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ABM Industries Incorporated (NYSE:ABM)

Q3 2008 Earnings Call

September 5, 2008 9:00 am ET

Executives

Henrik Slipsager - President & CEO

Jim Lusk – Exec. VP & CFO

Sara McConnell – Sr. VP & General Counsel

Analysts

David Gold - Sidoti & Co.

John Enrich – Ironworks Capital

Operator

Good day everyone and welcome to today’s ABM Industries Q3 fiscal year 2008 conference call. At this time I would like to turn the conference over to Mr. Henrik Slipsager; please go ahead sir.

Henrik Slipsager

Thank you. I am Henrik Slipsager, President and CEO of ABM. Joining me today are Jim Lusk, Executive VP and CFO, and Sara McConnell, our Senior VP and General Counsel.

On the call today, I will provide an overview of the third quarter ended July 31. Jim will discuss our financial details and then I will conclude our prepared remarks with a summary of our operational achievements for the quarter as well as provide an update on our guidance for the remainder of fiscal 2008.

Sarah McConnell

Thank you, Henrik. Before we begin, I need to tell you that our presentation today contains predictions, estimates, and other forward-looking statements. Our use of the words estimate, expect, and similar expressions are intended to identify these statements. These statements represent our current judgment on 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 Form 10-Q that we file with the SEC.

A reconciliation of ABM Industries’ operating profit to adjusted operating profit as well as a reconciliation of the 2008 guidance of net income from continuing operations per diluted share to adjusted net income from continuing operations can be found can be found at the Investor Relations section of our website, www.abm.com, under the heading Presentations.

Henrik Slipsager

Thank you Sarah, before I talk about our third quarter results I would like to briefly discuss the divestiture of our lighting business. Lighting has been our weakest performing segment and while we’ve been focused on improving this segment’s operations for several years, we’ve also been periodically reviewing our strategic options.

Based on our long-term goals and growth in our overall business we determined that lighting, this segment was simply not a good fit with our core business and not where we wanted to focus our financial and operational resources.

Before the close of the quarter on August 29, an agreement to sell substantially all of the operating assets of Amtech Lighting Services to Sylvania Lighting Services. Proceeds from the sale of the lighting business as well as the amount anticipated to be realized over time from the same assets primarily accounts receivables are expected to yield approximately $70 million to $75 million.

I would like to thank the employees at Amtech Lighting for all their hard work and positive contributions over the past many years and wish them good luck under their new leadership. We are very pleased with the outcome for lighting as we believe it is in the best interest of ABM and our shareholders and will enable us to apply our attention and capital to the organic and strategic expansion of our janitorial, engineering, parking, and security businesses.

Now on to our results, we are very pleased with our healthy third quarter sales and profit increases which demonstrate the effectiveness of our broad geographic footprint and customer base in a challenging economic and business environment. For the quarter we posted a 35% increase in revenue to approximately $391 million primarily due to $212 million contribution from one source.

Organic growth for the period was a solid 4%. Income from continuing operations grew 40% to $60.3 million as we benefited from a decrease in self insurance research relating to prior year claims and benefited from improved operation leverage.

Despite weakness in certain regions and economic sectors, we continued to execute well and posted top and bottom line increases in all operating segments. The acquisition of OneSource has provided the scale to enable us to better capitalize on growth opportunities while minimizing the impact of economic slowing in individual regions.

The integration of the OneSource acquisition remains on schedule with $9.9 million in synergies recorded during the third quarter. We continue to anticipate over $28 million of synergies for the fiscal year as previously communicated.

Additionally we expect $3 million to $5 million beyond the $14 million in annual tax cut savings from acquired OneSource net operating loss carry forwards, and from deducting goodwill amortization. We also continue to effectively manage our free cash flow reducing our outstanding debt by $16.5 million and paying out quarterly cash dividends.

Now I’d like to turn the call over to Jim for a financial review of our third fiscal quarter of 2008.

Jim Lusk

Thank you Henrik and good morning everyone. As Henrik previously mentioned we are pleased to announce that we’ve reached an agreement to sell substantially all the operating assets of Amtech Lighting. As a reminder we are accounting for the historical results of the lighting segment in discontinued operations so unless otherwise noted results discussed reflect continuing operations.

The company expects to realize a gain for tax purposes from the sale which will result in a tax charge to discontinued operations of approximately $2 million to $3 million in the fourth quarter of fiscal 2008. In aggregate we anticipate that Amtech Lighting will have approximately a $0.10 per diluted share impact to net loss from continuing operations.

We are very pleased with our third quarter results. Income from continuing operations was $16.3 million or $0.32 per diluted share, a 40% increase from $11.6 million or $0.23 per diluted share for the prior year third quarter.

Net income which includes the lighting segment was $16.4 million or $0.32 per diluted share compared to $12 million or $0.24 per diluted share a year ago. Our operating profit increased 86% to $29.9 million in the third quarter of fiscal 2008 from $16.1 million in the same period last year primarily due to the $9.9 million of cost saving synergies.

Our adjusted operating profit before items affecting comparability increased 37% to $29.8 million in the third quarter of fiscal 2008 from $21 million in the same period last, several one-time items affect comparability.

The adjusted operating profit excludes expenses of $6.5 million associated with corporate and infrastructure initiatives and the integration of OneSource and a benefit of $7.6 million from the reduction of the company’s self insurance reserves for prior years that increased operating profit.

Net these items reduced operating profit by $1.1 million in the third quarter of 2008 and increased operating profit by 4.9 in the third quarter of 2007. Our SG&A expense increased $26.1 million year-over-year due to the $17 million of expenses associated with the acquisition of OneSource.

Excluding OneSource SG&A increased $9.0 million due to the integration of OneSource operations, IT costs, severance bonuses related to the headquarter move to New York, and an increase in share-based compensation expense.

Interest expense increased $3.2 million in the quarter due to the drawdown of our credit facility for the OneSource and of [some of their] management acquisitions as well as interest accretion related to the OneSource insurance claims liability assumed as part of the acquisition.

The estimated annual effective tax rate on income from continuing operations excluding discrete items for the three months ended July 31, 2008 was 38% compared to 37.5% in the prior year mostly due to higher overall tax rates. The effective tax rate on income from continuing operations was 38.6% and 27.5% in the third quarter of 2008 and 2007 respectively due to certain discrete tax items.

For fiscal 2008 we continue to anticipate an effective tax rate of approximately 38%. Turning to our nine month results, income from continuing operations was $37.9 million or $0.74 per diluted share on revenue of $2.7 billion compared to $35.8 million or $0.71 per diluted share on revenue of $2 billion in the same period last year.

Net income in the first nine months of fiscal 2008 was $33.9 million or $0.66 per diluted share compared to $37.4 million or $0.74 per diluted share. On a nine month basis sales from discontinued operations were $80.4 million, a decrease of 7.2% and operating loss was $4.1 million compared to a profit of $1.6 million in the first nine months of fiscal 2007.

The difference is primarily due to the $4.5 million goodwill impairment charge taken in the second quarter of fiscal 2008. Operating profit for the first nine months of fiscal 2008 was $73.7 million compared to $53.1 million in the same period last year. As with Q2 results there were a number of items affecting comparability related to the corporate relocation acquisitions and changes to self insurance reserves among others.

Excluding these items adjusted operating profit increased 49.4% to $72.9 million in the first nine months of fiscal 2008 from $48.4 million in the same period last year.

Turning to the statement of cash flow, cash from operations for the first nine months of 2008 was $36.6 million compared to a net cash use of $9.6 million for the comparable period last year. Last year cash flow usage included a $34.9 million tax payment associated with the World Trade Center insurance proceeds.

In the first quarter we closed the acquisition of OneSource for a total purchase price of $390 million under a purchase price accounting at the time of closing we allocated $34.4 million to customer contracts and intangible assets and $278.6 million to goodwill.

During the quarter we made an adjustment of approximately $3.1 million increasing our purchase price allocation to goodwill to bring it to $285.2 million. We have not completed the allocation of the purchase price for the acquisition and anticipate it will be finalized during the remainder of 2008.

We ended the quarter with $5.3 million in cash down from $136 million at the end of fiscal 2007 primarily due to the acquisition of OneSource and southern management. We had $285 million outstanding under our line of credit as we continued to reduce our outstanding debt by $16.5 million during the third quarter and approximately $30 million since the inception of our borrowing which resulted from the acquisition of OneSource.

Day sales outstanding at quarter end were down one day to 53 days compared to 54 days for the second quarter. Insurance reserves at July 31 were $344 million which includes claims acquired from OneSource compared to $261 million at the end of fiscal 2007.

Self insurance claims paid during the quarter totaled $19.3 million compared to the $14.6 million in the third quarter of 2007.

Before concluding I want to remind everyone that we are approximately one year into a multi year project to transform our corporate platform and infrastructure. We have now successfully moved our corporate headquarters from San Francisco to New York and we have our first major system cutover on July 1. We remain on track with the implementation of our new ERP and payroll systems and we continue to expect to have the installation of all the major systems and the move to shared services completed during fiscal 2009.

I want to thank all the employees inside of ABM that have worked on this. It’s been a tremendous effort. With that let me turn it back to Henrik who will give us perspective on the third quarter operational performance by segment and the outlook for the remainder of 2008.

Henrik Slipsager

Thank you Jim, I will now briefly review the operational results for the third quarter as well as provide an update on our guidance for the remainder of fiscal 2008.

We remain encouraged by our growth from continuing operations as our geographic diversity and our customer base has enabled us to offset weakness in certain regions and economic sectors. For the third quarter janitorial sales increased by $229.6 million or 56.1% to $638.5 million due to $211 million of revenue contributions from OneSource which was acquired in the first quarter.

Excluding the impact of our OneSource acquisition janitorial sales were up 4.4%. The majority of the regions performed well with the exception of the southeast and northeast regions. The operating profit in both of these regions were adversely impacted by performance in our financial services sector as the drop for our higher margin discretionary services.

Janitorial operating profit increased by $9.8 million or 44.9% to $31.7 million. The increase was primarily due to $9.9 million of synergies generated from OneSource including the reduction of [inaudible] positions and back office functions, consolidations of facilities and reductions in professional fees and other services.

Overall solid execution on achieving cost savings synergies and good growth despite a soft US economy.

Parking sales increased by $3.8 million or 3.1% to $226.8 million due to higher lease and [inaudible] allowance revenues and increased services to existing customers. Operating profit for the third quarter of 2008 was $5.5 million up 12.9% due to additional profit from higher revenue.

I am very pleased with these results as we have benefited from our strategy to decrease exposure to off airport and leased lots.

Our security sales increased $3.5 million or 4.3% to $85.3 million due to growth in the north and continued growth in the Midwest regions from both new and existing customers. Operating profit for the third quarter increased nearly 7% to $2.1 million.

We continue to make progress in our security segment although the pace of growth is slower then we expected. Engineering sales increased $3.8 million or 5% due to new business and expansion of our services for the existing customers particularly in northern California and eastern regions.

Operating profit increased by 32% to $5.5 million as we benefited from operating leverage; another solid quarter from our fastest growing segment.

In summary we continue to deliver solid top and bottom line growth organically and through recent acquisitions. While we have seen weakness in certain regions and economic sectors our size and scale particularly following the acquisition of OneSource have enabled us to minimize but not eliminate the impact of the economic slowing in individual regions.

Acknowledging a general decline in discretionary spending in some customer sectors and regions we are narrowing net income from continuing operations per diluted share guidance for fiscal year 2008 to $1.00 to $1.05 and expected adjusted net income from continuing operations per diluted share for fiscal 2008 of $1.10 to $1.15.

The net income from continuing operations per diluted share guidance excluded the Amtech Lighting Service business which is presented as discontinued operations. At this time I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of David Gold - Sidoti & Co.

David Gold - Sidoti & Co.

Can you elaborate just a little more on the comment about the general decline in discretionary spending and particularly how that relates to janitorial?

Henrik Slipsager

There are certain parts of the janitorial services that are very dependent on extra service of discretionary spending and that is particularly in the northeast region or in particular New York where the sales of business and the pricing is separated from the main building towards tenant services. So when tenant service demands are lowered like its been in primarily the financial sectors over the past three months, you will see a major impact because our fixed cost base in the buildings don’t change.

So it’s basically our revenue are dropping at the same rate as our extra services decline but our cost base stays the same. So it’s primarily on the financial services piece. I have not seen it in many other areas and it’s not a vacancy thing it’s more a spending thing.

David Gold - Sidoti & Co.

So on that basis, essentially its incremental business that presumably is higher margin, these clients because you don’t have high related costs with it, you already have the people on staff in there, its just extra work that they can do, right?

Henrik Slipsager

Correct.

David Gold - Sidoti & Co.

If that continues is there anything that we can do to reduce related costs related or capacity related with that or is it not that easy?

Henrik Slipsager

I don’t think you’re going to see any changes in the way we’re running the jobs because basically with the existing Union situation it will be very difficult to cut labor but the key thing is when these contracts are up for renewal which happens pretty much annually if this continues, and we see it continuing into the future we will renegotiate the price because everybody is in the same boat. It’s not an ABM problem it’s a business problem.

David Gold - Sidoti & Co.

On the lighting business, the sale price, can you give us a sense of how much of that say would be upfront and how much is accounts receivable buyout that maybe comes over time?

Henrik Slipsager

It’s approximately half upfront and I would say probably of the remaining half you’ll see 70%-80% of that come in the first six months and the rest over the period, over the next two years. If I was to give you big numbers, $50-$60 million over the first six months and the remainder over the next 2.5 years.

Operator

Your next question comes from the line of John Enrich – Ironworks Capital

John Enrich – Ironworks Capital

Are there any receivables in other current assets or other non-current assets?

Jim Lusk

No.

John Enrich – Ironworks Capital

In previous releases you’ve broken out long-term receivables, its not a big number like $9 million, is that gone then or is that?

Jim Lusk

Part of that is related to the disposition of lighting and that would all go into the non-current assets of discontinued operations.

John Enrich – Ironworks Capital

What was long-term receivables is now in non-current assets of the--?

Jim Lusk

All the assets associated with the business go into either, go into those discontinued operations lines on the balance sheet.

John Enrich – Ironworks Capital

But what you’re saying is all of these non-current receivables were associated with lighting?

Jim Lusk

Yes, almost, most of them.

John Enrich – Ironworks Capital

What’s allowance for doubtful accounts this quarter, the provision?

Jim Lusk

It pretty much didn’t change from last quarter.

John Enrich – Ironworks Capital

What is then in other non-current assets, the $306.5 million this quarter, what’s in there? It’s a big number relative to your assets, I’m just wondering what it’s comprised of?

Jim Lusk

The pieces are, you’ve got insurance, deposits, things like that, investments, our auction rate securities in there, which we had classified to long-term assets; those are big chunks of them.

John Enrich – Ironworks Capital

How much are the securities these days?

Jim Lusk

We have about between $22million and $23 million.

Operator

It appears we have no further questions at this time; I would like to turn the call back over to management for any additional or closing remarks.

Henrik Slipsager

We would like to thank everybody for listening to our conference call for the third quarter and we are looking forward to talking to all of you after the end of our successful fourth quarter.

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Source: ABM Industries Incorporated F3Q08 (Qtr End 07/31/08) Earnings Call Transcript
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