Business context and reporting period
ABM Industries Incorporated provides integrated facility services—including janitorial, facility maintenance, parking, security, and building and energy solutions—primarily in the United States. This unaudited Form 10-Q covers the fiscal third quarter and nine months ended July 31, 2014; comparisons are with the corresponding 2013 periods.
Financial performance and position
| Metric | Three months ended July 31, 2014 | Nine months ended July 31, 2014 |
|---|---|---|
| Revenue | $1,276.1 million, up 4.9% | $3,733.9 million, up 4.5% |
| Operating profit | $33.7 million, up 17.4% | $85.5 million, up 4.8% |
| Net income | $19.4 million, versus $16.0 million | $47.7 million, versus $48.7 million |
| Diluted EPS | $0.34, versus $0.29 | $0.84, versus $0.87 |
| Gross margin | 10.3%, versus 10.0% | 10.1%, unchanged |
| Interest expense | $2.7 million, versus $3.4 million | $8.1 million, versus $9.7 million |
For the nine-month period, revenue growth was driven mainly by net new business, which contributed $131.8 million of the increase. Operating cash flow was $57.0 million, down from $84.3 million; management cited collection timing for client receivables and higher cash taxes. Investing activities used $39.2 million, including $28.5 million of capital expenditures and $12.4 million for acquisitions. Cash declined to $24.6 million from $32.6 million at October 31, 2013.
At July 31, total assets were $2,168.2 million and total liabilities were $1,214.5 million. Line-of-credit borrowings were $311.7 million; the $800 million facility had $373.2 million of borrowing capacity after outstanding borrowings and letters of credit, subject to covenants. ABM reported compliance with its covenants. The quarterly dividend declared was $0.155 per share; $25.9 million of dividends were paid in the nine months.
Material changes and operating trends
- Quarterly revenue and operating profit rose, while nine-month net income and diluted EPS declined year over year. The higher nine-month effective tax rate—41.6% versus 35.8%—was a principal factor; ABM attributed it mainly to the expiration of the Work Opportunity Tax Credit and its retroactive reinstatement in the prior-year period.
- Building & Energy Solutions was a significant growth contributor: nine-month revenue increased 21.4% and operating profit increased 73.3%, reflecting new contracts and acquisitions. Alpha Mechanical, acquired March 1, 2014, contributed to this segment.
- Facility Services revenue and operating profit declined for the nine months, with contract losses exceeding new business. Corporate expenses increased 11.8%, reflecting higher compensation, share-based compensation, legal costs, and a $3.4 million arbitration accrual, partly offset by lower depreciation.
- Parking revenue includes reimbursed managed-location costs reported in equal amounts as revenue and expense: $231.4 million for the nine months, versus $227.5 million in 2013. This pass-through affects reported revenue scale.
Outlook, commentary, risks and unusual items
- Management gave no specific revenue or earnings guidance. It expects operating cash flows, cash, available credit and capital-market access to fund requirements for the next 12 months, while cautioning that cash generation, operating improvements, borrowing availability and market access are not assured.
- Absent retroactive renewal of the Work Opportunity Tax Credit before October 31, 2014, management estimated a fiscal 2014 effective tax rate of 40%–42%, about 5–7 percentage points above fiscal 2013.
- Annual insurance reviews found favorable 2014 claim trends, but adverse prior-year developments, particularly in general liability and auto claims in California and New York and workers’ compensation in California. The evaluations reduced expected 2014 reserves by $6.2 million and increased prior-year reserves by $10.5 million, for a net $4.3 million increase. Further assessments, including certain acquired-business claims, were expected in the fourth quarter and could change expense.
- Probable litigation losses accrued totaled $5.0 million, including $3.4 million for an unfavorable arbitration decision that ABM contests. The estimated range of reasonably possible losses was $0–$95.8 million, including a possible $94.2 million impact from the Augustus California rest-break class action. The company appealed the underlying judgment and related fee decisions; actual exposure may exceed the estimated range.
- On August 1, 2014, after quarter-end, ABM acquired Airco Commercial Services for $17.8 million in cash, subject to adjustments; purchase accounting was incomplete. The company also identified government-contract award and start-date delays, possible early terminations and sequestration-related spending reductions as risks to its government business.
- Other disclosed risks include labor and employment claims, insurance-reserve uncertainty, client retention and financial health, acquisition integration, competition, and the possibility that new-business start-up costs pressure margins. Management reported effective disclosure controls and no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether receivable collections and operating cash flow improve, given the year-over-year cash-flow decline.
- Fourth-quarter actuarial findings and any resulting changes to insurance expense or reserves.
- Developments in the Augustus appeal, arbitration dispute, and other litigation contingencies.
- Fiscal 2014 tax-rate outcome and whether the Work Opportunity Tax Credit is renewed retroactively.
- Airco’s final purchase-price allocation and contribution, and whether new contracts and acquisitions translate into sustainable segment margins.
- Credit-facility availability and covenant compliance as borrowing, letters of credit, and operating needs change.