of 2001. 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. The restructuring charges are primarily non-cash and include 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. Severance costs relate to the termination of approximately 145 employees 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. 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 the increase in 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. These assets primarily related to notes receivable from former business owners that were collateralized by shares of the Company's stock. 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. Also included in this charge 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 reported income tax expense of $5.8 million for 2000 related to its pre-tax loss of $11.1 million primarily due to the writedown of non-deductible goodwill associated with the Company's 13 15 restructuring activities. The Company's provision for income taxes also 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. 1999 Compared to 1998 Revenues -- Revenues increased $516.1 million, or 60.4%, to $1.4 billion in 1999 compared to 1998. The increase in revenues over the prior year is primarily due to the acquisition of Purchased Companies in 1998 and 1999; however, the Company experienced lower internal revenue growth in the latter part of fiscal 1999 as compared to previous periods. The Company believes that this is primarily attributable to a slowing in the growth of the construction industry due to shortages in both labor and specialty building materials, which in turn impacted HVAC installations. Gross Profit -- Gross profit increased $86.3 million, or 41.8%, to $292.7 million in 1999 compared to 1998. The increase in gross profit is primarily due to the acquisitions described above. As a percentage of revenues, gross profit decreased from 24.2% in 1998 to 21.4% in 1999. This decrease primarily resulted from the change in classification of certain costs from SG&A to cost of services. These costs relate to activities that directly support project or service work. Management believes this revised presentation better aligns the presentation of cost of services and SG&A across all of our acquired operations. Excluding the effect of this change in classification for 1999 of approximately $37.2 million, gross profit as a percentage of revenues remained relatively unchanged at 24.1% in 1999 versus 24.2% in 1998. During 1999, the Company experienced increased gross profit margins from strong performances in commercial and industrial markets in the Northeast, Phoenix and Orlando as well as operating synergies achieved between its western Michigan companies. However, in the latter part of fiscal 1999 the Company has experienced lower internal revenue growth as a result of construction industry capacity issues as discussed above. In addition, there has been a shift in the mix of installation projects to higher labor-intensive projects with lower gross profit percentages, pricing competition in certain markets and execution shortfalls and inefficiencies as the Company sought stronger revenue growth levels. Selling, General and Administrative Expenses -- SG&A increased $57.0 million, or 43.5%, to $187.8 million in 1999 compared to 1998. Most of this increase was related to Purchased Companies along with an increase in corporate personnel and corporate office expenses commensurate with the increase in the number of Acquired Companies. As a percentage of revenues, SG&A decreased from 15.3% in 1998 to 13.7% in 1999. This decrease is primarily attributable to the change in classification of certain costs as described above. Excluding the effect of this change in classification for 1999 of approximately $37.2 million, SG&A expenses as a percentage of revenues increased from 15.3% for 1998 to 16.4% for 1999. This increase in SG&A as a percentage of revenues resulted primarily from lower internal revenue growth as discussed above and increased healthcare costs under the Company's self-insured medical plan. SG&A for 1998 includes $1.8 million of salaries and benefits paid to the former owners of the Pooled Companies which the former owners contractually agreed would not continue following their acquisition by Comfort Systems. Operating Income -- Operating income increased $24.7 million, or 36.1%, to $93.2 million in 1999 compared to 1998 primarily due to the addition of Purchased Companies. As a percentage of revenues, operating income decreased from 8.1% in 1998 to 6.8% in 1999. The decrease in operating income as a percentage of revenues resulted from issues discussed above. Other Expense, Net -- Other expense, net, increased $12.7 million, or 197.5%, to $19.1 million in 1999 compared to 1998 primarily due to the increase in interest expense related to the acquisition of the Purchased Companies. Income Tax Expense -- The Company's effective tax rate for 1999 was 42.9% as compared to 43.6% for 1998. 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. 14 16 LIQUIDITY AND CAPITAL RESOURCES Cash Flow -- For the year ended December 31, 2000, net cash provided by operating activities was $58.2 million, or an increase of $39.8 million over the prior year. This improvement primarily results from lengthier payment cycles on accounts payable and accrued liabilities, and from faster billing by the Company for its project work while maintaining the same average days to collect receivables once billed. Cash provided by operations for 1999 was $18.4 million and cash used in operations in 1998 was $5.5 million. Cash used in investing activities was $15.4 million for the year ended December 31, 2000, primarily in connection with purchases of property and equipment for $18.0 million. Cash flows used in investing activities for 1999 and 1998 were $46.5 million and $143.1 million, respectively. The uses of cash in 1999 and 1998 were primarily for the acquisition of purchased companies. Cash used in financing activities for the year ended December 31, 2000 was $30.4 million and was primarily attributable to net payments on long-term debt of $30.7 million. Net cash provided by financing activities in 1999 was $24.7 million and was due primarily to net borrowings of long-term debt which were used to fund acquisitions. Net cash provided by financing activities in 1998 was $137.5 million and was primarily attributable to the $16.7 million received from the second public offering and net borrowings of long-term debt of $124.2 million, which were primarily used to fund acquisitions. Revolving Credit Facility -- The Company amended its revolving credit facility (the "Credit Facility" or the "Facility") provided by Bank One, Texas, N.A. ("Bank One") and other banks (the "Bank Group") in March 2001. As amended, the Credit Facility provides the Company with a revolving line of credit of up to the lesser of $270 million or 80% of net accounts receivable. The Facility decreases to the lesser of $250 million or 80% of net accounts receivable as of December 31, 2001, and to the lesser of $240 million or 80% of net accounts receivable as of June 30, 2002. 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 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. Under the terms of the Credit Facility that were in effect as of June 30 and September 30, 2000, the Company was in violation of certain of the Facility's financial balance and ratio requirements. The Bank Group waived these violations. The restrictions and financial balance and ratio requirements currently effective under the Facility allow for performance during the first and second quarters of 2001 consistent with the Company's results in recent quarters, excluding restructuring and other nonrecurring charges. The Facility's restrictions and requirements then call for improvement from recent performance levels in the third and fourth quarters of 2001 and on a quarterly basis in 2002. The Facility also prohibits repurchase of the Company's stock and has relatively tight approval requirements on acquisitions. The Facility's requirements reflect tighter restrictions, greater specificity and smaller allowable variances on most financial balances and ratios than is typical for such agreements due to the Company's weaker results in 2000. While management believes its restructuring efforts and operating strategies along with general market conditions in the commercial/industrial HVAC and building automation controls industry will enable the Company to meet the 15 17 Facility's requirements, there can be no assurance that the Company will be successful in doing so. Management intends to seek more flexible terms under its borrowing relationships as its results and credit market conditions allow. As of December 31, 2000, the Company had $223.7 million in borrowings outstanding under the Credit Facility and had incurred interest expense at an average rate of approximately 8.9% for the year ended December 31, 2000. The Credit Facility's interest rate terms as summarized above are effective as of March 22, 2001 and currently result in an all-in floating interest rate under the Facility's LIBOR option of approximately 8.9%. As of December 31, 2000, the Company also had $2.0 million in letters of credit outstanding under the Facility, and unused borrowing capacity under the Facility of $41.6 million. As of March 23, 2001, $226.9 million in borrowings and $1.9 million in letters of credit were outstanding under the Facility, and $36.6 million in unused capacity was available. 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 $50.3 million as of December 31, 2000. Of these notes, $49.9 million bear interest, payable quarterly, at a weighted average interest rate of 5.8% and $0.4 million are non-interest bearing. In addition, $1.2 million of these notes are convertible by the holders into shares of the Company's Common Stock at a weighted average price of $25.27 per share. The originally scheduled maturities of the subordinated notes are $3.4 million in 2000, $24.0 million in 2001, $22.0 million in 2002, and $0.9 million in 2003. As a result of the Company's covenant violations in 2000 under the Credit Facility, the Bank Group required that originally scheduled principal payments to subordinate debt holders be suspended. This requirement took effect in October 2000. In March 2001, the Company entered into amended agreements with subordinate debt holders representing $44.4 million in principal, including all the principal originally scheduled to be paid through 2001. These amended agreements allow for partial payments against certain originally scheduled payment amounts, defer remaining principal balances to April 2003, and increase the interest rate on this debt to 10% per annum, payable quarterly. As a result of these amended agreements, the Company's annual maturities of subordinate debt are now $8.9 million in 2001, $6.6 million in 2002, and $34.8 million in 2003. Stock Repurchases -- 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. The Company does not expect further share repurchases under this program for the foreseeable future. Outlook -- The Company anticipates that available borrowings under its Credit Facility and cash flow from operations will be sufficient to meet the Company's normal working capital and capital expenditure needs. As noted above, the Company has agreed to relatively tight restrictions under the Credit Facility. If the Company violates any of these restrictions, it will be required to negotiate new terms with its banks. There can be no assurance that in that event, the Company will receive satisfactory new terms from its banks, or that if the Company needs additional financing, that such financing can be secured when needed or on terms the Company deems acceptable. 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. 16 18 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. 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 acquired 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, 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 on a quarterly or annual basis. The Company's success depends in part on its ability to integrate 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. 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. 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 of the individual businesses and to continue to expand the operations of these 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 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. Recently acquired businesses also involve a number of special risks, including failure of the acquired business to achieve expected results, diversion of management's attention and failure to retain various personnel of the acquired business. There are also risks associated with unanticipated events or liabilities resulting from the acquired businesses' operations prior to their acquisition. Any of these risks, or a combination of them, could have a material adverse effect on the Company's business, financial condition and results of operations. 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 in acquired businesses and at the corporate and regional level. The Company has a substantial amount of debt that could limit its ability to fund future working capital needs and increase its exposure during adverse economic conditions. 17 19 Such indebtedness could increase vulnerability to adverse operational performance and economic and industry conditions; limit the ability to fund future working capital, capital expenditures and other general corporate requirements; limit flexibility in planning for, or reacting to, changes in our business or industry; place the Company at a disadvantage compared to a competitor that has less debt. Such indebtedness, together with the financial and other restrictive covenants in our debt instruments, could limit our ability to borrow additional funds. Additionally, failing to comply with those covenants could result in an event of default, which, if not cured or waived, could have a material adverse effect on the Company. HVAC systems are also 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, 2000:
2001 2002 2003 2004 2005 THEREAFTER FAIR VALUE ------ ------ -------- ---- ---- ---------- ---------- Liabilities -- Long-Term Debt: Variable Rate Debt............ $ -- $ -- $223,700 $ -- $ -- $ -- $223,700 Average Interest Rate...... --% --% 8.9% --% --% --% 8.9% Fixed Rate Debt............... $9,066 $6,710 $ 34,912 $ 71 $ 43 $ 99 $ 50,901 Average Interest Rate...... 9.9% 6.2% 10.0% 6.6% 5.6% 5.0% 9.5%
18 20 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- Comfort Systems USA, Inc. Report of Independent Public Accountants.................. 20 Consolidated Balance Sheets............................... 21 Consolidated Statements of Operations..................... 22 Consolidated Statements of Stockholders' Equity........... 23 Consolidated Statements of Cash Flows..................... 24 Notes to Consolidated Financial Statements................ 25
19 21 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, 1999 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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, 1999 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Houston, Texas March 27, 2001 20 22 COMFORT SYSTEMS USA, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, ------------------- 1999 2000 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents................................. $ 3,664 $ 16,021 Accounts receivable, less allowance of $5,568 and $6,789................................................. 309,031 334,152 Other receivables......................................... 4,575 5,879 Inventories............................................... 20,907 19,399 Prepaid expenses and other................................ 11,471 10,568 Costs and estimated earnings in excess of billings........ 54,575 44,078 Net assets held for sale.................................. -- 3,197 -------- -------- Total current assets.............................. 404,223 433,294 PROPERTY AND EQUIPMENT, net................................. 41,964 40,085 GOODWILL, net............................................... 474,529 450,493 OTHER NONCURRENT ASSETS..................................... 13,814 2,538 -------- -------- Total assets...................................... $934,530 $926,410 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt...................... $ 3,353 $ 216 Current maturities of notes to affiliates and former owners................................................. 24,536 8,850 Accounts payable.......................................... 96,032 114,613 Accrued compensation and benefits......................... 36,187 40,880 Billings in excess of costs and estimated earnings........ 52,170 68,574 Other current liabilities................................. 23,604 26,942 -------- -------- Total current liabilities......................... 235,882 260,075 LONG-TERM DEBT, NET OF CURRENT MATURITIES................... 225,471 224,111 NOTES TO AFFILIATES AND FORMER OWNERS, NET OF CURRENT MATURITIES................................................ 52,473 41,424 OTHER LONG-TERM LIABILITIES................................. 1,739 561 -------- -------- Total liabilities................................. 515,565 526,171 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock, $.01 par, 5,000,000 shares authorized, none issued and outstanding............................ -- -- Common stock, $.01 par, 102,969,912 shares authorized, 39,258,913 shares issued............................... 393 393 Treasury stock, at cost, 1,695,524 and 2,002,629 shares, respectively........................................... (11,978) (13,119) Additional paid-in capital................................ 342,655 341,923 Retained earnings......................................... 87,895 71,042 -------- -------- Total stockholders' equity........................ 418,965 400,239 -------- -------- Total liabilities and stockholders' equity........ $934,530 $926,410 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 21 23 COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ---------------------------------- 1998 1999 2000 -------- ---------- ---------- REVENUES.................................................. $853,961 $1,370,035 $1,591,066 COST OF SERVICES.......................................... 647,512 1,077,329 1,306,816 -------- ---------- ---------- Gross profit.................................... 206,449 292,706 284,250 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.............. 130,370 187,771 225,894 GOODWILL AMORTIZATION..................................... 7,132 11,731 12,585 ACQUISITION RELATED EXPENSES.............................. 450 -- -- RESTRUCTURING CHARGES..................................... -- -- 25,344 -------- ---------- ---------- Operating income................................ 68,497 93,204 20,427 OTHER INCOME (EXPENSE): Interest income......................................... 957 841 514 Interest expense........................................ (7,633) (20,033) (26,886) Other................................................... 241 48 744 -------- ---------- ---------- Other expense, net.............................. (6,435) (19,144) (25,628) -------- ---------- ---------- REDUCTIONS IN NON-OPERATING ASSETS AND LIABILITIES, NET... -- -- (5,867) -------- ---------- ---------- INCOME (LOSS) BEFORE INCOME TAXES......................... 62,062 74,060 (11,068) INCOME TAX EXPENSE........................................ 27,049 31,738 5,785 -------- ---------- ---------- NET INCOME (LOSS)......................................... $ 35,013 $ 42,322 $ (16,853) ======== ========== ========== NET INCOME (LOSS) PER SHARE: Basic................................................... $ 1.06 $ 1.10 $ (0.45) ======== ========== ========== Diluted................................................. $ 1.04 $ 1.09 $ (0.45) ======== ========== ========== SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE: Basic................................................... 32,962 38,561 37,397 ======== ========== ========== Diluted................................................. 34,329 39,699 37,397 ======== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 22 24 COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
COMMON STOCK TREASURY STOCK ADDITIONAL TOTAL ------------------- --------------------- PAID-IN RETAINED STOCKHOLDERS' SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS EQUITY ---------- ------ ---------- -------- ---------- -------- ------------- BALANCE AT DECEMBER 31, 1997............. 28,013,436 $280 -- $ -- $205,829 $ 11,526 $217,635 Issuance of Common Stock: Second Public Offering............... 861,479 9 -- -- 15,892 -- 15,901 Acquisition of Purchased Companies... 9,212,573 92 -- -- 111,456 -- 111,548 Issuance of Employee Stock Purchase Plan shares........................ 29,362 -- -- -- 482 -- 482 Issuance of shares for options exercised.......................... 24,330 -- -- -- 319 -- 319 S Corporation distributions made by certain Pooled Companies............. -- -- -- -- -- (966) (966) Net income............................. -- -- -- -- -- 35,013 35,013 ---------- ---- ---------- -------- -------- -------- -------- BALANCE AT DECEMBER 31, 1998............. 38,141,180 381 -- -- 333,978 45,573 379,932 Issuance of Common Stock: Acquisition of Purchased Companies... 958,533 10 125,197 885 6,164 -- 7,059 Issuance of Employee Stock Purchase Plan shares........................ 142,276 2 -- -- 2,036 -- 2,038 Issuance of shares for options exercised.......................... 16,924 -- -- -- 477 -- 477 Common Stock repurchases............... -- -- (1,820,721) (12,863) -- -- (12,863) Net income............................. -- -- -- -- -- 42,322 42,322 ---------- ---- ---------- -------- -------- -------- -------- BALANCE AT DECEMBER 31, 1999............. 39,258,913 393 (1,695,524) (11,978) 342,655 87,895 418,965 Issuance of Common Stock: Issuance of Employee Stock Purchase Plan shares........................ -- -- 329,212 2,254 (732) -- 1,522 Common Stock repurchases............... -- -- (175,513) (1,224) -- -- (1,224) Shares exchanged in repayment of notes receivable........................... -- -- (385,996) (1,975) -- -- (1,975) Shares received from sale of businesses........................... -- -- (74,808) (196) -- -- (196) Net loss............................... -- -- -- -- -- (16,853) (16,853) ---------- ---- ---------- -------- -------- -------- -------- BALANCE AT DECEMBER 31, 2000............. 39,258,913 $393 (2,002,629) $(13,119) $341,923 $ 71,042 $400,239 ========== ==== ========== ======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 23 25 COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------- 1998 1999 2000 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)........................................... $ 35,013 $ 42,322 $ (16,853) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities -- Restructuring charges..................................... -- -- 25,344 Reductions in non-operating assets and liabilities, net... -- -- 5,867 Depreciation and amortization expense..................... 14,001 23,055 24,902 Bad debt expense.......................................... 1,253 1,650 5,883 Deferred tax expense (benefit)............................ 960 1,339 (2,590) Gain on sale of property and equipment.................... (274) (260) (697) Changes in operating assets and liabilities, net of effects of acquisitions of purchased companies -- (Increase) decrease in -- Receivables, net..................................... (34,915) (58,096) (36,791) Inventories.......................................... (788) (4,822) 1,103 Prepaid expenses and other current assets............ 2,437 3,213 2,734 Costs and estimated earnings in excess of billings... (7,926) (15,433) 9,373 Other noncurrent assets.............................. 113 (293) 2,002 Increase (decrease) in -- Accounts payable and accrued liabilities............. (14,991) 20,166 21,980 Billings in excess of costs and estimated earnings... 208 6,080 17,105 Other, net........................................... (616) (507) (1,190) --------- --------- --------- Net cash provided by (used in) operating activities...................................... (5,525) 18,414 58,172 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment....................... (11,137) (16,054) (18,037) Proceeds from sales of property and equipment............. 1,369 1,507 1,937 Cash paid for purchased companies, net of cash acquired... (133,338) (31,417) -- Proceeds from businesses sold............................. -- -- 713 Other..................................................... -- (500) -- --------- --------- --------- Net cash used in investing activities............. (143,106) (46,464) (15,387) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Payments on long-term debt................................ (109,508) (236,372) (314,360) Borrowings of long-term debt.............................. 233,684 271,706 283,634 S Corporation distributions paid by certain pooled companies.............................................. (966) -- -- Proceeds from issuance of common stock, net of offering costs.................................................. 16,702 2,258 1,522 Repurchases of common stock............................... -- (12,863) (1,224) Other..................................................... (2,393) -- -- --------- --------- --------- Net cash provided by (used in) financing activities...................................... 137,519 24,729 (30,428) --------- --------- --------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (11,112) (3,321) 12,357 CASH AND CASH EQUIVALENTS, beginning of year................ 18,097 6,985 3,664 --------- --------- --------- CASH AND CASH EQUIVALENTS, end of year...................... $ 6,985 $ 3,664 $ 16,021 ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements. 24 26 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2000 1. BUSINESS AND ORGANIZATION: Comfort Systems USA, Inc., a Delaware corporation ("Comfort Systems" and collectively with its subsidiaries, the "Company"), is a leading national provider of comprehensive heating, ventilation and air conditioning ("HVAC") installation, maintenance, repair and replacement services. The Company operates primarily in the commercial and industrial HVAC markets, and performs most of its services within manufacturing plants, office buildings, retail centers, apartment complexes, and healthcare, education and government facilities. In addition to standard HVAC services, the Company provides specialized applications such as process cooling, building automation control systems, electronic monitoring and process piping. Certain locations also perform related services such as electrical and plumbing. Approximately 58% of the Company's consolidated 2000 revenues were attributable to installation services, with the remaining 42% attributable to maintenance, repair and replacement services. 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 1998, 1999 and 2000 was approximately $6.6 million, $17.8 million and $25.8 million, respectively. Cash paid for income taxes in 1998, 1999 and 2000 was approximately $33.3 million, $33.6 million and $13.1 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. 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 periods not exceeding 40 years. 25 27 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) As of December 31, 1999 and 2000, accumulated amortization of goodwill was approximately $20.7 million and $32.9 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 recognizes revenue when services are performed except when work is being performed under a construction contract. Revenues from construction contracts are recognized on the percentage-of-completion method measured by the percentage of costs incurred to total estimated costs for each contract. Contract costs include all direct material (net of estimated rebates), labor and subcontract costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Provisions for the total estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions, estimated profitability and final contract settlements may result in revisions to costs and revenues, and their effects are recognized in the period in which the revisions are determined. Receivable balances billed but not paid by customers pursuant to retainage provisions in construction contracts 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 fiscal year. The retainage balances at December 31, 1999 and 2000 are $58.2 million and $67.7 million, respectively, and are included in accounts receivable. The current asset "Costs and estimated earnings in excess of billings" represents revenues recognized in excess of amounts billed. The current liability "Billings in excess of costs and estimated earnings" represents billings in excess of revenues recognized. 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 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 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. Certain pooled companies were S Corporations for income tax purposes and, accordingly, any income tax liabilities for the periods prior to the acquisition date are the responsibility of the respective stockholders. All acquired entities are subject to corporate income taxes subsequent to their acquisition. 26 28 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. 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 allowances as deemed necessary. 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 value of these instruments on the accompanying balance sheets approximates their fair value. ACCOUNTING PRONOUNCEMENT In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). This standard requires entities to recognize all derivative instruments (including certain derivative instruments embedded in other contracts) as assets or liabilities in its balance sheet and measure them at fair value. The statement requires that changes in the derivatives' fair value be recognized currently in earnings unless specific hedge accounting criteria are met. SFAS No. 133, as amended, is effective for the Company beginning January 1, 2001. The Company adopted these standards effective January 1, 2001 and there was no impact as the Company does not currently hold or trade derivative instruments. RECLASSIFICATIONS Certain reclassifications have been made in prior period financial statements to conform to current period presentation. During 1999, the Company began presenting certain costs in cost of services that relate to activities that directly support project or service work. These costs were previously presented in selling, general and administrative expenses ("SG&A"). Management believes this revised presentation better aligns cost of services and SG&A across all acquired operations. The change in classification in 1999 resulted in approximately $37.2 million of costs included in cost of services which would have been included in SG&A under the prior presentation. Exclusive of this change in classification, gross profit in 1999 would have been approximately $329.9 million. Prior periods were not restated. 3. RESTRUCTURING CHARGES: During 2000, the Company recorded restructuring charges of approximately $25.3 million primarily associated with restructuring efforts at certain underperforming operations and its decision to cease its e-commerce activities at Outbound Services, a subsidiary of the Company. 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. These actions are substantially complete except that the Company is seeking buyers for two operations it is holding for sale. The Company anticipates that these operations will be sold during the first half of 2001. The restructuring charges 27 29 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) are primarily non-cash and include 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. Severance costs relate to the termination of approximately 145 employees (approximately 90 of these employees were terminated as of December 31, 2000) 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 portions of the restructuring charges that are expected to result in cash disbursements, and how much of those amounts had been paid by December 31, 2000 (in thousands):
BALANCE AT DECEMBER 31, TOTAL ACCRUAL PAYMENTS 2000 ------------- -------- ------------ Severance......................................... $2,487 $(1,269) $1,218 Lease termination costs and other................. 2,920 (608) 2,312 ------ ------- ------ Total................................... $5,407 $(1,877) $3,530 ====== ======= ======
Aggregated financial information related to the operations and activities included in the restructuring charges is as follows (in thousands):
TWELVE MONTHS ENDED DECEMBER 31, ---------------------------- 1998 1999 2000 ------- ------- -------- Revenues............................................... $14,086 $50,235 $ 46,062 Operating income (loss)................................ $ 838 $ 1,427 $(17,053)
As of December 31, 2000, net assets held for sale are 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. These assets primarily related to notes receivable from former business owners that were collateralized by shares of the Company's stock. 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. Also included in this charge 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. 28 30 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. BUSINESS COMBINATIONS: POOLINGS During 1998, the Company acquired all of the outstanding stock of three businesses which were accounted for as poolings-of-interests in exchange for 1,437,767 shares of the Company's common stock ("Common Stock"). These companies provide HVAC and related services. The historical financial statements for 1998 include the operations of these poolings prior to their acquisition by the Company. PURCHASES During 1998, the Company acquired 52 businesses which were accounted for as purchases. These companies provide HVAC and related services. The aggregate consideration paid in these transactions was $161.2 million in cash, 9,212,573 shares of Common Stock with a fair value at the date of acquisition totaling $111.5 million, $57.4 million in the form of convertible subordinated notes and $3.1 million in the form of subordinated notes. 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 $49.3 million of these notes to eliminate the provisions relating to convertibility into Common Stock. The remaining convertible subordinated notes are convertible into 42,608 shares of Common Stock. 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 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. The accompanying consolidated balance sheets include allocations of the respective purchase prices to the assets acquired and liabilities assumed based on fair value. The allocations in 1999 resulted in $55.7 million in goodwill which represents the excess of the purchase price over the estimated fair value of the net assets acquired for the purchased companies. In conjunction with the acquisitions, goodwill was determined as follows (in thousands):
1999 -------- Fair value of assets acquired, net of cash acquired...... $(27,806) Liabilities assumed...................................... 20,138 Cash paid, net of cash acquired.......................... 31,417 Estimated fair value of stock consideration.............. 8,463 Issuance of notes........................................ 23,473 -------- Goodwill................................................. $ 55,685 ========
29 31 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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):
YEAR ENDED DECEMBER 31, ----------------------- 1998 1999 ---------- ---------- (UNAUDITED) Revenues.................................................... $1,355,733 $1,425,182 Net income.................................................. $ 40,657 $ 41,966 Net income per share -- diluted............................. $ 1.03 $ 1.06 Shares used in computing net income per share -- diluted.... 40,113 40,156
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 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):
ESTIMATED DECEMBER 31, USEFUL LIVES ----------------- IN YEARS 1999 2000 ------------ ------- ------- Land.................................................. N/A $ 178 $ 155 Transportation equipment.............................. 3-10 32,781 30,118 Machinery and equipment............................... 3-10 27,542 25,978 Computer and telephone equipment...................... 3-7 15,942 20,612 Buildings and leasehold improvements.................. 3-39 12,079 13,935 Furniture and fixtures................................ 3-10 8,815 9,146 ------- ------- 97,337 99,944 Less -- Accumulated depreciation...................... 55,373 59,859 ------- ------- Property and equipment, net......................... $41,964 $40,085 ======= =======
Depreciation expense for the years ended December 31, 1998, 1999 and 2000 was $6.9 million, $11.3 million and $12.3 million, respectively. 30 32 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS: Activity in the Company's allowance for doubtful accounts consists of the following (in thousands):
DECEMBER 31, -------------------------- 1998 1999 2000 ------ ------- ------- Balance at beginning of year............................... $1,698 $ 4,758 $ 5,568 Additions for bad debt expense............................. 1,253 1,650 5,883 Deductions for uncollectible receivables written off, net of recoveries............................................ (909) (1,940) (4,452) Allowance for doubtful accounts of purchased companies at date of acquisition...................................... 2,716 1,100 -- Allowance for doubtful accounts of businesses sold or held for sale................................................. -- -- (210) ------ ------- ------- Balance at end of year..................................... $4,758 $ 5,568 $ 6,789 ====== ======= =======
Other current liabilities consist of the following (in thousands):
DECEMBER 31, ----------------- 1999 2000 ------- ------- Accrued warranty costs...................................... $ 4,587 $ 4,715 Accrued insurance expense................................... 6,835 6,710 Deferred revenue............................................ 2,210 2,397 Other current liabilities................................... 9,972 13,120 ------- ------- $23,604 $26,942 ======= =======
Installation contracts in progress are as follows (in thousands):
DECEMBER 31, ------------------------- 1999 2000 ----------- ----------- Costs incurred on contracts in progress.................... $ 895,662 $ 1,252,685 Estimated earnings, net of losses.......................... 209,887 252,205 Less -- Billings to date................................... (1,103,144) (1,529,223) Less -- Amounts related to businesses held for sale........ -- (163) ----------- ----------- $ 2,405 $ (24,496) =========== =========== Costs and estimated earnings in excess of billings on uncompleted contracts.................................... $ 54,575 $ 44,078 Billings in excess of costs and estimated earnings on uncompleted contracts.................................... (52,170) (68,574) ----------- ----------- $ 2,405 $ (24,496) =========== ===========
31 33 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 8. LONG-TERM DEBT OBLIGATIONS: Long-term debt obligations consist of the following (in thousands):
DECEMBER 31, ------------------- 1999 2000 -------- -------- Revolving credit facility................................... $225,215 $223,700 Notes to affiliates and former owners....................... 77,009 50,274 Other....................................................... 3,609 627 -------- -------- Total debt........................................ 305,833 274,601 Less: current maturities.......................... 27,889 9,066 -------- -------- $277,944 $265,535 ======== ========
At December 31, 2000, future principal payments of long-term debt are as follows (in thousands): Year Ending December 31 -- 2001................................................... $ 9,066 2002................................................... 6,710 2003................................................... 258,612 2004................................................... 71 2005................................................... 43 Thereafter............................................. 99 -------- $274,601 ========
REVOLVING CREDIT FACILITY The Company amended its revolving credit facility (the "Credit Facility" or the "Facility") provided by Bank One, Texas, N.A. ("Bank One") and other banks (the "Bank Group") in March 2001. As amended, the Credit Facility provides the Company with a revolving line of credit of up to the lesser of $270 million or 80% of net accounts receivable. The Facility decreases to the lesser of $250 million or 80% of net accounts receivable as of December 31, 2001, and to the lesser of $240 million or 80% of net accounts receivable as of June 30, 2002. 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 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. 32 34 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Under the terms of the Credit Facility that were in effect as of June 30 and September 30, 2000, the Company was in violation of certain of the Facility's financial balance and ratio requirements. The Bank Group waived these violations. The restrictions and financial balance and ratio requirements currently effective under the Facility allow for performance during the first and second quarters of 2001 consistent with the Company's results in recent quarters, excluding restructuring and other nonrecurring charges. The Facility's restrictions and requirements then call for improvement from recent performance levels in the third and fourth quarters of 2001 and on a quarterly basis in 2002. The Facility also prohibits repurchase of the Company's stock and has relatively tight approval requirements on acquisitions. The Facility's requirements reflect tighter restrictions, greater specificity and smaller allowable variances on most financial balances and ratios than is typical for such agreements due to the Company's weaker results in 2000. While management believes its restructuring efforts and operating strategies along with general market conditions in the commercial/industrial HVAC and building automation controls industry will enable the Company to meet the Facility's requirements, there can be no assurance that the Company will be successful in doing so. Management intends to seek more flexible terms under its borrowing relationships as its results and credit market conditions allow. As of December 31, 2000, the Company had $223.7 million in borrowings outstanding under the Credit Facility and had incurred interest expense at an average rate of approximately 8.9% for the year ended December 31, 2000. The Credit Facility's interest rate terms as summarized above are effective as of March 22, 2001 and currently result in an all-in floating interest rate under the Facility's LIBOR option of approximately 8.9%. As of December 31, 2000, the Company also had $2.0 million in letters of credit outstanding under the Facility, and unused borrowing capacity under the Facility of $41.6 million. As of March 23, 2001, $226.9 million in borrowings and $1.9 million in letters of credit were outstanding under the Facility, and $36.6 million in unused capacity was available. 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 $50.3 million as of December 31, 2000. Of these notes, $49.9 million bear interest, payable quarterly, at a weighted average interest rate of 5.8% and $0.4 million are non-interest bearing. In addition, $1.2 million of these notes are convertible by the holders into shares of the Company's Common Stock at a weighted average price of $25.27 per share. The originally scheduled maturities of the subordinated notes are $3.4 million in 2000, $24.0 million in 2001, $22.0 million in 2002, and $0.9 million in 2003. As a result of the Company's covenant violations in 2000 under the Credit Facility, the Bank Group required that originally scheduled principal payments to subordinate debt holders be suspended. This requirement took effect in October 2000. In March 2001, the Company entered into amended agreements with subordinate debt holders representing $44.4 million in principal, including all the principal originally scheduled to be paid through 2001. These amended agreements allow for partial payments against certain originally scheduled payment amounts, defer remaining principal balances to April 2003, and increase the interest rate on this debt to 10% per annum, payable quarterly. As a result of these amended agreements, the Company's annual maturities of subordinate debt are now $8.9 million in 2001, $6.6 million in 2002, and $34.8 million in 2003. OTHER LONG-TERM OBLIGATION DISCLOSURES The Company estimates the fair value of long-term debt as of December 31, 1999 and 2000 to be approximately the same as the recorded value. 33 35 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company anticipates that available borrowings under its Credit Facility and cash flow from operations will be sufficient to meet the Company's normal working capital and capital expenditure needs. As noted above, the Company has agreed to relatively tight restrictions under the Credit Facility. If the Company violates any of these restrictions, it will be required to negotiate new terms with its banks. There can be no assurance that in that event, the Company will receive satisfactory new terms from its banks, or that if the Company needs additional financing, that such financing can be secured when needed or on terms the Company deems acceptable. 9. INCOME TAXES: The provision for income taxes consists of the following (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1999 2000 ------- ------- ------- Current -- Federal............................................... $21,650 $25,622 $ 4,841 State and Puerto Rico................................. 4,439 4,777 3,534 ------- ------- ------- 26,089 30,399 8,375 ------- ------- ------- Deferred -- Federal............................................... 907 2,067 (2,679) State and Puerto Rico................................. 53 (728) 89 ------- ------- ------- 960 1,339 (2,590) ------- ------- ------- $27,049 $31,738 $ 5,785 ======= ======= =======
The difference in income taxes provided for and the amounts determined by applying the federal statutory tax rate to income before income taxes result from the following (in thousands):
YEAR ENDED DECEMBER 31, --------------------------- 1998 1999 2000 ------- ------- ------- Income tax expense (benefit) at the statutory rate...... $21,713 $25,921 $(3,838) Increase (decrease) resulting from -- State income taxes, net of federal tax effect......... 3,148 2,567 1,652 Non-deductible goodwill amortization.................. 2,047 2,730 2,817 Non-deductible goodwill writeoffs related to restructuring...................................... -- -- 4,300 Non-deductible expenses............................... 364 492 778 Effect of S Corporation income previously taxed to the former owners...................................... (308) -- -- Non-deductible acquisition costs related to pooled companies.......................................... 157 -- -- Provision (benefit) recognized upon termination of Subchapter S election.............................. (101) -- -- Other................................................. 29 28 76 ------- ------- ------- $27,049 $31,738 $ 5,785 ======= ======= =======
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 34 36 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) been reflected in the financial statements but which is not includable in determining the Company's tax liabilities until future periods.
DECEMBER 31, ----------------- 1999 2000 ------- ------- (IN THOUSANDS) Deferred income tax assets -- Accounts receivable and allowance for doubtful accounts... $ 1,854 $ 2,652 Accrued liabilities and expenses.......................... 7,206 8,210 Net operating loss........................................ 1,343 4,355 Other..................................................... 630 541 ------- ------- Total deferred income tax assets.................. 11,033 15,758 ------- ------- Deferred income tax liabilities -- Property and equipment.................................... (1,113) (1,729) Long-term installation contracts.......................... (3,821) (995) Goodwill.................................................. (3,180) (5,833) Other..................................................... (628) (369) ------- ------- Total deferred income tax liabilities............. (8,742) (8,926) ------- ------- Less -- Valuation allowance................................. -- (1,951) ------- ------- Net deferred income tax assets.................... $ 2,291 $ 4,881 ======= =======
The deferred tax assets and liabilities reflected above are included in the consolidated balance sheets as follows (in thousands):
DECEMBER 31, --------------- 1999 2000 ------ ------ Deferred income tax assets -- Prepaid expenses and other................................ $ 983 $4,478 Other non-current assets.................................. 1,308 403 ------ ------ Total deferred income tax assets............................ $2,291 $4,881 ====== ======
At December 31, 2000, the Company has $56.3 million of available state net operating loss carryforwards for income tax purposes which expire 2012 through 2020. At December 31, 2000, 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 $3.6 million for 1998, $5.4 million for 1999, and $5.9 million for 2000. Of these amounts, approximately $2.5 million and $2.9 million was payable to the plans at December 31, 1999 and 2000, respectively. 35 37 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 $8.1 million for 1998, $14.6 million for 1999, and $17.7 million for 2000. 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, 1998, 1999 and 2000 was $6.7 million, $17.5 million, and $25.0 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 five to ten years and provide for certain escalations in the rental expenses each year. Included in the 1998, 1999 and 2000 rent expense above is approximately $3.9 million, $6.1 million and $8.0 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 -- 2001.................................................... $17,193 2002.................................................... 15,782 2003.................................................... 12,950 2004.................................................... 10,416 2005.................................................... 8,487 Thereafter.............................................. 16,349 ------- $81,177 =======
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 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 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 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. 36 38 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 12. STOCKHOLDERS' EQUITY: COMMON STOCK AND PREFERRED STOCK On June 16, 1998, the Company completed a second public offering (the "Second Public Offering") of 400,000 shares of its Common Stock. The net proceeds from this offering of $7.6 million, after deducting underwriting commissions, were used to repay debt. On July 21, 1998, the underwriters exercised their overallotment option in connection with the Second Public Offering completed in June 1998. An additional 461,479 shares of Common Stock were sold and the net proceeds of $8.8 million, after deducting underwriting commissions, were used to repay debt. 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. The Company does not expect further share repurchases under this program for the foreseeable future. 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 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, 2000, there are 1,395,217 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 had an anti-dilutive effect for the year ended December 31, 2000 because the Company reported a net loss during this period, and therefore, are 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. The Company has options outstanding to purchase 7.4 million shares of Common Stock at prices ranging from $2.875 to $21.438 per share as of December 31, 2000. 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 twelve 37 39 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) months ended December 31, 2000, 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. 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):
YEAR ENDED DECEMBER 31, ------------------------ 1998 1999 2000 ------ ------ ------ Common shares outstanding, end of period................... 38,141 37,563 37,256 Effect of using weighted average common shares outstanding.............................................. (5,179) 998 141 ------ ------ ------ Shares used in computing earnings per share -- basic....... 32,962 38,561 37,397 Effect of shares issuable under stock option plans based on the treasury stock method................................ 462 69 -- Effect of shares issuable related to convertible notes..... 905 1,069 -- ------ ------ ------ Shares used in computing earnings per share -- diluted..... 34,329 39,699 37,397 ====== ====== ======
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. 38 40 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes activity under the Company's stock option plans:
1998 1999 2000 ---------------------------- ---------------------------- ---------------------------- WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE FIXED OPTIONS SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE ------------- --------- ---------------- --------- ---------------- --------- ---------------- Outstanding at beginning of year........................ 2,537,203 $13.72 3,955,029 $15.51 4,557,133 $15.18 Granted....................... 1,495,500 $18.54 758,200 $13.36 3,692,000 $ 3.29 Exercised..................... (24,330) $13.45 (16,924) $13.00 -- $ -- Forfeited..................... (53,344) $16.01 (139,172) $14.78 (892,974) $13.95 Expired....................... -- $ -- -- $ -- -- $ -- --------- --------- --------- Outstanding at end of year.... 3,955,029 $15.51 4,557,133 $15.18 7,356,159 $ 9.35 ========= ========= ========= Options exercisable at year-end.................... 518,281 1,287,229 1,838,099 Weighted-average fair value of options granted during the year........................ $ 7.33 $ 6.26 $ 2.46
The following table summarizes information about fixed stock options outstanding at December 31, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ------------------------------ NUMBER WEIGHTED-AVERAGE NUMBER RANGE OF OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE EXERCISE PRICES AT 12/31/00 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/00 EXERCISE PRICE --------------- ----------- ---------------- ---------------- ----------- ---------------- $ 2.88- 7.63 3,717,700 9.44 years $ 3.34 37,040 $ 7.15 $11.75-16.88 2,417,067 4.03 years $13.82 1,270,142 $13.76 $17.88-21.44 1,221,392 4.50 years $18.79 530,917 $18.77 --------- --------- $ 2.88-21.44 7,356,159 6.84 years $ 9.35 1,838,099 $15.08 ========= =========
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, 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 Financial Accounting Standards Board 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 39 41 COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) recorded as an expense in the company's statement of operations. These effects for the Company are as follows (in thousands, except per share data):
1998 1999 2000 ------- ------- -------- Net Income (Loss) As reported.......................................... $35,013 $42,322 $(16,853) Pro forma for SFAS No. 123........................... $33,341 $39,519 $(20,065) Income (Loss) Per Share -- Basic As reported.......................................... $ 1.06 $ 1.10 $ (0.45) Pro forma for SFAS No. 123........................... $ 1.01 $ 1.02 $ (0.54) Income (Loss) Per Share -- Diluted As reported.......................................... $ 1.04 $ 1.09 $ (0.45) Pro forma for SFAS No. 123........................... $ 0.97 $ 1.01 $ (0.54)
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:
1998 1999 2000 ---------- ---------- ---------- Expected dividend yield......................... 0.00% 0.00% 0.00% Expected stock price volatility................. 44.87% 65.63% 52.42% Risk free interest rate......................... 5.00%-6.15% 4.64%-5.87% 5.58-6.94% Expected life of options........................ 4 years 4 years 4 years
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:
1998 1999 2000 ----------- ----------- ----------- Expected dividend yield.................... 0.00% 0.00% 0.00% Expected volatility........................ 42.10% 53.8% 76.24% Risk free interest rate.................... 5.19%-5.25% 4.56%-4.94% 6.00%-6.30% Expected life of purchase rights........... 0.5 years 0.5 years 0.5 years
The weighted average fair values of the purchase rights granted in 1998, 1999 and 2000 were $5.37 per share, $4.88 per share and $1.65 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. 40 42 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, 2000, 95,000 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, 2000. 14. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED): Quarterly financial information for the years ended December 31, 1999 and 2000 is summarized as follows (in thousands, except per share data):
YEAR ENDED DECEMBER 31, 1999 --------------------------------------------------------- QUARTER ENDED --------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 1999 1999 1999 1999 --------- -------- ------------- ------------ Revenues......................... $291,926 $341,493 $374,815 $361,801 Gross profit..................... $ 63,178 $ 76,239 $ 76,335 $ 76,954 Operating income................. $ 15,536 $ 30,023 $ 27,559 $ 20,086 Net income....................... $ 6,564 $ 14,645 $ 12,868 $ 8,245 Earnings per share: Basic.......................... $ 0.17 $ 0.38 $ 0.33 $ 0.22 Diluted........................ $ 0.17 $ 0.37 $ 0.33 $ 0.22
YEAR ENDED DECEMBER 31, 2000 --------------------------------------------------------- QUARTER ENDED --------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, 2000 2000 2000 2000 --------- -------- ------------- ------------ Revenues......................... $362,566 $404,970 $423,922 $399,608 Gross profit..................... $ 70,867 $ 70,638 $ 71,084 $ 71,661 Operating income (loss).......... $ 12,856 $ 10,802 $ (47)(b) $ (3,184)(c) Net income (loss)................ $ 4,008 $ (905)(a) $ (3,689)(b) $(16,267)(c) Earnings (loss) per share: Basic.......................... $ 0.11 $ (0.02) $ (0.10) $ (0.44) Diluted........................ $ 0.11 $ (0.02) $ (0.10) $ (0.44)
--------------- 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. (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. (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. 41 43 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, 2000. 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 19 of this report and is incorporated herein by reference. (2) Financial Statement Schedules: Report of Independent Public Accountants on Supplementary Data. Schedule II -- Valuation and Qualifying Accounts. All other schedules have been omitted since the required information is not significant or is included in the Consolidated Financial Statements or Notes thereto or is not applicable. (b) Reports on Form 8-K None. (c) Exhibits Reference is made to the Index of Exhibits beginning on page 46, which index is incorporated herein by reference. 42 44 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTARY DATA To Comfort Systems USA, Inc.: We have audited in accordance with auditing standards generally accepted in the United States, the consolidated financial statements of Comfort Systems USA, Inc. and subsidiaries included in this Annual Report on Form 10-K and have issued our report thereon dated March 27, 2001, in which we expressed an unqualified opinion. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The Valuation and Qualifying Accounts Schedule (Schedule II) listed in the index at Item 14(a) is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This information has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Houston, Texas March 27, 2001 43 45 COMFORT SYSTEMS USA, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (IN THOUSANDS)
ADDITIONS --------------------- BALANCE AT CHARGED TO CHARGED BALANCE BEGINNING COSTS AND TO OTHER AT END OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD ------------ ---------- -------- ---------- --------- Year ended December 31, 2000: Deducted from accounts receivable allowance for doubtful accounts............ $5,568 5,883 -- (4,662)(a),(b) $6,789 Accrued restructuring charges... $ -- 5,407 -- (1,877) $3,530 Year ended December 31, 1999: Deducted from accounts receivable allowance for doubtful accounts............ $4,758 1,650 1,100(c) (1,940)(a) $5,568 Year ended December 31, 1998: Deducted from accounts receivable allowance for doubtful accounts............ $1,698 1,253 2,716(c) (909)(a) $4,758
--------------- (a) Deductions for uncollectible receivables written off, net of recoveries. (b) Includes $210 of allowance for doubtful accounts related to businesses sold or held for sale. (c) Allowance for doubtful accounts of purchased companies at date of acquisition. 44 46 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 27, 2001 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.
SIGNATURE TITLE DATE --------- ----- ---- /s/ WILLIAM F. MURDY Chairman of the Board and Chief March 27, 2001 ----------------------------------------------------- Executive Officer William F. Murdy /s/ GARY E. HESS President, Chief Operating March 27, 2001 ----------------------------------------------------- Officer and Director Gary E. Hess /s/ J. GORDON BEITTENMILLER Executive Vice President, Chief March 27, 2001 ----------------------------------------------------- Financial Officer and J. Gordon Beittenmiller Director (principal accounting officer) /s/ HERMAN E. BULLS Director March 27, 2001 ----------------------------------------------------- Herman E. Bulls /s/ VINCENT J. COSTANTINI Director March 27, 2001 ----------------------------------------------------- Vincent J. Costantini /s/ ALFRED J. GIARDINELLI, JR. Director March 27, 2001 ----------------------------------------------------- Alfred J. Giardinelli, Jr. /s/ STEVEN S. HARTER Director March 27, 2001 ----------------------------------------------------- Steven S. Harter /s/ ROBERT J. POWERS Director March 27, 2001 ----------------------------------------------------- Robert J. Powers /s/ MARK P. SHAMBAUGH Director March 27, 2001 ----------------------------------------------------- Mark P. Shambaugh
45 47 INDEX OF EXHIBITS
INCORPORATED BY REFERENCE TO THE EXHIBIT INDICATED BELOW AND TO THE FILING WITH THE COMMISSION INDICATED BELOW ------------------------------- EXHIBIT EXHIBIT FILING OR NUMBER DESCRIPTION OF EXHIBITS NUMBER FILE NUMBER ------- ----------------------- -------- ----------- 3.1 -- Second Amended and Restated Certificate 3.1 333-24021 of Incorporation of the Registrant. 3.2 -- Certificate of Amendment dated May 21, 3.2 1998 Form 10-K 1998. 3.3 -- Bylaws of the Registrant, as amended. 3.3 1999 Form 10-K 4.1 -- Form of certificate evidencing ownership 4.1 333-24021 of Common Stock of the Registrant. 10.1 -- Comfort Systems USA, Inc. 1997 Long-Term 10.1 333-24021 Incentive Plan. 10.2 -- Comfort Systems USA, Inc. 1997 10.2 333-24021 Non-Employee Directors' Stock Plan. 10.3 -- Form of Employment Agreement between the 10.4 333-24021 Registrant and J. Gordon Beittenmiller. 10.4 -- Form of Employment Agreement between the 10.5 333-24021 Registrant and William George, III. 10.5 -- Form of Employment Agreement between the 10.6 333-24021 Registrant and Reagan S. Busbee. 10.6 -- Form of Employment Agreement between the 10.10 333-24021 Registrant, Eastern Heating & Cooling, Inc. and Alfred J. Giardinelli, Jr. 10.7 -- Employment Agreement between the 10.17 1998 Form 10-K Registrant, Shambaugh & Son, Inc. and Mark P. Shambaugh. 10.8 -- Form of Agreement among certain 10.16 333-24021 stockholders. 10.9 -- Third Amended and Restated Credit 10.25 333-38009 Agreement among the Company and its subsidiaries, Bank One, Texas, N.A., as agent and the banks listed therein dated December 14, 1998. 10.10 -- Lease dated October 31, 1998, between 10.28 1998 Form 10-K Mark Shambaugh and Shambaugh & Sons, Inc. (Opportunity Drive). 10.11 -- Lease dated October 31, 1998, between 10.29 1998 Form 10-K Mark Shambaugh and Shambaugh & Sons, Inc. (Di Salle Boulevard). 10.12 -- Lease dated October 31, 1998, between 10.30 1998 Form 10-K Mark Shambaugh and Shambaugh & Sons, Inc. (Speedway Drive). 10.13 -- Lease dated October 31, 1998, between 10.31 1998 Form 10-K Mark Shambaugh and Shambaugh & Sons, Inc. (South Bend).
46 48
INCORPORATED BY REFERENCE TO THE EXHIBIT INDICATED BELOW AND TO THE FILING WITH THE COMMISSION INDICATED BELOW ------------------------------- EXHIBIT EXHIBIT FILING OR NUMBER DESCRIPTION OF EXHIBITS NUMBER FILE NUMBER ------- ----------------------- -------- ----------- 10.14 -- Lease dated October 31, 1998, between 10.32 1998 Form 10-K Mark Shambaugh and Shambaugh & Sons, Inc. (Lafayette). 10.15 -- Form of Indemnity Agreement entered into 10.26 333-32595 by the Company with each of the following persons: J. Gordon Beittenmiller, Reagan S. Busbee, William George, III, Steven S. Harter, Robert J. Powers, Alfred J. Giardinelli, Jr., on June 27, 1997. 10.16 -- Indemnity Agreement between the Company 10.27 333-32595 and Notre Capital Ventures II, L.L.C. 10.17 -- Comfort Systems USA, Inc. 1998 Employee 10.28 333-38009 Stock Purchase Plan. 10.18 -- Agreement Regarding Sale of Stock between 10.2 Third Quarter 1997 Steve S. Harter and the Registrant dated Form 10-Q October 31, 1997. 10.19 -- Agreement Regarding Sale of Stock between 10.3 Third Quarter 1997 J. Gordon Beittenmiller and the Form 10-Q Registrant dated October 31, 1997. 10.20 -- Agreement Regarding Sale of Stock between 10.7 Third Quarter 1997 Alfred J. Giardinelli, Jr. and the Form 10-Q Registrant dated October 31, 1997. 10.21 -- Agreement Regarding Sale of Stock between 10.8 Third Quarter 1997 Robert J. Powers and the Registrant dated Form 10-Q October 31, 1997. 10.22 -- Agreement Regarding Sale of Stock between 10.13 Third Quarter 1997 Reagan S. Busbee and the Registrant dated Form 10-Q October 31, 1997. 10.23 -- Agreement Regarding Sale of Stock between 10.14 Third Quarter 1997 William George and the Registrant dated Form 10-Q October 31, 1997. 10.24 -- Agreement and Plan of Merger dated 2.1 November 1998 Form November 15, 1998 by and among the 8-K Registrant, Shambaugh & Son, Inc. 10.25 -- First Amendment to Credit Agreement among 10.63 1998 Form 10-K the Company and its Subsidiaries, Bank One, Texas, N.A., as agent and the banks listed Therein dated January 14, 2000. 10.26 -- Employment Agreement between the Filed Herewith Registrant and Gary E. Hess dated January 1, 2001. 10.27 -- Lease dated April 1, 1998, between Gary 10.53 1999 Form 10-K E. and Susan B. Hess and Hess Mechanical Corporation. 10.28 -- Employment Agreement between William F. 10.2 Second Quarter 2000 Murdy and the Registrant dated June 27, Form 10-Q 2000.
47 49
INCORPORATED BY REFERENCE TO THE EXHIBIT INDICATED BELOW AND TO THE FILING WITH THE COMMISSION INDICATED BELOW ------------------------------- EXHIBIT EXHIBIT FILING OR NUMBER DESCRIPTION OF EXHIBITS NUMBER FILE NUMBER ------- ----------------------- -------- ----------- 10.29 -- Note Modification Agreement between Mark 10.3 Second Quarter 2000 Shambaugh and the Registrant dated August Form 10-Q 8, 2000. 10.30 -- Third Amendment to Credit Agreement dated 10.5 Second Quarter 2000 as of August 11, 2000 amending the Third Form 10-Q Amended and Restated Credit Agreement dated December 14, 1998 among the Registrant and its subsidiaries, Bank One, Texas, N.A., as agent and the banks listed therein. 10.31 -- Amendment to 1998 Employee Stock Purchase 10.6 Second Quarter 2000 Plan dated May 18, 2000. Form 10-Q 10.32 -- Comfort Systems USA, Inc. 2000 Incentive 10.7 Second Quarter 2000 Plan. Form 10-Q 10.33 -- Fourth Amendment to Credit Agreement 10.1 Third Quarter 2000 dated as of November 13, 2000 amending Form 10-Q the Third Amended and Restated Credit Agreement dated December 14, 1998 among the Registrant and its subsidiaries, Bank One, Texas, N.A., as agent and the banks listed therein. 10.34 -- Fourth Amended and Restated Credit Filed Herewith Agreement dated as of March 22, 2001 among the Registrant and its subsidiaries, Bank One, Texas, N.A., as agent and the banks listed therein. 10.35 -- Employment Agreement between the Filed Herewith Registrant and Milburn Honeycutt dated January 2, 2001. 21.1 -- List of subsidiaries of Comfort Systems Filed Herewith USA, Inc. 23.1 -- Consent of Arthur Andersen LLP. Filed Herewith
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