What drove the revenue increase in 1999?

Most of the 60.4% revenue increase, to $1.37 billion, came from acquisitions of Purchased Companies in 1998 and 1999. Internal growth slowed in the second half of 1999 as construction labor and specialty materials shortages constrained HVAC installation activity.

Did profitability actually weaken in 1999?

Operating margin fell from 8.1% to 6.8%, and gross margin fell from 24.2% to 21.4%. Management attributes about $37.2 million of the gross margin decline to reclassifying certain costs from SG&A into cost of services, which makes the comparison with prior years imperfect. Excluding that change, gross margin was roughly unchanged, but SG&A pressure and lower internal growth weighed on operating margin.

How leveraged is the company and what are the financing risks?

Total debt was $305.8 million at year-end 1999, including $225.2 million under a variable-rate revolver that expires November 1, 2001, and $80.6 million of fixed-rate debt, largely notes to former owners of acquired businesses. Debt rose sharply to fund acquisitions, and the company says it may need additional equity or debt financing if it accelerates its acquisition program, with no assurance such financing would be available on acceptable terms.

Is the company's growth strategy dependent on continued acquisitions?

Yes. The company has grown primarily through acquisitions, and the filing notes that future acquisitions will proceed more opportunistically. Risks include difficulty integrating acquired businesses, retaining key personnel, unanticipated liabilities, and competition for acquisition targets from other consolidators and better-capitalized utilities and equipment manufacturers.

Are there any material legal or Year 2000 issues to be aware of?

Management states there are no pending legal proceedings expected to have a material adverse effect. The company spent about $800,000 on Year 2000 remediation, funded from operating cash flow, and reports no significant Y2K issues to date, though it cannot control third-party readiness.

FIX 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 16, 2000. Cited figures are marked; the original filing is the authoritative source.

Comfort Systems USA (NYSE: FIX), a Houston-based provider of commercial and industrial HVAC installation and maintenance, repair and replacement (MRR) services, reported strong top-line growth for fiscal 1999 driven by an aggressive acquisition program.

Revenues rose 60.4% to $1.37 billion^a, net income increased 20.9% to $42.3 million, and diluted EPS was $1.09. Roughly 60% of revenue came from installation and 40% from MRR, and about 97% came from commercial and industrial customers. Growth was acquisition-led: the company completed 107 acquisitions since its July 1997 IPO, 90 of them purchases, which contributed most of the increase in revenue and gross profit.

The filing also shows clear signs of underlying pressure. Internal (same-store) revenue growth slowed in the second half of 1999 because of construction labor and specialty materials shortages. Gross margin fell from 24.2% to 21.4%, though management attributed about $37.2 million^b of that compression to a reclassification of costs from SG&A into cost of services; excluding the reclassification, gross margin was roughly flat at about 24.1%.

Excluding the reclassification, SG&A rose as a percentage of revenue from 15.3% to 16.4%. Interest expense rose sharply to $20.0 million^c, and total debt reached $305.8 million, with $225.2 million drawn on a $300 million revolving credit facility that expires November 2001. Operating cash flow was $18.4 million, well below net income, and free cash flow after capital expenditures was modestly positive.

Investors should weigh the growth record against leverage, the dependence on continued acquisitions, margin and integration risk, and the stock's steep decline. Shares traded near $7.88^d in March 2000, down sharply from a 1998 high of $26.63, and the company has never paid a dividend and is repurchasing stock. The company's own risk factors highlight integration difficulties, labor shortages, cyclicality, and competition from better-capitalized utilities and equipment manufacturers.

02—Key points

Key Highlights

Revenue grew 60.4% to $1.37 billion in 1999, driven primarily by acquisitions; 107 companies acquired since the July 1997 IPO.
Net income rose to $42.3 million (diluted EPS $1.09) from $35.0 million in 1998, a 20.9% increase.
Gross margin declined to 21.4% from 24.2%, but about $37.2 million of costs were reclassified from SG&A into cost of services; excluding this, margin was roughly flat at 24.1%.
Internal revenue growth slowed in late 1999 due to construction labor and specialty materials shortages, and SG&A as a share of revenue rose to 16.4% excluding the reclassification.
Interest expense more than doubled to $20.0 million; total debt was $305.8 million, including $225.2 million drawn on the $300 million credit facility maturing November 2001.
Operating cash flow was $18.4 million, well below net income, reflecting growth in receivables and working capital needs.
The stock fell from a 1998 high of $26.63 to about $7.88 by March 2000; the company has never paid dividends and is repurchasing shares under a 4 million share authorization.

03—Questions

Frequently Asked Questions

What drove the revenue increase in 1999?
Most of the 60.4% revenue increase, to $1.37 billion, came from acquisitions of Purchased Companies in 1998 and 1999. Internal growth slowed in the second half of 1999 as construction labor and specialty materials shortages constrained HVAC installation activity.
Did profitability actually weaken in 1999?
Operating margin fell from 8.1% to 6.8%, and gross margin fell from 24.2% to 21.4%. Management attributes about $37.2 million of the gross margin decline to reclassifying certain costs from SG&A into cost of services, which makes the comparison with prior years imperfect. Excluding that change, gross margin was roughly unchanged, but SG&A pressure and lower internal growth weighed on operating margin.
How leveraged is the company and what are the financing risks?
Total debt was $305.8 million at year-end 1999, including $225.2 million under a variable-rate revolver that expires November 1, 2001, and $80.6 million of fixed-rate debt, largely notes to former owners of acquired businesses. Debt rose sharply to fund acquisitions, and the company says it may need additional equity or debt financing if it accelerates its acquisition program, with no assurance such financing would be available on acceptable terms.
Is the company's growth strategy dependent on continued acquisitions?
Yes. The company has grown primarily through acquisitions, and the filing notes that future acquisitions will proceed more opportunistically. Risks include difficulty integrating acquired businesses, retaining key personnel, unanticipated liabilities, and competition for acquisition targets from other consolidators and better-capitalized utilities and equipment manufacturers.
Are there any material legal or Year 2000 issues to be aware of?
Management states there are no pending legal proceedings expected to have a material adverse effect. The company spent about $800,000 on Year 2000 remediation, funded from operating cash flow, and reports no significant Y2K issues to date, though it cannot control third-party readiness.

04—Continue

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