ABM Industries F4Q07 (Qtr End 10/31/07) Earnings Call Transcript

ABM Industries, Inc. (ABM)

F4Q07 Earnings Call

December 12, 2007 9:00 am ET

Executives

Henrik C. Slipsager - President, Chief Executive Officer, Director

Linda S. Auwers - Senior Vice President, General Counsel, Secretary

George B. Sundby - Chief Financial Officer, Executive Vice President

Analysts

Jeff Kessler - Lehman Brothers

David Gold - Sidoti & Company

Presentation

Operator

Good morning. My name is Cindy and I will be your conference operator today. At this time, I would like to welcome everyone to the ABM Industries Incorporated fourth quarter earnings results conference call. (Operator Instructions) Mr. Slipsager, you may begin your conference.

Henrik C. Slipsager

Thank you. Good morning. I’m Henrik Slipsager, President and CEO of ABM. Joining me today are George Sundby, Executive VP and CFO; and Linda Auwers, our Senior VP and General Counsel.

On the call today, I will provide an overview of our achievement as a company for fiscal 2007. George will discuss our financials and then I will conclude our prepared remarks with an update on our recent OneSource acquisition, as well as provide guidance for fiscal ’08. Linda.

Linda S. Auwers

Thank you, Henrik. Our presentation today contains predictions, estimates, and other forward-looking statements. Our use of the words estimates, expects and similar expressions are intended to identify these statements. These statements represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are subject to risks and uncertainties that could cause our actual results to differ materially. Some of the important factors relating to our business are described in our annual report on Form 10-K, Form 8-K, and the forms 10-Q that we file with the SEC.

In addition, we’ll be providing non-GAAP guidance in today’s call. A reconciliation of non-GAAP guidance can be found in our fourth quarter and fiscal year 2007 financial results press release and on our website at www.abm.com, investor relations.

Henrik C. Slipsager

Thank you, Linda. Before we review our consolidated financial results and operating performance for the fourth quarter and year, I would like to highlight a few of ABM's accomplishments in fiscal ’07.

We completed two meaningful acquisitions that will accelerate our growth in the increasingly competitive and global service provider marketplace. In April, we acquired HealthCare Parking Systems of America, HPSA, a leader in the parking management services for hospitals, health centers, and medical office buildings nationwide, along with their management team. HPSA provide an important and strategic entry into the health related segment of the parking industry and immediate expansion into 10 new states, primarily in the East Coast. Our parking division now serves 39 states and we plan to leverage HPSA’s expertise and our existing regional operating infrastructures to further grow this segment.

In October, we announced plans to acquire facility service provider OneSource and we closed this transaction in November. OneSource is the leader in janitorial, landscape, and other specialized services for more than 10,000 commercial, industrial, institutional, and retail accounts in the U.S., Puerto Rico, and British Columbia.

Our janitorial division has been ABM's best and most consistent performer in recent years and this investment provides that team a broader based continued expansion domestically, as well as open new international opportunities as well.

In fact, OneSource will truly change the profile of ABM, increasing our annual revenue by nearly 30%, adding more than 30,000 employees, and enhancing our overall scale, breadth, and financial strength.

We continue to strengthen our balance sheet and recently established a new $450 million credit facility, replacing our existing $300 million facility. In fiscal ’07, net cash from continuing operations was $54.3 million, and that included a $34.9 million income tax payment related to the $80 million settlement for the World Trade Center insurance claim in fiscal ’06.

Our working capital increased by $40.6 million to $353.1 million from $312.5 million due to record revenue and incremental income generated in fiscal ’07.

We increased our dividend in ’07 by 9.1% to an all-time high quarterly rate of $0.12.

Through these and other achievements, we have further strengthened our position as the leader in the facility services and enhanced shareholder value.

I would like to turn the call over to George for a review of our fourth quarter and fiscal ’07 financial results. George.

George B. Sundby

Thank you and good morning and happy holidays to everyone. I would like to review the consolidated results for the fourth quarter ended October 31, as reported in yesterday’s earnings release. We expect to file our annual report on Form 10-K with the Securities and Exchange Commission later this month, hopefully before Christmas.

Turning to the fourth quarter results, as Henrik indicated for the quarter, net income was $15 million, or $0.30 per diluted share, compared to $61.6 million or $1.24 per diluted share a year ago. The decline is due primarily to the fourth quarter of 2006 benefiting from the $80 million pretax or $0.91 per diluted share World Trade Center insurance settlement.

Quarterly comparisons are also adversely impacted by the 2006 fourth quarter, including an insurance benefit of $9.4 million pretax, or $0.11 per diluted share, from the take-down of prior year insurance reserves, as compared to $2.5 million, or $0.03 per diluted share benefit in 2007.

Fourth quarter 2007 insurance benefits is from the receipt of updated actuarial studies and includes a $1.7 million benefit primarily from the continued favorable impact of the California 2004 worker comp reform. That is included in the corporate expense segment; a $200,000 pretax benefit in parking from its smaller airport specialty program; and a $600,000 benefit in janitorial from its Midwest worker compensation program.

Total revenue was $723.9 million compared to last year’s fourth quarter of $776.7 million. That includes that previously mentioned World Trade settlement of $80 million.

Sales and other income which totaled $723.9 million for the quarter was up $3.9 million and this increase is primarily from internal growth.

Turning to gross margin as a percent of sales, gross margin, which is defined as sales minus operating expenses and cost of goods sold, was 11.1% for the quarter compared to a 12.4% in the fourth quarter of ’06. The previously discussed insurance adjustments are included in operating expenses and cost of goods sold, and therefore are included in the previously mentioned gross margins.

Excluding the effects that the insurance adjustment had on the beginning of period insurance reserves, the fourth quarter and full year 2007 gross margin was 10.6% for each period versus comparable 2006 margins of 10.6% for the fourth quarter and 10.2% for the full year. We believe this is a better indicator of our health of our current portfolio of customer contracts.

The effective federal and state income tax rates for the fourth quarter of 2007 was 38.1% compared with last year’s fourth quarter of 43.2%. That higher rate in 2006 is associated with the higher state income tax applicable to the World Trade Center settlement. For 2008, we expect an effective tax rate of 37.5%.

Turning to the statement of cash flows, cash from operations for the fourth quarter was $63.9 million compared with the $97.8 million from last year’s fourth quarter. Again, the cash flow decrease is due to that fourth quarter receipt of $80 million, which was partially offset by excellent cash collections in the fourth quarter of ’07 resulting in a $30 million decrease in accounts receivable during the quarter.

As Henrik mentioned, we continue to have a very strong financial position with $136 million in cash at year-end and no debt. With the November 14th acquisition of OneSource, we are now in a debt position with approximately $280 million outstanding today under our new five-year, $450 million line of credit agreement.

At October 31, 2007, the largest component of working capital continues to be accounts receivable which, as previously mentioned, decreased $30 million to $370 million at the end of the year.

Day sales outstanding at quarter end decreased five days in the quarter to 52 days.

Accounts receivable 90 days past due also decreased by $9.1 million to $27.9 million, or 7.9% of our total outstanding. Our receivables allowance totaled $6.9 million at the end of the year compared with $7.5 million at the end of the third quarter.

Effective with our fourth quarter reporting, insurance reserves are now shown on our balance sheet without the benefit of our outside insurance coverage. This has resulted in the recognition of a $56 million estimated insurance recoverable and a correspondingly $56 million increase in the insurance reserves. This change has no impact on earnings nor cash flow. Insurance reserves net of the insurance receivables at October 31 were $205.1 million, which is up almost $10 million from the $195.2 million of a year ago. Self insurance claims paid during the year totaled $56.3 million, down slightly from the $57.4 million a year ago.

No shares were repurchased during the fourth quarter. Our 2007 authorization for 2 million shares expired unused at the end of the year.

As previously mentioned, we anticipate filing our Form 10-K annual report later this month. The Form 10-K will contain the report on our internal controls over financial reporting as required by section 404 of Sarbanes-Oxley.

As previously discussed, over the years our decentralized structure, the materiality considerations that result from our level of profitability requires a significant effort to evaluate and test the systems and processes for management to make this report.

We are currently finalizing management testing of controls that are performed at year-end and our overall evaluation of our system of internal controls. We expect to receive a clean certification from our auditors as we did in 2006.

On a personal note, as announced last March, I will not be moving with the company to New York and accordingly, this is my last earnings call for ABM Industries. It has been a pleasure working with many of you that follow ABM. I would like to take this opportunity to thank the Board of Directors, the employees of ABM, and especially Henrik Slipsager, an excellent CEO and boss, for the great support received over the past six years.

With that, it is my pleasure to turn the call back to Henrik, who will give his perspective on our 2007 performance and our outlook for 2008. Henrik.

Henrik C. Slipsager

Thank you, George. I will briefly review the operational results for the fourth quarter and year as well as provide guidance for fiscal ’08.

Our janitorial operation posted a fourth quarter revenue increase of $14 million, or 3.5%, compared to the same period in ’06. For the fiscal year, janitorial sales were up $57.8 million, or 3.7% to $1.6 billion with growth across the U.S.

Our janitorial segment enters into fiscal ’08 with solid sales momentum. Operating profits for janitorial increased by $2 million or 8.8% compared to the fourth quarter of ’06. Operating profit increased by $5.9 million or 7.2% for the full year. Operating margins for the year were 5.4%, up 20 basis points from fiscal ’06 -- a very, very good year for the janitorial team.

With the addition of OneSource and the initial progress we are making on achieving the $45 million to $50 million of cost synergy savings, this organization is very well positioned for ’08.

Parking sales increased $10.5 million, or 9.3%, while operating profit increased $0.5 million, or 11.6% during the fourth quarter of ’07 compared to ’06. Sales increased by $39.3 million, or 8.9% during ’07 compared to ’06, primarily due to HPSA, reimbursement for out-of-pocket expenses for managed parking lot clients, than due to new contracts and growth of existing contracts, and a $5 million gain in connection with the termination of the airport leasing garage lease. HPSA accounted for [$80 million] of revenue for the year. Operating profit increased $6.5 million, or 47.9% during ’07, comparing to 2006 operating results, were favorably impacted by lease termination, additional profits from HPSA, and increased sales.

Security sales increased $4.5 million, or 5.8% during the fourth quarter of ’07 compared to the fourth quarter of ’06. Operating profit increased by $300,000, or 14%, from the comparable period. For the year, sales increased by $13.6 million, or [404%], primarily due new business and increased service to existing clients. Operating profit increased $400,000, or 9.8% in ’07 compared to ’06, primarily due to additional profit from increased sales and the elimination of unprofitable contracts. Results were negatively impacted by a $1.7 million litigation settlement during ’07.

Sale for engineering increased $400,000, or 0.5%, and operating profit increased $100,000, or 2.2% during the fourth quarter of ’07 compared to the fourth quarter of ’06. Sales were up by $16.4 million, or 5.7% in ’07 compared to ’06, mainly due to new business and expansion of services to existing clients in the eastern, northern California, and mid-Atlantic regions.

Operating profit decreased by $1.1 million or 6.8% due to reduced profit margin in new business and higher G&A costs to support the growth in this business unit.

Lighting for the quarter saw increasing activity due to larger projects. Gap lighting shares though decreased by $3 million and operating profit Gap wise decreased by $900,000 in the fourth quarter of ’07 compared to the same quarter a year ago. For the full year, sales and profit [was pretty flat] compared to ’06.

In summary, we are pleased with our fourth quarter performance and believe we have strong momentum entering into fiscal ’08. We’ll continue to focus our financial management resources on the business in which we can grow to be a leading national provider and have a number of exciting initiatives underway.

Before I turn to guidance though, I would like to provide a brief update on the progress we are making with integration of OneSource into our janitorial organization. First and foremost, we are on schedule with our goal of recognizing during fiscal ’08 $28 million to $32 million of cost saving synergies. As of this week, we will achieve more than 50% of the targeted staff reductions in the personnel synergies [we identified].

Through this process, we have been able to retain the key members of the OneSource organization. We thank Cheryl Jones, former CEO of OneSource, for her capable assistance with the integration process and also positioning OneSource to achieve better than we anticipated earnings for ’08. We are currently evaluating the IT and payroll systems to determine how we can leverage the infrastructure in the two organizations.

It is very, very difficult not to feel extremely good about the addition of OneSource as part of our family.

We expect to drive OneSource’s business to realize improved operating margins fiscal ’08 and expect the acquisition to be accretive, excluding one-time implementation already in the second quarter. Longer term, we expect to continue margin improvement into ’09 and anticipate an additional $0.15 to $0.20 from OneSource.

Now turning to guidance for fiscal ’08 on a non-GAAP basis, we currently expect diluted earnings to be in the range of $1.15 to $1.25. This guidance excludes one-time expenses of approximately $20 million or $0.25 per diluted share associated with achieving synergies on OneSource as well as a major financial system upgrade, shared service implementation, and relocation of corporate headquarters. We currently expect these expenses to be evenly distributed over the four fiscal quarters.

In addition, fiscal ’08 has one additional week of labor which increased costs in janitorial fixed price contract by approximately $4 million, or $0.05 per diluted share.

On a GAAP basis, the company expects fiscal ’08 diluted earnings per share to be in the range of $0.90 to $1. For the first quarter, the company expects diluted earnings per share on a non-GAAP basis to be in the range of $0.14 to $0.18, and on a GAAP basis to be between $0.08 and $0.12. All guidance is exclusive of future acquisitions.

In addition, we expect to realize $14 million in incremental cash flow in fiscal ’08 from acquiring net operating loss carry-forwards and existing goodwill amortization related to the acquisition.

Before I open the call to questions, I would like to take a moment to thank George for his significant and valuable contribution to ABM over the past six years. He has played a substantial role in establishing ABM as an industry leader, particularly as he enhanced our financial and control environment, and more recently facilitated the transition to our new CFO, Jim Lusk, who will assume the responsibility on December 31st. This foundation of financial excellence will enable us to continue to grow our business. We wish him continued success in his future life.

At this time, I would like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jeff Kessler.

Jeff Kessler - Lehman Brothers

Thank you. First, George, it’s been great working with you these years and congratulations and I hope you do well in whatever you are doing, staying on the West Coast and having an easier time with it over there.

I guess we have a few questions here. In your 2008 guidance, what sort of top line numbers and growth rates are you assuming in the segments? Roughly adding on, are we just roughly adding on $800 million from OneSource, or what are the other areas that you are looking at?

And also, just to clarify about OneSource, are you going to be -- can you give us any other -- are there any other segments inside of OneSource, which I used to cover, obviously, that might be adding on to the other segments as well?

Henrik C. Slipsager

Okay. There’s a couple of questions there, Jeff.

Jeff Kessler - Lehman Brothers

Well, it’s all around OneSource.

Henrik C. Slipsager

Let me start with OneSource. Fiscal ’07, or the ’07 revenue [that we did with this] $827 million, I actually think the run-rate is around $840 million based upon the last one or two months, but you have to understand we are still looking into it. But it looks to be a very positive surprise, not a negative surprise.

Talking about growth, also for ’08, we’ve had a very, very strong sales month, which hopefully will reflect the higher-than-normal growth for the fiscal ’08. It’s early in the year but I’d rather start with something positive than try to catch up later on in the year.

On the segment side, we will be looking at engineering. They have a small engineering piece as part of OneSource. If it’s truly what we define as engineering and facility services, we will eventually move it over to that line of business during the course of the year. We should know that before the end of the first quarter what exactly is part of that particular line of business.

Did I answer all of your questions?

Jeff Kessler - Lehman Brothers

Can you talk about the landscaping business?

Henrik C. Slipsager

I’ll be happy to talk about the landscaping business. As we look at it now, we have a very small piece of landscaping business that we at one point in time will merge into the existing landscaping business and OneSource was a major operator of landscaping compared to [our two companies], and I look forward to learning much more about their landscaping operation in the future than I know about it right now.

Jeff Kessler - Lehman Brothers

Okay, your --

Henrik C. Slipsager

-- very much on the janitorial.

Jeff Kessler - Lehman Brothers

Okay, your pro forma $1.15 to $125 guidance I’m assuming includes the synergies that you are talking about. We’re talking 28 to 32 and ultimately $45 million to $50 million I guess of synergies. Clearly this is -- let me just put it as mildly conservative from any way, shape, or form. Somebody might say it’s disappointing. I’ll just describe it as conservative. How conservative are you, especially since it’s below the street and our estimates with regard to adding on -- if you just add on the savings on to what our estimates have been?

Henrik C. Slipsager

I think the key thing you have here, you have two factors. If you just looked at the $28 million to $32 million, you do have to subtract the interest on the $365 million and also you do have an impact if you lower earnings per share of depreciation of value of contracts, so I won’t call that too conservative. I think it’s pretty realistic from that perspective. We [will have] a negative impact in the first quarter, but we are going to have a positive impact already starting quarter number two.

But if you take 6%-plus of $365 million, I’m adding $20 million of interest per year that I didn’t have before and some of the reductions, even though we are slightly ahead of plan, are taking place today and yesterday and we continue with some of the space consolidation in the second or third quarter. So we are moving as fast as we can but I think the major, major, major benefit, you will see that in year two and three.

Jeff Kessler - Lehman Brothers

Okay, just a couple more questions; the self insurance reserve adjustment, clearly a cause of confusion for the last couple of years and yet again in the fourth quarter I think again. Can you go through without going through it in too much detail, going through the reserve adjustments and should we have -- should we basically be taking out that, the benefit that you received in the fourth quarter from your -- from what we deem to be the normalized earnings?

In other words, how do you look at these insurance adjustments? Because we -- are these a normal course of business that we are going to have to -- that obviously we deal with and as an analyst, are we just going to excise these every single quarter? Or is it something that -- is there a way for us to put a trendline through this?

Henrik C. Slipsager

Trust me -- I’m as frustrated with the way we do it as anybody else. It seems like people covering us, looking at us are penalizing us when it’s bad and we don’t get the benefit when it’s good.

If you look across the year, it’s amazingly flat. We went from doing one actuary study a year to up to now we are doing three actuals a year, one major study and two minor studies. And that was in order to minimize the variation in the old years.

And if you look at the [ultimate refurb], which I think is running $800 million to $900 million -- I’ll let George talk a little bit more about it afterwards -- a 1% variance in the actuarial numbers is $8 million on old years. And unfortunately, that has a major impact on our quarter.

The accounting rules are very clear. I don’t like them but they are very clear and that means that we have to accrue to a point estimate, if you have a better estimate than a range. I prefer the range but the accounting rules doesn’t exactly necessarily go as to what I prefer.

I’ll let George go through it again but I think overall, Jeff, the old years, you will see we are accruing exactly what the actuary tells us what to accrue and it is as frustrating for us as it is for them, but if you ask me if you should exclude it, I think if you exclude it in your evaluation [when I’ve got damage], yes, you should exclude it when I get benefits. You have to give me benefit if you penalize to [inaudible].

Jeff Kessler - Lehman Brothers

Okay. Finally, a question I ask every quarter about cross-selling and up-selling of the divisions and how that may help or hopefully help your operating margin. Are you satisfied with what is going on in that area?

Henrik C. Slipsager

Well, I will be satisfied with what’s going on in the cross-selling area. I think I’ve been crying about that for years.

I am very pleased with the overall improvement in our operating profit percentage I think is moving up. It’s a very stable move and it’s been a constant move, especially in the janitorial world. And I think you’ll see that continue, especially with the addition of OneSource where size is going to be very, very important. And I think the cross-selling might not be the biggest asset as part of this, but the multi-state and multi-national and multi-regional sales as part of this deal is going to hopefully add some more business than we expected to those deals.

George B. Sundby

Just to give you a little further information on the insurance reserves, if you look over the year, first quarter we had a $4.2 million benefit, then we had a $4.9 million adverse development, and then the $2.5 million in the fourth quarter.

I think you’ll see those numbers continue to shrink as the portfolio of claims is under now one third party administrator and I think we were getting our hands better around those claims going forward.

But as Henrik said, we do an actuarial study three times a year. It’s projecting losses since 1986, which is now over $1 billion in ultimate, and so minor movements by the actuary, or what the actuary does believe is minor, does impact ourselves.

So I would concur with Henrik that those results should continue to dwindle in the size and the magnitude but they definitely are a part of our earnings.

Jeff Kessler - Lehman Brothers

Okay, thanks and again, it’s been great working with you.

Operator

Your next question comes from the line of David Gold with Sidoti.

David Gold - Sidoti & Company

Good morning. George, definitely concur with Jeff on that one; it has been a lot of fun and certainly best of luck. A couple of questions, hopefully you can help me out; first of all, the $20 million or so, the one-time, can you give us a sense for how much of that is related to OneSource versus some of the other initiatives you are undertaking?

Henrik C. Slipsager

Yeah, I can give you some sense of this. Of the $20 million, around $5 million is specifically expected to be OneSource related. Another major chunk -- don’t want to give you a specific number but I think around $12 million is associated with project transform, which also includes -- no, I’m sorry, JD Edwards conversion and it’s something we are looking at right now, David, because one of the major, major positive surprises as part of the OneSource acquisition is that they -- as a matter of fact, they might have an older system but they have a better functional system than we do and they might have a system that’s more efficient than our existing system.

So we have planned, as we mentioned when we went to IBM, to do a major transformation this year to a much greater JD Edwards platform. But the findings as part of the acquisition has led us to now investigate to see if the direction that we already decided is the proper direction, to make sure we do it in the most economic and for operations, the best possible way.

So the biggest chunk of the whole thing is probably 60% of the whole thing is associated with the conversion of IT and then you’ve got a $5 million, or 25% of that whole thing associated with OneSource and that is associated primarily with severance costs as well as elimination of leases. Those are the major factors there and lastly, the last piece is related to the move to New York and [one other thing].

David Gold - Sidoti & Company

And on the IT conversion/JD Edwards, are you viewing that at this point as a one-year project or does it continue?

Henrik C. Slipsager

The conversion? No, we expect the project to be done -- if we continue the direction we are going right now, the project will be finalized some time late ’09 but right now, based upon our findings, I can’t give you -- if we decided to go with the OneSource route, if that’s going to change any timing, it’s too early for me to tell you that. As I said, we are looking into it now and as a matter of fact, my new CFO is going through a two-day full-day meeting discussing exactly the direction of the company going forward.

David Gold - Sidoti & Company

And then a question for George on the G&A; even if I blend back in the I think you said $1.7 million that would have been there in the quarter, you still had a lower showing or a better showing than would have expected and certainly on a year-to-year basis, you’re making progress there.

Anything I’m missing or not thinking about or are you guys just making real good progress there?

George B. Sundby

In our cost of -- in our SG&A?

David Gold - Sidoti & Company

Right.

George B. Sundby

No, I think we continue to make good progress in that area. Just on the -- going back to the OneSource, the accounting rules are a little bit unique in that as we consolidate, if we eliminate a OneSource branch, that goes to purchase accounting but if we decide to eliminate the ABM branch because the OneSource branch is better suited for our operations, then that goes through P&L. That’s why we’ve put up a $5 million target for next year, is some of those costs on the ABM side.

David Gold - Sidoti & Company

Interesting. And then just a couple of others; can you give a sense for what you’d expect D&A and CapEx to be for 2008?

George B. Sundby

For 2007, depreciation and amortization is going to be about $18 million. That excludes the share-based compensation, which we typically add back in there and that’s another 8. Going forward with OneSource now being in there, I would say it will probably be close to $25 million.

David Gold - Sidoti & Company

Twenty-five --

George B. Sundby

Depreciation and amortization.

David Gold - Sidoti & Company

And then the share-based will be on top of that?

George B. Sundby

Share-based should return back probably to a $5 million level. Last year we had accelerated in the first three quarters from our price vested options that are now behind us.

David Gold - Sidoti & Company

And then just a sense on CapEx, if you might.

George B. Sundby

I’m sorry. CapEx for the year was $22 million. With the project on the JD Edwards, it probably will be closer to $27 million, $28 million next year.

David Gold - Sidoti & Company

Very good. Appreciate the help from you both.

Operator

There are no further questions at this time.

Henrik C. Slipsager

Thank you very much for listening to us. Have a happy holiday and we will see you after the first quarter of ’08. Thank you.

Operator

This concludes today’s conference call. You may now disconnect.

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