ABM Industries Incorporated (NYSE:ABM) Q3 2023 Earnings Call Transcript

ABM Industries Incorporated (NYSE:ABM) Q3 2023 Earnings Call Transcript September 7, 2023

ABM Industries Incorporated misses on earnings expectations. Reported EPS is $0.79 EPS, expectations were $0.88.

Operator: Greetings and welcome to the ABM Industries Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Goldberg, Senior Vice President, Investor Relations. Thank you. You may begin.

Paul Goldberg: Good morning, everyone, and welcome to ABM’s Third Quarter 2023 Earnings Call. My name is Paul Goldberg, and I’m the Senior Vice President of Investor Relations at ABM. With me today are Scott Salmirs, our President and Chief Executive Officer; and Earl Ellis, our Executive Vice President and Chief Financial Officer. Please note that earlier this morning, we issued our press release announcing our third quarter 2023 financial results. A copy of that release and accompanying slide presentation can be found on our website abm.com. After Scott and Earl’s prepared remarks, we will host the Q&A session. But before we begin, I would like to remind you that our call and presentation today contain predictions, estimates, and other forward-looking statements.

Our use of the words, estimates, expects, and similar expressions are intended to identify these statements and they represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially. These factors are described in the slide that accompanies our presentation as well as in our filings with the SEC. During the course of this call, certain non-GAAP financial information will be presented. A reconciliation of historical non-GAAP numbers to GAAP financial measures is available at the end of the presentation and on the company’s website under the Investor tab. And with that, I would like to now turn the call over to Scott.

Scott Salmirs: Thanks, Paul. Good morning and thank you all for joining us today to discuss our third quarter results. Third quarter revenue grew 3.4% to $2 billion, including 2.5% organic growth. Our aviation, education and manufacturing and distribution segments performed well, driven by robust air travel, new education clients and our strong market positioning in M&D. These solid results were partially offset by lower activity in bundled energy solutions and delayed project starts in our Technical Solutions group and by the softening market conditions for janitorial services in business and industry. Our teams are acting to resolve project delays and technical solutions, which we believe to be transient and we’ve also proactively adjusted our cost structure to better match the current demand environment in B&I.

In addition to our cost management efforts, we have aggressively pursued price increases to cover the inflationary labor environment and reflects the value of the essential services we provide. I’ll now discuss the demand environment for each of our industry groups. Let’s begin with B&I. Office density rates remain relatively static in the third quarter at around 50% on a blended basis. Although the hybrid work model remains prevalent, we expect to see a gradual increase in the number of days per week employees spend at their office. In fact, many of our clients plan to mandate employees work an additional day per week in the office starting sometime after Labor Day. Accordingly, office density is likely to gradually improve, which should help stabilize our volume of work orders over time.

However, we are beginning to see what has been so prevalent in the media that as office leases expire, many clients are downsizing their office footprint given hybrid work models and the macroeconomic environment. This puts pressure on the demand side for us until vacant floors are re-leased and reoccupied. This trend will likely continue into 2024. We remain well positioned to navigate the challenges in commercial real estate given our flexible labor model. Also importantly, our multi-tenant commercial real estate profile largely consists of Class A and newer buildings. These properties have been less impacted than Class B and Class C properties and should be leased up fairly quickly. In addition, Engineering services constitute a sizable portion of our revenue in B&I.

This revenue stream is less impacted than janitorial services as HVAC and electrical systems must be maintained regardless of occupancy density. Finally, I would note that our B&I segment includes a large portion of non-multi-tenant locations such as corporate office towers and corporate campuses. This portion of B&I has seen more stability from a vacancy perspective. Summing it all up, we see the pressures on commercial real estate modestly impacting our revenue line but allowing us to protect margin through our labor model and the ability to manage our cost structure. Moving to Aviation. The leisure and business travel markets, including international travel, continue to be quite strong given pent-up demand. Our aviation team has executed well in this environment, managing through a historically tight labor market while ramping up service volumes to above pre-pandemic levels.

They’ve also done a great job winning new business, such as a significant recent expansion of one of the country’s busiest airports that included multiple service lines through our ABM Performance Solutions integrated offering, which is known as APS in the marketplace. Demand within our manufacturing and distribution segment has remained solid benefiting from our core e-commerce and logistics clients and from our diversification efforts, including expanded business with clients in the manufacturing, semiconductor and biopharma markets. These newer end markets continue to offer strong growth opportunities as clients increasingly outsource support services so they can focus on their core business operations and the momentum for onshoring manufacturing is continuing.

Of note, we booked a significant contract with a leading energy company in the third quarter, further diversifying our client base. We will continue to focus on new growth opportunities as we prepare for a large client of ours to rebid and rebalance their work needs over the next year. This is part of their normal business process and even after the bid. While we expect some revenue pressure, we also expect to maintain a disproportionate share of their business, having provided stellar service to them through a strong growth period. Moving to education. We continue to post mid-single-digit organic revenue growth, driven by 100% in-class learning and by the addition of new clients. We executed well on our sales pipeline and won several new contracts during the third quarter, including a sizable win with the Providence Rhode Island Public School District.

We are pleased that Providence has opted to utilize our APS offering, which, as I noted earlier, combines multiple service offerings into one comprehensive solution. Other notable education wins in the third quarter included the Prosper Texas Independent School District and Palm Beach State College in Florida. Our pipeline of new business opportunities remain strong and we expect to continue to win our fair share going forward. Moving to Technical Solutions. The global demand environment for EV charging infrastructure and microgrids particularly battery storage systems remains strong. Our ATS backlog now exceeds $450 million with EV and microgrid services representing over 60% of the total. At the same time, we are experiencing soft market conditions and bundled energy solutions, which includes HVAC, lighting and electrical system retrofits.

This is driven by reduced investment spending especially in K through 12 schools, primarily due to higher interest rates and the pressure that puts on project ROIs. ATS did not perform as we anticipated in the third quarter for two key reasons. First, we expected to complete a greater number of booked microgrid projects at multiple locations, specifically large battery systems for a large industrial client. This project was initially impacted by supply chain constraints in the first half of the year. With the supply chain having largely stabilized, we faced new delays relating to local permitting and utility issues. Because the deployment of large-scale battery storage system is relatively new, many local governments are not accustomed to dealing with the unique and complex requirements of these projects and permitting gets protracted.

We continue to work closely with our clients, and we are executing a plan to address near-term hurdles, including targeting alternative sites where appropriate. Turning to e-mobility. As we discussed on our last call, we expected the pace of EV charger installations to materially accelerate in the second half of the year as we began to deliver on several new programs, including one for a large automotive dealer network. Because of this particular auto OEM recently announced a change in its EV production goals, the dealerships have slowed their rollout in EV infrastructure to match the production schedule. We view the battery storage system delays as well as the project pushouts on EV as transitory and reflective of rapidly evolving markets experience disruptive change.

PI/Shutterstock.com

While we address the near-term challenges in this market, ABM remains well positioned in the EV charging space, given our track record of over 22,000 EV installations as well as our innovative technical capabilities that include end-to-end solutions. Also, the level of interest and bidding activity for EV infrastructure and microgrid has never been higher, so we remain really encouraged. Turning now to our ELEVATE initiative. We have continued to make important progress in reaching our long-term technology objectives. During the third quarter, we utilized our new cloud-based ERP system to complete our quarterly close for the Education segment. This platform, which provides significant efficiency and operational improvements will be rolled out to the remainder of ABM over the next two years as planned.

We also continue to leverage our workforce productivity and optimization tool, which provides our operations teams with advanced analytics into productivity levels across their portfolios. In fact, we’ve seen about a 10% improvement in gross margins on the jobs where the tool has been piloted. This capability will become even more critical going forward to effectively manage our labor utilization as we navigate the commercial office landscape. Additionally, we now have over 200 digital client dashboards deployed at sites across the country and feedback has been exceptionally positive. As we manage through some specific challenges, ABM remains resilient, supported by our leading market position, diversified industry groups and financial strength.

We continue to be the clear leader in facility services and we have expanded our long-term growth opportunity through strategic investments in fast-growing markets and will continue to do so. We’ve done a terrific job winning large new contracts in aviation and education as well as in manufacturing and distribution where we continue to expand. And although we’ve experienced some delays in ATS, we are confident our performance will improve as the market matures. In B&I, we’re fortunate that our portfolio remains heavily weighted towards better performing Class A commercial real estate and more stable engineering services, combined with our flexible labor model. Given the recent challenges in ATS and B&I, we expect full year 2023 adjusted EPS to come in at the bottom half of our prior outlook range.

Looking further ahead to next year, although our forecasting and budget process is in its early stages, it wouldn’t surprise me that fiscal 2024 adjusted EPS was slightly down from 2023 given the softness in the commercial office sector. We will share our more formal 2024 outlook on our Q4 earnings call in December. We are laser focused on overcoming these near-term challenges including tightly managing costs and making tough decisions to adjust our cost structure across the organization. Beyond that, we are building for the future by winning new business in attractive markets leveraging our ELEVATE technology and by using our strong free cash flow to enhance shareholder returns. We will also continue to invest for the long-term to position ABM for sustainable success.

Now I’ll turn it over to Earl for the financials.

Earl Ellis: Thank you, Scott, and good morning, everyone. For those of you following along with our earnings presentation, please turn to slide five. Third quarter revenue increased 3.4% to $2 billion, comprised of organic revenue growth of 2.5% and acquisition contribution of roughly 1%. Moving onto slide six. Net income in the third quarter was $98.1 million or $1.47 per diluted share, both up 73% as compared to last year. The increase in GAAP net income was driven by a gain from employee retention credits of $22.4 million. The adjustment of the fair value of contingent consideration of $37.2 million and tight expense controls, partially offset by higher interest expense and labor costs, project delays in ATS and lower commercial office space related volume.

Adjusted net income of $52.8 million and adjusted earnings per diluted share of $0.79 were both down 16% from the prior year period. The year-over-year changes in adjusted net income and adjusted EPS primarily reflected higher interest expense and slightly lower income from operations, partially offset by cost management and benefits from price increase. Adjusted EBITDA was essentially flat with the prior year at $125.3 million and adjusted EBITDA margin was 6.4% versus 6.6% last year. The margin decline was largely reflective of inefficiencies related to project delays in ATS and the impact of lower volumes in B&I, partially offset by cost initiatives. Now turning to our segment results beginning on slide seven. B&I revenue declined 1% year-over-year to $1 billion mainly due to reduced demand in the commercial office market.

Operating profit in B&I decreased to $78.9 million and operating margin declined to 7.7% as the impact of lower volume was partially offset by price increases and cost actions. Aviation revenue grew 17% to $238 million, marking the ninth consecutive quarter of year-over-year revenue growth. This increase was driven by strong demand for leisure and business travel. We expect demand within our Aviation segment to remain constructive going forward. Aviation’s operating profit was $11.7 million versus $9.5 million in the prior year period. And operating margin expanded 20 basis points to 4.9%. The increase in profit and margin primarily reflected higher volume and price increases, partially offset by increased labor costs. Turning to slide eight.

Manufacturing and distribution revenue grew 7% to $381.9 million, reflecting broad-based demand. Operating profit increased to $38.1 million while operating margin declined 60 basis points to 10%. Profit and margin performance was largely due to mix as new wins came in slightly below our historical margin in this segment. Education revenue increased 6% to $219.1 million, benefiting from the addition of new clients. Education operating profit was $15.9 million up 10% over the prior year period, while margin increased 30 basis points to 7.3%. These increases were largely attributable to increased organic revenue growth and labor efficiencies. Technical Solutions revenue grew 6% to $167.9 million, which was below our expectations heading into the quarter.

Revenue growth was comprised of 12% growth from RavenVolt partially offset by a 6% organic decline. As Scott mentioned, ATS revenue was negatively impacted by three factors, namely delays in certain RavenVolt battery storage projects. Ongoing softness in our bundled energy solutions markets as investment decisions are being impacted by higher interest rate environment and thirdly, the pushout of a large EV charging installation program. Backlog in ATS is now over $450 million, much of which is scheduled to convert to revenue in 2024. Also of note, supply chain issues in ATS have been stabilized which will be helpful as we move forward. ATS operating profit was $11.4 million and margin was 6.8% compared to operating profit of $15.4 million and margin of 9.7% last year.

The decrease in margin and profit were largely driven by inefficiency associated with project delays, changes in business mix and the amortization of intangibles related to the RavenVolt acquisition. Moving on to slide nine. We ended the third quarter with total debt of $1.4 billion including $58.4 million in standby letters of credit, resulting in total debt to pro forma adjusted EBITDA ratio of 2.3 times. At the end of Q3, we had available liquidity of $582.6 million, including cash and cash equivalents of $97.7 million. Free cash flow in the third quarter was still strong at $138 million. During the third quarter, we repurchased 644,000 shares of common stock at an average price of $42.10 for a total cost of $27.1 million. Interest expense was $20.9 million, up approximately $10 million from the prior year period, but down slightly on a sequential basis.

The year-over-year increase was primarily attributable to higher interest rates. Now let’s move on to our full year fiscal 2023 outlook as shown on slide 10. On a GAAP basis, we now expect EPS to be in the range of $3.52 to $3.62, up from our prior outlook, driven by gains from changes in items impacting comparability occurring in the third quarter, namely $0.26 related to employee retention credits and an incremental $0.59 related to an adjustment to the fair value of contingent consideration. As for the adjusted EPS, we are tightening to the lower end of our prior range largely reflecting project pushouts in ATS and ongoing softness in the commercial real estate market. As a result, we now expect full year 2023 adjusted EPS to be $3.40 to $3.50.

Our full year outlook for adjusted EBITDA margin, interest expense and tax rate before discrete items are all unchanged. Adjusted EBITDA margin is expected to be 6.5% to 6.8%. Interest expense is expected to be approximately $80 million and the tax rate before discrete items is expected to be between 29% and 30%. We also continue to expect to grow full year adjusted EBITDA in the mid-single -digits and for full year free cash flow to be in the range of $240 million to $270 million before the CARES Act repayment of $66 million, which was made in Q1 and combined full year integration and ELEVATE expenses of approximately $75 million to $80 million. With that, let me turn it back to Scott for closing comments.

Scott Salmirs: Thanks, Earl. I couldn’t be more pleased with our team’s efforts in the face of macroeconomic headwinds and the challenges in commercial real estate. Their unrelenting focus on client service and winning new business, combined with the mixture of our end markets, the resiliency of our culture and the extraordinary talent of our teammates, gives me great confidence we will successfully navigate any near-term challenges. With that, let’s take some questions.

See also 11 Best Conglomerate Stocks to Buy Now and 20 Biggest Reinsurance Companies in the World.

Q&A Session

Operator: Thank you. The floor is now open for questions. [Operator Instructions] Today’s first question is coming from Tim Mulrooney of William Blair. Please go ahead.

Samuel Kusswurm: Hey, this is Sam Kusswurm on for Tim. Scott, Earl hope you both are doing well.

Scott Salmirs: Hey, thanks.

Samuel Kusswurm: I guess to start here, you shared that you’re expecting the commercial real estate market to remain soft in 2024 and EPS may be down year-over-year. If that proves true, I guess I’m wondering how you think about that in terms of reaching your ELEVATE goals in 2025.

Scott Salmirs: Yes. Thanks for the question. Look, I think for us, I think we have to talk about 2021 when we set our ELEVATE goals and how much the market has changed, right? I mean we have this multigenerational structural shift in commercial real estate between hybrid work and the macroeconomic environment which is certainly going to put short-term pressure on us. And the interest rate environment has significantly changed since then, right? Not to mention what’s happened with wage inflation, especially in the blue-collar segment. So that’s definitely going to put pressure on us and we could see that pushing out our goals maybe a couple of years. But at the end of the day, we are firmly committed to these metrics and feel strongly we’re going to hit our 7.2% margin, our free cash flow targets.

The investments that we’re making in ELEVATE. The ROI that we’re seeing early on is so compelling between the hyper targeting tool and probably, although the year is not over, we believe we’re going to hit a fifth consecutive year in sales growth. So we’re excited about that. I mentioned in my prepared remarks that we’re seeing the labor productivity tool and the pilots, having 10% gross margin uplift. So we’re absolutely firmly committed to our targets. It’s just, again, maybe extended a couple of years.

Samuel Kusswurm: Got you. Appreciate that response. Maybe pivoting to your Technical Solution, but I think it was last quarter, there was some hope that the pause in some of your Technical Solution projects was going to reverse in the back half here. But now that’s looking more like in 2024. Can you give us a pulse on how clients are feeling right now? And are the projects still considered paused or have any clients canceled them altogether.

Scott Salmirs: Yes. No, that’s a great question. There’s been no cancellations. This is all part of our backlog, which are signed contracts. And I think for this — these are big chunky projects, a big battery storage projects. And we had initially some delays because of supply chain. We got over those hurdles. But now to get these installations in, you have to go through permitting, you have to deal with the utilities. And to give you a context on these battery storage projects, these battery farms that we’re putting in are the size of one, two, sometimes three football fields, right? And this is a new market that’s not really matured yet, right? So I think it’s new even for the local governments in terms of permitting. So we’re seeing them pushed out.

We’re having two of our nine projected projects happen this year. So they’re actually happening. It’s just really delayed starts and a reflection of the maturity of the market. But I have to tell you, when we reflect on the RavenVolt acquisition and the whole microgrid space. I think the only thing that’s happened in the last year is that we’re more resolved that this was an amazing acquisition for us and absolutely the right space. I mean alternative energy is kind of the future of this country. And just to give you one quick anecdote, our Chief Operating Officer is Danish and Louis in Denmark over the summer. And he was noting that when they give the weather forecast in Denmark, they give the weather forecast and they talk about how much of the country is operating on alternative power.