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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, 2007

Commission file number: 1-13011

Comfort Systems USA, Inc.
(Exact name of registrant as specified in its charter)

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

777 Post Oak Boulevard
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:

Title of Each Class
  Name of Each Exchange on
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o    No ý

        Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o    No ý

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

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

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o

        Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o    No ý

        As of February 25, 2008, the aggregate market value of the 39,331,386 shares of the registrant's common stock held by non-affiliates of the registrant was $557,719,053, based on the $14.18 last sale price of the registrant's common stock on the New York Stock Exchange on June 29, 2007.

        As of February 25, 2008, 40,100,652 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, 2007.





FORWARD-LOOKING STATEMENTS

        This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on the current plans and expectations of Comfort Systems USA, Inc. 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 include, among others, national or regional weakness in non-residential construction activity, difficulty in obtaining or increased costs associated with bonding, shortages of labor and specialty building materials, the use of incorrect estimates for bidding a fixed price contract, undertaking contractual commitments that exceed our labor resources, retention of key management, the Company's backlog failing to translate into actual revenue or profits, errors in the Company's percentage of completion method of accounting, the result of competition in the Company's markets, seasonal fluctuations in the demand for HVAC systems, the imposition of past and future liability from environmental, safety, and health regulations including the inherent risk associated with self-insurance, adverse litigation results and other risks detailed in the Company's reports filed with the Securities and Exchange Commission. Important factors that could cause actual results to differ are discussed under "Item 1A. Company Risk Factors." These forward-looking statements speak only as of the date of this filing. Comfort Systems USA, Inc. expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained herein to reflect any change in Comfort Systems USA, Inc.'s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.


PART I

        The terms "Comfort Systems," "we," "us," or "the Company" refer to Comfort Systems USA, Inc. or Comfort Systems USA, Inc. and its consolidated subsidiaries, as appropriate in the context.


ITEM 1. Business

        Comfort Systems USA, Inc., a Delaware corporation was established in 1997. We provide comprehensive heating, ventilation and air conditioning ("HVAC") installation, maintenance, repair and replacement services within the mechanical services industry. We have 40 operating units in 54 cities and 62 locations throughout the United States.

        We operate primarily in the commercial, industrial and institutional HVAC markets, and perform most of our services within office buildings, retail centers, apartment complexes, manufacturing plants, and healthcare, education and government facilities. In addition to standard HVAC services, we provide specialized applications such as building automation control systems, fire protection, process cooling, electronic monitoring and process piping. Certain locations also perform related activities such as plumbing and electrical service. Approximately 98% of our consolidated 2007 revenues were derived from commercial, industrial and institutional customers and large multi-family residential projects. Approximately 56% of our revenues were attributable to installation services in newly constructed facilities and 44% were attributable to maintenance, repair and replacement services. Our consolidated 2007 revenues were derived from the following service activities, all of which are in the mechanical services industry, the single industry segment we serve:

Service Activity

  Percentage of
Revenue

 
HVAC   78 %
Plumbing   14 %
Building Automation Control Systems   3 %
Other   5 %
   
 
Total   100 %
   
 

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        Our Internet address is http://www.comfortsystemsusa.com. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Our website also includes our code of ethics, titled "Corporate Compliance Policy: Standards and Procedures Regarding Business Practices," together with other governance materials including our corporate governance guidelines and our Board committee charters. Printed versions of our code of ethics and our corporate governance guidelines may be obtained upon written request to our Corporate Compliance Officer at our headquarters address.

Industry Overview

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

        Many factors positively affect HVAC industry growth, particularly (i) population growth, which has increased the need for commercial, industrial and institutional space, (ii) an aging installed base of buildings and HVAC environmental and energy efficiency equipment, (iii) increasing sophistication, complexity, and efficiency of HVAC systems, (iv) growing emphasis on environmental and energy efficiency, and (v) reduction or elimination of the refrigerants commonly used in older HVAC systems. We believe these factors should increase demand for the reconfiguration or replacement of existing HVAC systems and may also mitigate, to some extent, the effect on the HVAC industry of the cyclicality inherent in the traditional construction industry.

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

        Installation Services.    Installation services consist of "design and build" and "plan and spec" projects. In "design and build" projects, the commercial HVAC company 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 company. Companies that specialize in "design and build" projects generally have specially-trained HVAC engineers, CAD/CAM design systems and in-house sheet metal and prefabrication capabilities. These companies use a consultative approach with customers and tend to develop long-term relationships with building owners and developers, general contractors, architects, consulting engineers and property managers. "Plan and spec" installation refers to projects in which a third-party architect or consulting engineer designs the HVAC systems and the installation project is "put out for bid." We believe that "plan and spec" projects usually take longer to complete than "design and build" projects because the system design and installation process generally are not integrated, thus resulting in more frequent adjustments to the technical specifications of the project and corresponding changes in work requirements and schedules. These adjustments can occur during the bid process or during the project itself, in either case adding weeks or months to the project schedule.

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Furthermore, in "plan and spec" projects, the HVAC company is not responsible for project design and other parties must also approve any changes, thereby increasing overall project time and cost.

        Maintenance, Repair and Replacement Services.    These services include maintaining, repairing, replacing, reconfiguring and monitoring previously installed HVAC systems and building automation controls. The growth and aging of the installed base of HVAC systems and the demand for more efficient and sophisticated systems and building automation controls have fueled growth in this service line. The increasing complexity of these HVAC systems is leading many commercial, industrial and institutional building owners and property managers to increase attention to maintenance and to outsource maintenance and repair, often through service agreements with HVAC service providers. In addition, further restrictions have been 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 employed directly by a building owner or manager has not received this training. Increasingly, HVAC systems in commercial, industrial and institutional buildings are being remotely monitored through computer-based communications systems to improve energy efficiency and expedite problem diagnosis and correction, thereby allowing us to provide maintenance and repair services at a lower cost.

Strategy

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

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

        Achieve Operating Efficiencies.    We think we can achieve operating efficiencies and cost savings through purchasing economies, adopting "best practices" operating programs, and focusing on job management to deliver services in a cost-effective and efficient manner. We have placed great emphasis on improving the "job loop" at our locations—qualifying, estimating, pricing and executing projects effectively and efficiently, then promptly assessing project experience for applicability to current and future projects. We also use our combined purchasing to gain volume discounts on products and services such as HVAC components, raw materials, services, vehicles, bonding, insurance and employee benefits.

        Attract, Retain and Invest in our Employees.    We seek to attract and retain quality employees by providing them an enhanced career path from working for a larger company, the opportunity to realize a more stable income and attractive benefits packages. Over the past few years we have substantially increased our investment in training, including programs for project managers, field superintendents, service managers, sales managers, estimators, and more recently, leadership and development of key managers and leaders. We believe these programs can lead to significantly increased efficiency and growth.

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

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architects. We believe that although the end-use is ultimately residential, large multi-family projects have many of the same characteristics as commercial construction. Although we plan to continue our involvement in multi-family work, we have decided to focus a portion of our resources away from this work and we expect that as a result, the portion of our work that is multi-family will diminish somewhat in the future. Approximately 98% of our consolidated 2007 revenues were derived from commercial, industrial, and institutional customers and large multi-family residential projects.

        Leveraging Resources and Capabilities.    We believe significant operating efficiencies can be achieved by leveraging resources among our operating locations. For example, we have shifted certain prefabrication activities into centralized locations thereby increasing asset utilization in these centralized locations and redirecting prefabrication employees into other operational areas. We also allocate our engineering, field and supervisory labor from one operation to another to more fully use our employee base, meet our customers' needs, and share expertise. We believe we have realized scale benefits from combining purchasing, insurance, benefits, bonding, and financing activities across our operations. We also believe larger regional and national commercial, industrial, and institutional entities can benefit from consolidating their HVAC needs with service companies that are capable of providing those services regionally or nationally. In response to this opportunity, we operate a national call center to dispatch technicians to regional and national sites requiring service and use web-based proprietary information systems to maintain information on the customer's sites and equipment.

        Maintain a Diverse Customer, Geographic and Project Base.    We have what we believe is a well-diversified distribution of revenues across end-use sectors that reduces our exposure to negative developments in any given sector. We also believe we have a reasonable degree of geographical diversification, again reducing our exposure to negative developments in any given region. Our distribution of revenues in 2007 by end-use sector was as follows:

Multi-Family   19 %
Office Buildings   15 %
Education   14 %
Manufacturing   12 %
Healthcare   11 %
Government   9 %
Retail/Restaurants   9 %
Lodging and Entertainment   3 %
Residential   2 %
Distribution   1 %
Religious/Not for profit   1 %
Other   4 %
   
 
Total   100 %
   
 

        Approximately 86% of our revenues are earned on a project basis for installation of HVAC systems in newly constructed facilities or for replacement of HVAC systems in existing facilities. As of December 31, 2007, we had 4,040 projects in process with an aggregate contract value of approximately $1,757.0 million. Our average project takes six to nine months to complete, with an average contract price of approximately $435,000. This relatively small average project size, when taken together with the approximately 14% of our revenues derived from maintenance and service, provides us with what we

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believe is a reasonably broad base of work for a company involved in the construction services sector. A stratification of projects in progress as of December 31, 2007, by contract price is as follows:

Contract Price of Project

  No. of
Projects

  Aggregate Contract
Price Value (millions)

Under $1 million   3,751   $ 644.0
$1 million-$5 million   216     491.8
$5 million-$10 million   55     361.4
$10 million-$15 million   14     182.7
$15 million-$27 million   4     77.1
   
 

Total

 

4,040

 

$

1,757.0
   
 

        Seek Growth Through Expansion and Acquisitions.    We believe that we can increase our operating income by opportunistically entering new markets or service lines through expansion and acquisition. We have based such expansion on existing customers, relationships or expertise, and expect to selectively pursue such opportunities in the future. We continually seek opportunities to acquire businesses that have attractive valuations and meet other criteria involving financial, operational, management, and geographic considerations.

        We are investing in initiatives to expand the proportion of our revenues that are service based. We are actively concentrating our existing managerial resources and training and hiring experienced employees to procure and profitably perform service work. In some locations we have added service capability, and we believe our investments and efforts will stimulate growth in all aspects of the commercial HVAC and service and repair business.

Operations and Services Provided

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

        Installation Services.    Our installation business related to newly constructed facilities, which comprised approximately 56% of our consolidated 2007 revenues, involves the design, engineering, integration, installation and start-up of HVAC, building automation controls and related systems. We provide "design and build" and "plan and spec" installation services for office buildings, retail centers, apartment complexes, manufacturing plants, health care, education and government facilities and other commercial, industrial, and institutional facilities. In a "design and build" installation, working with the customer, we determine the needed capacity and energy efficiency of the HVAC system that best suits the proposed facility. We then estimate 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 plan. In "plan and spec" installation, we participate in a bid process to provide labor,

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equipment, materials and installation based on plans and engineering specifications provided by a customer, general contractor or consulting engineer.

        Once an agreement has been reached, we order the necessary materials and equipment for delivery to meet the project schedule. In many instances, we fabricate the ductwork and piping and assemble certain components for the system based on the mechanical drawing specifications, eliminating the need to subcontract ductwork or piping fabrication. Then we install the system at the project site, working closely with the general contractor. Our average project takes six to nine months to complete, with an average contract price of approximately $435,000. We also perform larger project work, with 289 contracts in progress at December 31, 2007 with contract prices in excess of $1 million. Our largest project currently in progress has a contract price of $26.3 million. Project contracts typically provide for periodic billings to the customer as we meet progress milestones or incur cost on the project. Project contracts in our industry also frequently allow for a small portion of progress billings or contract price to be withheld by the customer until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage.

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

        Maintenance, Repair and Replacement Services.    Our maintenance, repair and replacement services comprised approximately 44% of our consolidated 2007 revenues and include the maintenance, repair, replacement, reconfiguration and monitoring of HVAC systems and industrial process piping. Approximately two-thirds of our maintenance, repair and replacement revenues were derived from replacing and reconfiguring existing HVAC systems for commercial, industrial, and institutional customers. Replacement and reconfiguration are usually performed on a project basis and often use consultative expertise similar to that provided in the "design and build" installation market.

        Maintenance and repair services are provided either in response to service calls or under a service agreement. Service calls are coordinated by customer service representatives or dispatchers that use computer and communication technology to process orders, arrange service calls, communicate with customers, dispatch technicians and invoice customers. Service technicians work from service vehicles equipped with commonly used parts, supplies and tools to complete a variety of jobs. Commercial, industrial and institutional service agreements usually have terms of one to three years, with automatic annual renewals, and typically with 30-60 day cancellation notice periods. We also provide remote monitoring of temperature, pressure, humidity and air flow for HVAC systems. If the system is not operating within the specifications set forth by the customer and cannot be remotely adjusted, a service crew is dispatched to analyze and repair the system.

Sources of Supply

        The raw materials and components we use include HVAC system components, ductwork, steel, sheet metal and copper tubing and piping. These raw materials and components are generally available from a variety of domestic or foreign suppliers at competitive prices. Delivery times are typically short for most raw materials and standard components, but during periods of peak demand, may extend to

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one month or more. Over the last two years, many steel, iron and copper products, in particular, have experienced significant price fluctuation and some constrained availability. We estimate that direct purchase of these commodities comprises between 10% and 15% of our average project cost. We began taking steps early in 2004 to reduce commodity cost exposure. Among these steps were early buying of commodities for particular projects, or for general inventory, as well as including escalation and escape provisions in project bids and contracts wherever possible. The negative effects of unrecovered commodity cost inflation in our project results have been modest, and are reviewed further in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" later in this report.

        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 Carrier, Lennox, McQuay, Trane and York. The major suppliers of building automation control systems are Honeywell, Johnson Controls, Siemens, York, Automated Logic, Novar and Andover Control Corporation. We do not have any significant contracts guaranteeing us a supply of raw materials or components.

        We administer a portion of our procurement activities with Emcor Group, a larger publicly-held provider of electrical and mechanical services and facilities management. This coordination includes contractual arrangements with Emcor under which certain Emcor employees provide procurement management services to us.

Seasonality and Cyclicality

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

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

Sales and Marketing

        We have a diverse customer base, with no single customer accounting for more than 4% of consolidated 2007 revenues. Management and a dedicated sales force are responsible for developing and maintaining successful long-term relationships with key customers. Customers generally include building owners and developers and property managers, as well as general contractors, architects and consulting engineers. We intend to continue our emphasis on developing and maintaining long-term relationships with our customers by providing superior, high-quality service in a professional manner. We believe we can continue to leverage the diverse technical and marketing strengths at individual locations to expand the services offered in other local markets. With respect to multi-location service opportunities, we maintain a national sales force in our national accounts group.

Employees

        As of December 31, 2007, we had 6,461 employees. We have collective bargaining agreements covering 6 employees. We have not experienced and do not expect any significant strikes or work stoppages and believe our relations with employees covered by collective bargaining agreements are good.

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Recruiting, Training and Safety

        Our continued success depends, in part, on our ability to continue to attract, retain and motivate qualified engineers, service technicians, field supervisors and project managers. We believe our success in retaining qualified employees will be based on the quality of our recruiting, training, compensation, employee benefits programs and opportunities for advancement. We provide on-the-job training, technical training, apprenticeship programs, attractive benefit packages and career advancement opportunities within our company.

        We have established comprehensive safety programs throughout our operations to ensure that all technicians comply with safety standards we have established and that are established under federal, state and local laws and regulations. Additionally, we have implemented a "best practices" safety program throughout our operations, which provides employees with incentives to improve safety performance and decrease workplace accidents. Regional safety directors establish safety programs and benchmarking to improve safety within their region. Finally, our employment screening process seeks to determine that prospective employees have requisite skills, sufficient background references and acceptable driving records, if applicable. Our rate of incidents recordable under the standards of the Occupational Safety and Health Administration ("OSHA") per 100 employees per year, also known as the OSHA recordable rate, was 3.20 during 2007. This level was 56% better than the most recently published OSHA rate for our industry. We have improved our OSHA recordable rate every year since we first began tracking it nine years ago.

Risk Management, Insurance and Litigation

        The primary risks in our operations are bodily injury, property damage and workers' compensation injuries. We retain the risk for worker's compensation, employer's liability, auto liability, general liability and employee group health claims resulting from uninsured deductibles per incident or occurrence. Because we have very large deductibles, the vast majority of our claims are paid by us, so as a practical matter we self-insure the great majority of these risks. Losses up to such per-incident deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages utilizing the assistance of an actuary to project the extent of these obligations.

        We are subject to certain claims and lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in our consolidated financial statements. While we cannot predict the outcome of these proceedings, in our opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results or financial condition, after giving effect to provisions already recorded.

        In addition to the matters described above, we have accrued $6.2 million for potential and asserted backcharges from several customers of our large multi-family operation based in Texas. The related expense is included in "Costs of Services" and the accrual is included in "Other Current Liabilities". We believe these accruals reflect a probable outcome with respect to such backcharges and potential backcharges, however, if we are not successful in resolving these disputes, we may in the future experience a material adverse effect on our operating results.

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

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Competition

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

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

Vehicles

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

Governmental Regulation and Environmental Matters

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

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

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

Executive Officers

        We have five executive officers.

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        William F. Murdy, age 66, has served as our Chairman of the Board and Chief Executive Officer since June 2000. Prior to this he was Interim President and Chief Executive Officer of Club Quarters, a privately-owned chain of membership hotels. From January 1998 through July 1999, Mr. Murdy served as President, Chief Executive Officer and Chairman of the Board of LandCare USA, a publicly-traded commercial landscape and tree services company. He was primarily responsible for organizing LandCare USA and its listing as a publicly-traded company on the New York Stock Exchange in July 1998. LandCare USA was acquired in July 1999 by another publicly-traded company specializing in services to homeowners and commercial facilities. From 1989 through December 1997, Mr. Murdy was President and Chief Executive Officer of General Investment and Development Company, a privately-held real estate operating company. From 1981 to 1989, Mr. Murdy served as the Managing General Partner of the Morgan Stanley Venture Capital Fund. From 1974 to 1981, Mr. Murdy served as the Senior Vice President, among other positions, of Pacific Resources, Inc., a publicly-traded company involved primarily in petroleum refining and marketing.

        Thomas N. Tanner, age 59, has served as our Executive Vice President and Chief Operating Officer since May 2005, was our Senior Vice President and Chief Operating Officer from June 2004 to May 2005, and served as Senior Vice President, Operations from January 2004 to May 2004. From May 2001 to December 2003, Mr. Tanner was our East Region Vice President and from May 1999 to May 2001 was our East Region Controller. From September 1980 until May 1999, Mr. Tanner was Vice President and Chief Financial Officer of three related companies that were ultimately acquired by Comfort Systems: Armani Plumbing and Mechanical, Inc., Woodcock & Associates, Inc., and abj Fire Protection Co., Inc.

        William George, age 43, has served as our Executive Vice President and Chief Financial Officer since May 2005, was our Senior Vice President, General Counsel and Secretary from May 1998 to May 2005, and was our Vice President, General Counsel and Secretary from March 1997 to April 1998. From October 1995 to February 1997, Mr. George was Vice President and General Counsel of American Medical Response, Inc., a publicly-traded healthcare transportation company. From September 1992 to September 1995, Mr. George practiced corporate and antitrust law at Ropes & Gray, a Boston, Massachusetts law firm.

        Julie S. Shaeff, age 42, has served as our Senior Vice President and Chief Accounting Officer since May 2005, was our Vice President and Corporate Controller from March 2002 to May 2005, and was our Assistant Corporate Controller from September 1999 to February 2002. From 1996 to August 1999, Ms. Shaeff was Financial Accounting Manager—Corporate Controllers Group for Browning-Ferris Industries, Inc., a publicly-traded waste services company. From 1987 to 1995, she held various positions with Arthur Andersen LLP. Ms. Shaeff is a Certified Public Accountant.

        Trent T. McKenna, age 35, has served as our Vice President, General Counsel and Secretary since May 2005 and was our Associate General Counsel from August 2004 to May 2005. From February 1999 to August 2004, Mr. McKenna was a practicing attorney in the area of complex commercial litigation in the Houston, TX office of Akin Gump Strauss Hauer & Feld LLP, an international law firm.


ITEM 1A. Company Risk Factors

Our business is subject to a variety of risks. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not known to us or not described below, which we have not determined to be material, may also impair our business operations. You should carefully consider the risks described below, together with all the information included in this report. Our business, financial condition and results of operations could be adversely affected by the occurrence of any risk. Such risk events may cause actual results to differ materially from expected and historical results, and the trading price of our common stock could decline.

11


Because we bear the risk of cost overruns in most of our contracts, we may experience reduced profits or, in some cases, losses under these contracts if costs increase above our estimates.

        Our contract prices are established largely upon estimates and assumptions, which include assumptions about future economic conditions, prices and availability of labor, equipment and materials and other factors outside our control. If these estimates prove to be inaccurate or circumstances change such as unanticipated technical problems, difficulties in obtaining permits or approvals, changes in local laws or labor conditions, weather delays, fluctuations in cost of raw materials, or our suppliers' or subcontractors' inability to perform, cost overruns may occur, and we could experience reduced profits or a loss for the project. Additionally, in certain circumstances, we guarantee project completion or the achievement of certain acceptance and performance testing levels by a scheduled date. Failure to meet schedule or performance requirements could result in additional costs to us. While we may seek to recover these amounts as claims from the supplier, vendor, subcontractor or other third party responsible for the delay or for providing non-conforming products or services, we cannot be certain that we will recover all or any part of these costs in all circumstances. Performance problems for existing and future projects could cause our actual results of operations to differ materially from those anticipated by us as well as damaging our reputation within our industry and our customer base.

Our backlog is subject to unexpected adjustments and cancellations, which means that amounts included in our backlog may not result in actual revenue or translate into profits.

        We cannot guarantee that the revenues projected in our backlog will be realized or, if realized, will result in profits. Projects may remain in our backlog for an extended period of time or project cancellations or scope adjustments may occur with respect to contracts reflected in our backlog. Finally, poor project or contract performance could also impact our profits. The revenue projected from our backlog may not be realized or, if realized, may not result in profits.

We may be adversely impacted by the seasonal and cyclical nature of the markets we serve, and an economic downturn in the industries we serve may result in certain of our customers being unable to pay us on a timely basis, or at all, and lead to a decrease in demand for our services.

        The demand for our services is dependent upon the existence of construction projects and service requirements within the industries in which we operate. Any downturn in the commercial, industrial and institutional HVAC markets or any other of our markets could adversely impact our performance. The industries we operate in have been and will continue to be vulnerable to general downturns and are cyclical in nature. As a result, our results may vary depending upon the demand for projects within the industries we serve.

A significant portion of our business depends on our ability to provide surety bonds. We may be unable to compete for work on certain projects if we are not able to obtain the necessary surety bonds.

        In the past we have expanded and we intend to continue to expand the number of total contract dollars that require an underlying bond. Surety market conditions are currently difficult as a result of significant losses incurred by many surety companies. Consequently, less overall bonding capacity is available in the market and terms have become more expensive and restrictive. We may not be able to maintain a sufficient level of bonding capacity in the future, which could preclude us from being able to bid for certain contracts and successfully contract with certain customers. Additionally, even if we are able to successfully increase bonding capacity to sufficiently bond future work, we may be required to post collateral to secure bonds which would decrease the liquidity that we would have available for other purposes. If our surety companies were to limit or eliminate our access to bonding, our alternatives would include seeking bonding capacity from other surety companies, increasing business with clients that do not require bonds and posting other forms of collateral for project performance, such as letters of credit or cash. We may be unable to secure these alternatives in a timely manner, on

12



acceptable terms, or at all. As such, if we were to experience an interruption or reduction in the availability of bonding capacity, it is likely we would be unable to compete for or work on certain projects.

Our use of the percentage-of-completion method of accounting could result in a reduction or reversal of previously recorded revenues or profits.

        A material portion of our revenues are recognized using the percentage-of-completion method of accounting. The percentage-of-completion accounting practices that we use result in our recognizing contract revenues and earnings ratably over the contract term in the proportion that our actual costs bear to our estimated contract costs. The earnings or losses recognized on individual contracts are based on estimates of contract revenues, costs and profitability. We review our estimates of contract revenues, costs and profitability on an ongoing basis. Prior to contract completion, we may adjust our estimates on one or more occasions as a result of change orders to the original contract, collection disputes with the customer on amounts invoiced or claims against the customer for increased costs incurred by us due to customer-induced delays and other factors. Contract losses are recognized in the fiscal period when the loss is determined. Contract profit estimates are also adjusted in the fiscal period in which it is determined that an adjustment is required. As a result of the requirements of the percentage-of-completion method of accounting, the possibility exists, for example, that we could have estimated and reported a profit on a contract over several periods and later determined, usually near contract completion, that all or a portion of such previously estimated and reported profits were overstated. If this occurs, the full aggregate amount of the overstatement will be reported for the period in which such determination is made, thereby eliminating all or a portion of any profits from other contracts that would have otherwise been reported in such period or even resulting in a loss being reported for such period. On a historical basis, we believe that we have made reasonably reliable estimates of the progress towards completion on our long-term contracts. However, given the uncertainties associated with these types of contracts, it is possible for actual costs to vary from estimates previously made, which may result in reductions or reversals of previously recorded revenues and profits.

Intense competition in our industry could reduce our market share and our profits.

        The markets we serve are highly competitive. Our industry is characterized by many small companies whose activities are geographically concentrated. We compete on the basis of our technical expertise and experience, financial and operational resources, nationwide presence, industry reputation and our dependability. While we believe our customers consider a number of these factors in awarding available contracts, a large portion of our work is awarded through a bid process. Consequently, price is often the principal factor in determining which contractor is selected, especially on smaller, less complex projects. Smaller competitors are sometimes able to win bids for these projects based on price alone due to their lower cost and financial return requirements. Intense competition is expected to continue in our industry, presenting us with significant challenges in our ability to maintain strong growth rates and acceptable profit margins. If we are unable to meet these competitive challenges, we could lose market share to our competitors and experience an overall reduction in our profits.

If we are unable to attract and retain qualified managers and employees, we will be unable to operate efficiently, which could reduce our profitability.

        Our business is labor intensive, and many of our operations experience a high rate of employment turnover. At times of low unemployment rates in the United States, it will be more difficult for us to find qualified personnel at low cost in some geographic areas where we operate. Additionally, our business is managed by a small number of key executive and operational officers. We may be unable to hire and retain the sufficient skilled labor force necessary to operate efficiently and to support our

13



growth strategy. Our labor expenses may increase as a result of a shortage in the supply of skilled personnel. Labor shortages, increased labor costs or the loss of key personnel could result in reduced profitability, which would negatively impact our business.

Past and future environmental, safety and health regulations could impose significant additional costs on us that reduce our profits.

        HVAC systems are subject to various environmental statutes and regulations, including the Clean Air Act and those regulating the production, servicing and disposal of certain ozone depleting refrigerants used in HVAC systems. There can be no assurance that the regulatory environment in which we operate will not change significantly in the future. Various local, state and federal laws and regulations impose licensing standards on technicians who install and service HVAC systems. Our failure to comply with these laws and regulations could subject us to substantial fines and potentially the loss of our licenses. It is impossible to predict the full nature and effect of judicial, legislative or regulatory developments relating to health and safety regulations and environmental protection regulations applicable to our operations.

We are effectively self-insured against many potential liabilities, and our risk management policies and procedures may leave us exposed to unidentified or unanticipated risks.

        Although we maintain insurance policies with respect to our related exposures, these policies are subject to high deductibles; as such, we are effectively self-insured for substantially most of our claims. We actuarially determine any liabilities for unpaid claims and associated expenses for the three major lines of coverage (Worker's Compensation, General Liability and Auto Liability). The determination of such claims and expenses and the appropriateness of the estimated liability are reviewed and updated quarterly. However, insurance liabilities are difficult to assess and estimate due to the many relevant factors, the effects of which are often unknown, including the severity of an injury, the determination of our liability in proportion to other parties, the number of incidents that have occurred but are not reported and the effectiveness of our safety program. Our accruals are based upon known facts, historical trends (both internal trends and industry averages) and our reasonable estimate of our future expenses and we believe such accruals to be adequate. However, our risk management strategies and techniques may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk. If any of the variety of instruments, processes and strategies we utilize to manage our exposure to various types of risk are not effective, we may incur losses that are not covered by our insurance policies or that exceed our accruals or that exceed our coverage limits.

If we experience delays and/or defaults in customer payments, we could be unable to recover all expenditures.

        Because of the nature of our contracts, at times we commit resources to projects prior to receiving payments from the customer in amounts sufficient to cover expenditures on projects as they are incurred. Delays in customer payments may require us to make a working capital investment. If a customer defaults in making its payments on a project in which we have devoted resources, it could have a material negative effect on our results of operations.

Actual and potential claims, lawsuits and proceedings could ultimately reduce our profitability and liquidity and weaken our financial condition.

        We are likely to continue to be named as a defendant in legal proceedings claiming damages from us in connection with the operation of our business. Most of the actions against us arise out of the normal course of our performing services on project sites. We also are and are likely to continue to be a plaintiff in legal proceedings against customers, in which we seek to recover payment of contractual amounts due to us as well as claims for increased costs incurred by us. When appropriate we establish provisions against possible certain exposures, and we adjust such provisions from time to time according

14



to ongoing exposure. If in the future our assumptions and estimates related to such exposures prove to be inadequate or wrong, we could experience a reduction in our profitability and liquidity and a weakening of our financial condition. In addition, claims, lawsuits and proceedings may harm our reputation or divert management resources away from operating our business.

Our recent and future acquisitions may not be successful.

        We expect to continue to pursue extremely selective acquisitions of businesses. We cannot assure you that we will be able to locate acquisitions or that we will be able to consummate any such transactions on terms and conditions acceptable to us, or that such transactions will be successful. Acquisitions may expose us to additional business risks that are different than those we have traditionally experienced. We also may encounter difficulties integrating acquisitions and successfully managing the growth we expect to experience from these acquisitions.

        We may choose to finance future acquisitions with debt, equity, cash or a combination of the three. We can give no assurances that such future acquisitions will not be dilutive to earnings or disruptive to the payment of a shareholder dividend. To the extent that we are successful in making acquisitions, such acquisitions involve a number of risks, including, but not limited to:

        The failure to successfully integrate acquisitions could have an adverse effect on our business, financial condition and results of operations.

Our common stock, which is listed on the New York Stock Exchange, has from time-to-time experienced significant price and volume fluctuations. These fluctuations are likely to continue in the future, and our stockholders may not be able to resell their shares of common stock at or above the purchase price paid.

        The market price of our common stock may change significantly in response to various factors and events beyond our control. A variety of events may cause the market price of our common stock to fluctuate significantly, including the following: (i) the risk factors described in this Report on Form 10-K; (ii) a shortfall in operating revenue or net income from that expected by securities analysts and investors; (iii) changes in securities analysts' estimates of our financial performance or the financial performance of our competitors or companies in our industry generally; (iv) general conditions in our customers' industries; (v) general conditions in the securities markets; (vi) our announcements of significant contracts, milestones, acquisitions; (vii) our relationship with other companies; (viii) our investors' view of the sectors and markets in which we operate; and (ix) additions or departures of key personnel. Some companies that have volatile market prices for their securities have been subject to security class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion of our management's attention and resources. This could have a material adverse effect on our business, results of operations and financial condition.

15


If we do not effectively manage our growth, our existing infrastructure may become strained, and we may be unable to increase revenue growth.

        The growth that we have experienced, and in the future may experience, may provide challenges to our organization, requiring us to expand our personnel and our operations. Future growth may strain our infrastructure, operations and other managerial and operating resources. If our business resources become strained, our earnings may be adversely affected and we may be unable to increase revenue growth. Further, we may undertake contractual commitments that exceed our labor resources, which could also adversely affect our earnings and our ability to increase revenue growth.

Our earnings have previously been negatively impacted by goodwill impairment charges. Earnings for future periods may be further affected by additional impairment charges.

        When we acquire a business, we record an asset called "goodwill" equal to the excess amount paid for the business, including liabilities assumed, over the fair value of the tangible and intangible assets of the business acquired. In 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 141, which requires that all business combinations be accounted for using the purchase method of accounting and that certain intangible assets acquired in a business combination be recognized as assets apart from goodwill. Also in 2001, the FASB issued SFAS No. 142, which provides that goodwill and other intangible assets that have indefinite useful lives not be amortized, but instead must be tested at least annually for impairment, and intangible assets that have finite useful lives should continue to be amortized over their useful lives. SFAS No. 142 also provides specific guidance for testing goodwill and other non-amortized intangible assets for impairment. SFAS No. 142 requires management to make certain estimates and assumptions to allocate goodwill to reporting units and to determine the fair value of reporting unit net assets and liabilities, including, among other things, an assessment of market conditions, projected cash flows, investment rates, cost of capital and growth rates, which could significantly impact the reported value of goodwill and other intangible assets. We perform an annual goodwill impairment review in the fourth quarter of every fiscal year. Additionally, we perform a goodwill impairment review whenever events or changes in circumstances indicate the carrying value may not be recoverable. At some future date we may determine that an additional significant impairment has occurred in the value of our unamortized intangible assets or fixed assets, which could require us to write off an additional portion of our assets and could adversely affect our financial condition or our reported results of operations.

Failure or circumvention of our disclosure controls and procedures or internal controls over financial reporting could seriously harm our business.

        We plan to continue to maintain and strengthen internal controls and procedures to enhance the effectiveness of our disclosure controls and internal controls over financial reporting. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, and not absolute, assurances that the objectives of the system are met. Any failure of our disclosure controls and procedures or internal controls over financial reporting could harm our financial condition and results of operations.

Our charter contains certain anti-takeover provisions that may inhibit or delay a change in control.

        Our certificate of incorporation authorizes our Board of Directors to issue, without stockholder approval, one or more series of preferred stock having such preferences, powers and relative, participating, optional and other rights (including preferences over the common stock respecting dividends and distributions and voting rights) as the Board of Directors may determine. The issuance of this "blank-check" preferred stock could render more difficult or discourage an attempt to obtain control by means of a tender offer, merger, proxy contest or otherwise. Additionally, certain provisions

16



of the Delaware General Corporation Law may also discourage takeover attempts that have not been approved by the Board of Directors.

Failure to successfully comply with Section 404 of the Sarbanes-Oxley Act of 2002 on a timely basis could seriously harm our business.

        Section 404 of the Sarbanes-Oxley Act of 2002 requires our management to report on our internal controls over financial reporting and also requires our independent registered public accountants to attest to this report. Although we have historically been able to successfully comply with Section 404, in the future, we may not be successful in complying with Section 404 on a timely basis. The failure to comply with Section 404 could harm our financial condition and results of operations.


ITEM 1B. Unresolved Staff Comments

        None.


ITEM 2. Properties

        We lease the real property and buildings from which we operate. Our facilities are located in over twenty-five states and Puerto Rico and consist of offices, shops, maintenance and warehouse facilities. Generally, leases range from three to ten years and are on terms we believe to be commercially reasonable. A majority of these premises are leased from individuals or entities with whom we have no other business relationship. In certain instances these leases are with current or former employees. To the extent we renew, enter into leases or otherwise change leases with current or former employees, we enter into such agreements on terms that reflect a fair market valuation for the properties. Leased premises range in size from approximately 1,000 square feet to 130,000 square feet. To maximize available capital, we generally intend to continue to lease our properties, but may consider owning properties where we believe ownership would be more economical. We believe that our facilities are sufficient for our current needs.

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


ITEM 3. Legal Proceedings

        We are subject to certain claims and lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in our consolidated financial statements. While we cannot predict the outcome of these proceedings, in our opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results or financial condition, after giving effect to provisions already recorded.


ITEM 4. Submission of Matters to a Vote of Security Holders

        None.

17



PART II

ITEM 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

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

 
  High
  Low
  Cash
Dividends
Declared

First Quarter, 2006   $ 13.66   $ 8.88   $ 0.035
Second Quarter, 2006   $ 15.72   $ 11.82   $ 0.035
Third Quarter, 2006   $ 14.50   $ 11.42   $ 0.035
Fourth Quarter, 2006   $ 14.08   $ 10.42   $ 0.035
First Quarter, 2007   $ 14.00   $ 11.73   $ 0.035
Second Quarter, 2007   $ 14.54   $ 11.75   $ 0.035
Third Quarter, 2007   $ 18.30   $ 12.14   $ 0.035
Fourth Quarter, 2007   $ 15.54   $ 10.90   $ 0.045

        As of February 25, 2008, there were approximately 436 stockholders of record of our Common Stock, and the last reported sale price on that date was $11.38 per share.

        We expect to continue paying cash dividends quarterly although there is no assurance as to future dividends because they depend on future earnings, capital requirements, and financial condition. In addition, our revolving credit agreement limits the amount of dividends we can pay at any time that the ratio of our total indebtedness less cash and cash equivalents to our Credit Facility Adjusted EBITDA exceeds 1.0.

        The following Corporate Performance Graph and related information shall not be deemed "soliciting material" or to be "filed" with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Comfort Systems USA, Inc., The S&P 500 Index
And the Russell 2000 Index

GRAPHIC

*
$100 invested on 12/31/02 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.

Copyright © 2008, Standard & Poor's, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

18


Recent Sales of Unregistered Securities

        None.

Issuer Purchases of Equity Securities

        On March 29, 2007, our Board of Directors (the "Board") approved a stock repurchase program to acquire up to one million shares of our outstanding common stock. On November 16, 2007, the Board approved an extension of our stock repurchase program to cover an additional 401,200 shares of our outstanding common stock. The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. During the year ended December 31, 2007, we purchased our common shares in the following amounts at the following average prices:

Period

  Total
Number of
Shares
Purchased

  Average
Price Paid
Per Share

  Total Number of
Shares Purchased as
Part of Publicly
Announced Plans or
Programs

  Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs

April 1-April 30     $     1,000,000

May 1-May 31

 

10,000

 

$

13.80

 

10,000

 

990,000

June 1-June 30

 

3,400

 

$

13.48

 

13,400

 

986,600

July 1-July 31

 

25,100

 

$

13.16

 

38,500

 

961,500

August 1-August 31

 

126,700

 

$

14.18

 

165,200

 

834,800

September 1-September 30

 

96,100

 

$

14.35

 

261,300

 

738,700

October 1-October 31

 

2,100

 

$

14.17

 

263,400

 

736,600

November 1-November 30

 

419,600

 

$

12.56

 

683,000

 

718,200

December 1-December 31

 

176,900

 

$

11.67

 

859,900

 

541,300
   
       
 

 

 

859,900

 

$

12.87

 

859,900

 

541,300
   
             

19



ITEM 6. Selected Financial Data

        The following selected historical financial data has been derived from our audited financial statements and should be read in conjunction with the historical Consolidated Financial Statements and related notes.

 
  Year Ended December 31,
 
  2003
  2004
  2005
  2006
  2007
 
  (in thousands)

STATEMENT OF OPERATIONS DATA:                              
  Revenues   $ 732,025   $ 767,358   $ 892,549   $ 1,056,525   $ 1,109,534
  Operating income(a)   $ 5,907   $ 24,089   $ 1,065   $ 44,522   $ 49,871
  Income (loss) from continuing operations   $ (807 ) $ 13,679   $ (14,869 ) $ 28,717   $ 32,466
  Discontinued operations—                              
    Operating results, net of tax   $ 438   $ (3,447 ) $ (1,309 ) $ (203 ) $
    Estimated gain (loss) on disposition, including tax   $ (5,210 ) $ 481   $ 9,952   $ 210   $
  Net income (loss)   $ (5,579 ) $ 10,713   $ (6,226 ) $ 28,724   $ 32,466
 
Income (loss) per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
  Basic—                              
  Income (loss) from continuing operations   $ (0.02 ) $ 0.36   $ (0.38 ) $ 0.71   $ 0.80
  Discontinued operations—                              
    Income (loss) from operations     0.01     (0.09 )   (0.03 )   (0.01 )  
    Estimated gain (loss) on disposition     (0.14 )   0.01     0.25     0.01    
   
 
 
 
 
  Net income (loss)   $ (0.15 ) $ 0.28   $ (0.16 ) $ 0.71   $ 0.80
   
 
 
 
 
  Diluted—                              
  Income (loss) from continuing operations   $ (0.04 ) $ 0.35   $ (0.38 ) $ 0.70   $ 0.79
  Discontinued operations—                              
    Income (loss) from operations     0.01     (0.09 )   (0.03 )   (0.01 )  
    Estimated gain (loss) on disposition     (0.14 )   0.01     0.25     0.01    
   
 
 
 
 
  Net income (loss)   $ (0.17 ) $ 0.27   $ (0.16 ) $ 0.70   $ 0.79
   
 
 
 
 
  Cash dividends per share           $ 0.025   $ 0.140   $ 0.150
   
 
 
 
 
BALANCE SHEET DATA:                              
  Working capital   $ 93,003   $ 106,478   $ 130,915   $ 158,811   $ 168,930
  Total assets   $ 351,110   $ 383,116   $ 408,683   $ 461,765   $ 547,067
  Total debt, excluding discount   $ 10,394   $ 8,822   $   $   $ 1,500
  Total stockholders' equity   $ 200,660   $ 216,597   $ 213,523   $ 242,714   $ 262,578

(a)
Included in operating income are goodwill impairment charges of $2.7 million, $0.6 million and $33.9 million for 2003, 2004 and 2005. There are no goodwill impairment charges for 2006 and 2007.

20



ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this annual report on Form 10-K. Also see "Forward-Looking Statements" discussion.

Introduction and Overview

        We are a national provider of comprehensive HVAC installation, maintenance, repair and replacement services within the mechanical services industry. The services we provide address a very broad need, as air is circulated through almost all commercial, industrial and institutional buildings virtually year-round. We operate primarily in the commercial, industrial and institutional HVAC markets and perform most of our services within office buildings, retail centers, apartment complexes, manufacturing plants, and healthcare, education and government facilities. In addition to standard HVAC services, we provide specialized applications such as building automation control systems, fire protection, process cooling, electronic monitoring and process piping. Certain locations also perform related activities such as electrical service and plumbing.

        Approximately 86% of our revenues are earned on a project basis for installation of HVAC systems in newly constructed facilities or for replacement of HVAC systems in existing facilities. Customers hire us to ensure such systems deliver specified or generally expected heating, cooling, conditioning and circulation of air in a facility. This entails installing core system equipment such as packaged heating and air conditioning units, or in the case of larger facilities, separate core components such as chillers, boilers, air handlers, and cooling towers. We also typically install connecting and distribution elements such as piping and ducting. Our responsibilities usually require conforming the systems to pre-established engineering drawings and equipment and performance specifications, which we frequently participate in establishing. Our project management responsibilities include staging equipment and materials to project sites, deploying labor to perform the work, and coordinating with other service providers on the project, including any subcontractors we might use to deliver our portion of the work.

        When competing for project business, we usually estimate the costs we will incur on a project, then propose a bid to the customer that includes a contract price and other performance and payment terms. Our bid price and terms are intended to cover our estimated costs on the project and provide a profit margin to us commensurate with the value of the installed system to the customer, the risk that project costs or duration will vary from estimate, the schedule on which we will be paid, the opportunities for other work that we might forego by committing capacity to this project, and other costs that we incur more broadly to support our operations but which are not specific to the project. Typically customers will seek bids from competitors for a given project. While the criteria on which customers select the winning bid vary widely and include factors such as quality, technical expertise, on-time performance, post-project support and service, and company history and financial strength, we believe that price is the most influential factor for most customers in choosing an HVAC installation and service provider.

        After a customer accepts our bid, we generally enter into a contract with the customer that specifies what we will deliver on the project, what our related responsibilities are, and how much and when we will be paid. Our overall price for the project is typically set at a fixed amount in the contract, although changes in project specifications or work conditions that result in unexpected additional work are usually subject to additional payment from the customer via what are commonly known as change orders. Project contracts typically provide for periodic billings to the customer as we meet progress milestones or incur cost on the project. Project contracts in our industry also frequently allow for a

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small portion of progress billings or contract price to be withheld by the customer until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage.

        Labor and overhead costs account for the majority of our cost of service. Accordingly, labor management and utilization have the most impact on our project performance. Given the fixed price nature of much of our project work, if our initial estimate of project costs is wrong or we incur cost overruns that cannot be recovered in change orders, we can experience reduced profits or even significant losses on fixed price project work. We also perform some project work on a cost-plus or a time and materials basis, under which we are paid our costs incurred plus an agreed-upon profit margin. These margins are typically less than fixed-price contract margins because there is less risk of unrecoverable cost overruns in cost-plus or time and materials work.

        As of December 31, 2007, we had 4,040 projects in process. Our average project takes six to nine months to complete, with an average contract price of approximately $435,000. Our projects generally require working capital funding of equipment and labor costs. Customer payments on periodic billings generally do not recover these costs until late in the job. Our average project duration together with typical retention terms as discussed above generally allow us to complete the realization of revenue and earnings in cash within one year. Because of the integral nature of HVAC and related controls systems to most buildings, we have the legal right in almost all cases to attach liens to buildings or related funding sources when we have not been fully paid for installing systems, except with respect to some government buildings. The service work that we do, which is discussed further below, usually does not give rise to lien rights.

        We also perform larger HVAC projects. As of December 31, 2007, we had four projects in process with a contract price of between $15 and $26 million, 14 projects between $10 million and $15 million, 55 projects between $5 million and $10 million, and 216 projects between $1 million and $5 million. Taken together, projects with contract prices of $1 million or more totaled $1,113.0 million of aggregate contract value as of December 31, 2007, or approximately 63%, out of a total contract value for all projects in progress of $1,757.0 million. Generally, projects closer in size to $1 million will be completed in one year or less. It is unusual for us to work on a project that exceeds two years in length.

        In addition to project work, approximately 14% of our revenues represent maintenance and repair service on already-installed HVAC and controls systems. This kind of work usually takes from a few hours to a few days to perform. Prices to the customer are usually based on the equipment and materials used in the service as well as technician labor time. We usually bill the customer for service work when it is complete, typically with payment terms of up to thirty days. We also provide maintenance and repair service under ongoing contracts. Under these contracts, we are paid regular monthly or quarterly amounts and provide specified service based on customer requirements. These agreements typically cover periods ranging from one to three years and are cancelable on 30 to 60 days notice.

        A relatively small but growing portion of our revenues comes from national and regional account customers. These customers typically have multiple sites, and contract with us to perform maintenance and repair service. These contracts may also provide for us to perform new or replacement systems installation. We operate a national call center to dispatch technicians to sites requiring service. We perform the majority of this work with our own employees, with the balance being subcontracted to third parties that meet our performance qualifications. We will also typically use proprietary information systems to maintain information on the customer's sites and equipment, including performance and service records, and related cost data. These systems track the status of ongoing service and installation work, and may also monitor system performance data. Under these contractual relationships, we usually provide consolidated billing and credit payment terms to the customer.

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        We manage our 40 operating units based on a variety of factors. Financial measures we emphasize include profitability, and use of capital as indicated by cash flow and by other measures of working capital principally involving project cost, billings and receivables. We also monitor selling, general, administrative and indirect project support expense, backlog, workforce size and mix, growth in revenues and profits, variation of actual project cost from original estimate, and overall financial performance in comparison to budget and updated forecasts. Operational factors we emphasize include project selection, estimating, pricing, management and execution practices, labor utilization, safety, training, and the make-up of both existing backlog as well as new business being pursued, in terms of project size, technical application and facility type, end-use customers and industries, and location of the work.

        Most of our operations compete on a local or regional basis. Attracting and retaining effective operating unit managers is an important factor in our business, particularly in view of the relative uniqueness of each market and operation, the importance of relationships with customers and other market participants such as architects and consulting engineers, and the high degree of competition and low barriers to entry in most of our markets. Accordingly, we devote considerable attention to operating unit management quality, stability, and contingency planning, including related considerations of compensation, and non-competition protection where applicable.

        As an HVAC and building controls services provider, we operate in the broader nonresidential construction services industry and are affected by trends in this sector. While we do not have operations in all major cities of the US, we believe our national presence is sufficiently large that we experience trends in demand for and pricing of our services that are consistent with trends in the national nonresidential construction sector. As a result, we monitor the views of major construction sector forecasters along with macroeconomic factors they believe drive the sector, including trends in gross domestic product, interest rates, business investment, employment, demographics, and the general fiscal condition of federal, state and local governments. Although nonresidential construction activity has demonstrated periods of both significant growth and decline, it has grown at a compound annual rate of approximately 4.2% over the last twenty-five years.

        Spending decisions for building construction, renovation and system replacement are generally made on a project basis, usually with some degree of discretion as to when and if projects proceed. With larger amounts of capital, time, and discretion involved, spending decisions are affected to a significant degree by uncertainty, particularly concerns about macroeconomic and geopolitical trends. We have experienced periods of time, such as after the terrorist incidents on September 11, 2001 in the US, and prior to and during the war in Iraq that occurred in early 2003, when uncertainty caused a significant slowdown in decisions to proceed with installation and replacement project work. We believe that the current economic environment is favorable relative to the activity levels of recent years.

        Nonresidential building construction and renovation activity, as reported by the federal government, declined over the three year period of 2001 to 2003 and has expanded moderately during 2004 and 2005, and was strong during 2006 and 2007. During the decline and through 2003, we responded to market challenges by pursuing work in sectors less affected by this downturn, such as government, educational, and health care facilities, and by establishing marketing initiatives that take advantage of our size and range of expertise. We also responded to declining gross profits over those years by reducing our selling, general, and administrative expenses, and our indirect project and service overhead costs. We believe our efforts in these areas partially offset the decline in our profitability over

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that period. We have experienced notable improvements in both industry activity as well as our own results since 2004, as discussed further under "Results of Operations" below.

        As a result of our sale of certain assets and our continued strong emphasis on cash flow, our debt outstanding is now zero, and we have substantial uncommitted cash balances, as discussed further in "Liquidity and Capital Resources" below. On February 20, 2007, we put a new credit facility in place with considerably less restrictive terms than those of our previous facilities. In addition, we have added a second surety to further support our bonding needs, and we believe our relationships with the surety markets are positive in light of our strong current results and financial position. We have generated positive free cash flow in each of the last nine calendar years and will continue our emphasis in this area. We believe that the relative size and strength of our balance sheet and surety support as compared to most companies in our industry represent competitive advantages for us.

        As discussed at greater length in "Results of Operations" below, we have seen increased activity levels in our industry since 2004. We expect price competition to continue to be strong, as local and regional competitors respond cautiously to changing conditions. We will continue our efforts to find the more active sectors in our markets, and to increase our regional and national account business. However, our primary emphasis for 2008 will be on internal execution and margin improvement, rather than on revenue growth. We plan to continue our involvement in multi-family work; however, we have decided to focus a portion of our resources away from this work and we expect that as a result, the portion of our work that is multi-family will diminish somewhat in the future. In addition to the work we have done on our underperforming units, we have increased our focus on project qualification, estimating, pricing and management, and on service performance. This focus includes significant increases in unit level training.

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

        Approximately 86% of our revenues were earned on a project basis and recognized through the percentage of completion method of accounting. Under this method as provided by American Institute of Certified Public Accountants Statement of Position 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," contract revenue recognizable at any time during the life of a contract is determined by multiplying expected total contract revenue by the percentage of contract costs incurred at any time to total estimated contract costs ("cost to cost method"). More specifically, as part of the negotiation and bidding process in which we engage in connection with obtaining installation contracts, we estimate our contract costs, which include all direct materials (exclusive of rebates), labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. These contract costs

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are included in our results of operations under the caption "Cost of Services." Then, as we perform under those contracts, we measure such costs incurred, compare them to total estimated costs to complete the contract, and recognize a corresponding proportion of contract revenue. Labor costs are considered to be incurred as the work is performed. Subcontract labor is recognized as the work is performed, but is generally subjected to approval as to milestones or other evidence of completion. Non-labor project cost consists of purchased equipment, prefabricated materials and other materials. Purchased equipment on our projects is substantially produced to job specifications and is a value added element to our work. The costs are considered to be incurred when title is transferred to us, which typically is upon delivery to the worksite. Prefabricated materials, such as ductwork and piping, are generally performed at our shops and recognized as contract costs when fabricated for the unique specifications of the job. Other materials cost are not significant and are generally recorded when delivered to the worksite. This measurement and comparison process requires updates to the estimate of total costs to complete the contract, and these updates may include subjective assessments.

        Our contracts typically provide for a schedule of billings or invoices to the customer based on reaching agreed-upon milestones or as we incur costs. The schedules for such billings usually do not precisely match the schedule on which we incur costs. As a result, contract revenues recognized in the statement of operations can and usually do differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenues recognized on a contract as of a given date exceed cumulative billings to the customer under the contract are reflected as a current asset in our balance sheet under the caption "Costs and estimated earnings in excess of billings." Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenues recognized on the contract are reflected as a current liability in our balance sheet under the caption "Billings in excess of costs and estimated earnings."

        The percentage of completion method of accounting is also affected by changes in job performance, job conditions, and final contract settlements. These factors may result in revisions to estimated costs and, therefore, revenues. Such revisions are frequently based on further estimates and subjective assessments. We recognize these revisions in the period in which they are determined. If such revisions lead us to conclude that we will recognize a loss on a contract, the full amount of the estimated ultimate loss is recognized in the period we reach that conclusion, regardless of the percentage of completion of the contract.

        Revisions to project costs and conditions can give rise to change orders under which the customer agrees to pay additional contract price. Revisions can also result in claims we might make against the customer to recover project variances that have not been satisfactorily addressed through change orders with the customer. Except in certain circumstances, we do not recognize revenues or margin based on change orders or claims until they have been agreed upon with the customer. The amount of revenue associated with unapproved change orders and claims is currently immaterial. Variations from estimated project costs could have a significant impact on our operating results, depending on project size, and the recoverability of the variation via additional customer payments.

        We are required to estimate the collectibility of accounts receivable and provide an allowance for doubtful accounts for receivable amounts we believe we will not ultimately collect. This requires us to make certain judgments and estimates involving, among others, the creditworthiness of the customer, our prior collection history with the customer, ongoing relationships with the customer, the aging of past due balances, our lien rights, if any, in the property where we performed the work, and the availability, if any, of payment bonds applicable to our contract. These estimates are re-evaluated and adjusted as additional information is received.

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        We are substantially self-insured for worker's compensation, employer's liability, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. Loss estimates associated with the larger and longer-developing risks—worker's compensation, auto liability and general liability—are reviewed by a third party actuary quarterly. We believe these accruals are adequate. However, insurance liabilities are difficult to estimate due to unknown factors, including the severity of an injury, the determination of our liability in proportion to other parties, timely reporting of occurrences, ongoing treatment or loss mitigation, general trends in litigation recovery outcomes and the effectiveness of safety and risk management programs. Therefore, if actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period that such experience becomes known.

        We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain. We perform this evaluation quarterly. Estimations of required valuation allowances include estimates of future taxable income. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the activity underlying these assets becomes deductible. We consider projected future taxable income and tax planning strategies in making this assessment. If actual future taxable income differs from our estimates, we may not realize deferred tax assets to the extent we have estimated.

        In most businesses we have acquired, the value we paid to buy the business was greater than the value of specifically identifiable net assets in the business. Under generally accepted accounting principles, this excess is termed goodwill and is recognized as an asset at the time the business is acquired. It is generally expected that future net earnings from an acquired business will exceed the goodwill asset recognized at the time the business is bought.

        Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" requires us to assess our goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred. Impairment must be reflected when the value of a given business unit in excess of its tangible net assets falls below the goodwill asset balance carried for that unit on our books. If other business units have had increases in the value of their respective goodwill balances, such increases may not be recorded under SFAS No. 142. Accordingly, such increases may not be netted against impairments at other business units. The requirements for assessing whether goodwill assets have been impaired involve market-based information. This information, and its use in assessing goodwill, entails some degree of subjective assessment.

        We currently perform our annual impairment testing as of October 1 and any impairment charges resulting from this process are reported in the fourth quarter. We segregate our operations into reporting units based on the degree of operating and financial independence of each unit and our related management of them. These reporting units are tested for impairment by comparing the unit's fair value to its carrying value. The fair value of each reporting unit is estimated using a discounted cash flow model combined with market valuation approaches. Significant estimates and assumptions are used in assessing the fair value of reporting units. These estimates and assumptions involve future cash flows, growth rates, discount rates, weighted average cost of capital and estimates of market valuations for each of the reporting units.

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        We recorded a goodwill impairment charge of $33.9 million in operating results during the fourth quarter of 2005. During 2005, we experienced modest revenue growth and improved profitability due to increased industry activity and favorable market conditions. However, the revenue, operating profits and cash flows for certain reporting units were lower than expected despite these favorable market conditions. Primarily based upon this trend, the revenue, earnings and cash flow projections for certain reporting units were revised downward for the next several years as compared to previous projections. As a result, an impairment charge was recognized in 2005 for reporting units including operations in San Diego, Houston, Grand Rapids, central Iowa, Birmingham, Buffalo and Albany. We did not have a goodwill impairment charge in 2006 and 2007.

Results of Operations (in thousands):

Table 1—Historical Results

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
Revenues   $ 892,549   100.0 % $ 1,056,525   100.0 % $ 1,109,534   100.0 %
Cost of services     744,407   83.4 %   885,508   83.8 %   912,471   82.2 %
   
     
     
     
Gross profit     148,142   16.6 %   171,017   16.2 %   197,063   17.8 %
Selling, general and administrative expenses     113,285   12.7 %   126,620   12.0 %   147,158   13.3 %
Goodwill impairment     33,877   3.8 %            
(Gain) loss on sale of assets     (85 )     (125 )     34    
   
     
     
     
Operating income     1,065   0.1 %   44,522   4.2 %   49,871   4.5 %
Interest income (expense), net     (323 )     1,969   0.2 %   2,670   0.2 %
Other income     107       100       5    
Write-off of debt costs     (870 ) (0.1 %)            
   
     
     
     
Income (loss) before income taxes     (21 )     46,591   4.4 %   52,546   4.7 %
Income tax expense     14,848         17,874         20,080      
   
     
     
     
Income (loss) from continuing operations     (14,869 ) (1.7 %)   28,717   2.7 %   32,466   2.9 %
Discontinued operations—                                
  Operating loss, net of tax     (1,309 )       (203 )            
  Estimated gain on disposition, including tax     9,952         210              
   
     
     
     
Net income (loss)   $ (6,226 )     $ 28,724       $ 32,466      
   
     
     
     

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Table 2—Supplemental Non-GAAP Disclosure—Operating Results of Ongoing Operations Excluding Certain Items

        The following table presents information excluding write-off of debt costs and goodwill impairment charges. We have included this table because we believe it offers an additional view of the core results of our continuing operations in a way we find useful in managing these operations, and in a way which also responds to frequent questions we receive about the Company from third parties. However, this presentation of operating results is not in accordance with generally accepted accounting principles, and should not be considered an alternative to income as determined under generally accepted accounting principles and presented above in Table 1—Historical Results. In particular, impairment charges under the goodwill accounting rules are generally expected to occur periodically as goodwill recognized in connection with the acquisition of businesses responds over time to changes in those businesses' markets and operations. We recorded a goodwill impairment charge in 2005.

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
Income (loss) from continuing operations (after tax)   $ (14,869 )     $ 28,717       $ 32,466      
Goodwill impairment (after tax)     33,955                      
Write-off of debt costs (after tax)     479                      
   
     
     
     
Income from continuing operations (after tax), excluding goodwill impairment and the write-off of debt costs   $ 19,565   2.2 % $ 28,717   2.7 % $ 32,466   2.9 %
   
     
     
     
Diluted earnings per share—income from continuing operations (after tax), excluding goodwill impairment and the write-off of debt costs   $ 0.49       $ 0.70       $ 0.79      

2007 Compared to 2006

        Revenues—Revenues increased $53.0 million, or 5.0% to $1,109.5 million in 2007 compared to 2006. Approximately 2.9% of the increase in revenues related to internal growth and the remaining 2.1% resulted from the acquisitions of Madera Mechanical in March 2007 and Air Systems Engineering in October 2007. The internal growth was from general improvements throughout the United States especially in office buildings (approximately $33.4 million), manufacturing (approximately $25.0 million) and institutions ($24.5 million). We have seen increased activity, primarily in our Florida, Maryland, Arizona, and Colorado operations, partially offset by the planned downsizing of our large multi-family operation based in Texas.

        Backlog reflects revenues still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenues and service work and short duration projects which are generally billed as performed do not flow through backlog. Accordingly, backlog represents only a portion of our revenues for any given future period, and it represents revenues that are likely to be reflected in our operating results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.

        Backlog as of December 31, 2007 was $786.7 million, a 3.9% decrease from September 30, 2007 backlog of $818.5 million, and a 20.3% increase from December 31, 2006 backlog of $653.8 million. The sequential decrease is primarily from our Tennessee, Maryland, Alabama operations as well as our Texas based multi-family operation. Approximately 17.4% of the year-over-year increase in backlog is primarily from our Alabama, Colorado, Wisconsin and Southern California operations, and the remaining 2.9% resulted from our acquisitions of Madera and Air Systems Engineering. We plan to

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continue our involvement in multi-family work; however, we have decided to focus a portion of our resources away from this work and we expect that as a result, the portion of our work that is multi- family will diminish somewhat in the future.

        Following the three-year period of industry activity declines from 2001-2003 noted previously, we saw modest year-over-year revenue increases at our ongoing operations beginning in mid-2003 and continuing throughout 2007. Based on our backlog and forecasts from industry construction analysts, we expect that activity levels in our industry will remain at high levels throughout 2008.

        Along with the indications noted above that industry activity will continue to be at high levels in 2008, there remain the following cautionary factors in the industry environment, each of which is discussed at greater length in the Introduction above. Since HVAC and related installation and replacement decisions are capital decisions usually involving some amount of discretion, they tend to be affected to a greater degree by macroeconomic or geopolitical uncertainty. Negative developments or events in these arenas, should they occur, will likely cause end users to defer HVAC and related spending decisions, thereby reducing our revenues.

        We continue to experience a noticeable amount of price competition in our markets, which restrains our ability to increase revenues.

        While we believe industry activity will continue to be at high levels in 2008, in view of all of the foregoing factors, we may experience modest revenue growth or revenue declines in upcoming periods. In addition, if general economic activity in the US slows significantly from current levels, we may realize decreases in revenue and lower operating margins.

        Gross Profit—Gross profit increased $26.0 million, or 15.2%, to $197.1 million in 2007 compared to 2006. As a percentage of revenues, historical gross profit for 2007 was 17.8%, up from 16.2% in 2006. The increase in gross profit resulted primarily from broad-based improvements in profitability from higher margin projects in a number of our markets as well as improved profitability at our Wisconsin operation (approximately $2.1 million), California operation (approximately $1.5 million) and strong job performance at our Alabama and Northern Georgia operations (approximately $4.9 million). The increase was partially offset by continued underperformance at our large multi-family operation based in Texas (approximately $17.5 million).

        As noted in the Introduction above, we are currently placing a greater emphasis on internal execution and margin improvement than on revenue growth. This includes a strong focus on those of our units that have underperformed, along with increased training efforts on project qualification, estimating, pricing and management, and on service performance. While we believe these efforts will help us increase gross profits, we cannot assure that this will occur. Further, if we are successful in these efforts, we cannot assure that they will offset adverse industry trends, if such trends occur.

        Selling, General and Administrative Expenses ("SG&A")—SG&A increased $20.5 million, or 16.2% for 2007 as compared to 2006. As a percentage of revenues, SG&A increased from 12.0% in 2006 to 13.3% in 2007. This is primarily due to higher compensation accruals due to strong performance at a number of our operations, and increase in the number of selling and overhead personnel for new or expanded service operations and the acquisition and start-up of new operations.

        Interest Income, Net—Interest income, net was $2.0 million in 2006 and $2.7 million in 2007. The increase in interest income is due to interest income earned from higher cash balances in the current year. See "Liquidity and Capital Resources" for a detail of the components of interest income (expense), net for 2006 and 2007.

        Income Tax Expense—Our effective tax rate associated with results from continuing operations for 2007 was 38.2%, as compared to 38.4% in 2006. Historically, our effective tax rate was generally higher than statutory (federal and state) rates because of the effect of certain expenses that were not deductible for tax purposes. However, in the current year, the increase in the deduction for certain of

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our construction-related activities (discussed further below) and our tax-exempt interest income has allowed our effective tax rate to be lower than statutory rates. Adjustments to tax reserves are analyzed and adjusted quarterly as events occur to warrant such changes. Adjustments to tax reserves are a component of the effective tax rate. The decrease in the effective tax rate is primarily due to an increase in the production activity deduction from 3% in 2006 to 6% in 2007 and a change in expected tax expense in a certain jurisdiction. We currently estimate that our effective tax rate for 2008 will be between 38% and 40%.

        Sale of Assets to MESA Energy Systems, Inc.—On June 1, 2006, we, along with our wholly-owned subsidiary, ARC Comfort Systems USA, Inc. ("ARC"), entered into an asset purchase agreement to sell certain assets of ARC to Mesa Energy Systems, Inc. (a subsidiary of Emcor Group, Inc.) for approximately $0.7 million in cash. These assets were sold at book value. The after-tax losses of this company of $1.5 million and $0.2 million, for 2005 and 2006, respectively, have been reported in discontinued operations under "Operating loss, net of income tax benefit."

        Sale of Companies to ALC—On December 31, 2005, we sold two operations to Automated Logic Corporation and Automated Logic Contracting Services, Inc. (together, "ALC") for approximately $22.9 million in cash, net of transaction costs and a purchase price adjustment based upon the closing balance sheet for the transferred assets. The receivable related to this sale was paid during the first quarter of 2006. We paid $7.0 million in taxes related to this transaction during the first quarter of 2006. The after-tax income of these companies of $1.3 million for 2005 has been reported in discontinued operations under "Operating loss, net of income tax benefit." The gain recognized during 2005 on the sale of these units was $9.8 million, including tax expense, and was reported in discontinued operations under "Estimated gain on disposition, including income taxes." During the fourth quarter of 2006, we recorded an additional gain of $0.1 million, net of tax, related to the collection of certain receivables.

        Outlook—Although there is uncertainty as to the overall economy for 2008, we believe that activity for our industry will continue to be at reasonably high levels in 2008 and we are encouraged by our current level of backlog. Our primary emphasis for 2008 will continue to be on margin improvement rather than revenue growth. Our ongoing margin efforts include a focus on improving the results of units that incurred losses or subpar income in 2007 as well as on intensified project and service performance training at the unit level. During 2007, our large multi-family operation based in Texas had an operating loss of approximately $20 million. We have changed the management of this operation, and have made decisions to exit certain activities and geographic markets where we believe we cannot be profitable at a level to compensate for the associated operating risks. Based on these margin improvement efforts (especially with our large multi-family operation based in Texas), our increased level of backlog as compared to prior year and on our perception regarding economic conditions for our industry over the coming year, we expect that our 2008 profitability will improve as compared to our 2007 results.

2006 Compared to 2005

        Revenues—Revenues increased $164.0 million, or 18.4% to $1,056.5 million in 2006 compared to 2005. The revenue growth stemmed primarily from generally improving nonresidential facilities markets throughout the United States especially in markets such as the multi-family sector (approximately $86.8 million), office buildings (approximately $37.9 million) and schools (approximately $45.2 million). We have seen increased activity, primarily in our Texas, California, Tennessee and Maryland operations, resulting from the start-up of several large projects.

        Backlog reflects revenues still to be recognized under contracted or committed installation and replacement project work. Project work generally lasts less than one year. Service agreement revenues

30



and service work and short duration projects which are generally billed as performed do not flow through backlog. Accordingly, backlog represents only a portion of our revenues for any given future period, and it represents revenues that are likely to be reflected in our operating results over the next six to twelve months. As a result, we believe the predictive value of backlog information is limited to indications of general revenue direction over the near term, and should not be interpreted as indicative of ongoing revenue performance over several quarters.

        Backlog associated with continuing operations as of December 31, 2006 was $653.8 million, a 3.7% decrease from September 30, 2006 backlog of $678.9 million, and a 3.9% decrease from December 31, 2005 backlog of $680.6 million. The sequential and year over year decrease is primarily from one of our larger multi-family operations working through its larger than usual existing backlog. We plan to continue our involvement in multi-family work; however, we have decided to focus a portion of our resources away from this work and we expect that as a result, the portion of our work that is multi-family will diminish somewhat in the future.

        Gross Profit—Gross profit increased $22.9 million, or 15.4%, to $171.0 million in 2006 compared to 2005. As a percentage of revenues, historical gross profit for 2006 was 16.2%, down from 16.6% in 2005. The decrease in gross profit percentage resulted primarily from an increased proportion of new construction work due to stronger activity, and by job underperformance at our Connecticut operations (approximately $3.2 million), and at our large multi-family operation based in Texas (approximately $2.3 million). These decreases were partially offset by improved profitability at our Southern California operation (approximately $1.9 million). In addition, we realized higher risk management expense in 2006 ($3.4 million) primarily due to general liability claims associated with our work in the multi-family market.

        Selling, General and Administrative Expenses ("SG&A")—SG&A increased $13.3 million, or 11.8% for 2006 as compared to 2005. This is primarily due to an increase in the number of overhead personnel to manage internal growth. As a percentage of revenues, SG&A declined from 12.7% in 2005 to 12.0% in 2006. This decrease is consistent with our effort to control our SG&A expenses as we experience internal revenue growth.

        Goodwill Impairment—We recorded goodwill impairment charges of $33.9 million during the fourth quarter of 2005 and recorded no goodwill impairment charge in 2006. During 2005, we experienced modest revenue growth and improved profitability due to increased industry activity and favorable market conditions. However, the revenue, operating profits and cash flows for certain reporting units were lower than expected despite these favorable market conditions. Primarily based upon this trend, the revenue, earnings and cash flow projections for certain reporting units were revised downward for the next several years as compared to previous projections. As a result, an impairment charge of $33.9 million was recognized in 2005 for these reporting units including operations in San Diego, Houston, Grand Rapids, central Iowa, Birmingham, Buffalo and Albany. Impairment must be reflected when the value of a given business unit in excess of its tangible net assets falls below the goodwill asset balance carried for that unit on our books. If other business units have had increases in the value of their respective goodwill balances, such increases may not be recorded under SFAS No. 142. Accordingly, such increases may not be netted against impairments at other business units.

        Interest Income (Expense), Net—Interest expense, net was $0.3 million in 2005 and interest income, net was $2.0 million in 2006. The decrease in interest expense, net is a result of payments on the term loan throughout 2005 thereby having no debt outstanding in 2006, and the increase in interest income is due to interest income earned from higher cash balances in the current year. See "Liquidity and Capital Resources" for a detail of the components of interest income (expense), net for 2005 and 2006.

        Write off of debt costs—The second quarter of 2005 includes a non-cash write off of $0.9 million of deferred financing costs resulting from the replacement of our previous credit facility.

31


        Income Tax Expense—Our effective tax rate associated with results from continuing operations for 2006 was 38.4%. Excluding effects of the goodwill impairment charge, our 2005 effective tax rate was 43.6%. Our effective tax rate is generally higher than statutory rates because of the effect of certain expenses that are not deductible for tax purposes. In addition, adjustments to tax reserves are analyzed and adjusted quarterly as events occur to warrant such changes. Adjustments to tax reserves are a component of the effective tax rate. The decrease in the effective tax rate is primarily due to an improvement in operating results which dilutes the impact of non-deductible expenses and adjustments to our tax reserves. Furthermore, our state tax rate is lower due to the change in where our income is being earned.

        During 2004, the American Jobs Creation Act of 2004 was signed into law. The primary effect of this legislation was to permit us to claim a deduction for 3% of earnings related to certain of our construction-related activities beginning in 2005. This deduction modestly decreased our effective tax rate.

        Sale of Assets to MESA Energy Systems, Inc.—On June 1, 2006, we, along with our wholly-owned subsidiary, ARC Comfort Systems USA, Inc. ("ARC"), entered into an asset purchase agreement to sell certain assets of ARC to Mesa Energy Systems, Inc. (a subsidiary of Emcor Group, Inc.) for approximately $0.7 million in cash. These assets were sold at book value. The after-tax losses of this company of $1.5 million and $0.2 million, for 2005 and 2006, respectively, have been reported in discontinued operations under "Operating loss, net of income tax benefit."

        Sale of Companies to ALC—On December 31, 2005, we sold two operations to Automated Logic Corporation and Automated Logic Contracting Services, Inc. (together, "ALC") for approximately $22.9 million in cash, net of transaction costs and a purchase price adjustment based upon the closing balance sheet for the transferred assets. The receivable related to this sale was paid during the first quarter of 2006. We paid $7.0 million in taxes related to this transaction during the first quarter of 2006. The after-tax income of these companies of $1.3 million for 2005 has been reported in discontinued operations under "Operating loss, net of income tax benefit." The gain recognized during 2005 on the sale of these units was $9.8 million, including tax expense, and was reported in discontinued operations under "Estimated gain on disposition, including income taxes." During the fourth quarter of 2006, we recorded an additional gain of $0.1 million, net of tax, related to the collection of certain receivables.

        Individual Sales of Operating Companies—In 2005, we also sold two small operating companies in separate transactions and shutdown the operations at another small operating company. The after-tax loss of these companies was $1.2 million in 2005, and has been reported in discontinued operations under "Operating loss, net of income tax benefit." The gain recognized on the sale of these units was $0.1 million, including tax expense, and was reported in discontinued operations under "Estimated gain on disposition, including income taxes."

        Sale of Companies to Emcor—In March 2002, we sold 19 operations to Emcor Group, Inc. ("Emcor"). The total purchase price was $186.25 million, including the assumption by Emcor of approximately $22.1 million of subordinated notes to former owners of certain of the divested companies. Of Emcor's purchase price, $5 million was deposited into an escrow account to secure potential obligations on our part to indemnify Emcor for future claims and contingencies arising from events and circumstances prior to closing, all as specified in the transaction documents. Of this escrow, $4 million has been applied in determining our liability to Emcor in connection with the settlement of certain claims. The remaining $1 million of escrow is available for book purposes to apply to any future claims and contingencies in connection with this transaction, and has not been recognized as part of the Emcor transaction purchase price.

32


        There are ongoing open matters relating to this transaction that we continue to address with Emcor. We do not believe these open matters, either individually or in the aggregate, will have a material effect on our financial position when ultimately resolved. We maintain reserves for these matters, net of amounts receivable from escrow that we believe will ultimately be applied in settling these matters. During the second quarter of 2004, we concluded that the related reserves should be reduced by $0.3 million, net of tax benefit. Additionally, during the fourth quarter of 2004, we reduced these reserves by $0.2 million, net of tax. During the third quarter of 2005, we reduced tax reserves by $0.1 million in connection with the resolution of state tax examinations. These amounts are reflected in discontinued operations in 2004 and 2005 in the caption "Estimated gain on disposition, including income tax benefit (expense)."

Liquidity and Capital Resources

 
  Year ended December 31,
 
 
  2005
  2006
  2007
 
 
  (in thousands)

 
Cash provided by (used in):                    
  Operating activities   $ 37,446   $ 17,734   $ 83,642  
  Investing activities   $ (6,769 ) $ 17,721   $ (18,132 )
  Financing activities   $ (7,660 ) $ (762 ) $ (16,165 )
Free cash flow:                    
  Cash provided by operating activities   $ 37,446   $ 17,734   $ 83,642  
  Taxes paid related to the sale of businesses         7,020      
  Purchases of property and equipment     (6,188 )   (8,113 )   (11,088 )
  Proceeds from sales of property and equipment     696     477     265  
   
 
 
 
Free cash flow   $ 31,954   $ 17,118   $ 72,819  
   
 
 
 

        Cash Flow—We define free cash flow as cash provided by operating activities excluding items related to sales of businesses, less customary capital expenditures, plus the proceeds from asset sales. Positive free cash flow represents funds available to invest in significant operating initiatives, to acquire other companies, or to reduce a company's outstanding debt or equity. If free cash flow is negative, additional debt or equity is generally required to fund the outflow of cash. Free cash flow may be defined differently by other companies.

        Our business does not require significant amounts of investment in long-term fixed assets. The substantial majority of the capital used in our business is working capital that funds our costs of labor and installed equipment deployed in project work until our customers pay us. Customary terms in our industry allow customers to withhold a small portion of the contract price until after we have completed the work, typically for six months. Amounts withheld under this practice are known as retention or retainage. Our average project duration together with typical retention terms generally allow us to complete the realization of revenue and earnings in cash within one year. Accordingly, we believe free cash flow, by encompassing both profit margins and the use of working capital over our approximately one year working capital cycle, is an effective measure of operating effectiveness and efficiency. We have included free cash flow information here for this reason, and because we are often asked about it by third parties evaluating us. However, free cash flow is not considered under generally accepted accounting principles to be a primary measure of an entity's financial results, and accordingly free cash flow should not be considered an alternative to operating income, net income, or amounts shown in our consolidated statements of cash flows as determined under generally accepted accounting principles.

        For the year ended December 31, 2007, we had free cash flow of $72.8 million as compared to $17.1 million in 2006. This increase is a result of higher profitability and significant working capital

33



efficiency primarily due to lower revenue growth as compared to 2006 primarily in our multi-family operations.

        During 2006, we collected approximately $25.7 million, primarily related to the sale of two operations to Automated Logic Corporation and Automated Logic Contracting Services, Inc. of $23.8 million and $0.7 million related to the sale of ARC to Mesa Energy Systems, Inc. For the year ended December 31, 2006, we had free cash flow of $17.1 million as compared to $32.0 million in 2005. This decrease resulted primarily from an investment in working capital due to higher activity levels.

        On March 29, 2007, our Board of Directors approved a stock repurchase program to acquire up to one million shares of our outstanding common stock. On November 16, 2007, the Board approved an extension of our stock repurchase program to cover an additional 401,200 shares of our outstanding common stock. We repurchased 859,900 shares for approximately $11.1 million under our share repurchase program for the year ended December 31, 2007. This share repurchase is reflected as a financing outflow in our consolidated statements of cash flows.

        Credit Facility—In June 2005, we entered into a $75.0 million senior credit facility (the "Original Facility") provided by a syndicate of banks. The Original Facility was available for borrowings and letters of credit and was scheduled to expire on June 30, 2009. On February 20, 2007, we amended the credit facility (the "Facility"), increasing the available borrowing capacity to $100.0 million and amending certain covenants. The Facility will expire in February 2012. The Facility is secured by the capital stock of our current and future subsidiaries. As of December 31, 2007, the total of the Facility was $100.0 million, with no outstanding borrowings, $37.9 million in letters of credit outstanding, and $62.1 million of credit available.

        We have a choice of two interest rate options for borrowings under the Facility; these rates are floating rates determined by the broad financial markets, meaning they can and do move up and down from time to time. Excluding the amortization of debt financing and arrangement costs, we estimate that the interest rate applicable to the borrowings under the Facility would be approximately 5.85% as of December 31, 2007. We incurred approximately $0.7 million in financing and professional costs in connection with the arrangement of the Original Facility and the current Facility. These costs are amortized on a straight-line basis as a non-cash charge to interest expense over the term of the Facility in an amount of approximately $0.1 million per year. Commitment fees are payable on the portion of the capacity not in use for borrowings or letters of credit at any given time. These fees range from 0.20%-0.30% per annum, based on the ratio of debt to Credit Facility Adjusted EBITDA.

        Interest expense included the following primary elements (in thousands):

 
  Year Ended December 31,
 
  2005
  2006
  2007
Interest expense on borrowings, and unused commitment fees   $ 391   $ 166   $ 161
Letter of credit fees     389     351     347
Amortization of deferred debt arrangement costs and discount     295     99     107
   
 
 
Total   $ 1,075   $ 616   $ 615
   
 
 

        When a previous credit facility was replaced in 2005, a corresponding amount of deferred debt arrangement costs were written off. This charge of $0.9 million is reported as "Write-off of debt costs" in our consolidated statement of operations for the year ended December 31, 2005.

        Covenant compliance is assessed as of each quarter end. We were in compliance with all of the financial covenants as of December 31, 2007. Credit Facility Adjusted EBITDA is defined under the Facility for financial covenant purposes as net earnings for the four quarters ending as of any given

34



quarterly covenant compliance measurement date, plus the corresponding amounts for (a) interest expense; (b) income taxes; (c) depreciation and amortization; and (d) other non-cash charges. The following is a reconciliation of Credit Facility Adjusted EBITDA to net income (in thousands):

Net income   $ 32,466  
Income taxes     20,080  
Interest income, net     (2,670 )
Depreciation and amortization expense     6,853  
   
 
Credit Facility Adjusted EBITDA   $ 56,729  
   
 

        The Facility's principal financial covenants include:

        Leverage Ratio—The Facility requires that the ratio of our total indebtedness less cash and cash equivalents to our Credit Facility Adjusted EBITDA not exceed 2.50.

        Fixed Charge Coverage Ratio—The Facility requires that the ratio of Credit Facility Adjusted EBITDA, less non-financed capital expenditures, tax provision, dividends and amounts used to repurchase stock to the sum of interest expense and scheduled principal payments be at least 1.50. Capital expenditures, tax provision, dividends and stock repurchase payments are defined under the Facility for purposes of this covenant to be amounts for the four quarters ending as of any given quarterly covenant compliance measurement date. The calculation of the fixed charge coverage ratio excludes acquisitions, stock repurchases and the payment of cash dividends, provided that the Leverage Ratio does not exceed 1.0.

        Other Restrictions—The Facility permits acquisitions of up to $25.0 million per transaction, or $50.0 million in the aggregate. However, these limitations only apply when the Leverage Ratio is greater than 1.0.

        Note to Former Owner—We issued a subordinated note to the former owner of Air Systems Engineering, Inc. as part of the consideration used to acquire the company. This note had an outstanding balance of $1.5 million as of December 31, 2007. This note bears interest, payable quarterly, at a weighted average interest rate of 6.0%.

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

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

        Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. The letters of credit we provide are actually issued by our lenders through the Facility as described above. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders. Depending on the circumstances of such a reimbursement, we may also have to record a charge to earnings for the reimbursement. Absent a claim, there is no payment or reserving of funds by

35



us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of the Facility's capacity just the same as actual borrowings. Claims against letters of credit are rare in our industry. To date we have not had a claim made against a letter of credit that resulted in payments by a lender or by us. We believe that it is unlikely that we will have to fund claims under a letter of credit in the foreseeable future.

        Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the sureties for any expenses or outlays they incur. To date, we are not aware of any losses to our sureties in connection with bonds the sureties have posted on our behalf, and we do not expect such losses to be incurred in the foreseeable future.

        Surety market conditions are currently challenging as a result of significant losses incurred by many sureties in recent periods, both in the construction industry as well as in certain larger corporate bankruptcies. As a result, less bonding capacity is available in the market and terms have become more restrictive. Further, under standard terms in the surety market, sureties issue bonds on a project-by-project basis, and can decline to issue bonds at any time. Historically, approximately 25% to 30% of our business has required bonds. While we have enjoyed a longstanding relationship with our primary surety and we have added another surety to further support our bonding needs, current market conditions as well as changes in our sureties' assessment of our operating and financial risk could cause our sureties to decline to issue bonds for our work. If that were to occur, our alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics, including a significant amount of cash on our balance sheet, would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenues and profits to decline in the near term.

        The following recaps the future maturities of our contractual obligations as of December 31, 2007 (in thousands):

 
  Twelve Months Ended December 31,
   
   
 
  2008
  2009
  2010
  2011
  2012
  Thereafter
  Total
Liabilities—Note to Former Owner   $ 375   $ 375   $ 375   $ 375   $   $   $ 1,500
Interest payable   $ 58   $ 58   $ 58   $ 58   $   $   $ 232

Operating lease obligations

 

$

9,601

 

$

7,414

 

$

4,416

 

$

3,329

 

$

2,743

 

$

7,086

 

$

34,589

        Absent any significant commitments of capital for items such as capital expenditures, acquisitions, dividends and share repurchases, it is reasonable to expect us to continue to maintain excess cash on its balance sheet. Therefore, we assumed that we would continue our current status of not utilizing any borrowings under our revolving loan.

        As of December 31, 2007 we also have $37.9 million letter of credit commitments, all of which expire in 2008. The substantial majority of these letters of credit are posted with insurers who disburse funds on our behalf in connection with our worker's compensation, auto liability and general liability insurance program. These letters of credit provide additional security to the insurers that sufficient financial resources will be available to fund claims on our behalf, many of which develop over long periods of time, should we ever encounter financial duress. Posting of letters of credit for this purpose is a common practice for entities that manage their self-insurance programs through third-party insurers

36



as we do. While all of these letter of credit commitments expire in 2008, we expect nearly all of them, particularly those supporting our insurance programs, will be renewed annually.

        Other than the operating lease obligations noted above, we have no significant purchase or operating commitments outside of commitments to deliver equipment and provide labor in the ordinary course of performing project work.

        Outlook—We have generated positive net free cash flow for the last nine calendar years, most of which occurred during challenging economic and industry conditions. We also expect to have significant borrowing capacity under our credit facility and substantial uncommitted cash balances. We believe these factors will provide us with sufficient liquidity to fund our operations for the foreseeable future.

New Accounting Pronouncements

        In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 is an interpretation of FASB Statement No. 109, "Accounting for Income Taxes," and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes. We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our results of operations.

        In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements ("Statement 157")," effective for fiscal years beginning after November 15, 2007. Statement 157 provides guidance for using fair value to measure assets and liabilities. The statement applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The statement does not expand the use of fair value in any new circumstances. On February 12, 2008, the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2") that amends Statement 157 to delay the effective date for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008. We have not determined the effect, if any, the adoption of Statement 157 will have on our financial position and results of operations.

        In December 2007, the FASB issued Statement No. 141(Revised 2007), "Business Combinations" ("Statement 141(R))." Statement 141(R) requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141(R) also changes the accounting treatment for certain specific items. Statement 141(R) applies prospectively to business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2008. We will adopt the provisions of Statement 141(R) for business combinations on January 1, 2009.


ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk

        We are exposed to market risk primarily related to potential adverse changes in interest rates as discussed below. Management is actively involved in monitoring exposure to market risk and continues to develop and utilize appropriate risk management techniques. We are not exposed to any other significant financial market risks including commodity price risk, foreign currency exchange risk or interest rate risks from the use of derivative financial instruments. We do not use derivative financial instruments.

        We have limited exposure to changes in interest rates due to our lack of indebtedness for borrowed money under our revolving credit facility. We have a debt facility under which we may borrow funds in the future. We do not currently foresee any borrowing needs under our revolving credit facility. Our debt with fixed interest rates consist of a note to a former owner.

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        The following table presents principal amounts (stated in thousands) and related average interest rates by year of maturity for our debt obligations and their indicated fair market value at December 31, 2007:

 
  Twelve Months Ended December 31,
   
   
 
 
  2008
  2009
  2010
  2011
  2012
  Thereafter
  Fair Value
 
Fixed Rate Debt   $ 375   $ 375   $ 375   $ 375   $   $   $ 1,500  
Average Interest Rate     6.0 %   6.0 %   6.0 %   6.0 %           6.0 %

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ITEM 8. Financial Statements and Supplemental Data


INDEX TO FINANCIAL STATEMENTS

 
  Page
Comfort Systems USA, Inc.    
  Management's Report on Internal Control over Financial Reporting   40
  Report of Independent Registered Public Accounting Firm   41
  Report of Independent Registered Public Accounting Firm   42
  Consolidated Balance Sheets   43
  Consolidated Statements of Operations   44
  Consolidated Statements of Stockholders' Equity   45
  Consolidated Statements of Cash Flows   46
  Notes to Consolidated Financial Statements   47

39



Management's Report on Internal Control over Financial Reporting

        Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007 based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        Ernst & Young LLP, an independent registered public accounting firm, as stated in their report which is included elsewhere herein, has issued an attestation report auditing the effectiveness of our internal control over financial reporting as of December 31, 2007.

40



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Comfort Systems USA, Inc.

        We have audited the accompanying consolidated balance sheets of Comfort Systems USA, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2007. 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 audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 audits provide a reasonable basis for our opinion.

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comfort Systems USA, Inc. at December 31, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.

        As discussed in Note 2 to the consolidated financial statements, effective January 1, 2007, the Company adopted Financial Accounting Standard Board (FASB) Interpretation No. 48 "Accounting for Uncertainty in Income Taxes (an interpretation of FASB Statement No. 109)." Additionally, as discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004) "Share-Based Payment."

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Comfort Systems USA, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 26, 2008 expressed an unqualified opinion thereon.

Houston, Texas
February 26, 2008

41



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of Comfort Systems USA, Inc.

        We have audited Comfort Systems USA, Inc.'s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Comfort Systems USA, Inc.'s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

        We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

        A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

        Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

        In our opinion, Comfort Systems USA, Inc. maintained in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Comfort Systems USA, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2007 and our report dated February 26, 2008 expressed an unqualified opinion thereon.

Houston, Texas
February 26, 2008

42



COMFORT SYSTEMS USA, INC.

CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share Amounts)

 
  December 31,
 
 
  2006
  2007
 
ASSETS              
CURRENT ASSETS:              
  Cash and cash equivalents   $ 90,286   $ 139,631  
  Accounts receivable, less allowance for doubtful accounts of $3,301 and $3,807, respectively     234,763     261,402  
  Other receivables     5,920     7,255  
  Inventories     8,762     9,397  
  Prepaid expenses and other     13,644     14,475  
  Costs and estimated earnings in excess of billings     23,680     18,463  
  Assets related to discontinued operations     221      
   
 
 
      Total current assets     377,276     450,623  
PROPERTY AND EQUIPMENT, net     15,504     21,442  
GOODWILL     62,954     68,621  
OTHER NONCURRENT ASSETS     6,031     6,381  
   
 
 
      Total assets   $ 461,765   $ 547,067  
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY              

CURRENT LIABILITIES:

 

 

 

 

 

 

 
  Current maturities of long-term debt   $   $  
  Current maturities of note to former owner         375  
  Accounts payable     81,180     90,866  
  Accrued compensation and benefits     35,058     42,768  
  Billings in excess of costs and estimated earnings     65,949     104,236  
  Income taxes payable     734     377  
  Accrued self-insurance expense     19,618     21,288  
  Other current liabilities     15,476     21,783  
  Liabilities related to discontinued operations     450      
   
 
 
      Total current liabilities     218,465     281,693  
LONG-TERM DEBT, NET OF CURRENT MATURITIES          
NOTE TO FORMER OWNER, NET OF CURRENT MATURITIES         1,125  
OTHER LONG-TERM LIABILITIES     586     1,671  
   
 
 
      Total liabilities     219,051     284,489  
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, 40,710,003 and 41,123,365 shares issued, respectively     407     411  
  Treasury stock, at cost, zero and 781,415 shares, respectively         (9,973 )
  Additional paid-in capital     339,589     336,996  
  Deferred compensation          
  Retained earnings (deficit)     (97,282 )   (64,856 )
   
 
 
      Total stockholders' equity     242,714     262,578  
   
 
 
      Total liabilities and stockholders' equity   $ 461,765   $ 547,067  
   
 
 

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

43



COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Data)

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
REVENUES   $ 892,549   $ 1,056,525   $ 1,109,534  
COST OF SERVICES     744,407     885,508     912,471  
   
 
 
 
        Gross profit     148,142     171,017     197,063  

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

 

 

113,285

 

 

126,620

 

 

147,158

 
GOODWILL IMPAIRMENT     33,877          
(GAIN) LOSS ON SALE OF ASSETS     (85 )   (125 )   34  
   
 
 
 
        Operating income     1,065     44,522     49,871  

OTHER INCOME (EXPENSE):

 

 

 

 

 

 

 

 

 

 
  Interest income     752     2,585     3,285  
  Interest expense     (1,075 )   (616 )   (615 )
  Write-off of debt costs     (870 )        
  Other     107     100     5  
   
 
 
 
        Other income (expense)     (1,086 )   2,069     2,675  
   
 
 
 
INCOME (LOSS) BEFORE INCOME TAXES     (21 )   46,591     52,546  
INCOME TAX EXPENSE     14,848     17,874     20,080  
   
 
 
 
INCOME (LOSS) FROM CONTINUING OPERATIONS     (14,869 )   28,717     32,466  

DISCONTINUED OPERATIONS:

 

 

 

 

 

 

 

 

 

 
 
Operating loss, net of income tax benefit of $818, $160 and $—

 

 

(1,309

)

 

(203

)

 


 
 
Estimated gain on disposition, including income tax benefit (expense) of $(7,103), $68 and $—

 

 

9,952

 

 

210

 

 


 
   
 
 
 
NET INCOME (LOSS)   $ (6,226 ) $ 28,724   $ 32,466  
   
 
 
 

INCOME (LOSS) PER SHARE:

 

 

 

 

 

 

 

 

 

 
  Basic—                    
  Income (loss) from continuing operations   $ (0.38 ) $ 0.71   $ 0.80  
  Discontinued operations—                    
      Loss from operations     (0.03 )   (0.01 )    
      Estimated gain on disposition     0.25     0.01      
   
 
 
 
  Net income (loss)   $ (0.16 ) $ 0.71   $ 0.80  
   
 
 
 
 
Diluted—

 

 

 

 

 

 

 

 

 

 
  Income (loss) from continuing operations   $ (0.38 ) $ 0.70   $ 0.79  
  Discontinued operations—                    
      Loss from operations     (0.03 )   (0.01 )    
      Estimated gain on disposition     0.25     0.01      
   
 
 
 
  Net income (loss)   $ (0.16 ) $ 0.70   $ 0.79  
   
 
 
 

SHARES USED IN COMPUTING INCOME (LOSS) PER SHARE:

 

 

 

 

 

 

 

 

 

 
      Basic     39,298     40,247     40,573  
   
 
 
 
      Diluted     39,298     41,146     41,334  
   
 
 
 

DIVIDENDS PER SHARE

 

$

0.025

 

$

0.140

 

$

0.150

 
   
 
 
 

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

44



COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

(In Thousands, Except Share Amounts)

 
  Common Stock
  Treasury Stock
   
   
   
   
 
 
  Additional
Paid-In
Capital

  Deferred
Compensation

  Retained
Earnings
(Deficit)

  Total
Stockholders'
Equity

 
 
  Shares
  Amount
  Shares
  Amount
 
BALANCE AT DECEMBER 31, 2004   39,258,913   $ 393   (24,462 ) $ (148 ) $ 337,719   $ (1,587 ) $ (119,780 ) $ 216,597  
  Issuance of Stock:                                              
    Issuance of shares for options exercised including tax benefit   650,954     6   114,959     835     2,987             3,828  
    Issuance of restricted stock   82,500     1           574     (575 )        
  Shares received in lieu of tax withholding payment on vested restricted stock         (40,797 )   (318 )               (318 )
  Forfeiture of unvested restricted stock   (12,500 )     (50,000 )   (372 )   (74 )   360         (86 )
  Dividends                 (999 )           (999 )
  Amortization of deferred compensation                 60     667         727  
  Other         300     3     (3 )            
  Net loss                         (6,226 )   (6,226 )
   
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2005   39,979,867     400           340,264     (1,135 )   (126,006 )   213,523  
  Issuance of Stock:                                              
    Issuance of shares for options exercised including tax benefit   592,636     6   61,360     786     3,868             4,660  
    Issuance of restricted stock   137,500     1           (1 )            
  Shares received in lieu of tax withholding payment on vested restricted stock         (46,985 )   (597 )               (597 )
  Statement 123R adoption                 (1,135 )   1,135          
  Stock-based compensation expense                 1,800             1,800  
  Forfeiture of unvested restricted stock         (14,375 )   (189 )   151             (38 )
  Tax benefit from vesting of restricted stock                 316             316  
  Dividends                 (5,674 )           (5,674 )
  Net income                         28,724     28,724  
   
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2006   40,710,003     407           339,589         (97,282 )   242,714  
  Issuance of Stock:                                              
    Issuance of shares for options exercised including tax benefit   239,743     2   111,857     1,539     918             2,459  
    Issuance of restricted stock   173,619     2   2,246     32     (34 )            
  Shares received in lieu of tax withholding payment on vested restricted stock         (35,618 )   (481 )               (481 )
  Stock-based compensation expense                 2,521             2,521  
  FIN 48 adoption                           (40 )   (40 )
  Tax benefit from vesting of restricted stock                 127             127  
  Dividends                 (6,125 )           (6,125 )
  Share repurchase         (859,900 )   (11,063 )               (11,063 )
  Net income                         32,466     32,466  
   
 
 
 
 
 
 
 
 
BALANCE AT DECEMBER 31, 2007   41,123,365   $ 411   (781,415 ) $ (9,973 ) $ 336,996   $   $ (64,856 ) $ 262,578  
   
 
 
 
 
 
 
 
 

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

45



COMFORT SYSTEMS USA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
CASH FLOWS FROM OPERATING ACTIVITIES:                    
Net income (loss)   $ (6,226 ) $ 28,724   $ 32,466  
Adjustments to reconcile net income (loss) to net cash provided by operating activities                    
  Estimated gain on disposition of discontinued operations     (9,952 )   (210 )    
  Write-off of debt costs     870          
  Depreciation and amortization expense     4,818     5,266     6,853  
  Goodwill impairment     33,877          
  Bad debt expense     1,769     686     1,523  
  Deferred tax expense (benefit)     3,336     (887 )   (729 )
  Tax benefit of stock-based compensation expense (pre-Statement 123R)     1,267          
  Amortization of debt financing costs     295     99     107  
  Loss (gain) on sale of assets     (36 )   (125 )   34  
  Stock-based compensation expense     519     1,762     2,521  
  Changes in operating assets and liabilities, net of effects of acquisitions and divestitures— (Increase) decrease in—                    
      Receivables, net     (26,439 )   (38,849 )   (21,156 )
      Inventories     1,553     (713 )   (345 )
      Prepaid expenses and other current assets     (1,365 )   (435 )   (1,266 )
      Costs and estimated earnings in excess of billings     2,217     (688 )   5,847  
      Other noncurrent assets     (518 )   427     473  
    Increase (decrease) in—                    
      Accounts payable and accrued liabilities     12,028     17,187     20,746  
      Billings in excess of costs and estimated earnings     19,368     12,509     36,630  
      Other long-term liabilities     65     1     (62 )
      Taxes paid related to the sale of businesses         (7,020 )    
   
 
 
 
        Net cash provided by operating activities     37,446     17,734     83,642  
   
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:                    
    Purchases of property and equipment     (6,188 )   (8,113 )   (11,088 )
    Proceeds from sales of property and equipment     696     477     265  
    Proceeds from businesses sold, net of cash sold and transaction costs     1,666     25,737     38  
    Cash paid for acquisition and intangible assets, net of cash acquired     (2,943 )   (380 )   (7,347 )
   
 
 
 
        Net cash provided by (used in) investing activities     (6,769 )   17,721     (18,132 )
   
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES:                    
    Net borrowings on revolving line of credit              
    Payments on other long-term debt     (8,822 )       (734 )
    Borrowings of other long-term debt              
    Debt financing costs     (400 )       (312 )
    Payments of dividends to shareholders     (999 )   (5,674 )   (6,125 )
    Share repurchase             (11,544 )
    Excess tax benefit of stock-based compensation         2,487     1,247  
    Proceeds from exercise of options     2,561     2,425     1,303  
   
 
 
 
        Net cash used in financing activities     (7,660 )   (762 )   (16,165 )
   
 
 
 
NET INCREASE IN CASH AND CASH EQUIVALENTS     23,017     34,693     49,345  
CASH AND CASH EQUIVALENTS, beginning of year—continuing operations and discontinued operations     32,576     55,593     90,286  
   
 
 
 
CASH AND CASH EQUIVALENTS, end of year—continuing operations and discontinued operations   $ 55,593   $ 90,286   $ 139,631  
   
 
 
 

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

46



COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2007

1. Business and Organization

        Comfort Systems USA, Inc., a Delaware corporation provides comprehensive heating, ventilation and air conditioning ("HVAC") installation, maintenance, repair and replacement services within the mechanical services industry. We operate primarily in the commercial, industrial and institutional HVAC markets, and perform most of our services within office buildings, retail centers, apartment complexes, manufacturing plants, and healthcare, education and government facilities. In addition to standard HVAC services, we provide specialized applications such as building automation control systems, fire protection, process cooling, electronic monitoring and process piping. Certain locations also perform related activities such as electrical service and plumbing. Approximately 56% of our consolidated 2007 revenues are attributable to installation of systems in newly constructed facilities, with the remaining 44% attributable to maintenance, repair and replacement services. The following service activities account for our consolidated 2007 revenues: HVAC—78%, plumbing—14%, building automation control systems—3%, and other—5%. These service activities are within the mechanical services industry which is the single industry segment we serve.

2. Summary of Significant Accounting Policies

        These financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements include all wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

        We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.

        Cash paid for interest in 2005, 2006 and 2007 was approximately $0.8 million, $0.5 million and $0.5 million, respectively. Cash paid for income taxes for continuing operations in 2005, 2006 and 2007 was approximately $13.0 million, $15.6 million and $20.1 million, respectively. Cash paid for income taxes for discontinued operations in 2005, 2006 and 2007 was approximately $0.1 million, $7.1 million and zero, respectively. The taxes paid for discontinued operations for 2006 related to the sale in 2005 of two operations to Automated Logic Corporation and Automated Logic Contracting Services, Inc. These taxes are included in the caption "Taxes paid related to the sale of business" in the accompanying consolidated statement of cash flows.

        Inventories consist of parts and supplies that we purchase and hold 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 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.

47


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

2. Summary of Significant Accounting Policies (Continued)

        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 "Gain on sale of assets" in the statement of operations.

        Goodwill represents the excess of the aggregate purchase price paid in acquisitions over the fair value of the net tangible and intangible assets acquired.

        Long-lived assets are comprised principally of goodwill, intangible assets, property and equipment, and deferred income tax assets. We periodically evaluate whether events and circumstances have occurred that indicate that the remaining balances of these assets may not be recoverable. We use estimates of future income from operations and cash flows, as well as other economic and business factors, to assess the recoverability of these assets.

        Approximately 86% of our revenues were earned on a project basis and recognized through the percentage of completion method of accounting. Under this method as provided by American Institute of Certified Public Accountants Statement of Position 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts," ("SOP 81-1") contract revenue recognizable at any time during the life of a contract is determined by multiplying expected total contract revenue by the percentage of contract costs incurred at any time to total estimated contract costs ("cost to cost method"). More specifically, as part of the negotiation and bidding process in which we engage in connection with obtaining installation contracts, we estimate our contract costs, which include all direct materials (exclusive of rebates), labor and subcontract costs and indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. These contract costs are included in our results of operations under the caption "Cost of Services." Then, as we perform under those contracts, such costs are measured as incurred, compared to total estimated costs to complete the contract, and a corresponding proportion of contract revenue is recognized. Labor costs are considered to be incurred as the work is performed. Subcontractor labor is recognized as the work is performed, but is generally subjected to approval as to milestones or other evidence of completion. Non-labor project cost consists of purchased equipment, prefabricated materials and other materials. Purchased equipment on our projects are substantially all produced to job specifications and are a value added element to our work. The costs are considered to be incurred when title is transferred to us, which typically is upon delivery to the work site. Prefabricated materials, such as ductwork and piping, are generally performed at our shops and recognized as contract costs when fabricated for the unique specifications of the job. Other materials cost are not significant and are generally recorded when delivered to the work site. This measurement and comparison process requires updates to the estimate of total costs to complete the contract, and these updates may include subjective assessments.

        Project contracts typically provide for a schedule of billings or invoices to the customer based on reaching agreed-upon milestones or as we incur costs. The schedules for such billings usually do not

48


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

2. Summary of Significant Accounting Policies (Continued)


precisely match the schedule on which costs are incurred. As a result, contract revenues recognized in the statement of operations can and usually do differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenues recognized on a contract as of a given date exceed cumulative billings to the customer under the contract are reflected as a current asset in our balance sheet under the caption "Costs and estimated earnings in excess of billings." Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenues recognized on the contract are reflected as a current liability in our balance sheet under the caption "Billings in excess of costs and estimated earnings."

        The percentage of completion method of accounting is also affected by changes in job performance, job conditions, and final contract settlements. These factors may result in revisions to estimated costs and, therefore, revenues. Such revisions are frequently based on further estimates and subjective assessments. The effects of these revisions are recognized in the period in which the revisions are determined. When such revisions lead to a conclusion that a loss will be recognized on a contract, the full amount of the estimated ultimate loss is recognized in the period such a conclusion is reached, regardless of the percentage of completion of the contract.

        Revisions to project costs and conditions can give rise to change orders under which the customer agrees to pay additional contract price. Revisions can also result in claims we might make against the customer to recover project variances that have not been satisfactorily addressed through change orders with the customer. Except in certain circumstances, we do not recognize revenues or margin based on change orders or claims until they have been agreed upon with the customer. The amount of revenue associated with unapproved change orders and claims is currently immaterial.

        Variations from estimated project costs could have a significant impact on our operating results, depending on project size, and the recoverability of the variation via additional customer payments.

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

        Accounts receivable include amounts billed to customers under retention or retainage provisions in construction contracts. Such provisions are standard in our industry and usually allow for a small portion of progress billings or the contract price to be withheld by the customer until after we have completed work on the project, typically for a period of six months. Based on our experience with similar contracts in recent years, billings for such retention balances at each balance sheet date are finalized and collected within the subsequent year. Retention balances at December 31, 2006 and 2007 are $61.1 million and $62.8 million, respectively, and are included in accounts receivable.

        The carrying value of our receivables, net of the allowance for doubtful accounts, represents their estimated net realizable value. We estimate our allowance for doubtful accounts based upon the creditworthiness of our customers, prior collection history, ongoing relationships with our customers, the aging of past due balances, our lien rights, if any, in the property where we performed the work, and the availability, if any, of payment bonds applicable to the contract. The receivables are written off when they are deemed to be uncollectible.

49


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

2. Summary of Significant Accounting Policies (Continued)

        We are substantially self-insured for worker's compensation, employer's liability, auto liability, general liability and employee group health claims, in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. Loss estimates associated with the larger and longer-developing risks—worker's compensation, auto liability and general liability—are reviewed by a third-party actuary quarterly. Our self-insurance arrangements are further discussed in Note 12 "Commitments and Contingencies."

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

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

        We regularly evaluate valuation allowances established for deferred tax assets for which future realization is uncertain. We perform this evaluation each quarter. Estimations of required valuation allowances include estimates of future taxable income. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the activity underlying these assets becomes deductible. We consider projected future taxable income and tax planning strategies in making this assessment. If actual future taxable income is less than the estimates, we may not realize all or a portion of the recorded deferred tax assets.

        Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123R, "Share-Based Payment" ("Statement 123R") using the modified-prospective method. See Note 14 "Stock-Based Compensation."

        In June 2006, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 is an interpretation of SFAS No. 109, "Accounting for Income Taxes," and it seeks to reduce the diversity in practice associated with certain aspects of measurement and recognition in accounting for income taxes. In addition, FIN 48 requires expanded disclosure with respect to the uncertainty in income taxes. We adopted FIN 48 on January 1, 2007. The adoption of FIN 48 did not have a material impact on our results of operations. See Note 10 "Income Taxes."

50


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

2. Summary of Significant Accounting Policies (Continued)

        In September 2006, the FASB issued Statement No. 157, "Fair Value Measurements ("Statement 157")," effective for fiscal years beginning after November 15, 2007. Statement 157 provides guidance for using fair value to measure assets and liabilities. The statement applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The statement does not expand the use of fair value in any new circumstances. On February 12, 2008, the FASB issued FASB Staff Position No. 157-2, "Effective Date of FASB Statement No. 157" ("FSP 157-2") that amends Statement 157 to delay the effective date for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008. We have not determined the effect, if any, the adoption of Statement 157 will have on our financial position and results of operations.

        In December 2007, the FASB issued Statement No. 141(Revised 2007), "Business Combinations" ("Statement 141(R))." Statement 141(R) requires an acquiring entity to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141(R) also changes the accounting treatment for certain specific items. Statement 141(R) applies prospectively to business combinations for which the acquisition date is on or after the first annual reporting period beginning on or after December 15, 2008. We will adopt the provisions of Statement 141(R) for business combinations on January 1, 2009.

        Our activities are within the mechanical services industry, which is the single industry segment we serve. Under SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," each operating subsidiary represents an operating segment and these segments have been aggregated, as the operating units meet all of SFAS No. 131's aggregation criteria.

        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, revenues and expenses, and disclosures regarding contingent assets and liabilities. Actual results could differ from those estimates. The most significant estimates used in our financial statements affect revenue and cost recognition for construction contracts, the allowance for doubtful accounts, self-insurance accruals, deferred tax assets, warranty accruals, and the quantification of fair value for reporting units in connection with the our goodwill impairment testing.

        We provide services in a broad range of geographic regions. Our credit risk primarily consists of receivables from a variety of customers including general contractors, property owners and developers, and commercial and industrial companies. We regularly review our accounts receivable and estimate an allowance for uncollectible amounts. We have a diverse customer base, with no single customer accounting for more than 4% of consolidated 2007 revenues.

51


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

2. Summary of Significant Accounting Policies (Continued)

        Our financial instruments consist of cash and cash equivalents, accounts receivable, receivables from related parties, other receivables, accounts payable, a note to a former owner and a revolving credit facility. We believe that the carrying values of these instruments on the accompanying balance sheets approximate their fair values.

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

3. Acquisitions

        On October 1, 2007, we completed the acquisition of Air Systems Engineering, Inc. ("Air Systems"), an HVAC contractor based in Tacoma, Washington. The total consideration paid in this transaction was approximately $5.6 million, comprised of $3.6 million of cash, a contingent payment of $0.3 million, assumed capital lease obligations of $0.2 million and a note payable to the seller for $1.5 million. The consolidated balance sheet of Comfort Systems includes a preliminary allocation of the purchase price to the assets acquired and liabilities assumed based on estimates of fair value. The results of Air Systems are included in our consolidated financial statements from October 1, 2007 through December 31, 2007.

        On March 9, 2007, we completed the acquisition of Madera Mechanical Company ("Madera"), an HVAC contractor based in Tucson, Arizona. The total consideration paid in this transaction was approximately $5.4 million, comprised of $5.2 million of cash and a contingent payment of $0.2 million. The consolidated balance sheet of Comfort Systems includes a preliminary allocation of the purchase price to the assets acquired and liability assumed based on estimates of fair value. The results of operations of Madera are included in our consolidated financial statements from March 9, 2007 through December 31, 2007.

        On January 17, 2005, we completed the acquisition of Granite State Plumbing & Heating ("Granite"), an HVAC contractor located near Manchester, New Hampshire. This acquisition has increased our presence in the Northeast, specifically in the Boston region and southern New Hampshire. The total consideration paid in this transaction was approximately $2.9 million, comprised entirely of cash, including cash acquired. The fair value of the tangible net assets acquired exceeded the total consideration paid. As a result, the long-term fixed assets of the acquisition were reduced by this excess amount. Our consolidated balance sheet includes an allocation of the purchase price to the assets acquired and liabilities assumed based on estimates of fair value. The results of operations of Granite are included in our consolidated financial statements from January 17, 2005 through December 31, 2007.

4. Discontinued Operations

        Sale of Assets to MESA Energy Systems, Inc.—On June 1, 2006, we, along with our wholly- owned subsidiary, ARC Comfort Systems USA, Inc. ("ARC"), entered into an asset purchase agreement to sell certain assets of ARC to Mesa Energy Systems, Inc. (a subsidiary of Emcor Group, Inc.) for

52


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

4. Discontinued Operations (Continued)


approximately $0.7 million in cash. These assets were sold at book value. The after-tax losses of this company of $1.5 million and $0.2 million for the years ended December 31, 2005 and 2006, respectively, have been reported in discontinued operations under "Operating loss, net of income tax benefit."

        Sale of Companies to ALC—On December 31, 2005, we sold two operations to Automated Logic Corporation and Automated Logic Contracting Services, Inc. (together, "ALC") for approximately $22.9 million in cash, net of transaction costs and a purchase price adjustment based upon the closing balance sheet for the transferred assets. The receivable related to this sale was paid during the first quarter of 2006. The gain recognized on the sale of these units was $9.8 million, including tax expense, and was reported in discontinued operations under "Estimated gain on disposition, including income tax benefit (expense)." During the fourth quarter of 2006, we recorded an additional gain of $0.1 million, net of tax, related to the collection of certain receivables. We paid $7.0 million in taxes related to this transaction during the first quarter of 2006. The after-tax income of these companies of $1.3 million in 2005 has been reported in discontinued operations under "Operating loss, net of income tax benefit."

        Individual Sales of Operating Companies—In 2005, we sold two small operating companies in separate transactions and shutdown the operations at another small operating company. The after-tax loss of these companies was $1.2 million in 2005, and has been reported in discontinued operations under "Operating loss, net of income tax benefit." The gain recognized on the sale of these units was $0.1 million, including tax expense, and was reported in discontinued operations under "Estimated gain on disposition, including income taxes."

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

 
  December 31,
2006

  December 31,
2007

Accounts receivable, net   $ 216   $
Other current assets, net     5    
   
 
  Total assets   $ 221   $
   
 

Accounts payable. 

 

$

27

 

$

Other current liabilities     423    
   
 
  Total liabilities   $ 450   $
   
 

        Revenues and pre-tax losses related to the operations discontinued in 2005 and 2006 are as follows (in thousands):

 
  Year Ended December 31,
 
  2005
  2006
  2007
Revenues   $ 37,831   $ 2,564   $
Pre-tax loss   $ (2,127 ) $ (363 ) $

53


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

4. Discontinued Operations (Continued)

        Our consolidated statements of operations and the related earnings per share amounts have been restated to reflect the effects of the discontinued operations. No interest expense is allocated to discontinued operations.

        Sale of Companies to Emcor—In March 2002, we sold 19 operations to Emcor Group, Inc. ("Emcor"). The total purchase price was $186.25 million, including the assumption by Emcor of approximately $22.1 million of subordinated notes to former owners of certain of the divested companies. Of Emcor's purchase price, $5 million was deposited into an escrow account to secure potential obligations on our part to indemnify Emcor for future claims and contingencies arising from events and circumstances prior to closing, all as specified in the transaction documents. Of this escrow, $4 million has been applied in determining our liability to Emcor in connection with the settlement of certain claims. The remaining $1 million of escrow is available for book purposes to apply to any future claims and contingencies in connection with this transaction, and has not been recognized as part of the Emcor transaction purchase price.

        There are ongoing open matters relating to this transaction that we continue to address with Emcor. We do not believe these open matters, either individually or in the aggregate, will have a material effect on our financial position when ultimately resolved. We maintain reserves for these matters, net of amounts receivable from escrow that we believe will ultimately be applied in settling these matters. During the third quarter of 2005, we reduced tax reserves by $0.1 million in connection with the resolution of state tax examinations. This is reflected in the caption "Estimated gain on disposition, including income tax benefit (expense)" in 2005.

5. Goodwill and Other Intangible Assets

        In most businesses we have acquired, the value paid to buy the business was greater than the value of specifically identifiable net assets in the business. Under generally accepted accounting principles, this excess is termed goodwill and is recognized as an asset at the time the business is acquired. It is generally expected that future net earnings from an acquired business will exceed the goodwill asset recognized at the time the business is bought. We do not amortize goodwill in accordance with SFAS No. 142 "Goodwill and Other Intangible Assets."

        SFAS No. 142 requires companies to assess goodwill asset amounts for impairment each year, and more frequently if circumstances suggest an impairment may have occurred. Impairment must be reflected when the value of a given business unit in excess of its tangible net assets falls below the goodwill asset balance carried for that unit on our books. If other business units have had increases in the value of their respective goodwill balances, such increases may not be recorded under SFAS No. 142. Accordingly, such increases may not be netted against impairments at other business units.

        We currently perform our annual impairment testing as of October 1 and any impairment charges resulting from this process are reported in the fourth quarter. We segregated our operations into reporting units based on the degree of operating and financial independence of each unit and our related management of them. These reporting units are tested for impairment by comparing the unit's fair value to its carrying value. The fair value of each reporting unit was estimated using a discounted cash flow model combined with market valuation approaches. Significant estimates and assumptions are used in assessing the fair value of reporting units. These estimates and assumptions involved future

54


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

5. Goodwill and Other Intangible Assets (Continued)


cash flows, growth rates, discount rates, weighted average cost of capital and estimates of market valuations for each of the reporting units.

        During 2005, we experienced modest revenue growth and improved profitability due to increased industry activity and favorable market conditions. However, the revenue, operating profits and cash flows for certain reporting units were lower than expected despite these favorable market conditions. Primarily based upon this trend, the revenue, earnings and cash flow projections for certain reporting units were revised downward for the next several years as compared to previous projections. As a result, an impairment charge of $33.9 million was recognized in 2005 for these reporting units including operations in San Diego, Houston, Grand Rapids, central Iowa, Birmingham, Buffalo and Albany. We did not have a goodwill impairment charge in 2006 and 2007.

        The changes in the carrying amount of goodwill are as follows (in thousands):

 
  December 31, 2006
  December 31, 2007
Balance at beginning of year   $ 62,954   $ 62,954
Goodwill related to sale of operation        
Goodwill related to acquisition of business         5,667
Impairment adjustment        
   
 
Goodwill balance at end of year   $ 62,954   $ 68,621
   
 

        As of December 31, 2007, we have accrued contingent payments of approximately $0.5 million related to prior acquisitions.

        Other intangible assets consist of the following (dollars in thousands):

 
   
  December 31, 2006
  December 31, 2007
 
 
  Estimated
Useful Lives in
Years

  Gross
Carrying
Amount

  Accumulated
Amortization

  Gross
Carrying
Amount

  Accumulated
Amortization

 
Customer relationships   1-7   $ 758   $ (227 ) $ 1,377   $ (386 )
Backlog   1-2             680     (345 )
Noncompete agreements   5-7             230     (22 )
Tradenames   5-10             690     (37 )
       
 
 
 
 
  Total       $ 758   $ (227 ) $ 2,977   $ (790 )
       
 
 
 
 

55


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

5. Goodwill and Other Intangible Assets (Continued)

        The intangible assets reflected above are included in "Other Noncurrent Assets" in the consolidated balance sheets. The amounts attributable to customer relationships, noncompete agreements and tradenames are being amortized to selling, general and administrative expenses on a straight-line method over periods from one to ten years. The amounts attributable to backlog are being amortized to cost of sales on a proportionate method over the remaining backlog period. Amortization expense for the years ended December 31, 2005, 2006 and 2007 was $13,000, $0.2 million and $0.7 million, respectively.

        At December 31, 2007, future amortization expense of intangible assets are as follows (in thousands):

Year ending December 31—      
  2008   $ 708
  2009     352
  2010     249
  2011     249
  2012     201
  Thereafter     278
   
    Total   $ 2,037
   

6. Restructuring Charges

        We recorded restructuring charges of approximately $3.2 million pre-tax in 2003. These charges included approximately $1.5 million for severance costs and retention bonuses primarily associated with the curtailment of our energy efficiency marketing activities, a reorganization of our national accounts operations as well as a reduction in corporate personnel. The restructuring charges for this period also included approximately $1.6 million for remaining lease obligations and $0.1 million of other costs recorded in connection with the actions described above. We increased our accrual for these remaining lease obligations by $0.3 million in 2005, $0.1 million in 2006 and $34,000 in 2007 based on revised estimates of when and to what extent we believe we can sublease the related facilities. These increases to the accrual were included in "Cost of Services" and in "Selling, General and Administrative Expenses" in our consolidated statement of operations. Accrued lease termination costs remaining from past restructuring charges are expected to be completed by 2009.

        The following table shows the remaining liabilities associated with the cash portion of the restructuring charges as of December 31, 2005, 2006 and 2007 (in thousands):

Lease termination costs and other:

  Balance at
Beginning of Period

  Additions
  Payments
  Balance at
End of Period

Year ended December 31, 2005   $ 1,281   $ 273 (a) $ (593 ) $ 961
Year ended December 31, 2006   $ 961   $ 88 (a) $ (363 ) $ 686
Year ended December 31, 2007   $ 686   $ 34 (a) $ (396 ) $ 324

(a)
These charges were included in "Cost of Services" and in "Selling, General and Administrative Expenses" in our consolidated statement of operations.

56


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

7. Property and Equipment

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

 
   
  December 31,
 
 
  Estimated
Useful Lives
in Years

 
 
  2006
  2007
 
Transportation equipment   2-7   $ 8,638   $ 12,720  
Machinery and equipment   3-10     15,218     16,170  
Computer and telephone equipment   3-7     14,523     15,949  
Buildings and leasehold improvements   3-40     8,588     10,226  
Furniture and fixtures   3-10     3,872     4,229  
       
 
 
          50,839     59,294  
Less—Accumulated depreciation         (35,335 )   (37,852 )
       
 
 
  Property and equipment, net       $ 15,504   $ 21,442  
       
 
 

        Depreciation expense for the years ended December 31, 2005, 2006 and 2007 was $4.2 million, $5.0 million and $6.1 million, respectively.

8. Detail of Certain Balance Sheet Accounts

        Activity in our allowance for doubtful accounts consists of the following (in thousands):

 
  December 31,
 
 
  2005
  2006
  2007
 
Balance at beginning of year   $ 5,171   $ 3,538   $ 3,301  
Additions for bad debt expense     1,202     686     1,523  
Deductions for uncollectible receivables written off, net of recoveries     (2,835 )   (923 )   (1,077 )
Allowance for doubtful accounts of acquired companies at date of acquisition             60  
   
 
 
 
Balance at end of year   $ 3,538   $ 3,301   $ 3,807  
   
 
 
 

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

 
  December 31,
 
  2006
  2007
Accrued warranty costs   $ 4,313   $ 5,958
Other current liabilities     8,827     6,896
Accrued backcharges         6,181
Accrued sales and use tax     1,104     1,697
Deferred revenue     1,232     1,051
   
 
    $ 15,476   $ 21,783
   
 

57


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

8. Detail of Certain Balance Sheet Accounts (Continued)

        Contracts in progress are as follows (in thousands):

 
  December 31,
 
 
  2006
  2007
 
Costs incurred on contracts in progress   $ 1,177,317   $ 852,233  
Estimated earnings, net of losses     256,177     192,412  
Less—Billings to date     (1,475,763 )   (1,130,418 )
   
 
 
    $ (42,269 ) $ (85,773 )
   
 
 
Costs and estimated earnings in excess of billings on uncompleted contracts   $ 23,680   $ 18,463  
Billings in excess of costs and estimated earnings on uncompleted contracts     (65,949 )   (104,236 )
   
 
 
    $ (42,269 ) $ (85,773 )
   
 
 

9. Long-Term Debt Obligations

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

 
  December 31,
 
 
  2006
  2007
 
Revolving credit facility   $   $  
Note to former owner         1,500  
   
 
 
  Total debt         1,500  
  Less—current maturities of note to former owner         (375 )
   
 
 
  Total long-term portion of debt   $   $ 1,125  
   
 
 

        At December 31, 2007, future principal payments of long-term debt are as follows (in thousands):

Year ending December 31—      
  2008   $ 375
  2009     375
  2010     375
  2011     375
   
    $ 1,500
   

        In June 2005, we entered into a $75.0 million senior credit facility (the "Original Facility") provided by a syndicate of banks. The Original Facility was available for borrowings and letters of credit and was scheduled to expire on June 30, 2009. On February 20, 2007, we amended the credit facility (the "Facility"), increasing the available borrowing capacity to $100.0 million and amending certain covenants. The Facility will expire in February 2012. The Facility is secured by the capital stock

58


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

9. Long-Term Debt Obligations (Continued)

of our current and future subsidiaries. As of December 31, 2007, the total of the Facility was $100.0 million, with no outstanding borrowings, $37.9 million in letters of credit outstanding, and $62.1 million of credit available.

        Certain of our vendors require letters of credit to ensure reimbursement for amounts they are disbursing on our behalf, such as to beneficiaries under our self-funded insurance programs. We have also occasionally used letters of credit to guarantee performance under our contracts and to ensure payment to our subcontractors and vendors under those contracts. Our lenders issue such letters of credit through the Facility. A letter of credit commits the lenders to pay specified amounts to the holder of the letter of credit if the holder demonstrates that we have failed to perform specified actions. If this were to occur, we would be required to reimburse the lenders for amounts they fund to honor the letter of credit holder's claim. Absent a claim, there is no payment or reserving of funds by us in connection with a letter of credit. However, because a claim on a letter of credit would require immediate reimbursement by us to our lenders, letters of credit are treated as a use of Facility capacity just the same as actual borrowings. We have never had a claim made against a letter of credit that resulted in payments by a lender or by us and believe such claim is unlikely in the foreseeable future.

        A common practice in our industry is the posting of payment and performance bonds with customers. These bonds are offered by financial institutions known as sureties, and provide assurance to the customer that in the event we encounter significant financial or operational difficulties, the surety will arrange for the completion of our contractual obligations and for the payment of our vendors on the projects subject to the bonds. In cooperation with its lenders, we granted our surety a first lien on assets such as receivables, costs and estimated earnings in excess of billings, and equipment specifically identifiable to projects for which bonds are outstanding, as collateral for potential obligations under bonds. As of December 31, 2007 the amount of these assets was approximately $81.0 million.

        The Facility contains financial covenants defining various financial measures and the levels of these measures with which we must comply. Covenant compliance is assessed as of each quarter end. We were in compliance with the financial covenants as of December 31, 2007. Credit Facility Adjusted EBITDA is defined under the Facility for financial covenant purposes as net earnings for the four quarters ending as of any given quarterly covenant compliance measurement date, plus the corresponding amounts for (a) interest expense; (b) income taxes; (c) depreciation and amortization; and (d) other non-cash charges. The following is a reconciliation of Credit Facility Adjusted EBITDA to net income (in thousands):

Net income   $ 32,466  
Income taxes     20,080  
Interest income, net     (2,670 )
Depreciation and amortization expense     6,853  
   
 
Credit Facility Adjusted EBITDA   $ 56,729  
   
 

59


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

9. Long-Term Debt Obligations (Continued)

        The Facility's principal financial covenants include:

        Leverage Ratio—The Facility requires that the ratio of our total indebtedness less cash and cash equivalents to our Credit Facility Adjusted EBITDA not exceed 2.50.

        Fixed Charge Coverage Ratio—The Facility requires that the ratio of Credit Facility Adjusted EBITDA, less non-financed capital expenditures, tax provision, dividends and amounts used to repurchase stock to the sum of interest expense and scheduled principal payments be at least 1.50. Capital expenditures, tax provision, dividends and stock repurchase payments are defined under the Facility for purposes of this covenant to be amounts for the four quarters ending as of any given quarterly covenant compliance measurement date. The calculation of the fixed charge coverage ratio excludes acquisitions, stock repurchases and the payment of cash dividends, provided that the Leverage Ratio does not exceed 1.0.

        Other Restrictions—The Facility permits acquisitions of up to $25.0 million per transaction, or $50.0 million in the aggregate. However, these limitations only apply when the Leverage Ratio is greater than 1.0.

        While the Facility's financial covenants do not specifically govern capacity under the Facility, if our debt level under the Facility at a quarter-end covenant compliance measurement date were to cause us to violate the Facility's debt-to-Credit Facility Adjusted EBITDA covenant, our borrowing capacity under the Facility could be restricted by the lenders.

        We have a choice of two interest rate options for borrowings under the Facility, the Base Rate Option and the Eurodollar Rate Option. Under the Base Rate Option, the interest rate is determined based on the higher of the Federal Funds Rate plus 0.5% or the prime lending rate offered by Citibank, N.A.. Additional margins are then added to the higher of these two rates. These additional margins are determined based on the ratio of our total debt outstanding as of a given quarter end to our "Credit Facility Adjusted EBITDA" for the twelve months ending as of that quarter end, as shown below.

        Under the Eurodollar Rate Option, borrowings bear interest based on designated one to six-month Eurodollar rates that correspond very closely to rates described in various general business media sources as the London Interbank Offered Rate or "LIBOR." Additional margins are then added to LIBOR for borrowings based on the Company's ratio of debt to Credit Facility Adjusted EBITDA, as shown below.

        Letter of credit fees under the Facility are also based on our ratio of debt to Credit Facility Adjusted EBITDA, as shown below.

        The interest rates underlying the Base Rate and Eurodollar Rate Options under the Facility are floating rates determined by the broad financial markets, meaning they can and do move up and down

60


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

9. Long-Term Debt Obligations (Continued)


from time to time. For illustrative purposes, the following are the respective market rates as of December 31, 2007 relating to interest options under the Facility:

Base Rate Option—The higher of:      
Federal Funds Rate plus 0.50%   4.75 %
Citibank, N.A. Prime Rate   7.25 %

Eurodollar Rate Option:

 

 

 
One-month LIBOR   4.60 %
Six-month LIBOR   4.60 %
 
 
  Debt to Credit Facility Adjusted EBITDA
 
 
  Less than 0.75
  0.75 to 1.25
  1.25 to 2.00
  2.00 or greater
 
Additional Per Annum Interest Margin Added Under:                  
  Base Rate Option   0.25 % 0.50 % 0.75 % 1.00 %
  Eurodollar Rate Option   1.25 % 1.50 % 1.75 % 2.00 %

Commitment fees on any portion of the Revolving Loan capacity not in use for borrowings or letters of credit at any given time

 

0.20

%

0.20

%

0.25

%

0.30

%

        We incurred approximately $0.7 million in financing and professional costs in connection with the arrangement of the Original Facility and the current Facility. These costs are amortized on a straight-line basis as a non-cash charge to interest expense over the term of the Facility. Excluding the amortization of debt financing and arrangement costs, we estimate that the interest rate applicable to borrowings under the Facility would be approximately 5.85% as of December 31, 2007.

        The credit facility that preceded our current one was in place from December 2003 to June 2005. Interest expense included the following primary elements (in thousands):

 
  Year Ended December 31,
 
  2005
  2006
  2007
Interest expense on borrowings, and unused commitment fees   $ 391   $ 166   $ 161
Letter of credit fees     389     351     347
Amortization of deferred debt arrangement costs     295     99     107
   
 
 
Total   $ 1,075   $ 616   $ 615
   
 
 

        When our previous credit facilities were reduced in size or terminated, corresponding amounts of deferred debt arrangement costs were written off. This charge in the amount of $0.9 million is reported as "Write-off of debt costs" in our consolidated statement of operations for the year ended December 31, 2005.

61


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

9. Long-Term Debt Obligations (Continued)

        We issued a subordinated note to the former owner of Air Systems Engineering, Inc. as part of the consideration used to acquire the company. This note had an outstanding balance of $1.5 million as of December 31, 2007. This note bears interest, payable quarterly, at a weighted average interest rate of 6.0%.

10. Income Taxes

        The provision for income taxes relating to continuing operations consists of the following (in thousands):

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
Current—                    
  Federal   $ 9,592   $ 16,639   $ 16,910  
  State and Puerto Rico     2,113     2,122     3,899  
   
 
 
 
      11,705     18,761     20,809  
   
 
 
 

Deferred—

 

 

 

 

 

 

 

 

 

 
  Federal     948     (1,236 )   (513 )
  State and Puerto Rico     2,195     349     (216 )
   
 
 
 
      3,143     (887 )   (729 )
   
 
 
 
    $ 14,848   $ 17,874   $ 20,080  
   
 
 
 

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

 
  Year Ended December 31,
 
 
  2005
  2006
  2007
 
Income tax expense (benefit) at the statutory rate   $ (7 ) $ 16,307   $ 18,391  
Changes resulting from—                    
  State income taxes, net of federal tax effect     2,481     1,412     2,172  
  Increase (decrease) in valuation allowance     131     355     229  
  Increase (decrease) in contingency reserves     (14 )   (419 )   62  
  Non-deductible goodwill impairment     11,857          
  Non-deductible expenses     619     289     314  
  Production activity deduction     (182 )   (320 )   (975 )
  Other     (37 )   250     (113 )
   
 
 
 
    $ 14,848   $ 17,874   $ 20,080  
   
 
 
 

62


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

10. Income Taxes (Continued)

        Significant components of the net deferred tax assets and net deferred tax liabilities as reflected on the balance sheet are as follows:

 
  December 31,
 
 
  2006
  2007
 
 
  (In thousands)

 
Deferred income tax assets—              
  Accounts receivable and allowance for doubtful accounts   $ 1,258   $ 1,450  
  Goodwill     3,217     1,492  
  Accrued liabilities and expenses     11,277     13,894  
  State net operating loss carryforwards     2,611     2,053  
  Other     962     1,112  
   
 
 
      Total deferred income tax assets   $ 19,325   $ 20,001  
   
 
 

Deferred income tax liabilities—

 

 

 

 

 

 

 
  Property and equipment     (595 )   (712 )
  Long-term contracts     (689 )   (2,389 )
  Intangible assets         (456 )
  Other     (255 )   (25 )
   
 
 
      Total deferred income tax liabilities     (1,539 )   (3,582 )
   
 
 
Less—Valuation allowance     (2,616 )   (2,348 )
   
 
 
      Net deferred income tax assets   $ 15,170   $ 14,071  
   
 
 

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

 
  December 31,
 
  2006
  2007
Deferred income tax assets—            
  Prepaid expenses and other   $ 10,456   $ 11,229
  Other noncurrent assets     4,714     2,842
   
 
    Total deferred income tax assets   $ 15,170   $ 14,071
   
 

        As of December 31, 2007, we had $2.1 million of future tax benefits related to $54 million of available state net operating loss carryforwards ("NOLs") which expire between 2008 and 2027. Valuation allowances of $2.0 million and $0.3 million, respectively, have been recorded against net deferred tax assets of state NOLs and certain other net state deferred tax assets. We recorded a decrease in valuation allowances of $0.3 million for the year ended December 31, 2007. A deferred tax asset for state NOLs, net of related valuation allowance, of $0.1 million reflects our conclusion that it is likely that this asset will be realized based upon expected future earnings in certain subsidiaries. We update this assessment of the realizability of deferred tax assets relating to state net NOLs annually. We have future tax benefits of $0.1 million related to a capital loss carryover of $0.2 million which

63


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

10. Income Taxes (Continued)


expires in 2008 and 2009. A valuation allowance of $0.1 million has been recorded against the net deferred tax asset of the capital loss carryover.

        We adopted the provisions of FIN 48 on January 1, 2007. As a result of the adoption of FIN 48, we recognized an increase of approximately $40,000 in the liability for unrecognized tax benefits, which was accounted for as a decrease to the January 1, 2007 balance of retained earnings. Our liability for unrecognized tax benefits was approximately $0.8 million and $0.9 million, respectively, as of the date of adoption and as of December 31, 2007. This liability is included in "Other Long-Term Liabilities" in the consolidated balance sheets. As of December 31, 2007, approximately $0.4 million of unrecognized tax benefits, if recognized in future periods, would impact our effective tax rate. We do not expect that the total amount of unrecognized tax benefits will significantly increase or decrease within the next twelve months.

        We recognize potential interest and penalties related to unrecognized tax benefits in income tax expense. In conjunction with the adoption of FIN 48, we recognized approximately $0.2 million for the payment of interest and penalties at January 1, 2007, which is included as a component of the $0.8 million unrecognized tax benefit noted above. During the years ended December 31, 2005, 2006 and 2007, we recognized approximately $(0.2) million, $(0.2) million, and $0.1 million in interest and penalties. We had approximately $0.1 million and $0.2 million for the payment of interest and penalties accrued at December 31, 2006 and 2007, respectively. Our tax records are subject to review by the Internal Revenue Service for the 2004 tax year forward and by various state authorities for the 2000 tax year forward.

        A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

Balance at January 1, 2007   $ 568  
Additions based on tax positions related to the current year     107  
Additions for tax positions of prior years     308  
Reductions for tax positions of prior years     (320 )
Settlements      
   
 
Balance at December 31, 2007   $ 663  
   
 

11. Employee Benefit Plans

        We and certain of our 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 our operating locations. The defined contribution plans generally provide for contributions up to 2.5% of covered employees' salaries or wages. These contributions totaled $3.1 million for 2005, $3.3 million for 2006 and $3.9 million in 2007. Of these amounts, approximately $0.3 million and $0.3 million were payable to the plans at December 31, 2006 and 2007, respectively.

        Certain of our subsidiaries also participate or have participated in various multi-employer pension plans for the benefit of employees who are union members. As of December 31, 2006 and 2007, we

64


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

11. Employee Benefit Plans (Continued)


had 6 employees who were union members. During 2006, two of our operating locations withdrew from multi-employer pension plans; accordingly, we are subject to unfunded pension plan liability related to these two withdrawals. We have accrued $0.5 million in anticipation of these liabilities as of December 31, 2007. The data available from administrators of other 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 our employees participate or previously participated. Our contributions to these plans were approximately $0.1 million for 2005 and zero for 2006 and 2007.

12. Commitments and Contingencies

        We lease certain facilities and equipment under noncancelable operating leases. Rent expense for the years ended December 31, 2005, 2006 and 2007 was $14.9 million, $14.7 million, and $16.7 million, respectively. We recognize escalating rental payments that are quantifiable at the inception of the lease on a straight-line basis over the lease term. Concurrent with the acquisitions of certain acquired companies, we entered into various agreements with previous owners to lease land and buildings used in our operations. The terms of these leases generally range from three to ten years and certain leases provide for escalations in the rental expenses each year, the majority of which are based on inflation. Included in the 2005, 2006 and 2007 rent expense above are approximately $2.5 million, $2.4 million and $2.5 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—      
  2008   $ 9,601
  2009     7,414
  2010     4,416
  2011     3,329
  2012     2,743
  Thereafter     7,086
   
    $ 34,589
   

        We are subject to certain claims and lawsuits arising in the normal course of business. We maintain various insurance coverages to minimize financial risk associated with these claims. We have estimated and provided accruals for probable losses and related legal fees associated with certain litigation in the accompanying consolidated financial statements. While we cannot predict the outcome of these proceedings, in management's opinion and based on reports of counsel, any liability arising from these matters individually and in the aggregate will not have a material effect on our operating results or financial condition, after giving effect to provisions already recorded.

        In addition to the matters described above, we have accrued $6.2 million for potential and asserted backcharges from several customers of our large multi-family operation based in Texas. The related expense is included in "Costs of Services" and the accrual is included in "Other Current Liabilities".

65


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

12. Commitments and Contingencies (Continued)


We believe these accruals reflect a probable outcome with respect to such backcharges and potential backcharges, however, if we are not successful in resolving these disputes, we may in the future experience a material adverse effect on our operating results.

        Many customers, particularly in connection with new construction, require us to post performance and payment bonds issued by a financial institution known as a surety. If we fail to perform under the terms of a contract or to pay subcontractors and vendors who provided goods or services under a contract, the customer may demand that the surety make payments or provide services under the bond. We must reimburse the surety for any expenses or outlays it incurs. To date, we are not aware of any losses to our sureties in connection with bonds the sureties have posted on our behalf, and do not expect such losses to be incurred in the foreseeable future.

        Surety market conditions are currently challenging as a result of significant losses incurred by many sureties in recent periods, both in the construction industry as well as in certain larger corporate bankruptcies. As a result, less bonding capacity is available in the market and terms have become more restrictive. Further, under standard terms in the surety market, sureties issue bonds on a project-by-project basis, and can decline to issue bonds at any time. Historically, approximately 25% to 30% of our business has required bonds. While we have enjoyed a longstanding relationship with our primary surety and have added another surety to further support our bonding needs, current market conditions as well as changes in the sureties' assessment of our operating and financial risk could cause the sureties to decline to issue bonds for our work. If that were to occur, the alternatives include doing more business that does not require bonds, posting other forms of collateral for project performance such as letters of credit or cash, and seeking bonding capacity from other sureties. We would likely also encounter concerns from customers, suppliers and other market participants as to our creditworthiness. While we believe our general operating and financial characteristics, including a significant amount of cash on our balance sheet, would enable us to ultimately respond effectively to an interruption in the availability of bonding capacity, such an interruption would likely cause our revenues and profits to decline in the near term.

        We are substantially self-insured for worker's compensation, employer's liability, auto liability, general liability and employee group health claims, in view of the relatively high per-incident deductibles we absorb under our insurance arrangements for these risks. Losses up to deductible amounts are estimated and accrued based upon known facts, historical trends and industry averages. Loss estimates associated with the larger and longer-developing risks, such as worker's compensation, auto liability and general liability, are reviewed by a third-party actuary quarterly.

        Our self-insurance arrangements currently are as follows:

66


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

12. Commitments and Contingencies (Continued)

13. Stockholders' Equity

        In March 1997, our stockholders approved the 1997 Long-Term Incentive Plan (the "1997 Plan") which provides for the granting of incentive or non-qualified stock options, stock appreciation rights, restricted or deferred stock, dividend equivalents or other incentive awards to our directors, employees and consultants. Aggregate options granted under the 1997 Plan may not exceed 13% of the total number of shares of Common Stock outstanding at the time of any grant under the plan. The options we have granted under the 1997 Plan had exercise prices that were equal to the fair market value of the Common Stock on the date of grant, and which 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. The 1997 Plan expired in March 2007.

        In May 2000, our stockholders approved the 2000 Incentive Plan (the "2000 Plan") which provides for the granting of incentive or non-qualified stock options, restricted stock or performance awards to directors, employees and other persons or entities as approved by the Board of Directors. The options

67


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

13. Stockholders' Equity (Continued)


we have granted under the 2000 Plan have exercise prices that were equal to the fair market value of the Common Stock on the date of grant, and which 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. Under the 2000 Plan, 3.5 million shares were authorized for issuance, of which none remain available for issuance as of December 31, 2007.

        In May 2006, our stockholders approved the 2006 Equity Incentive Plan (the "2006 Plan") which provides for the granting of incentive or non-qualified stock options, stock appreciation rights, restricted or deferred stock, dividend equivalents or other incentive awards to directors, employees and consultants. The number of shares authorized and reserved for issuance under the 2006 Plan is 3,200,000 shares. As of December 31, 2007, there were 2,768,316 shares available for issuance under this plan. The 2006 Plan will expire in May 2016.

        In March 1997, our stockholders approved the 1997 Non-Employee Directors' Stock Plan (the "Directors' Plan"), which provides for the granting of stock options or stock appreciation rights to non-employees. The number of shares authorized and reserved for issuance under the Directors' Plan was 500,000 shares. Under the Directors' Plan, each non-employee director was granted options to purchase 10,000 shares at the time of the director's initial election. In addition, each non-employee director was automatically granted options to purchase an additional 10,000 shares at each annual meeting of the stockholders that is more than two months after the date of the director's initial election. All options were granted with an exercise price equal to the fair market value at the date of grant and were immediately vested upon grant. The 1997 Plan expired in March 2007.

        In May 2006, our stockholders approved our 2006 Stock Options/SAR Plan for Non-Employee Directors (the "2006 Directors Plan"), which provides for the granting of stock options or stock appreciation rights to non-employees. The number of shares authorized and reserved for issuance under the 2006 Directors Plan is 500,000 shares. Outstanding options may be canceled and reissued under terms specified in the plan. As of December 31, 2007, there were 460,000 shares available for issuance under this plan. The 2006 Directors Plan will expire in May 2016.

        Under the 2006 Directors Plan, each participant who has served since at least the previous annual meeting and is continuing in office and each newly elected non-employee director will be awarded an award covering 10,000 shares (which will be the maximum number of shares of Common Stock subject to awards that may be granted to any participant in the aggregate in any calendar year). All options will be granted with an exercise price equal to the fair market value at the date of grant and become exercisable on the first anniversary of the date of grant. The options expire after ten years from the date of grant if unexercised.

        We have never altered the price of any option after its grant.

        On March 29, 2007, our Board of Directors (the "Board") approved a stock repurchase program to acquire up to one million shares our outstanding common stock. On November 16, 2007, the Board approved an extension of our stock repurchase program to cover an additional 401,200 shares of our

68


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

13. Stockholders' Equity (Continued)

outstanding common stock. The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. The Board may modify, suspend, extend or terminate the program at any time. We repurchased 859,900 shares for the year ended December 31, 2007, at an average price of $12.87 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, warrants and contingently issuable restricted stock.

        Under EPS calculation methods established by generally accepted accounting principles, including the effect of options whose exercise price exceeds the average market price of the Common Stock for a given period would increase calculated EPS. This impact is called "anti-dilutive." Generally accepted accounting principles for determining EPS require that any options or other common stock equivalents whose inclusion in determining EPS would have an anti-dilutive effect be excluded. Accordingly, options to purchase 0.1 million shares of Common Stock at prices ranging from $12.75 to $21.125 per share which were outstanding for the year ended December 31, 2006, and options to purchase 0.1 million shares at prices ranging from $13.51 to $21.125 per share which were outstanding for the year ended December 31, 2007, were not included in the computation of diluted EPS because they were anti-dilutive.

        Including options in an EPS calculation for a period in which a loss is reported is also anti-dilutive. Accordingly, because we reported a loss from continuing operations for the year ended December 31, 2005, options to purchase 0.9 million shares of common stock at prices ranging from $1.90 to $21.438 per share were excluded from the computation of diluted EPS because they were anti-dilutive.

        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,
 
  2005
  2006
  2007
Common shares outstanding, end of period(a)   39,737   40,462   40,029
Effect of using weighted average common shares outstanding   (439 ) (215 ) 544
   
 
 
Shares used in computing earnings per share—basic   39,298   40,247   40,573
Effect of shares issuable under stock option plans based on the treasury stock method     818   704
Effect of contingently issuable restricted shares     81   57
   
 
 
Shares used in computing earnings per share—diluted   39,298   41,146   41,334
   
 
 

(a)
Excludes 242,917, 247,709 and 312,532 shares of unvested contingently issuable restricted stock outstanding as of December 31, 2005, 2006 and 2007 respectively (see Note 14 "Stock-Based Compensation.")

69


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

14. Stock-Based Compensation

        We have various stock-based compensation plans which are administered by the compensation committee of the Board of Directors. Prior to January 1, 2006, we accounted for those plans under the recognition and measurement provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Based Compensation." No stock-based employee compensation cost was recognized in the consolidated statements of operations for the year ended December 31, 2005, except with respect to the amortization of the intrinsic value of restricted stock grants totaling $0.5 million. Options granted under our equity compensation plans had an exercise price equal to the market value of the underlying common stock on the date of grant and all terms were fixed; accordingly, no expense was recognized under APB Opinion No. 25. Effective January 1, 2006, we adopted the fair value recognition provisions of Statement 123R, using the modified-prospective-transition method. Results for prior periods have not been restated.

        Total stock-based compensation expense was $1.8 million ($1.1 million after tax or $0.03 per basic share and $0.03 per diluted share) and $2.5 million ($1.6 million after tax or $0.04 per basic share and $0.04 per diluted share) for the years ended December 31, 2006 and 2007, respectively.

        The following table sets forth pro forma information as if compensation expense for the year ended December 31, 2005 had been determined consistent with the requirements of Statement No. 123. For purposes of this pro forma disclosure, the value of the stock options was estimated using a Black-Scholes option-pricing formula and amortized to expense over the options' vesting periods (in thousands, except per share amounts):

 
  Year Ended December 31, 2005
 
Net loss as reported   $ (6,226 )
Add: Stock-based compensation included in reported net income, net of tax     337  
Less: Compensation expense per Statement 123, net of tax     (1,028 )
   
 
Pro forma net loss   $ (6,917 )
   
 
Net loss per share—Basic        
  Net loss per share as reported   $ (0.16 )
  Pro forma net loss per share   $ (0.18 )
Net loss per share—Diluted        
  Net loss per share as reported   $ (0.16 )
  Pro forma net loss per share   $ (0.18 )

        Prior to adopting Statement 123R, we presented the benefits of tax deductions in excess of recognized compensation costs ("excess tax benefits") as operating cash flows in the consolidated statements of cash flows. Statement 123R requires these excess tax benefits to be reported as financing cash flows.

70


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

14. Stock-Based Compensation (Continued)

Stock Options—

        The following table summarizes activity under our stock option plans:

 
  2005
  2006
  2007
Stock Options

  Shares
  Weighted-
Average
Exercise Price

  Shares
  Weighted-
Average
Exercise Price

  Shares
  Weighted-
Average
Exercise Price

Outstanding at beginning of year   3,508,051   $ 5.49   2,667,863   $ 4.18   1,933,742   $ 4.30
Granted   467,500   $ 6.60   65,000   $ 12.87   186,550   $ 12.31
Exercised   (765,913 ) $ 3.34   (653,996 ) $ 3.71   (351,600 ) $ 3.67
Forfeited   (175,750 ) $ 7.79   (93,625 ) $ 6.35   (11,250 ) $ 12.75
Expired   (366,025 ) $ 9.90   (51,500 ) $ 12.73   (10,000 ) $ 13.00
   
       
       
     
Outstanding at end of year   2,667,863   $ 4.18   1,933,742   $ 4.30   1,747,442   $ 5.18
   
       
       
     
Options exercisable at end of year   1,795,113         1,448,992         1,375,642      

        The total intrinsic value of options exercised during the years ended December 31, 2005, 2006 and 2007 was $3.5 million, $6.0 million and $3.4 million, respectively. Stock options outstanding as of December 31, 2007 have a weighted-average remaining contractual term of 5.1 years and an aggregate intrinsic value of $13.4 million. Stock options exercisable as of December 31, 2007 have a weighted-average remaining contractual term of 4.2 years and an aggregate intrinsic value of $12.1 million. As of December 31, 2007, we have 1,720,147 shares that are vested or expected to vest; these shares have a weighted average exercise price of $5.11 per share, have a weighted-average remaining contractual term of 5.0 years and an aggregate intrinsic value of $13.2 million.

        The following table summarizes information about stock options outstanding at December 31, 2007:

 
  Options Outstanding
  Options Exercisable
Range of
Exercise Prices

  Number
Outstanding
at 12/31/07

  Weighted-
Average
Remaining
Contractual
Life

  Weighted-
Average
Exercise Price

  Number
Exercisable
at 12/31/07

  Weighted-
Average
Exercise Price

$1.90-2.875   591,392   4.12   $ 2.31   591,392   $ 2.31
$3.39-7.94   905,750   4.70   $ 4.97   720,500   $ 4.55
$11.94-13.51   238,429   9.08   $ 12.42   53,750   $ 12.89
$15.03-21.125   11,871   2.27   $ 18.14   10,000   $ 18.72
   
           
     
$1.90-21.125   1,747,442   5.08   $ 5.18   1,375,642   $ 4.01
   
           
     

        The fair value of each option award is estimated, based on several assumptions, on the date of grant using the Black-Scholes option valuation model. Upon adoption of Statement 123R, we modified our methods used to determine these assumptions based on the Securities and Exchange Commission's

71


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

14. Stock-Based Compensation (Continued)


Staff Accounting Bulletin No. 107. The fair values and the assumptions used for the 2005-2007 grants are shown in the table below:

 
  2005
  2006
  2007
Weighted-average fair value per share of options granted   $4.22   $5.53   $5.44

Fair value assumptions:

 

 

 

 

 

 
  Expected dividend yield   0.00%   1.09%-1.10%   0.93%-1.17%
  Expected stock price volatility   61.23%-63.99%   45%   45%
  Risk-free interest rate   3.91%-4.31%   4.81%-4.94%   4.46%-4.68%
  Expected term   7 years   5.0-6.3 years   5.5-6.0 years

        Stock options are accounted for as equity instruments, and compensation cost is recognized using straight-line vesting over the four-year vesting period. As of December 31, 2007, the unrecognized compensation cost related to stock options was $1.1 million, which is expected to be recognized over a weighted-average period of 1.4 years. The total fair value of shares vested during the year ended December 31, 2007 was $0.7 million.

        The following table summarizes information about nonvested stock option awards as of December 31, 2007 and changes for the year ended December 31, 2007:

Stock Options

  Shares
  Weighted Average
Grant Date
Fair Value

Nonvested at December 31, 2006   484,750   $ 3.20
Granted   186,550   $ 5.44
Vested   (288,250 ) $ 2.47
Forfeited   (11,250 ) $ 5.85
   
     
Nonvested at December 31, 2007   371,800   $ 4.81
   
     

        We generally issue new shares for stock options and restricted stock, unless treasury shares are available.

Restricted Stock—

        The following table summarizes activity under our restricted stock plans:

Restricted Stock

  2005
  2006
  2007
 
Unvested at beginning of year   325,000   242,917   156,042  
Granted   82,500   45,833   104,454  
Vested   (102,083 ) (118,333 ) (111,042 )
Forfeited   (62,500 ) (14,375 )  
Expired        
   
 
 
 
Unvested at end of year   242,917   156,042   149,454  
   
 
 
 

        Approximately $0.5 million of compensation expense related to restricted stock will be recognized over a weighted-average period of 0.4 years. The total fair value of shares vested during year ended December 31, 2007 was $1.1 million. The weighted-average fair value per share of restricted stock shares awarded during 2005, 2006 and 2007 was $5.58, $11.07 and $11.98, respectively. The aggregate intrinsic value of restricted stock vested during the years ended December 31, 2005, 2006 and 2007 was $0.5 million, $1.5 million and $1.8 million, respectively.

72


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

15. Quarterly Results of Operations (Unaudited)

Quarterly financial information for the years ended December 31, 2006 and 2007 is summarized as follows (in thousands, except per share data):

 
  2006
 
  Q1
  Q2
  Q3
  Q4
Revenues   $ 236,385   $ 264,390   $ 287,676   $ 268,074
Gross profit   $ 36,768   $ 42,464   $ 46,209   $ 45,576
Operating income   $ 7,045   $ 12,099   $ 14,155   $ 11,223
Income from continuing operations   $ 4,534   $ 7,717   $ 8,967   $ 7,499

Discontinued operations—

 

 

 

 

 

 

 

 

 

 

 

 
  Operating results, net of tax   $ (207 ) $ (5 ) $ (5 ) $ 14
  Estimated gain on disposition, including tax   $   $ 209   $   $ 1
Net income   $ 4,327   $ 7,921   $ 8,962   $ 7,514

INCOME PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 
  Basic—                        
    Income from continuing operations   $ 0.11   $ 0.19   $ 0.22   $ 0.19
    Discontinued operations—                        
      Income from operations                
      Estimated gain on disposition         0.01        
   
 
 
 
    Net income   $ 0.11   $ 0.20   $ 0.22   $ 0.19
   
 
 
 
 
Diluted—

 

 

 

 

 

 

 

 

 

 

 

 
    Income from continuing operations   $ 0.11   $ 0.19   $ 0.22   $ 0.18
    Discontinued operations—                        
      Income from operations                
      Estimated gain on disposition                
   
 
 
 
    Net income   $ 0.11   $ 0.19   $ 0.22   $ 0.18
   
 
 
 

Cash flow from operations

 

$

(20,508

)

$

8,586

 

$

5,556

 

$

24,100

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COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

15. Quarterly Results of Operations (Unaudited) (Continued)

 
  2007
 
  Q1
  Q2
  Q3
  Q4
Revenues   $ 249,640   $ 280,520   $ 286,090   $ 293,284
Gross profit   $ 36,514   $ 51,723   $ 54,298   $ 54,528
Operating income   $ 2,156   $ 16,543   $ 18,093   $ 13,079
Income from continuing operations   $ 1,806   $ 10,501   $ 11,478   $ 8,681

Discontinued operations—

 

 

 

 

 

 

 

 

 

 

 

 
  Operating results, net of tax   $   $   $   $
  Estimated gain on disposition, including tax   $   $   $   $
Net income   $ 1,806   $ 10,501   $ 11,478   $ 8,681

INCOME PER SHARE:

 

 

 

 

 

 

 

 

 

 

 

 
  Basic—                        
    Income from continuing operations   $ 0.04   $ 0.26   $ 0.28   $ 0.21
    Discontinued operations—                        
      Income from operations                
      Estimated gain on disposition                
   
 
 
 
    Net income   $ 0.04   $ 0.26   $ 0.28   $ 0.21
   
 
 
 
 
Diluted—

 

 

 

 

 

 

 

 

 

 

 

 
    Income from continuing operations   $ 0.04   $ 0.25   $ 0.28   $ 0.21
    Discontinued operations—                        
      Income from operations                
      Estimated gain on disposition                
   
 
 
 
    Net income   $ 0.04   $ 0.25   $ 0.28   $ 0.21
   
 
 
 

Cash flow from operations

 

$

(12,828

)

$

21,224

 

$

17,145

 

$

58,101

        Our quarterly results of operations and the related earnings per share amounts have been restated to reflect the effects of discontinued operations.

        The sums of the individual quarterly earnings per share amounts do not necessarily 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 options and contingently issuable restricted stock in each quarter.

16. Subsequent Events

        On February 27, 2008, we announced that the Board of Directors approved an extension of our stock repurchase program to cover an additional 0.7 million shares of our outstanding common stock. Our existing stock repurchase program had previously authorized the repurchase of up to 1.4 million shares of our outstanding common stock. Through February 26, 2008, we had repurchased 1.1 million shares of our common stock at an aggregate price of approximately $13.8 million. This extension of the stock repurchase program will permit us to repurchase up to an additional 1.0 million shares of our

74


COMFORT SYSTEMS USA, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

December 31, 2007

16. Subsequent Events (Continued)


currently outstanding common stock beyond what had already been repurchased as of February 26, 2008.

        The share repurchases will be made from time to time at our discretion in the open market or privately negotiated transactions as permitted by securities laws and other legal requirements, and subject to market conditions and other factors. We expect that the share repurchases will be financed with available cash. The Board may modify, suspend, extend or terminate the program at any time.

75



ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

        None.


ITEM 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

        Our executive management is responsible for ensuring the effectiveness of the design and operation of our disclosure controls and procedures. We carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective as of the end of the period covered by this report.

Internal Controls over Financial Reporting

        Management's report on our internal controls over financial reporting can be found in Item 8 of this report. The Independent Registered Public Accounting Firm's Attestation Report on the effectiveness of our internal controls over financial reporting can also be found in Item 8 of this report.

Changes in Internal Control over Financial Reporting

        There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934) during the three months ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting.


ITEM 9B. Other Information

        None.

76



PART III

ITEM 10. Directors and Executive Officers of the Registrant

        We have adopted a code of ethics that applies to our principal executive officer, our principal financial officer, and our principal accounting officer, as well as to our other employees. This code of ethics consists of our Corporate Compliance Policy. The Company has made this code of ethics available on our website, as described in Item 1 of this annual report on Form 10-K. If we make substantive amendments to this code of ethics or grant any waiver, including any implicit waiver, we will disclose the nature of such amendment or waiver on our website or in a report on Form 8-K within four business days of such amendment or waiver.

        The other information called for by this item has been omitted in accordance with the instructions to Form 10-K. We will file with the Commission a definitive proxy statement including the other information to be disclosed under this item in the 120 days following December 31, 2007 and such information is hereby incorporated by reference.


ITEMS 11, 12, 13 AND 14.

        These items have been omitted in accordance with the instructions to Form 10-K. We 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, 2007 and such information is hereby incorporated by reference.

77



PART IV

ITEM 15. Exhibits and Financial Statement Schedules.

(a)    The following documents are filed as part of this annual report on Form 10-K:

        (1)   Consolidated Financial Statements (Included Under Item 8): Reference is made to the Index to the Consolidated Financial Statements is included on page 39 of this annual report on Form 10-K which index is incorporated herein by reference.

        (2)   Financial Statement Schedules:

        (3)   Reference is made to the Index of Exhibits beginning on page 79 of this annual report on Form 10-K which index is incorporated herein by reference.

78



SIGNATURES

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

    COMFORT SYSTEMS USA, INC.

 

 

By:

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

 

 

By:

/s/  
WILLIAM GEORGE      
      William George
Executive Vice President and Chief Financial Officer

 

 

By:

/s/  
JULIE S. SHAEFF      
      Julie S. Shaeff
Senior Vice President and Chief Accounting Officer

Date: February 27, 2008

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

Signature
  Title
  Date

 

 

 

 

 
/s/  WILLIAM F. MURDY      
William F. Murdy
  Chairman of the Board and Chief Executive Officer   February 27, 2008

/s/  
HERMAN E. BULLS      
Herman E. Bulls

 

Director

 

February 27, 2008

/s/  
FRANKLIN MYERS      
Franklin Myers

 

Director

 

February 27, 2008

/s/  
ALFRED J. GIARDINELLI, JR.      
Alfred J. Giardinelli, Jr.

 

Director

 

February 27, 2008

/s/  
JAMES H. SCHULTZ      
James H. Schultz

 

Director

 

February 27, 2008

/s/  
ROBERT D. WAGNER, JR.      
Robert D. Wagner, Jr.

 

Director

 

February 27, 2008

79



INDEX OF EXHIBITS

 
   
   
  Incorporated by Reference to the Exhibit Indicated Below and to the Filing with the Commission Indicated Below
Exhibit
Number

   
  Description of Exhibits
  Exhibit
Number

  Filing or
File Number

3.1     Second Amended and Restated Certificate of Incorporation of the Registrant.   3.1   333-24021
3.2     Certificate of Amendment dated May 21, 1998.   3.2   1998 Form 10-K
3.3     Certificate of Amendment dated July 19, 2003.   3.3   2003 Form 10-K
3.4     Bylaws of Registrant, as amended.   3.3   1998 Form 10-K
4.1     Form of certificate evidencing ownership of Common Stock of the Registrant.   4.1   333-24021
*10.1     Comfort Systems USA, Inc. 1997 Long-Term Incentive Plan   10.1   333-24021
*10.2     Comfort Systems USA, Inc. 1997 Non-Employee Directors' Stock Plan   10.2   333-24021
*10.3     Amendment to the 1997 Non-Employee Directors' Stock Plan dated May 23, 2002.   10.3   Second Quarter 2002 Form 10-Q/A
*10.4     Comfort Systems USA, Inc. 2006 Equity Incentive Plan   10.4   333-138377
*10.5     Comfort Systems USA, Inc. 2006 Stock Options/SAR Plan for Non-Employee Directors.   10.5   333-138377
*10.6     Form of Option Award under the Comfort Systems USA, Inc. 2006 Equity Incentive Plan.   10.6   2006 Form 10-K
*10.7     Form of Option Award under the Comfort Systems USA, Inc. 2006 Stock Options/SAR Plan for Non-Employee Directors.   10.7   2006 Form 10-K
*10.8     Employment Agreement dated June 27, 2000 by and among Comfort Systems USA (Texas), L.P. and William F. Murdy.   10.2   Second Quarter 2000 Form 10-Q
*10.9     Employment Agreement dated December 1, 2003 by and among Comfort Systems USA (Texas), L.P. and William George.   10.8   2003 Form 10-K
*10.10     Employment Agreement dated January 1, 2004 by and among Comfort Systems USA (Texas), L.P. and Thomas N. Tanner.   10.10   2003 Form 10-K
*10.11     Employment Agreement dated December 1, 2003 by and among Comfort Systems USA (Texas), L.P. and Julie S. Shaeff.   10.10   2006 Form 10-K
*10.12     Employment Agreement dated January 1, 2006 by and among Comfort Systems USA (Texas), L.P. and Trent T. McKenna.   10.12   2006 Form 10-K
*10.13     Employment Agreement between the Company, Eastern Heating & Cooling, Inc. and Alfred J. Giardinelli, Jr.   10.1   Second Quarter 2003 Form 10-Q
*10.14     Form of Restricted Stock Award Agreement between William F. Murdy and the Company dated March 22, 2002.   10.2   First Quarter 2002 Form 10-Q

80


10.15     Amended and Restated Credit Agreement by and among the Company and Wachovia Bank, N.A., Bank of Texas, N.A., Capital One, N.A. and Certain Financial Institutions dated as of February 20, 2007.   10.1   February 26, 2007 Form 8-K
*10.16     Restricted Stock Award Agreement dated June 8, 2004 by the Company to William F. Murdy.   10.1   Second Quarter 2004 Form 10-Q
*10.17     Restricted Stock Award Agreement dated June 8, 2004 by the Company to William George.   10.3   Second Quarter 2004 Form 10-Q
*10.18     Restricted Stock Award Agreement dated June 8, 2004 by the Company to Thomas N. Tanner.   10.4   Second Quarter 2004 Form 10-Q
*10.19     Restricted Stock Award Agreement dated June 8, 2004 by the Company to Julie S. Shaeff.   10.18   2005 Form 10-K
*10.20     Restricted Stock Award Agreement dated April 1, 2006 by the Company to William F. Murdy.   10.20   2006 Form 10-K
*10.21     Restricted Stock Award Agreement dated April 1, 2006 by the Company to William George.   10.21   2006 Form 10-K
*10.22     Restricted Stock Award Agreement dated April 1, 2006 by the Company to Thomas N. Tanner.   10.22   2006 Form 10-K
*10.23     Restricted Stock Award Agreement dated April 1, 2006 by the Company to Julie S. Shaeff.   10.23   2006 Form 10-K
*10.24     Restricted Stock Award Agreement dated April 1, 2006 by the Company to Trent T. McKenna.   10.24   2006 Form 10-K
*10.25     Form Restricted Stock Award Agreement dated March 28, 2007.   10.25   Filed Herewith
21.1     List of subsidiaries of Comfort Systems USA, Inc.       Filed Herewith
23.1     Consent of Ernst & Young LLP.       Filed Herewith
31.1     Rule 13a-14(a) Certification of William F. Murdy pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.       Filed Herewith
31.2     Rule 13a-14(a) Certification of William George pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.       Filed Herewith
32.1     Section 1350 Certification of William F. Murdy pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.       Furnished Herewith
32.2     Section 1350 Certification of William George pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.       Furnished Herewith

*
—Management contract or compensatory plan

81




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DOCUMENTS INCORPORATED BY REFERENCE
FORWARD-LOOKING STATEMENTS
PART I
PART II
INDEX TO FINANCIAL STATEMENTS
Management's Report on Internal Control over Financial Reporting
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
COMFORT SYSTEMS USA, INC. CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share Amounts)
COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In Thousands, Except Per Share Data)
COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In Thousands, Except Share Amounts)
COMFORT SYSTEMS USA, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands)
COMFORT SYSTEMS USA, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2007
PART III
PART IV
SIGNATURES
INDEX OF EXHIBITS

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Exhibit 10.25

[EXECUTIVE NAME]

COMFORT SYSTEMS USA, INC.
2006 Equity Incentive Plan
Restricted Stock Award Agreement

Comfort Systems USA, Inc.
777 Post Oak Blvd, Suite 500
Houston, Texas 77056

Ladies and Gentlemen:

        The undersigned (i) acknowledges that he or she has received an award (the "Award") of restricted stock from Comfort Systems USA, Inc., a Delaware corporation (the "Company") under the 2006 Equity Incentive Plan (the "Plan"), subject to the terms set forth below and in the Plan; (ii) further acknowledges receipt of a copy of the Plan as in effect on the date hereof; and (iii) agrees with the Company as follows:


2


3



        Very truly yours,

 

 

 

 

[SIGNATURE]
[EXECUTIVE NAME]

The foregoing Restricted Stock
Award Agreement is hereby accepted:

 

 

COMFORT SYSTEMS USA, INC.

 

 

By:

 

[SIGNATURE]
[TITLE]

 

 

4




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Exhibit 21.1

COMFORT SYSTEMS USA, INC.—SUBSIDIARIES

ENTITY NAME

  DOMESTIC JURISDICTION
  FORMATION DATE
Accurate Air Systems, Inc.    Delaware   06/29/2007
Accu-Temp GP, Inc.    Delaware   05/21/1998
Accu-Temp LP, Inc.    Delaware   05/20/1998
ACI Mechanical, Inc.    Delaware   06/26/1998
Air Systems Engineering, Inc.    Washington   05/18/1973
AirTemp, Inc.    Delaware   10/15/1998
ARC Comfort Systems USA, Inc.    Delaware   03/17/1998
Atlas-Accurate Holdings, L..L..C.    Delaware   12/28/1998
Atlas Comfort Systems USA, Inc.    California   07/31/2007
Atlas Comfort Systems USA, L.L.C.    Delaware   06/29/2007
Batchelor's Mechanical Contractors, Inc.    Alabama   03/16/1981
BCM Controls Corporation   Massachusetts   10/03/1984
California Comfort Systems USA, Inc.    California   05/18/1983
Climate Control, Inc.    Delaware   09/17/1998
Comfort Systems USA (Arkansas), Inc.    Delaware   03/17/1998
Comfort Systems USA (Atlanta), Inc.    Georgia   01/25/2005
Comfort Systems USA (Baltimore), Inc.    Delaware   10/15/1998
Comfort Systems USA (Bristol), Inc.    Delaware   08/25/1997
Comfort Systems USA (Carolinas), Inc.    Delaware   06/09/2006
Comfort Systems USA (Florida), Inc.    Florida   10/04/1976
Comfort Systems USA G.P., Inc.    Delaware   08/12/1998
Comfort Systems USA (Hartford), Inc.    Delaware   08/25/1997
Comfort Systems USA (Intermountain), Inc.    Utah   05/06/1969
Comfort Systems USA (Kentucky), Inc.    Kentucky   02/10/1981
Comfort Systems USA National Accounts, LLC   Indiana   07/28/1998
Comfort Systems USA (Ohio), Inc.    Ohio   10/10/1979
Comfort Systems USA (Pasadena), Inc.    Texas   06/29/2007
Comfort Systems USA Puerto Rico, Inc.    Puerto Rico   05/31/1998
Comfort Systems USA (Southeast), Inc.    Delaware   03/24/1998
Comfort Systems USA (Syracuse), Inc.    New York   03/08/1965
Comfort Systems USA (Texas), L.P.    Texas   08/14/1998
Comfort Systems USA (Twin Cities), Inc.    Minnesota   08/01/2001
Comfort Systems USA (Western Michigan), Inc.    Michigan   07/21/1989
CS53 Acquisition Corp.    Delaware   01/26/1999
Design Mechanical Incorporated   Delaware   10/30/1997
Eastern Heating & Cooling, Inc.    New York   12/19/1988
Eastern Refrigeration Co., Inc.    New York   01/30/1990
Granite State Holdings Company, Inc.    Delaware   11/02/2005
Granite State Plumbing & Heating, LLC   Delaware   07/31/2001
H & M Mechanical, Inc.    Delaware   06/25/1998
Helm Corporation   Colorado   10/26/1972
Hess Mechanical Corporation   Delaware   03/17/1998
Hudson River Heating and Cooling, Inc.    Delaware   08/19/2005
H-VAC Supply, L.L.C.    Puerto Rico   10/18/06
HydroKool, L.L.C.    Delaware   03/16/2006
Madera Mechanical Company   Arizona   06/02/1983
Mechanical Technical Services, Inc.    Delaware   06/29/2007
MJ Mechanical Services, Inc.    Delaware   12/12/1997
North American Mechanical, Inc.    Delaware   03/17/1998

Quality Air Heating and Cooling, Inc.    Michigan   09/10/1980
Quality Professional Employer Organization LLC   Delaware   12/01/2004
S.I. Goldman Company, Inc.    Delaware   03/17/1998
S.M. Lawrence Company, Inc.    Tennessee   03/08/1973
SA Associates, Inc.    Utah   03/27/1984
Salmon & Alder, LLC   Utah   07/08/1996
Seasonair, Inc.    Maryland   10/28/1966
Sheren Plumbing & Heating, Inc.    Delaware   01/26/1999
Temp-Right Service, Inc.    Delaware   09/25/1997
The Capital Refrigeration Company   Delaware   08/06/1998
Tri-City Mechanical, Inc.    Arizona   12/23/1977



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COMFORT SYSTEMS USA, INC.—SUBSIDIARIES

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Exhibit 23.1


CONSENT OF INDEPENDENT AUDITORS

        We consent to the incorporation by reference in the following Registration Statements:

of our reports dated February 27, 2008, with respect to the consolidated financial statements of Comfort Systems USA, Inc., Comfort Systems USA, Inc. management's assessment of the effectiveness of internal control over financial reporting, and the effectiveness of internal control over financial reporting of Comfort Systems USA, Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 2007.

    Ernst & Young, LLP

 

 

Houston, Texas
February 27, 2008



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CONSENT OF INDEPENDENT AUDITORS

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Exhibit 31.1

CERTIFICATION

        I, William F. Murdy, Chairman of the Board and Chief Executive Officer of Comfort Systems USA, Inc. (the "Company"), certify that:

Date: February 27, 2008

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



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CERTIFICATION

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Exhibit 31.2

CERTIFICATION

        I, William George, Executive Vice President and Chief Financial Officer of Comfort Systems USA, Inc. (the "Company"), certify that:

Date: February 27, 2008

    By:   /s/ WILLIAM GEORGE
William George
Executive Vice President and Chief Financial Officer



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CERTIFICATION

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Exhibit 32.1

CERTIFICATION PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002*

        In connection with the Annual Report of Comfort Systems USA, Inc. (the "Company") on Form 10-K for the year ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William F. Murdy, Chairman of the Board and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:


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

*
A signed original of this written statement required by Section 906 has been provided to Comfort Systems USA, Inc. and will be retained by Comfort Systems USA, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.



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CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

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Exhibit 32.2

CERTIFICATION PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002*

        In connection with the Annual Report of Comfort Systems USA, Inc. (the "Company") on Form 10-K for the year ended December 31, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William George, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:


    By:   /s/ WILLIAM GEORGE
William George
Executive Vice President and Chief Financial Officer

*
A signed original of this written statement required by Section 906 has been provided to Comfort Systems USA, Inc. and will be retained by Comfort Systems USA, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.



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CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002