Registration No. 333-32595
                                                Filed Pursuant to Rule 424(b)(3)


                          COMFORT SYSTEMS USA, INC.

                       8,000,000 Shares of Common Stock

                 Supplement No. 4 dated February 23, 1999 to
                         Prospectus dated May 5, 1998


MATERIAL ACQUISITION

      A copy of the Company's Current Report on Form 8-K/A is attached hereto.

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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

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

                                   FORM 8-K/A
                                 CURRENT REPORT

                     PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934

     Date of Report (date of earliest event reported):   November 15, 1998
                        Commission File Number: 1-13011

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

                DELAWARE                            76-0484996
      (State or other jurisdiction               (I.R.S. Employer 
             of incorporation)                  Indentification No.)


                               777 POST OAK BLVD.
                                    SUITE 500
                              HOUSTON, TEXAS 77056
               (Address of Principal Executive offices) (Zip Code)

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 830-9600

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                           COMFORT SYSTEMS USA, INC.
                       FINANCIAL STATEMENTS AND EXHIBITS

ITEM 7.  FINANCIAL STATEMENTS AND EXHIBITS

(A)  FINANCIAL STATEMENTS OF THE BUSINESS ACQUIRED

     This Form 8-K/A is being filed to include in the Current Report on Form 8-K
filed by the Registrant with the Securities and Exchange Commission on November
15, 1998 the financial statements and pro forma financial information required
by Item 7.

     The required financial statements of the business acquired by the
Registrant are included as an exhibit to the Form 8-K/A.

(B)  PRO FORMA FINANCIAL INFORMATION

     The required pro forma financial information of the Registrant is included
as an exhibit to this
Form 8-K/A.

(C)  EXHIBITS

                                        PAGE
                                        -----
Comfort Systems USA, Inc. Pro Forma
     Introduction to Unaudited Pro
      Forma Combined Financial
      Statements.....................     F-2
     Pro Forma Combined Balance Sheet
      (unaudited)....................     F-3
     Pro Forma Combined Statements of
      Operations (unaudited).........     F-4
     Notes to Pro Forma Combined
      Financial Statements
      (unaudited)....................     F-6
Shambaugh & Son, Inc.
  Financial Statements as of
  September 30, 1998 and 1997
     Balance Sheets (unaudited)......    F-11
     Statements of Income
      (unaudited)....................    F-12
     Statements of Shareholder's
      Equity (unaudited).............    F-13
     Statements of Cash Flows
      (unaudited)....................    F-14
     Notes to Financial Statements
      (unaudited)....................    F-15
  Financial Statements as of December
  31, 1997
     Report of Independent
     Auditors........................    F-23
     Balance Sheet...................    F-24
     Statement of Income.............    F-25
     Statement of Shareholder's
     Equity..........................    F-26
     Statement of Cash Flows.........    F-27
     Notes to Financial Statements...    F-28
Consent of Crowe, Chizek and Company
LLP..................................    F-35

                                      F-1

                           COMFORT SYSTEMS USA, INC.
       INTRODUCTION TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
                             BASIS OF PRESENTATION

     Comfort Systems USA, Inc. ("Comfort Systems" and collectively with its
subsidiaries, the "Company") was founded in 1996 to become a leading national
provider of HVAC services focusing primarily on commercial and industrial
markets. On July 2, 1997, Comfort Systems completed the initial public offering
(the "IPO") of its common stock (the "Common Stock") and simultaneously
acquired in separate concurrent transactions, twelve companies (collectively
referred to as the "Founding Companies"). For financial statement purposes,
Comfort Systems has been identified as the accounting acquirer. Subsequent to
the IPO, and through September 30, 1998, the Company acquired 70 HVAC and
related businesses. Of the 70 acquisitions, 17 were accounted for as
poolings-of-interests (the "Pooled Companies") and 53 were accounted for as
purchases (the "Purchased Companies").

     On November 15, 1998, Comfort Systems acquired Shambaugh & Son, Inc.
("S&S"). Pursuant to the rules of the Securities and Exchange Commission, S&S
is considered a "significant subsidiary."

     The following unaudited pro forma combined balance sheet reflects the
acquisition of S&S as if it had occurred on September 30, 1998. The following
unaudited pro forma combined statement of operations presents the Company,
restated for the Pooled Companies, and the restatement of S&S, the Founding
Companies and Purchased Companies as if the acquisitions by the Company occurred
on January 1, 1997.

     Comfort Systems has preliminarily analyzed the savings that it expects to
be realized from reductions in salaries and certain benefits to the former
owners. To the extent the former owners of S&S, the Founding Companies, the
Purchased Companies and the Pooled Companies have agreed prospectively to
reductions in salary, bonuses and benefits, these reductions have been reflected
in the pro forma combined statements of operations. With respect to other
potential cost savings, Comfort Systems has not and cannot quantify these
savings. It is anticipated that these savings will be offset by costs related to
Comfort Systems' corporate management and by the costs associated with being a
public company. However, because these costs cannot be accurately quantified at
this time, they have not been included in the pro forma financial information of
Comfort Systems.

     The pro forma adjustments are based on estimates, available information and
certain assumptions and may be revised, as additional information becomes
available. The pro forma financial data do not purport to represent what Comfort
Systems' financial position or results of operations would actually have been if
such transactions in fact had occurred on those dates and are not necessarily
representative of the Comfort Systems' financial position or results of
operations for any future period. Since the Company, S&S, the Founding
Companies, Purchased Companies and Pooled Companies were not under common
control or management, historical combined results may not be comparable to, or
indicative of, future performance. The unaudited pro forma combined financial
statements should be read in conjunction with the other financial statements and
notes thereto included elsewhere in this Form 8-K/A.

                                      F-2

                           COMFORT SYSTEMS USA, INC.
                        PRO FORMA COMBINED BALANCE SHEET
                               SEPTEMBER 30, 1998
                                 (IN THOUSANDS)
                                  (UNAUDITED)
COMFORT PRO FORMA PRO FORMA SYSTEMS S&S ADJUSTMENTS COMBINED --------- --------- ------------ ---------- ASSETS CURRENT ASSETS: Cash and cash equivalents.......... $ 9,687 $ 1,861 $ (500) $ 11,048 Marketable securities.............. -- 6,808 (3,565) 3,243 Accounts receivable................ 194,605 35,864 -- 230,469 Less -- Allowance............... 3,526 455 -- 3,981 --------- --------- ------------ ---------- Accounts receivable, net... 191,079 35,409 -- 226,488 Other receivables.................. 2,360 246 (194) 2,412 Inventories........................ 13,209 1,595 -- 14,804 Prepaid expenses and other......... 10,602 363 1,314 12,279 Costs and estimated earnings in excess of billings.............. 26,595 5,044 -- 31,639 --------- --------- ------------ ---------- Total current assets....... 253,532 51,326 (2,945) 301,913 PROPERTY AND EQUIPMENT, net.......... 26,054 7,230 (3,360) 29,924 GOODWILL, net........................ 310,452 104 75,264 385,820 OTHER NONCURRENT ASSETS.............. 10,611 4,713 (1,894) 13,430 --------- --------- ------------ ---------- Total assets............... $ 600,649 $ 63,373 $ 67,065 $731,087 ========= ========= ============ ========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current maturities of long-term debt............................ $ 6,821 $ 562 $ (384) $ 6,999 Accounts payable................... 56,728 11,402 -- 68,130 Accrued compensation and benefits........................ 21,280 4,490 -- 25,770 Billings in excess of costs and estimated earnings.............. 31,220 9,700 -- 40,920 Income taxes payable............... 3,259 -- -- 3,259 Other current liabilities.......... 16,856 2,177 40 19,073 --------- --------- ------------ ---------- Total current liabilities............. 136,164 28,331 (344) 164,151 DEFERRED INCOME TAXES................ 889 -- 203 1,092 LONG-TERM DEBT, NET OF CURRENT MATURITIES......................... 127,969 2,532 85,833 216,334 OTHER LONG-TERM LIABILITIES.......... 1,309 -- -- 1,309 --------- --------- ------------ ---------- Total liabilities.......... 266,331 30,863 85,692 382,886 COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Preferred stock.................... -- -- -- -- Common stock....................... 349 3,185 (3,169) 365 Additional paid-in capital......... 300,644 -- 13,867 314,511 Retained earnings.................. 33,325 29,325 (29,325) 33,325 --------- --------- ------------ ---------- Total stockholders' equity.................. 334,318 32,510 (18,627) 348,201 --------- --------- ------------ ---------- Total liabilities and stockholders' equity.... $ 600,649 $ 63,373 $ 67,065 $731,087 ========= ========= ============ ==========
The accompanying notes are an integral part of this pro forma combined financial statement. F-3 COMFORT SYSTEMS USA, INC. PRO FORMA COMBINED STATEMENT OF OPERATIONS NINE MONTHS ENDED SEPTEMBER 30, 1998 (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
PURCHASED COMPANIES THROUGH COMFORT ACQUISITION PRO FORMA PRO FORMA SYSTEMS DATE S&S ADJUSTMENTS COMBINED -------- ----------- ---------- ----------- --------- REVENUES................................ $559,339 $ 133,407 $ 141,209 $ -- 833,955 COST OF SERVICES........................ 423,223 112,193 113,773 -- 649,189 -------- ----------- ---------- ----------- --------- Gross profit....................... 136,116 21,214 27,436 -- 184,766 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES.............................. 87,609 21,448 18,469 (3,876) 123,650 GOODWILL AMORTIZATION................... 4,642 3 3 2,870 7,518 -------- ----------- ---------- ----------- --------- Operating income (loss)............ 43,865 (237) 8,964 1006 53,598 OTHER INCOME (EXPENSE): Interest expense, net.............. (3,731) (42) (97) (6,189) (10,059) Other.............................. 156 (419) 182 194 113 -------- ----------- ---------- ----------- --------- Other income (expense)........ (3,575) (461) 85 (5,995) (9,946) -------- ----------- ---------- ----------- --------- INCOME (LOSS) BEFORE INCOME TAXES....... 40,290 (698) 9,049 (4,989) 43,652 PROVISION (BENEFIT) FOR INCOME TAXES.... 17,687 (305) 130 1,944 19,456 -------- ----------- ---------- ----------- --------- NET INCOME (LOSS)....................... $ 22,603 $ (393) $ 8,919 $(6,933) $ 24,196 ======== =========== ========== =========== ========= NET INCOME PER SHARE: Basic.............................. $ .71 $ .67 ======== ========= Diluted............................ $ .70 $ .67 ======== ========= SHARES USED IN COMPUTING NET INCOME PER SHARE: Basic.............................. 31,689 35,893 ======== ========= Diluted............................ 32,179 36,383 ======== =========
The accompanying notes are an integral part of these pro forma combined financial statements. F-4 COMFORT SYSTEMS USA, INC. PRO FORMA COMBINED STATEMENT OF OPERATIONS YEAR ENDED DECEMBER 31, 1997 (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
COMBINED PURCHASED FOUNDING COMPANIES COMPANIES THROUGH COMBINED THROUGH ACQUISITION PRO FORMA PRO FORMA SYSTEMS JUNE 30, 1997 DATE S&S ADJUSTMENTS COMBINED ---------- ------------- ----------- ---------- ----------- --------- REVENUES............................. $ 297,649 $86,900 $ 442,581 $ 157,535 $ -- $ 984,665 COST OF SERVICES..................... 220,418 62,395 350,449 121,387 -- 754,649 ---------- ------------- ----------- ---------- ----------- --------- Gross profit............... 77,231 24,505 92,132 36,148 -- 230,016 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES........................... 68,775 17,430 71,670 24,299 (35,323) 146,851 GOODWILL AMORTIZATION................ 1,851 -- -- 3 7,967 9,821 ---------- ------------- ----------- ---------- ----------- --------- Operating income........... 6,605 7,075 20,462 11,846 27,356 73,344 OTHER INCOME (EXPENSE): Interest expense, net........... (146) (236) 14 (45) (12,446) (12,859) Other........................... (839) 227 682 420 (135) 355 ---------- ------------- ----------- ---------- ----------- --------- Other income (expense)..... (985) (9) 696 375 (12,581) (12,504) ---------- ------------- ----------- ---------- ----------- --------- INCOME BEFORE INCOME TAXES........... 5,620 7,066 21,158 12,221 14,775 60,840 PROVISION FOR INCOME TAXES........... 7,743 537 1,193 107 16,265 25,845 ---------- ------------- ----------- ---------- ----------- --------- NET INCOME (LOSS).................... $ (2,123) $ 6,529 $ 19,965 $ 12,114 $ (1,490) $ 34,995 ========== ============= =========== ========== =========== ========= NET INCOME (LOSS) PER SHARE: Basic........................... $ (.11) $ 1.02 ========== ========= Diluted (Reflects the interest effect of $1,610 related to the assumed conversion of outstanding convertible notes)........................ $ (.11) $ 1.00 ========== ========= SHARES USED IN COMPUTING NET INCOME (LOSS) PER SHARE: Basic........................... 18,953 34,238 ========== ========= Diluted......................... 18,953 36,671 ========== =========
The accompanying notes are an integral part of these pro forma combined financial statements. F-5 COMFORT SYSTEMS USA, INC. NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS (UNAUDITED) 1. GENERAL: Comfort Systems USA, Inc. ("Comfort Systems" and collectively with its subsidiaries, the "Company") was founded in 1996 to become a leading national provider of HVAC services focusing primarily on commercial and industrial markets. On July 2, 1997, Comfort Systems completed the initial public offering (the "IPO") of its common stock (the "Common Stock") and simultaneously acquired in separate concurrent transactions, twelve companies (collectively referred to as the "Founding Companies"). For financial statement purposes, Comfort Systems has been identified as the accounting acquirer. Subsequent to IPO, and through September 30, 1998, the Company acquired 70 HVAC and related businesses. Of the 70 acquisitions, 17 were accounted for as poolings-of-interests and were restated (the "Pooled Companies") and 53 were accounted for as purchases (the "Purchased Companies"). On November 15, 1998, Comfort Systems acquired Shambaugh & Son, Inc. ("S&S"). Pursuant to the rules of the Securities and Exchange Commission, S&S is considered a "significant subsidiary." 2. BUSINESS COMBINATIONS: The accompanying pro forma combined balance sheet as of September 30, 1998 includes allocations of the respective purchase prices to the assets acquired and liabilities assumed based on preliminary estimates of fair value and is subject to adjustment. The preliminary allocations resulted in $385.8 million of total pro forma combined goodwill including, $75.3 million of goodwill related to S&S, which represents the excess of purchase price over the estimated fair value of the net assets acquired for S&S, the Founding Companies and the Purchased Companies. 3. UNAUDITED PRO FORMA COMBINED BALANCE SHEET ADJUSTMENTS: (a) Records the S Corporation distributions of S&S for $6.3 million which consisted primarily of $3.6 million of marketable securities, $3.4 million of property and equipment, $0.9 million of cash surrender value of key man life insurance policies and $1.1 million of notes receivables, offset by the reduction of certain notes payable of $2.7 million related to the property and equipment distributed. (b) Records the estimated purchase price of S&S by Comfort Systems consisting of $58.4 million in cash, $29.8 million in principal amount of convertible subordinated notes, and approximately $0.5 million of costs related to the acquisition, and an aggregate of 1,610,889 shares of Common Stock. The cash portion of the purchase price was funded by borrowings. (c) Records deferred income tax assets and liabilities. F-6 COMFORT SYSTEMS USA, INC. NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED) The following table summarizes unaudited pro forma combined balance sheet adjustments (in thousands):
ADJUSTMENT -------------------------------- PRO FORMA (A) (B) (C) ADJUSTMENT --------- ---------- --------- ----------- ASSETS Cash................................. $ -- $ (500) $ -- $ (500) Marketable securities................ (3,565) -- -- (3,565) Other receivables.................... (194) -- -- (194) Prepaid expenses and other........... (9) -- 1,323 1,314 --------- ---------- --------- ----------- Total current assets....... (3,768) (500) 1,323 (2,945) Property and equipment, net.......... (3,360) -- -- (3,360) Goodwill, net........................ -- 76,344 (1,080) 75,264 Other noncurrent assets.............. (1,894) -- -- (1,894) --------- ---------- --------- ----------- Total assets............... $ (9,022) $ 75,844 $ 243 $ 67,065 ========= ========== ========= =========== LIABILITIES AND STOCKHOLDER'S EQUITY Current maturities of long-term debt................................. $ (384) $ -- $ -- $ (384) Other current liabilities............ -- -- 40 40 --------- ---------- --------- ----------- Total current liabilities................ (384) -- 40 (344) Deferred income taxes................ -- -- 203 203 Long-term debt, net of current maturities......................... (2,337) 88,170 -- 85,833 --------- ---------- --------- ----------- Total liabilities.......... (2,721) 88,170 243 85,692 --------- ---------- --------- ----------- Stockholders' equity: Common stock.................... -- (3,169) -- (3,169) Additional paid-in capital...... -- 13,867 -- 13,867 Retained earnings............... (6,301) (23,024) -- (29,325) --------- ---------- --------- ----------- Total stockholders' equity..................... (6,301) (12,326) -- (18,627) --------- ---------- --------- ----------- Total liabilities and stockholders' equity............................. $ (9,022) $ 75,844 $ 243 $ 67,065 ========= ========== ========= ===========
F-7 COMFORT SYSTEMS USA, INC. NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED) 4. UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS ADJUSTMENTS: NINE MONTHS ENDED SEPTEMBER 30, 1998 (a) Reflects (i) the reductions in salaries, bonuses and benefits to the former owners of S&S, the Founding, Pooled and Purchased Companies, which they contractually agreed would take effect as of their respective acquisition dates; and (ii) the reversal of $0.5 million of acquisition costs related to the Pooled Companies. (b) Reflects the incremental amortization of goodwill using a 40-year life. (c) Reflects the incremental interest expense on borrowings of $200.5 million that would have been necessary to fund S Corporation distributions, cash consideration and notes issued for acquisitions subsequent to the IPO, including $58.4 million of cash consideration and $29.8 million of notes issued related to S&S. (d) Reflects the incremental provision for federal and state income taxes relating to the other statements of operations adjustments and for income taxes on S&S, Purchased and Founding Companies, and Pooled Companies which were C Corporations. (e) Reflects the reversal of gains and losses from sales of fixed assets related to Purchased and Founding Companies. The following table summarizes unaudited pro forma combined statement of operations adjustments (in thousands):
ADJUSTMENT ----------------------------------------------------- PRO FORMA (A) (B) (C) (D) (E) ADJUSTMENTS --------- --------- --------- --------- --------- ------------ SELLING, GENERAL AND ADMINISTRATION EXPENSES........................... $ (3,876) $ -- $ -- $ -- $ -- $ (3,876) GOODWILL AMORTIZATION................ -- 2,870 -- -- -- 2,870 --------- --------- --------- --------- --------- ------------ OPERATING INCOME..................... 3,876 (2,870) -- -- -- 1006 OTHER INCOME (EXPENSE): Interest expense................... -- -- (6,189) -- -- (6,189) Other.............................. -- -- -- -- 194 194 --------- --------- --------- --------- --------- ------------ INCOME (LOSS) BEFORE INCOME TAXES.... 3,876 (2,870) (6,189) -- 194 (4,989) PROVISION FOR INCOME TAXES........... -- -- -- 1,944 -- 1,944 --------- --------- --------- --------- --------- ------------ NET INCOME (LOSS).................... $ 3,876 $ (2,870) $ (6,189) $ (1,944) $ 194 $ (6,933) ========= ========= ========= ========= ========= ============
F-8 COMFORT SYSTEMS USA, INC. NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED) YEAR ENDED DECEMBER 31, 1997 (a) Reflects (i) the reductions in salaries, bonuses and benefits to the former owners of S&S, the Founding, Pooled and Purchased Companies, which they contractually agreed would take effect as of their respective acquisition dates; (ii) the reduction in rent expense of $0.1 million; and (iii) the reversal of $0.6 million of acquisition costs related to the Pooled Companies. (b) Reflects the incremental amortization of goodwill using a 40-year life. (c) Reflects the incremental interest expense on borrowings of $200.5 million, net of interest incurred on distributed notes, that would have been necessary to fund S Corporation distributions, cash consideration and notes issued for the acquisitions subsequent to the IPO, including $58.4 million of cash consideration and $29.8 million of notes issued related to S&S. (d) Reflects the incremental provision for federal and state income taxes relating to the other statements of operations adjustments and for income taxes on S&S, Purchased and Founding Companies, and Pooled Companies which were C Corporations. (e) Reflects the reduction in compensation expense related to the non-recurring, non-cash compensation charge of $11.6 million recorded by Comfort Systems in the first quarter of 1997 related to Common Stock issued to management of and consultants to the Company, offset by the increase in compensation expense to reflect the ongoing salaries received by corporate management of Comfort Systems of $0.4 million as though those salaries were being paid prior to the IPO. The issuance of Common Stock was made in contemplation of the IPO and acquisition of the Founding Companies, and no future issuances of this nature are anticipated. (f) Reflects the reversal of gains and losses from sales of fixed assets related to Purchased and Founding Companies. The following table summarizes unaudited pro forma combined statement of operations adjustments (in thousands):
ADJUSTMENT ---------------------------------------------------------------- PRO FORMA (A) (B) (C) (D) (E) (F) ADJUSTMENTS --------- --------- --------- --------- --------- --------- ----------- SELLING, GENERAL AND ADMINISTRATION EXPENSES.............................. $ (24,197) $ -- $ -- $ -- $ (11,126) $ -- (35,323) GOODWILL AMORTIZATION................... -- 7,967 -- -- -- -- 7,967 --------- --------- --------- --------- --------- --------- ----------- OPERATING INCOME........................ 24,197 (7,967) -- -- 11,126 -- 27,356 OTHER INCOME (EXPENSE): Interest expense.................... -- -- (12,446) -- -- -- (12,446) Other............................... -- -- -- -- -- (135) (135) --------- --------- --------- --------- --------- --------- ----------- INCOME (LOSS) BEFORE INCOME TAXES....... 24,197 (7,967) (12,446) -- 11,126 (135) 14,775 PROVISION FOR INCOME TAXES.............. -- -- -- 16,265 -- -- 16,265 --------- --------- --------- --------- --------- --------- ----------- NET INCOME (LOSS)....................... $ 24,197 $ (7,967) $ (12,446) $ (16,265) $ 11,126 $ (135) $ (1,490) ========= ========= ========= ========= ========= ========= ===========
F-9 COMFORT SYSTEMS USA, INC. NOTES TO PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED) (UNAUDITED) 5. EARNINGS PER SHARE: The following table summarizes weighted average shares outstanding (in thousands): NINE MONTHS YEAR ENDED ENDED DECEMBER 31, SEPTEMBER 30, 1997 1998 ------------ ------------- Shares issued in connection with the acquisitions of the Founding Companies.......................... 9,721 9,721 Shares sold pursuant to the Offering........................... 6,100 6,100 Shares issued to Notre Capital Ventures II, L.L.C., Comfort Systems' management and consultants........................ 4,240 4,240 Shares issued in connection with the acquisitions of the Pooled Companies.......................... 5,946 5,946 Shares sold in connection with the underwriter's overallotment for the IPO and Second Public Offering..... 434 1,037 Shares issued in connection with the acquisitions of the Purchased Companies.......................... 7,063 7,063 Shares sold in Second Public Offering........................... -- 152 Shares issued in connection with the Employee Stock Purchase Plan....... -- 6 Shares issued in connection with the exercise of stock options.......... -- 17 Shares issued in connection with the acquisition of S&S................. 1,611 1,611 Less: Shares sold in the IPO that were not used for the cash portion of the acquisition of the Founding Companies.......................... 877 -- ------------ ------------- Weighted average shares outstanding -- Basic............... 34,238 35,893 Weighted average portion of shares related to stock options under the treasury stock method.............. 193 490 Weighted average shares related to the issuance of convertible notes 2,240 --(A) ------------ ------------- Weighted average shares outstanding -- Diluted............. 36,671 36,383 ============ ============= (A) The effect of assumed conversion of outstanding convertible notes is antidilutive at September 30, 1998 and therefore excluded from the weighted average shares calculation. F-10 SHAMBAUGH AND SON, INC. BALANCE SHEETS SEPTEMBER 30, 1998 AND 1997 1998 1997 -------------- -------------- ASSETS Current assets Cash and cash equivalents....... $ 1,861,014 $ 4,372,761 Available for sale securities... 6,808,242 3,828,873 Accounts receivable -- net...... 35,408,575 26,556,960 Costs and estimated earnings in excess of billings on contracts in process.......... 5,044,002 5,488,555 Inventories, material and supplies...................... 1,595,368 1,504,339 Notes receivable................ 246,242 305,359 Other current assets............ 363,092 1,043,433 -------------- -------------- Total current assets....... 51,326,535 43,100,280 Property and equipment, net.......... 7,229,547 6,669,484 Other assets Investments in limited partnerships.................. 2,100,000 1,000,000 Notes receivable................ 1,075,226 1,321,468 Other assets.................... 1,642,134 1,482,384 -------------- -------------- 4,817,360 3,803,852 -------------- -------------- $ 63,373,442 $ 53,573,616 ============== ============== LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities Current maturities of long-term debt.......................... $ 562,127 $ 416,307 Accounts payable................ 11,402,575 9,322,672 Billings in excess of costs and estimated earnings on contracts in process.......... 9,699,639 7,004,699 Accrued payroll and related liabilities................... 4,490,480 3,081,542 Accrued expenses................ 2,176,618 1,691,141 -------------- -------------- Total current liabilities............. 28,331,439 21,516,361 Long-term debt....................... 2,532,006 2,722,005 Shareholder's equity Common stock, no par value: 3,000 shares authorized, 2,072 shares issued and outstanding................... 3,185,032 3,185,032 Retained earnings............... 30,359,531 26,123,088 Unrealized gain (loss) on available-for-sale securities.................... (1,034,566) 27,130 -------------- -------------- 32,509,997 29,335,250 -------------- -------------- $ 63,373,442 $ 53,573,616 ============== ============== See accompanying notes to financial statements. F-11 SHAMBAUGH AND SON, INC. STATEMENTS OF INCOME NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
1998 1997 ------------------------- ------------------------- % TO % TO AMOUNT REVENUE AMOUNT REVENUE --------------- ------- --------------- ------- Earned revenue on contracts.......... $ 141,209,204 100.0% $ 116,120,729 100.0% Costs of earned revenue on contracts.......................... 113,773,202 80.6 90,857,039 78.2 --------------- ------- --------------- ------- GROSS PROFIT......................... 27,436,002 19.4 25,263,690 21.8 General and administrative expenses........................... 18,472,011 13.1 17,227,261 14.8 --------------- ------- --------------- ------- OPERATING INCOME..................... 8,963,991 6.3 8,036,429 7.0 Other income......................... 84,902 .1 195,291 .1 --------------- ------- --------------- ------- INCOME BEFORE INCOME TAXES........... 9,048,893 6.4 8,231,720 7.1 Provision for income taxes........... 129,851 .1 106,470 .1 --------------- ------- --------------- ------- NET INCOME........................... $ 8,919,042 6.3% $ 8,125,250 7.0% =============== ======= =============== =======
See accompanying notes to financial statements. F-12 SHAMBAUGH AND SON, INC. STATEMENT OF SHAREHOLDER'S EQUITY NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR- TOTAL COMMON RETAINED SALE SHAREHOLDER'S STOCK EARNINGS SECURITIES EQUITY ---------- ----------- -------------- ------------- Balance at January 1, 1997........... $3,045,684 $24,109,694 $ 56,236 $ 27,211,614 Net income for the nine months ended September 30, 1997................. -- 8,125,250 -- 8,125,250 Change in unrealized gains on available-for-sale securities...... -- -- (29,106) (29,106) Capital contribution................. 139,348 -- -- 139,348 Dividends............................ -- (6,111,856) -- (6,111,856) ---------- ----------- -------------- ------------- Balance at September 30, 1997........ $3,185,032 $26,123,088 $ 27,130 $ 29,335,250 ========== =========== ============== ============= Balance at January 1, 1998........... $3,185,032 $25,676,489 $ (6,945) $ 28,854,576 Net income for nine months ended September 30, 1998................. -- 8,919,042 -- 8,919,042 Change in unrealized loss on available-for-sale securities...... -- -- (1,027,621) (1,027,621) Dividends............................ -- (4,236,000) -- (4,236,000) ---------- ----------- -------------- ------------- Balance at September 30, 1998........ $3,185,032 $30,359,531 $ (1,034,566) $ 32,509,997 ========== =========== ============== =============
See accompanying notes to financial statements. F-13 SHAMBAUGH AND SON, INC. STATEMENTS OF CASH FLOWS NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997 1998 1997 --------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES Net income......................... $ 8,919,042 $ 8,125,250 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization... 994,563 830,208 Equity in net loss of affiliated company....................... -- 27,748 Provision for losses on accounts receivable.................... 105,165 94,957 Gain on sale of equipment....... (5,891) (37,610) Gain on sale of available-for-sale securities.................... (57,181) (109,877) Change in assets and liabilities Accounts receivable, net...... (6,317,712) 5,809,978 Inventories................... (55,140) 54,744 Prepaid and other current items...................... (162,839) (762,659) Accounts payable.............. 2,159,959 (4,089,038) Billings relative to costs and estimated earnings on contracts in process....... 307,386 626,245 Accrued expenses.............. 854,604 (336,947) --------------- -------------- Total adjustments.......... (2,177,086) 2,107,749 --------------- -------------- Net cash from operating activities............ 6,741,956 10,232,999 CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures............... (1,608,538) (827,803) Increase in cash value of life insurance....................... (136,316) (136,316) Available-for-sale securities purchased....................... (12,048,286) (6,241,314) Proceeds on sale of available-for-sale securities... 7,962,696 4,987,825 Purchase of investments in limited partnerships.................... -- (1,000,000) Collections on notes receivable.... 142,174 170,115 Deposits and other assets.......... 166,716 512,087 Proceeds from sale of property and equipment....................... 5,891 37,610 --------------- -------------- Net cash from investing activities................. (5,515,663) (2,497,796) CASH FLOWS FROM FINANCING ACTIVITIES Capital contribution............... -- 139,348 Additional borrowing on long-term debt............................ 376,935 -- Repayment of debt.................. (307,155) (304,980) Dividends.......................... (4,236,000) (6,111,856) --------------- -------------- Net cash from financing activities................. (4,166,220) (6,277,488) --------------- -------------- Net change in cash and cash equivalents........................ (2,939,927) 1,457,715 Cash and cash equivalents at beginning of period................ 4,800,941 2,915,046 --------------- -------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD............................. $ 1,861,014 $ 4,372,761 =============== ============== Supplemental disclosures of cash flow information Cash paid during the period for Interest...................... $ 404,670 $ 462,196 State income taxes............ 128,973 106,470 See accompanying notes to financial statements. F-14 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS SEPTEMBER 30, 1998 AND 1997 NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS: Shambaugh and Son, Inc. operates a construction business to contract mechanical, electrical, fire protection, food processing, refrigeration, temperature and process controls, water and waste water treatment projects. It also operates a mobile home park, leases commercial real estate and provides computer consulting services. The construction contracts occasionally extend for periods in excess of one year and provide for progress billings in amounts which are commensurate with the extent of performance under the contracts. In addition to the primary location in Fort Wayne, Indiana, there are branch offices in Southfield and Kalamazoo, Michigan; Chicago, Illinois; Toledo, Ohio; and South Bend, Indianapolis and Lafayette, Indiana. REVENUE RECOGNITION: The Company accounts for revenue on construction contracts on the basis of the percentage of completion of individual contracts. Under this method, the earned portion of the total contract is based on the percentage of completion as computed from a comparison of total costs incurred to date to total projected cost on the contract. As described in the preceding paragraph, revenue is based on the amount of costs incurred to date over total estimated costs. Management estimates the amount of costs to complete a given contract based on information available at each balance sheet date. Estimates of costs to complete certain contracts could change significantly in the near term and other contracts are subject to cost reviews by the customer. The ultimate outcome of these estimates and contracts subject to customer review are not known. Due to these uncertainties, it is at least reasonably possible that completion costs will be significantly different. At the time a loss on a contract becomes probable, the entire estimated loss is accrued. For contracts which extend over more than one fiscal year, changes in job performance, job conditions, estimated profitability and final contract settlements which result in revisions to costs and income are recognized in the accounting period when these matters become known. Claims for additional contract revenue are recognized when realization of the claim is assured and the amount can reasonably be determined. Individual contract costs include direct material, subcontract, direct labor and labor fringe costs. Indirect costs are those related to contract performance such as indirect labor, supplies, tools, repairs and maintenance costs. General and administrative costs are expensed as incurred. ACCOUNTS RECEIVABLE: The Company follows the practice of filing liens within the statutory time frame on construction projects where collection problems are anticipated. The liens act as security for collection of construction receivables and have the effect of restricting the customer's ability to subsequently transfer title of the constructed property and to obtain certain kinds of financing without first satisfying the lien. PROPERTY AND EQUIPMENT: Property and equipment are carried at cost. The Company provides for depreciation using annual rates which are sufficient to amortize the cost of depreciable assets over their estimated useful lives. Depreciation is computed using straight-line and accelerated methods over estimated useful lives ranging from 3 to 40 years. BENEFIT COST: The Company is liable for certain costs related to employee health and accident benefit programs and workmen's compensation. The Company's responsibility for losses on these programs is limited to amounts not insured. Costs are charged to income when incurred. INCOME TAXES: The Company, with the consent of its shareholder, has elected to have its income taxed under Section 1362 of the Internal Revenue Code, and a similar section of certain state income tax laws. These provide that, in lieu of corporate income taxes, the shareholder is taxed on his proportionate F-15 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) share of the Company's taxable income. Therefore, the provision for income taxes represents certain state income taxes paid by the Company. EXCESS OF COST OVER NET ASSETS ACQUIRED: The excess of cost over net assets acquired is being amortized on the straight-line method over a 40-year period. INVENTORIES: The inventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. INVESTMENT: The Company's 50% investment in D&M Realty Corp. is accounted for by the equity method. As of September 30, 1997, D&M Realty Corp. was liquidated and its net assets were contributed to Shambaugh & Son, Inc. SECURITIES: The Company classifies securities into held-to-maturity, available-for-sale, and trading categories. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those which the Company may decide to sell if needed for liquidity, asset-liability management, or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains or losses included as a separate component of equity. Trading securities are bought principally for sale in the near term, and are reported at fair value with unrealized gains or losses included in earnings. As of September 30, 1998 and 1997, all securities were classified as available for sale. Realized gains or losses are determined based on the amortized cost of the specific security sold. Securities with declines in fair value below amortized cost that are other than temporary are written down to fair value by a charge to earnings. CASH AND CASH EQUIVALENTS: For purposes of reporting cash flows, the Company considers all liquid investments with an original maturity of three months or less to be cash equivalents. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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. NOTE 2 -- OTHER INCOME (EXPENSE) Other income (expense) consists of the following: 1998 1997 ------------ ------------ Interest expense..................... $ (421,048) $ (462,196) Equity in net loss of affiliated company............................ -- (27,748) Interest income...................... 323,472 324,818 Gain on sale of available-for-sale securities......................... 57,181 109,877 Gain on sale of equipment............ 5,891 37,610 Rental revenue....................... 236,784 244,137 Miscellaneous income (expense)....... (117,378) (31,207) ------------ ------------ $ 84,902 $ 195,291 ============ ============ F-16 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 -- SECURITIES The carrying value and estimated market value of investments in equity and debt securities at September 30, 1998 and 1997 is as follows:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSS VALUE ---------- ----------- ----------- ---------- September 30, 1998: Available-for-sale securities: Bonds........................... $1,350,607 $ 5,731 $ 33,069 $1,323,269 Common stock.................... 4,966,937 57,452 981,613 4,042,776 Preferred stock................. 1,525,264 11,480 94,547 1,442,197 ---------- ----------- ----------- ---------- $7,842,808 $74,663 $ 1,109,229 $6,808,242 ========== =========== =========== ========== GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSS VALUE ---------- ----------- ----------- ---------- September 30, 1997: Available-for-sale securities: Common stock.................... $ 471,875 $-- $ 4,675 $ 467,200 Preferred stock................. 3,184,805 31,805 -- 3,216,610 Bonds........................... 145,063 -- -- 145,063 ---------- ----------- ----------- ---------- $3,801,743 $31,805 $ 4,675 $3,828,873 ========== =========== =========== ========== TOTAL NET SALE TOTAL COST NET PURCHASES PROCEEDS OF SALES GAIN (LOSS) ----------- ------------ ------------ ------------ For the period ended September 30, 1998: Available-for-sale securities: Bonds........................... $ 863,815 $ 214,625 $ 215,000 $ (375) Common stock.................... 9,419,643 6,061,132 6,039,497 21,635 Preferred stock................. 1,742,112 1,662,053 1,628,302 33,751 Limited partnership............. 22,716 24,886 22,716 2,170 ----------- ------------ ------------ ------------ $12,048,286 $ 7,962,696 $ 7,905,515 $ 57,181 =========== ============ ============ ============ TOTAL NET SALE TOTAL COST NET PURCHASES PROCEEDS OF SALES GAIN (LOSS) ----------- ------------ ------------ ------------ For the period ended September 30, 1997: Available-for-sale securities: Municipal bond fund............. $ 145,063 $ -- $ -- $ -- Common stock.................... 1,711,001 1,819,985 1,752,323 67,662 Preferred stock................. 4,385,250 2,973,072 2,932,625 40,447 Limited partnership............. -- 194,768 193,000 1,768 ----------- ------------ ------------ ------------ $ 6,241,314 $ 4,987,825 $ 4,877,948 $ 109,877 =========== ============ ============ ============
At September 30, 1998 and 1997, the Company has investments in limited partnerships of $2,100,000 and $1,000,000 representing approximately 2% of an investment fund, respectively. These investments have restrictions on the Company's ability to sell or withdraw its capital investment for a five year period from F-17 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) the date of each capital investment. The Company has recorded these investments at cost in absence of the Company's belief of a reliable market value due to the restrictions placed upon its ability to transfer. NOTE 4 -- ACCOUNTS RECEIVABLE Accounts receivable are summarized as follows at September 30: 1998 1997 -------------- -------------- Accounts receivable on contracts..... $ 30,702,970 $ 23,555,042 Contract retentions.................. 5,160,770 3,446,875 -------------- -------------- 35,863,740 27,001,917 Allowance for doubtful accounts...... (455,165) (444,957) -------------- -------------- $ 35,408,575 $ 26,556,960 ============== ============== NOTE 5 -- CONTRACTS IN PROCESS Information with respect to contracts in process at September 30 is as follows: 1998 1997 --------------- --------------- Costs incurred on contracts in process............................ $ 173,427,718 $ 171,032,772 Estimated earnings on contracts in process............................ 30,360,958 27,032,812 --------------- --------------- 203,788,676 198,065,584 Billings to date..................... 208,444,313 199,581,728 --------------- --------------- $ (4,655,637) $ (1,516,144) =============== =============== Included in accompanying balance sheet under the following captions: 1998 1997 -------------- -------------- Costs and estimated earnings in excess of billings on contracts in process............................ $ 5,044,002 $ 5,488,555 Billings in excess of costs and estimated earnings on contracts in process............................ (9,699,639) (7,004,699) -------------- -------------- $ (4,655,637) $ (1,516,144) ============== ============== NOTE 6 -- OTHER CURRENT ASSETS Other current assets consist of the following at September 30: 1998 1997 ---------- ------------ Due from related parties............. $ 258,049 $ 728,400 Accounts receivable, other........... 71,853 243,359 Prepaid expenses and sundry receivables........................ 33,190 71,674 ---------- ------------ $ 363,092 $ 1,043,433 ========== ============ F-18 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 -- NOTES RECEIVABLE Notes receivable consist of the following at September 30: 1998 1997 ------------ ------------ Note receivable, shareholder, monthly payments of $10,498 including interest at 5.23%, balance due July 2000, secured by a real estate mortgage on mechanical fabrication shop............................... $ 555,499 $ 649,727 Notes receivable, shareholder, monthly payments totaling $11,620 including interest at 5.23%, balance due July 2000, secured by real estate mortgages on office buildings in Ft. Wayne and South Bend, Indiana...................... 693,567 793,869 Note receivable, monthly payments totaling $418 including interest at 9.25%, balance due December 2001, secured by Front Street real estate............................. 14,632 17,835 Note receivable, monthly payments of $670 including interest at 10%, final payment due July 1998, secured by Adam Center Road real estate mortgage.................... 15,019 15,019 Note receivable, related party, monthly payments of $2,357 including interest at 8%, final payment due November 2000, unsecured (Indianapolis building).......................... -- 78,875 Note receivable, related party, monthly payments of $3,004 including interest at 8%, final payment due November 1999, unsecured (private carrier)........ 42,751 71,502 ------------ ------------ 1,321,468 1,626,827 Current portion...................... 246,242 305,359 ------------ ------------ $ 1,075,226 $ 1,321,468 ============ ============ NOTE 8 -- OTHER ASSETS Other assets consist of the following at September 30: 1998 1997 ------------ ------------ Investment in captive insurance company............................ $ 36,000 $ 36,000 Cash surrender value of life insurance.......................... 1,364,856 1,207,758 Unamortized goodwill................. 103,739 106,941 Deposits and other assets............ 137,539 131,685 ------------ ------------ $ 1,642,134 $ 1,482,384 ============ ============ NOTE 9 -- PROPERTY AND EQUIPMENT Property and equipment consist of the following at September 30: 1998 1997 --------------- --------------- Land, buildings and improvements..... $ 8,373,793 $ 8,273,172 Furniture and office equipment....... 4,670,632 3,943,925 Machinery, equipment and vehicles.... 6,354,959 5,713,888 --------------- --------------- 19,399,384 17,930,985 Accumulated depreciation............. (12,169,837) (11,261,501) --------------- --------------- $ 7,229,547 $ 6,669,484 =============== =============== F-19 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 10 -- NOTES PAYABLE, BANKS The Company has available an unsecured line of credit totaling $6,000,000 bearing interest at the lesser of the six-month LIBOR plus 1.75% or the Bank's prime rate. The line of credit expires on May 31, 1999. As of September 30, 1998 and 1997, there were no amounts due on the line. The Company has available two leasing lines of credit totaling $4,000,000 for equipment purchases bearing interest at the three year treasury bill rate plus 1.25%. These lines of credit expire on May 31, 1999 and September 1, 1999. As of September 30, 1998, there was $989,815 outstanding on the line, utilized for operating lease purposes. NOTE 11 -- OPERATING LEASES The Company leases equipment, vehicles and office space under noncancelable operating lease arrangements. These leases expire at various dates through 2002. Rent expense for these leases included in the income statement for the nine months ended September 30, 1998 and 1997 was $944,083 and $924,197, respectively. Future minimum lease payments for operating leases in effect at September 30, 1998 are as follows: 1999................................. $ 1,022,568 2000................................. 576,122 2001................................. 244,997 2002................................. 56,370 ------------ $ 1,900,057 ============ In addition the Company rents, on a month to month basis, transportation equipment with a company related through common ownership. The lease provides for monthly rents of $9,000. Rental expense for this lease was $77,000 and $63,000 for the nine months ended September 30, 1998 and 1997, respectively. NOTE 12 -- CAPITAL LEASES The Company is obligated under various capital leases for offices, warehouse facilities, and a fabricating shop owned by a shareholder. The leases expire at various dates over the next five to eight years and require annual payments adjusted for increases in the Consumer Price Index. The following represents property under the capital leases at September 30: 1998 1997 ------------ ------------ Building and improvements............ $ 5,017,056 $ 5,017,056 Less accumulated depreciation........ 3,189,357 2,863,206 ------------ ------------ $ 1,827,699 $ 2,153,850 ============ ============ F-20 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) The following is a schedule by year of future minimum lease payments under the capital leases together with the present value of the net minimum lease payments as of September 30, 1998: 1999................................. $ 943,440 2000................................. 943,440 2001................................. 943,440 2002................................. 593,440 2003................................. 343,440 Thereafter........................... 798,080 ------------ Total future minimum lease payments........................... 4,565,280 Amount representing interest expense............................ 1,809,635 ------------ $ 2,755,645 ============ NOTE 13 -- LONG-TERM DEBT Long-term debt consists of the following at September 30: 1998 1997 ------------ ------------ Capital lease obligations (Note 13)................................ $ 2,755,645 $ 3,106,173 Note payable, payable in monthly installments of $4,147 including interest at 5.17%, through March 1998, secured by computer equipment.......................... -- 24,514 Note payable, payable in monthly installments of $2,000 including interest at 8% through December 1997, secured by equipment......... -- 7,625 Notes payable, payable in monthly installments of $10,780 including interest at 1.9% through March 2001, secured by equipment......... 338,488 -- ------------ ------------ 3,094,133 3,138,312 Current maturities................... 562,127 416,307 ------------ ------------ $ 2,532,006 $ 2,722,005 ============ ============ Maturities of long-term debt, including capital lease obligations, for the next five years are as follows: 1999................................. $ 562,127 2000................................. 626,097 2001................................. 658,090 2002................................. 399,444 2003................................. 217,478 NOTE 14 -- TRANSACTIONS WITH RELATED PARTIES The Company has leases (see Notes 12 and 13), notes receivable (see Note 7) and advances (see Note 6) with related parties. Additionally, for the nine month period ended September 30, 1998 and 1997, the Company paid $5,371,529 and $2,962,273, respectively to a related party for subcontract and material costs. As of September 30, 1998 and 1997, the Company had accounts payable to this related party of $1,875,805 and $847,945, respectively. F-21 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 15 -- PENSION PLAN The Company has adopted a trusteed employees' pension and savings plan. The plan covers all employees not covered by collective bargaining agreements, after completion of one year of service. Discretionary contributions are determined by the Board of Directors. The plan allows, pursuant to Section 401(k) of the Internal Revenue Code, employees to redirect a portion of their annual compensation as a contribution to the plan. In addition, the Company has a matching contribution of up to 7.5% of eligible compensation in certain situations. Employer contributions totaled $356,876 and $308,062 for the nine months ended September 30, 1998 and 1997, respectively. Information from the plan's administrators is not available to permit the Company to determine its share of the unfunded vested benefits. The Company also made contributions of $3,063,751 and $2,641,240 for the nine months ended September 30, 1998 and 1997, respectively, to collectively bargained, multi-employer defined-benefit pension plans in accordance with provisions of labor contracts. Information from the plans' administrators is not available to permit the Company to determine its share of unfunded vested benefits, if any. NOTE 16 -- CAPTIVE INSURANCE PROGRAM The Company is a shareholder in a captive insurance company which required an investment of $36,000. Premiums for workers' compensation, general liability and auto are paid to the captive insurance company. The Company may be required to pay additional premiums if claims are significantly higher than expected. However, the maximum amount of such possible additional costs is limited due to reinsurance. As of September 30, 1998, the maximum potential additional premium which could be assessed is approximately $1,343,228 (this covers the policy periods from October 1, 1995 to September 30, 1998). The Company does not believe any material assessment is likely. The captive agreement requires that one half of this amount be secured, so the Company obtained a letter of credit for the secured amount. NOTE 17 -- SUBSEQUENT EVENTS On November 15, 1998, 100% of the Company's stock was sold to Comfort Systems USA. F-22 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholder Shambaugh and Son, Inc. Fort Wayne, Indiana We have audited the accompanying balance sheet of Shambaugh and Son, Inc. as of December 31, 1997 and the related statements of income, shareholder's equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Shambaugh and Son, Inc. as of December 31, 1997, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. Crowe, Chizek and Company LLP South Bend, Indiana February 24, 1998 F-23 SHAMBAUGH AND SON, INC. BALANCE SHEET DECEMBER 31, 1997 ASSETS Current assets Cash and cash equivalents....... $ 4,800,941 Available for sale securities... 3,693,092 Accounts receivable -- net...... 29,196,028 Costs and estimated earnings in excess of billings on contracts in process..................... 4,333,101 Inventories, material and supplies....................... 1,540,228 Notes receivable................ 293,817 Other current assets............ 200,253 -------------- Total current assets....... 44,057,460 Property and equipment, net.......... 6,615,572 Other assets Investments in limited partnerships................... 2,100,000 Notes receivable................ 1,169,825 Other assets.................... 1,672,534 -------------- 4,942,359 -------------- $ 55,615,391 ============== LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities Current maturities of long-term debt........................... $ 409,312 Accounts payable................ 9,242,616 Billings in excess of costs and estimated earnings on contracts in process..................... 8,681,352 Accrued payroll and related liabilities.................... 4,529,785 Accrued expenses................ 1,282,709 -------------- Total current liabilities............... 24,145,774 Long-term debt....................... 2,615,041 Shareholder's equity Common stock, no par value: 3,000 shares authorized, 2,072 shares issued and outstanding.................... 3,185,032 Retained earnings............... 25,676,489 Unrealized gain (loss) on available-for-sale securities..................... (6,945) -------------- 28,854,576 -------------- $ 55,615,391 ============== See accompanying notes to financial statements. F-24 SHAMBAUGH AND SON, INC. STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 1997 % TO AMOUNT REVENUE --------------- ------- Earned revenue on contracts.......... $ 157,535,128 100.0% Costs of earned revenue on contracts.......................... 121,387,346 77.1 --------------- ------- GROSS PROFIT......................... 36,147,782 22.9 General and administrative expenses........................... 24,301,439 15.4 --------------- ------- OPERATING INCOME..................... 11,846,343 7.5 Other income......................... 374,783 .2 --------------- ------- INCOME BEFORE INCOME TAXES........... 12,221,126 7.7 Provision for income taxes........... 107,475 .1 --------------- ------- NET INCOME........................... $ 12,113,651 7.6% =============== ======= See accompanying notes to financial statements. F-25 SHAMBAUGH AND SON, INC. STATEMENT OF SHAREHOLDER'S EQUITY YEAR ENDED DECEMBER 31, 1997
UNREALIZED GAIN (LOSS) ON TOTAL COMMON RETAINED AVAILABLE-FOR- SHAREHOLDER'S STOCK EARNINGS SALE SECURITIES EQUITY ------------ --------------- --------------- ------------- Balance at January 1, 1997........... $ 3,045,684 $ 24,109,694 $ 56,236 $ 27,211,614 Net income for the year ended December 31, 1997.................. -- 12,113,651 -- 12,113,651 Change in unrealized gain (loss) on available-for-sale securities...... -- -- (63,181) (63,181) Capital contribution................. 139,348 -- -- 139,348 Dividends............................ -- (10,546,856) -- (10,546,856) ------------ --------------- --------------- ------------- Balance at December 31, 1997......... $ 3,185,032 $ 25,676,489 $ (6,945) $ 28,854,576 ============ =============== =============== =============
See accompanying notes to financial statements. F-26 SHAMBAUGH AND SON, INC. STATEMENT OF CASH FLOWS YEAR ENDED DECEMBER 31, 1997 CASH FLOWS FROM OPERATING ACTIVITIES Net income......................... $ 12,113,651 Adjustments to reconcile net income to net cash from operating activities Depreciation and amortization... 1,453,374 Provision for losses on accounts receivable..................... 38,623 Gain on sale of equipment....... (1,329) Gain on sale of available-for-sale securities..................... (139,974) Change in assets and liabilities Accounts receivable, net... 3,227,244 Inventories................ 18,855 Prepaid and other current items..................... 80,521 Accounts payable........... (4,169,094) Billings relative to costs and estimated earnings on contracts in process...... 3,458,352 Accrued expenses........... 702,864 -------------- Total adjustments....... 4,669,436 -------------- Net cash from operating activities........... 16,783,087 CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures............... (1,444,414) Increase in cash value of life insurance....................... (157,098) Available-for-sale securities purchased....................... (10,482,798) Proceeds on sale of available-for-sale securities... 9,361,112 Purchase of investments in limited partnerships.................... (2,100,000) Collections on notes receivable.... 381,300 Deposits and other assets.......... 367,265 Proceeds from sale of property and equipment....................... 51,888 Additional advances on notes receivable...................... (48,000) -------------- Net cash from investing activities........... (4,070,745) CASH FLOWS FROM FINANCING ACTIVITIES Capital contribution............... 139,348 Repayment of debt.................. (418,939) Dividends.......................... (10,546,856) -------------- Net cash from financing activities........... (10,826,447) -------------- Net change in cash and cash equivalents........................ 1,885,895 Cash and cash equivalents at beginning of year.................. 2,915,046 -------------- CASH AND CASH EQUIVALENTS AT END OF YEAR............................... $ 4,800,941 ============== Supplemental disclosures of cash flow information Cash paid during the year for Interest........................ $ 601,294 State income taxes.............. 112,398 See accompanying notes to financial statements. F-27 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1997 NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS: Shambaugh and Son, Inc. operates a construction business to contract mechanical, electrical, fire protection, food processing, refrigeration, temperature and process controls, water and waste water treatment projects. It also operates a mobile home park, leases commercial real estate and provides computer consulting services. The construction contracts occasionally extend for periods in excess of one year and provide for progress billings in amounts which are commensurate with the extent of performance under the contracts. In addition to the primary location in Fort Wayne, Indiana, there are branch offices in Southfield and Kalamazoo, Michigan; Chicago, Illinois; Toledo, Ohio; and South Bend, Indianapolis and Lafayette, Indiana. REVENUE RECOGNITION: The Company accounts for revenue on construction contracts on the basis of the percentage of completion of individual contracts. Under this method, the earned portion of the total contract is based on the percentage of completion as computed from a comparison of total costs incurred to date to total projected cost on the contract. As described in the preceding paragraph, revenue is based on the amount of costs incurred to date over total estimated costs. Management estimates the amount of costs to complete a given contract based on information available at each balance sheet date. Estimates of costs to complete certain contracts could change significantly in the near term and other contracts are subject to cost reviews by the customer. The ultimate outcome of these estimates and contracts subject to customer review are not known. Due to these uncertainties, it is at least reasonably possible that completion costs will be significantly different. At the time a loss on a contract becomes probable, the entire estimated loss is accrued. For contracts which extend over more than one fiscal year, changes in job performance, job conditions, estimated profitability and final contract settlements which result in revisions to costs and income are recognized in the accounting period when these matters become known. Claims for additional contract revenue are recognized when realization of the claim is assured and the amount can reasonably be determined. Individual contract costs include direct material, subcontract, direct labor and labor fringe costs. Indirect costs are those related to contract performance such as indirect labor, supplies, tools, repairs and maintenance costs. General and administrative costs are expensed as incurred. ACCOUNTS RECEIVABLE: The Company follows the practice of filing liens within the statutory time frame on construction projects where collection problems are anticipated. The liens act as security for collection of construction receivables and have the effect of restricting the customer's ability to subsequently transfer title of the constructed property and to obtain certain kinds of financing without first satisfying the lien. PROPERTY AND EQUIPMENT: Property and equipment are carried at cost. The Company provides for depreciation using annual rates which are sufficient to amortize the cost of depreciable assets over their estimated useful lives. BENEFIT COST: The Company is liable for certain costs related to employee health and accident benefit programs and workmen's compensation. The Company's responsibility for losses on these programs is limited to amounts not insured. Costs are charged to income when incurred. INCOME TAXES: The Company, with the consent of its shareholder, has elected to have its income taxed under Section 1362 of the Internal Revenue Code, and a similar section of certain state income tax laws. These provide that, in lieu of corporate income taxes, the shareholder is taxed on his proportionate F-28 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) share of the Company's taxable income. Therefore, the provision for income taxes represents certain state income taxes paid by the Company. EXCESS OF COST OVER NET ASSETS ACQUIRED: The excess of cost over net assets acquired is being amortized on the straight-line method over a 40-year period. INVENTORIES: The inventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. INVESTMENT: The Company's 50% investment in D&M Realty Corp. is accounted for by the equity method. SECURITIES: The Company classifies securities into held-to-maturity, available-for-sale, and trading categories. Held-to-maturity securities are those which the Company has the positive intent and ability to hold to maturity, and are reported at amortized cost. Available-for-sale securities are those which the Company may decide to sell if needed for liquidity, asset-liability management, or other reasons. Available-for-sale securities are reported at fair value, with unrealized gains or losses included as a separate component of equity. Trading securities are bought principally for sale in the near term, and are reported at fair value with unrealized gains or losses included in earnings. Realized gains or losses are determined based on the amortized cost of the specific security sold. Securities with declines in fair value below amortized cost that are other than temporary are written down to fair value by a charge to earnings. CASH AND CASH EQUIVALENTS: For purposes of reporting cash flows, the Company considers all liquid investments with an original maturity of three months or less to be cash equivalents. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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. NOTE 2 -- OTHER INCOME (EXPENSE) Other income (expense) consists of the following for the year ended December 31, 1997: Interest expense..................... $ (602,896) Equity in net income (loss) of affiliated company................. (27,748) Interest income...................... 557,635 Gain on sale of available-for-sale securities......................... 139,974 Gain on sale of equipment............ 1,329 Rental revenue....................... 306,489 Miscellaneous income................. -- ------------ $ 374,783 ============ F-29 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 -- SECURITIES The carrying value and estimated market value of investments in available for sale securities at December 31, 1997 is as follows:
GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSS VALUE ---------- ---------- ---------- ---------- Available-for-sale securities: Bonds........................... $ 701,792 $ 610 $ -- $ 702,402 Common stock.................... 1,586,791 32,265 (50,046) 1,569,010 Preferred stock................. 1,411,454 17,699 (7,473) 1,421,680 ---------- ---------- ---------- ---------- $3,700,037 $ 50,574 $ (57,519) $3,693,092 ========== ========== ========== ==========
Contractual maturities of debt securities at December 31, 1997 is as follows: AMORTIZED COST FAIR VALUE --------- ---------- Due two to five years................ $ 155,560 $ 155,560 Due six to ten years................. 295,608 296,218 Due after ten years.................. 250,624 250,624 --------- ---------- $ 701,792 $ 702,402 ========= ==========
TOTAL NET SALE TOTAL COST NET PURCHASES PROCEEDS OF SALES GAIN (LOSS) ----------- ----------- ---------- ----------- For the year ended December 31, 1997: Available-for-sale securities: Bonds...................... $ 701,792 $ -- $ -- $ -- Common stock............... 3,629,428 2,642,701 2,555,833 86,868 Preferred stock............ 6,151,579 6,523,643 6,472,305 51,338 Limited partnership........ -- 194,768 193,000 1,768 ----------- ----------- ---------- ----------- $10,482,798 $ 9,361,112 $9,221,138 $ 139,974 =========== =========== ========== ===========
At December 31, 1997, the Company has investments in limited partnerships of $2,100,000 representing approximately 2% of an investment fund, respectively. These investments have restrictions on the Company's ability to sell or withdraw its capital investment for a five year period from the date of each capital investment. The Company has recorded these investments at cost in absence of the Company's belief of a reliable market value due to the restrictions placed upon its ability to transfer. NOTE 4 -- ACCOUNTS RECEIVABLE Accounts receivable are summarized as follows at December 31: Accounts receivable on contracts..... $ 25,583,038 Contract retentions.................. 3,962,990 -------------- 29,546,028 Allowance for doubtful accounts...... (350,000) -------------- $ 29,196,028 ============== F-30 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 5 -- CONTRACTS IN PROCESS Information with respect to contracts in process as of December 31, 1997 is as follows: Costs incurred on contracts in process............................ $ 141,182,703 Estimated earnings on contracts in process............................ 28,014,546 --------------- 169,197,249 Billings to date..................... 173,545,500 --------------- $ (4,348,251) =============== Included in accompanying balance sheet under the following captions: Costs and estimated earnings in excess of billings on contracts in process............................ $ 4,333,101 Billings in excess of costs and estimated earnings on contracts in process............................ (8,681,352) -------------- $ (4,348,251) ============== NOTE 6 -- OTHER CURRENT ASSETS Other current assets consist of the following at December 31, 1997: Due from related parties............. $ 91,777 Accounts receivable, other........... 43,370 Prepaid expenses and sundry receivables........................ 65,106 ---------- $ 200,253 ========== NOTE 7 -- NOTES RECEIVABLE Notes receivable consist of the following at December 31, 1997: Note receivable, shareholder, monthly payments of $10,498 including interest at 5.23%, balance due July 2000, secured by a real estate mortgage on mechanical fabrication shop............................... $ 555,499 Notes receivable, shareholder, monthly payments totaling $11,620 including interest at 5.23%, balance due July 2000, secured by real estate mortgages on office buildings in Ft. Wayne and South Bend, Indiana...................... 693,567 Note receivable, monthly payments totaling $418 including interest at 9.25%, balance due December 2001, secured by Front Street real estate. Note was refinanced on December 4, 1996................... 16,701 Note receivable, monthly payments of $670 including interest at 10%, final payment due July 1998, secured by Adam Center Road real estate mortgage.................... 15,019 Note receivable, related party, monthly payments of $2,357 including interest at 8%, final payment due November 2000, unsecured (Indianapolis building).......................... 73,346 Note receivable, related party, monthly payments of $3,004 including interest at 8%, final payment due November 1999, unsecured (private carrier)........ 63,869 Note receivable, related party, monthly payments of $1,515 including interest at 8.50%, balance due October 2000, unsecured (SFLP)............................. $ 45,641 ------------ 1,463,642 Current portion...................... 293,817 ------------ $ 1,169,825 ============ F-31 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 8 -- OTHER ASSETS Other assets consist of the following at December 31, 1997: Investment in captive insurance company............................ $ 36,000 Cash surrender value of life insurance.......................... 1,228,540 Unamortized goodwill................. 106,141 Deposits and other assets............ 301,853 ------------ $ 1,672,534 ============ As of September 30, 1997, D & M Realty Corp. was liquidated and its net assets were contributed to Shambaugh and Son, Inc. NOTE 9 -- PROPERTY AND EQUIPMENT Property and equipment consist of the following at December 31, 1997: Land, buildings and improvements................... $ 8,305,740 Furniture and office equipment...................... 4,139,721 Machinery, equipment and vehicles....................... 5,323,056 -------------- 17,768,517 ============== METHOD OF USEFUL DEPRECIATION LIFE ------------ ---------- Accumulated depreciation: Land, buildings and improvements............... SL 15-40 yrs. 4,511,168 Furniture and office equipment.................. SL 7-10 yrs. 2,688,068 Machinery, equipment and vehicles................... SL 3-7 yrs. 3,953,709 -------------- 11,152,945 -------------- Net property and equipment... $ 6,615,572 ============== NOTE 10 -- NOTES PAYABLE, BANKS The Company has available an unsecured line of credit totaling $6,000,000 bearing interest at prime minus one-half of one percent. The line of credit expires on May 31, 1998. As of December 31, 1997, there was no amount due on the line. The Company has available two leasing lines of credit totaling $4,000,000 for equipment leasing bearing interest at the three year treasury bill rate plus 1.25%. These lines of credit expire on May 31, 1998 and September 1, 1999. As of December 31, 1997, there was $315,629 utilized on the line for operating lease purposes. F-32 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 11 -- OPERATING LEASES The Company leases equipment, vehicles and office space under noncancelable operating lease arrangements. These leases expire at various dates through November 2001. Rent expense for these leases included in the income statement for the year ended December 31, 1997 was $1,232,263. Future minimum lease payments for operating leases in effect at December 31, 1997 are as follows: 1998................................. $ 1,107,457 1999................................. 727,384 2000................................. 285,083 2001................................. 108,047 ------------ $ 2,227,971 ============ In addition the Company rents, on a month to month basis, transportation equipment with a company related through common ownership. The lease provides for monthly rents of $7,000. Rental expense for this lease was $84,000 for the year ended December 31, 1997. NOTE 12 -- CAPITAL LEASES The Company is obligated under various capital leases for offices, warehouse facilities, and a fabricating shop owned by a shareholder. The leases expire at various dates over the next five to eight years and require annual payments adjusted for increases in the Consumer Price Index. The following represents property under the capital leases at December 31, 1997: Building and improvements............ $ 5,017,056 Less accumulated depreciation........ (2,944,744) ------------ $ 2,072,312 ============ The following is a schedule by year of future minimum lease payments under the capital leases together with the present value of the net minimum lease payments as of December 31, 1997: 1998................................. $ 943,440 1999................................. 943,440 2000................................. 943,440 2001................................. 943,440 2002................................. 443,440 Thereafter........................... 1,055,660 ------------ Total future minimum lease payments............................. 5,272,860 Amount representing interest expense.............................. 2,260,843 ------------ $ 3,012,017 ============ F-33 SHAMBAUGH AND SON, INC. NOTES TO FINANCIAL STATEMENTS -- (CONTINUED) NOTE 13 -- LONG-TERM DEBT Long-term debt consists of the following at December 31, 1997: Capital lease obligations (Note 12)................................ $ 3,012,017 Note payable, payable in monthly installments of $4,147 including interest at 5.17%, through March 1998, secured by computer equipment.......................... 12,336 ------------ 3,024,353 Current maturities................... 409,312 ------------ $ 2,615,041 ============ Maturities of long-term debt, including capital lease obligations, for the next five years are as follows: 1998................................. $ 409,312 1999................................. 452,722 2000................................. 516,396 2001................................. 589,139 2002................................. 273,607 NOTE 14 -- TRANSACTIONS WITH RELATED PARTIES The Company has leases (see Notes 12 and 13), notes receivable (see Note 7) and advances (see Note 6) with related parties. Additionally, for the year ended December 31, 1997, the Company paid $4,390,215 to a related party for subcontract and material costs. As of December 31, 1997, the Company had accounts payable to this related party of $399,061. NOTE 15 -- PENSION PLAN The Company has adopted a trusteed employees' pension and savings plan. The plan covers all employees not covered by collective bargaining agreements, after completion of one year of service. Discretionary contributions are determined by the Board of Directors. The plan allows, pursuant to Section 401(k) of the Internal Revenue Code, employees to redirect a portion of their annual compensation as a contribution to the plan. In addition, the Company has a matching contribution of up to 7.5% of eligible compensation in certain situations. Employer contributions totaled $488,153 for the year ended December 31, 1997. The Company also made contributions of $3,506,698 for the year ended December 31, 1997 to collectively bargained, multi-employer defined-benefit pension plans in accordance with provisions of labor contracts. Information from the plans' administrators is not available to permit the Company to determine its share of unfunded vested benefits, if any. NOTE 16 -- CAPTIVE INSURANCE PROGRAM The Company is a shareholder in a captive insurance company which required an investment of $36,000. Premiums for workers' compensation, general liability and auto are paid to the captive insurance company. The Company may be required to pay additional premiums if claims are significantly higher than expected. However, the maximum amount of such possible additional costs is limited due to reinsurance. As of December 31, 1997, the maximum potential additional premium which could be assessed is approximately $1,162,000 (this covers the policy periods from October 1, 1995 to March 31, 1998). The captive agreement requires that one half of this amount be secured, so the Company obtained a letter of credit for the secured amount. F-34 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the use in this Registration Statement of Comfort Systems USA, Inc. on Form 8-K/A of our report dated February 24, 1998 relating to the financial statements of Shambaugh & Son, Inc. as of December 31, 1997 and for the year then ended appearing elsewhere in this registration statement. Crowe, Chizek and Company LLP /s/ CROWE, CHIZEK AND COMPANY LLP South Bend, Indiana January 26, 1999 F-35