UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-K

 

 

Commission File Number: 1-8929

 

ABM INDUSTRIES INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

212/297-0200

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of April 30, 2009 (the last business day of registrant’s most recently completed second fiscal quarter), non-affiliates of the registrant beneficially owned shares of the registrant’s common stock with an aggregate market value of $803,996,952, computed by reference to the price at which the common stock was last sold.

 

Number of shares of common stock outstanding as of November 30, 2009: 51,710,364.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement to be used by the Company in connection with its 2010 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K.

 

 

ABM Industries Incorporated
Form 10-K
For the Fiscal Year Ended October 31, 2009

TABLE OF CONTENTS

 

 

 

 

ABM Industries Incorporated (“ABM”), through its subsidiaries (collectively, the “Company”) is a leading provider of facility services in the United States. With 2009 revenues in excess of $3.4 billion, the Company provides janitorial, parking, security and engineering services for thousands of commercial, industrial, institutional and retail client facilities in hundreds of cities, primarily throughout the United States. The Company employs over 91,000 people; the vast majority of whom are service employees.

 

On November 14, 2007, the Company acquired OneSource Services, Inc. (“OneSource”), a provider of outsourced facilities services including janitorial, landscaping, general repair and maintenance and other specialized services for commercial, industrial, institutional and retail client facilities, primarily in the United States, for an aggregate purchase price of $390.5 million. OneSource’s operations are included in the Janitorial segment since the date of its acquisition.

 

On October 31, 2008, the Company completed the sale of substantially all of the assets of its Lighting segment, excluding accounts receivable and certain other assets, to Sylvania Lighting Services Corp (“Sylvania.”) for approximately $34.0 million in cash, which included certain adjustments and payment to the Company of $0.6 million pursuant to a transition services agreement. Sylvania assumed certain liabilities under certain contracts and leases relating to the period after the closing. The remaining assets and liabilities associated with the Lighting segment have been classified as assets and liabilities of discontinued operations for all periods presented. The results of operations of the Lighting segment for all periods presented are classified as “(Loss) income from discontinued operations, net of taxes.”

 

The Company was reincorporated in Delaware on March 19, 1985, as the successor to a business founded in California in 1909. The Company’s corporate headquarters are located at 551 Fifth Avenue, Suite 300, New York, New York 10176. The telephone number is (212) 297-0200. The Company’s website is www.abm.com. Through the “SEC Filings” link on the Investor Relations section of the Company’s website, the following filings and amendments to those filings are made available free of charge, as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: (1) Annual Reports on Form 10-K, (2) Quarterly Reports on Form 10-Q, (3) Current Reports on Form 8-K, (4) Proxy Statements, and (5) filings by the Company’s directors and executive officers under Section 16(a) of the Securities Exchange Act of 1934. The Company’s Corporate Governance Guidelines, Code of Business Conduct and the charters of its Audit, Compensation and Governance Committees are available through the “Governance” link on the Investor Relations section of the Company’s website and are also available in print, free of charge, to those who request them. Information contained on the Company’s website shall not be deemed incorporated into, or to be a part of, this Annual Report on Form 10-K.

 

Segment Information

 

The Company conducts business through a number of subsidiaries, which are grouped into four segments based on the nature of the business operations. At October 31, 2009 the four reportable segments were:

 

 

The business activities of the Company by reportable segment are more fully described below.

 

n Janitorial.  Certain of the Company’s subsidiaries provide a wide range of essential janitorial services for clients, primarily throughout the United States, in a variety of facilities, including commercial office buildings, industrial buildings, retail stores, shopping centers, warehouses, airport terminals, health facilities and educational institutions, stadiums and arenas, and government buildings. These services include, among other things, floor cleaning and finishing, window washing, furniture polishing, carpet cleaning and dusting, and other building cleaning services. The Company’s Janitorial subsidiaries operate in all 50 states. The Company’s Janitorial business operates under thousands of individually negotiated building maintenance contracts, most of which are obtained by competitive bidding. These arrangements include “fixed price” agreements, “cost-plus” agreements and “tag” (extra service) work. Fixed price arrangements are contracts in which the client agrees to pay a fixed fee every month over a specified contract term. A variation of a fixed price arrangement is a square-foot arrangement, under which monthly billings are fixed based on the vacant square footage serviced. Cost-plus arrangements are agreements in which the clients reimburse the Company for the agreed-upon amount of wages and benefits, payroll taxes, insurance charges and other expenses associated with the contracted work, plus a

profit percentage. Tag work generally represents supplemental services requested by clients outside of the standard contract terms. Examples are clean up after tenant moves, construction clean up and snow removal. Tag work generally produces higher margins. Profit margins on contracts tend to be inversely proportional to the size of the contract, as large-scale contracts tend to be more competitively priced than small or standalone agreements. The majority of the Company’s Janitorial contracts are for one to three year periods and contain automatic renewal clauses, but are subject to termination by either party after 30 to 90 days’ written notice.

 

n Parking.  Certain of the Company’s subsidiaries provide parking and transportation services operating through 26 offices in 35 states and the District of Columbia. The Company operates parking lots and garages including, but not limited to, facilities at airports in the following cities: Austin, Texas; Dallas/Ft. Worth, Texas; Honolulu, Hawaii; Minneapolis/St. Paul, Minnesota; Omaha, Nebraska; Orlando, Florida; San Jose, California; Tampa, Florida; and Toronto, Canada. The Company also provides shuttle bus services at 14 airports. Nearly all contracts are obtained by competitive bidding. There are three types of arrangements for parking services: managed locations, leased locations, and allowance locations. Under the management arrangements, the Company manages the underlying parking facility for the owner in exchange for a management fee. Management contract terms are generally from one to three years, and often can be terminated without cause upon 30 days’ notice and may also contain renewal clauses. The Company passes through revenues and expenses from managed locations to the facility owner under the terms and conditions of the management contract. Under leased location arrangements, the Company leases these parking facilities from the owner and are responsible for a majority of the operating expenses incurred. The Company retains all revenues from monthly and transient parkers and pays rent to the owner per the terms and conditions of the lease. The lease terms generally range from one to five years and provide for payment of a fixed amount of rent plus a percentage of revenues. The leases usually contain renewal options and may be terminated by the owner for various reasons, including development of the real estate. Leases which expire may continue on a month-to-month basis. Under allowance arrangements, the Company is paid a fixed or hourly fee to provide parking services. The Company is then responsible for the agreed upon operating expenses based on the agreement terms. Allowance contract terms are generally from one to three years, and often can be terminated without cause upon 30 days’ notice and may also contain renewal clauses. The Company continues to improve parking operations through the increased use of technology, including enhancements to the SCORE⁴ proprietary revenue control software, implementation of the Company’s client access software ABM4WD.com, and on-line payment software.

 

n Security.  Certain of the Company’s subsidiaries provide security services to a wide range of businesses. The Company’s Security subsidiaries operate from 50 offices in 34 states and the District of Columbia. Security services include staffing of security officers, mobile patrol services, investigative services, electronic monitoring of fire, life safety systems and access control devices, and security consulting services. Clients served include Class “A” High rise, Commercial, Industrial, Retail, Medical, Petro-chemical, and residential facilities. Security Staffing, or “Guarding” is the provision of dedicated security officers to a client facility. This component is the core of the security business and represents the largest portion of its revenues. Mobile Patrol is the use of roving security officers in vehicles that serve multiple locations and customers across a pre-defined geographic area. Investigative Services includes white collar crime investigation, undercover operations, and background screening services. Electronic monitoring is primarily achieved through the subsidiary’s partnership with a major systems integrator. The revenues for Security are generally based on actual hours of service at contractually specified rates. In some cases, flat monthly billing or single rate billing is used, especially in the case of Mobile Patrol and Investigative Services. The majority of Security contracts are for one year periods and generally contain automatic renewal clauses, but are subject to termination by either party after 30 to 90 days’ written notice. Nearly all Security contracts are obtained by competitive bidding. The Company has benefited from the implementation of AuditMatic^® reporting and incident tracking software and various technology offerings, and was awarded The Homeland Security Safety Act Certification.

 

n Engineering.  Certain of the Company’s subsidiaries provide client facilities with on-site engineers to operate and maintain mechanical, electrical and plumbing systems utilizing, in part, computerized maintenance management systems. The Company’s Engineering subsidiaries maintain national ISO 9000 Certification (“ISO”) in 9 branches operating in 36 states and the District of Columbia. ISO is a family of standards for quality management comprised of a rigorous set of guidelines and good business practices against which companies are evaluated through a

comprehensive independent audit process. Certain of the Company’s Engineering services are designed to maintain equipment at optimal efficiency for client locations including high-rise office buildings, schools, computer centers, shopping malls, manufacturing facilities, museums and universities. The Company’s Engineering services also provide clients with streamlined, centralized control and coordination of multiple facility service needs. This approach offers the efficiencies, service and cost benefits expected in the highly-competitive market for outsourced business services. By leveraging the core competencies of other service offerings, the Company attempts to reduce overhead (such as redundant personnel) for the Company’s clients by providing multiple services under a single contract, with one contact and one invoice. The Company’s National Service Call Center provides centralized dispatching, emergency services, accounting and related reports to financial institutions, high-tech companies and other clients regardless of industry or size. The Company’s Engineering services also include energy management services which provide comprehensive, cost-efficient solutions to help curb the Company’s clients rising cost of utilities within a facility, reduce energy consumption, and minimize the carbon footprint of a facility. Investments made by clients in energy efficiency solutions are typically recouped through reduced energy costs over a period of time. The majority of the Company’s Engineering contracts are cost-plus arrangements are agreements in which the clients reimburse the Company for the agreed-upon amount of wages and benefits, payroll taxes, insurance charges and other expenses associated with the contracted work, plus a profit percentage. The majority of the Company’s Engineering contracts are for three year periods and may contain renewal clauses, but are subject to termination by either party after 30 to 90 days’ written notice. Nearly all Engineering contracts are obtained by competitive bidding.

 

See Note 15 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplemental Data,” for the operating results of the reportable segments.

 

Trademarks

 

The Company believes that it owns or is licensed to use all corporate names, tradenames, trademarks, service marks, copyrights, patents and trade secrets that are material to the Company’s operations.

 

Competition

 

The Company believes that each aspect of its business is highly competitive, and that such competition is based primarily on price and quality of service. The Company provides nearly all its services under contracts originally obtained through competitive bidding. The low cost of entry in the facility services business has led to strongly competitive markets comprised of a large number of mostly regional and local owner-operated companies, primarily located in major cities throughout the United States. The Company also competes with the operating divisions of a few large, diversified facility services and manufacturing companies on a national basis. Indirectly, the Company competes with building owners and tenants that can perform one or more of the Company’s services internally. Furthermore, competitors may have lower costs because privately owned companies operating in a limited geographic area may have significantly lower labor and overhead costs. These strong competitive pressures could inhibit the Company’s success in bidding for profitable business and its ability to increase prices as costs rise, thereby reducing margins.

 

Sales and Marketing

 

The Company’s sales and marketing efforts are conducted by its corporate, subsidiary, regional, branch and district offices. Sales, marketing, management and operations personnel in each of these offices participate directly in selling and servicing clients. The broad geographic scope of these offices enables the Company to provide a full range of facility services through intercompany sales referrals, multi-service “bundled” sales and national account sales.

 

The Company has a broad client base in a variety of facilities, including, but not limited to, commercial office buildings, industrial buildings, retail stores, shopping centers, warehouses, airports, health facilities and educational institutions, stadiums and arenas, and government buildings. No client accounted for more than 5% of the Company’s revenues during 2009, 2008 or 2007.

 

Employees

 

As of October 31, 2009, the Company employed approximately 91,000 employees. Over 38,000 of these employees are covered under collective bargaining agreements. There are over 5,000 employees with executive, managerial, supervisory, administrative, professional, sales, marketing, office, or clerical responsibilities.

Environmental Matters

 

The Company’s operations are subject to various federal, state and/or local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment, such as discharge into soil, water and air, and the generation, handling, storage, transportation and disposal of waste and hazardous substances. These laws generally have the effect of increasing costs and potential liabilities associated with the conduct of the Company’s operations. In addition, from time to time the Company is involved in environmental matters at certain of its locations or in connection with its operations. Historically, the cost of complying with environmental laws or resolving environmental issues relating to United States locations or operations has not had a material adverse effect on the Company’s financial position, results of operations or cash flows. The Company does not believe that the resolution of known matters at this time will be material.

 

 

The executive officers of the Company on December 22, 2009 were as follows:

 

 

 

Risks Relating to our Operations

 

Risks relating to our acquisition strategy may adversely impact our results of operations.  A significant portion of our historic growth was generated by acquisitions and we expect to continue to acquire businesses in the future as part of our growth strategy. A slowdown in acquisitions could lead to a slower growth rate, constant or lower margins, as well as lower revenues growth.

 

There can be no assurance that any acquisition we make in the future will provide us with the benefits that we anticipate when entering into the transaction. The process of integrating an acquired business may create unforeseen difficulties and expenses. The areas in which we may face risks include, but are not limited to:

 

 

We are subject to intense competition that can constrain our ability to gain business, as well as our profitability.  We believe that each aspect of our business is highly competitive, and that such competition is based primarily on price and quality of service. We provide nearly all our services under contracts originally obtained through competitive bidding. The low cost of entry to the facility services business has led to strongly competitive markets consisting primarily of regional and local owner-operated companies. We also compete with a few large, diversified facility services and manufacturing companies on a national basis. Indirectly, we compete with building owners and tenants that can perform internally one or more of the services that we provide. These building owners and tenants have an increased advantage in locations where our services are subject to sales tax and internal operations are not. Competitors may have lower costs because privately owned companies operating in a limited geographic area may have significantly lower labor and overhead costs. These strong competitive pressures could impede our success in bidding for profitable business and our ability to increase prices even as costs rise, thereby reducing margins.

 

We have high deductibles for certain insurable risks, and therefore we are subject to volatility associated with those risks.  We are subject to certain insurable risks such as workers’ compensation, general liability, automobile and property damage. We maintain commercial insurance policies that provide $150.0 million (or $75.0 million with respect to claims acquired from OneSource in 2008) of coverage for certain risk exposures above our deductibles (i.e., self-insurance retention limits). Our deductibles, currently and historically, have generally ranged from $0.5 million to $1.0 million per occurrence (in some cases somewhat higher in California). We are also responsible for claims in excess of our insurance coverage. Pursuant to our management and service contracts, we allocate a portion of our insurance-related costs to certain clients, including workers’ compensation insurance, at rates that, because of the scale of our operations and claims experience, we believe are competitive. A material change in our insurance costs due to a change in the number of claims, costs or premiums, could have a material effect on our operating results. Should we be unable to renew our umbrella and other commercial insurance policies at competitive rates, it would have an adverse impact on our business, as would the incurrence of catastrophic uninsured claims or the inability or refusal of our insurance carriers to pay otherwise insured claims. Further, to the extent that we self-insure, deterioration in claims management could increase claim costs, particularly in the workers’ compensation area. Additionally, although we engage third-party experts to assist us in estimating appropriate self-insurance accounting reserves, the determination of those reserves is dependent upon significant actuarial judgments that have a material impact on our reserves. For example, quantitative assessments of the impact of recently enacted legislation/regulation and/or court rulings require a great deal of actuarial judgment, which are then updated as actual experience reflecting those changed environment factors

becomes available. Changes in our insurance reserves as a result of our periodic evaluations of the related liabilities will likely cause significant volatility in our operating results that might not be indicative of the operations of our ongoing business.

 

An increase in costs that we cannot pass on to clients could affect our profitability.  We negotiate many contracts under which our clients agree to pay certain costs related to workers’ compensation and other insurance coverage where we self-insure much of our risk. If actual costs exceed the rates specified in the contracts, our profitability may decline unless we can negotiate increases in these rates. In addition, if our costs, particularly workers’ compensation, other insurance costs, labor costs, payroll taxes, and fuel costs, exceed those of our competitors, we may lose existing business unless we reduce our rates to levels that may not fully cover our costs.

 

We primarily provide our services pursuant to agreements which are cancelable by either party upon 30 to 60 days’ notice.  Our clients can unilaterally decrease the amount of services we provide or terminate all services pursuant to the terms of our service agreements. Any loss of a significant number of clients could in the aggregate materially adversely affect our operating results.

 

Our success depends on our ability to preserve our long-term relationships with clients.  The business associated with long-term relationships is generally more profitable than that associated with short-term relationships because we incur start-up costs under many new contracts. Once these costs are expensed or fully depreciated over the appropriate periods, the underlying contracts become more profitable. Our loss of long-term clients could have an adverse impact on our profitability even if we generate equivalent revenues from new clients.

 

Transition to a Shared Services Function could create disruption in functions affected.  Historically, we performed accounting functions, such as accounts payable, accounts receivable payment applications and payroll, in a decentralized manner through regional accounting centers in our businesses. In 2007, we began consolidating these functions into a shared services center in Houston, Texas, and in 2008, in an additional facility in Atlanta, Georgia. Although many of the previously decentralized accounting functions have transitioned to the shared services centers, certain additional accounting functions will be moved to the centers in the future. The continued migration of these accounting functions to our shared services center could lead to turnover of personnel with critical knowledge about our clients and employees and result in disruption of our processes and controls relating to accounts receivable and payroll.

 

We incur significant accounting and other control costs that reduce profitability.  As a publicly traded corporation, we incur certain costs to comply with regulatory requirements. If regulatory requirements were to become more stringent or if accounting or other controls thought to be effective later fail, we may be forced to make additional expenditures, the amounts of which could be material. Most of our competitors are privately owned so our accounting and control costs can be a competitive disadvantage. Should revenues decline or if we are unsuccessful at increasing prices to cover higher expenditures for internal controls and audits, the costs associated with regulatory compliance will rise as a percentage of revenues.

 

Risks Related to Market and Economic Conditions

 

A decline in commercial office building occupancy and rental rates could affect our revenues and profitability.  Our revenues are affected by commercial real estate occupancy levels. In certain geographic areas and service segments, our most profitable revenues are known as tag jobs, which are services performed for tenants in buildings in which our business performs building services for the property owner or management company. A decline in occupancy rates could result in a decline in fees paid by landlords, as well as tag work, which would lower revenues, and create pricing pressures and therefore lower margins. In addition, in those areas where the workers are unionized, decreases in revenues can be accompanied by relative increases in labor costs if we are obligated by collective bargaining agreements to retain workers with seniority and consequently higher compensation levels and cannot pass through these costs to clients.

 

Deterioration in economic conditions in general could further reduce the demand for facility services and, as a result, reduce our earnings and adversely affect our financial condition.  Changes in global, national and local economic conditions could have a negative impact on our business. Adverse changes in occupancy levels may further reduce demand, depress prices for our services and cause our clients to cancel their agreements to purchase our services, thereby possibly reducing earnings and adversely affecting our business and results of operations. Additionally, adverse economic conditions may result in clients cutting back on discretionary spending, such as tag work. Since, a

significant portion of Parking revenues is tied to the number of airline passengers and hotel guests, Parking results could be adversely affected by curtailment of business and personal travel.

 

Financial difficulties or bankruptcy of one or more of our major clients could adversely affect our results.  Future revenues and our ability to collect accounts receivable depend, in part, on the financial strength of clients. We estimate an allowance for accounts we do not consider collectible and this allowance adversely impacts profitability. In the event clients experience financial difficulty, and particularly if bankruptcy results, profitability is further impacted by our failure to collect accounts receivable in excess of the estimated allowance. Additionally, our future revenues would be reduced by the loss of these clients.

 

Our ability to operate and pay our debt obligations depends upon our access to cash.  Because ABM conducts business operations through operating subsidiaries, we depend on those entities to generate the funds necessary to meet financial obligations. Delays in collections, which could be heightened by disruption in the credit markets and the financial services industry, or legal restrictions could restrict our subsidiaries’ ability to make distributions or loans to ABM. The earnings from, or other available assets of, these operating subsidiaries may not be sufficient to make distributions to enable us to pay interest on debt obligations when due or to pay the principal of such debt. As of October 31, 2009, we had $118.6 million of standby letters of credit collaterizing self-insurance claims and $42.5 million of insurance deposits that represent amounts collateralizing OneSource self-insurance claims that we can not access for operations. In addition, $25.0 million original principal amount of our investment portfolio is invested in auction rate securities which are not actively traded. In the event we need to liquidate our auction rate securities prior to a successful auction, our expected holding period, or their scheduled maturity, we might not be able to do so without realizing further losses.

 

Future declines in the fair value of our investments in auction rate securities could negatively impact our earnings.  Future declines in the fair value of our investments in auction rate securities that we deem temporary, will be recorded to accumulated other comprehensive income, net of taxes. If at any time in the future we determine that a decline in fair value is other-than-temporary, we will record a charge to earnings for the credit loss portion of the impairment. In addition, the significant assumptions used in estimating credit losses may be different than actual realized losses, which could impact our earnings.

 

Uncertainty in the credit markets may negatively impact our costs of borrowing, our ability to collect receivables on a timely basis and our cash flow.  The United States and global economies and the financial and credit markets continue to experience declines or slow growth and there continues to be diminished liquidity and credit availability. These conditions may have a material adverse effect on our operations and our costs of borrowing. In addition, the tightening of credit in financial markets may adversely affect the ability of our customers to obtain financing, which could adversely impact our ability to collect amounts due from such customers or result in a decreases, or cancellation, of our services under our client contracts. Declines in our ability to collect receivables or in the level of our customers’ spending could adversely affect the results of our operations and our liquidity.

 

Risks Relating to Indebtedness and Impairment Charges

 

Any future increase in the level of debt or in interest rates can affect our results of operations.  Any future increase in the level of debt will likely increase our interest expense. Unless the operating income associated with the use of these funds exceeds the debt expense, borrowing money will have an adverse impact on our results. In addition, incurring debt requires that a portion of cash flow from operating activities be dedicated to interest payments and principal payments. Debt service requirements could reduce our ability to use our cash flow to fund operations and capital expenditures, and to capitalize on future business opportunities (including additional acquisitions). Because current interest rates on our debt are variable, an increase in prevailing rates would increase our interest costs. Further, our credit facility agreement contains both financial covenants and covenants that limit our ability to engage in specified transactions, which may also constrain our flexibility.

 

An impairment charge could have a material adverse effect on our financial condition and results of operations.  Under Accounting Standards Codification^tm (“ASC”) 350, “Intangibles — Goodwill and Other” (“ASC 350”), we are required to test acquired goodwill for impairment on an annual basis based upon a fair value approach. Goodwill represents the excess of the amount we paid to acquire our subsidiaries and other businesses over the fair value of their net assets at the dates of the acquisitions. We have chosen to perform

our annual impairment reviews of goodwill at the beginning of the fourth quarter of each fiscal year. We also are required to test goodwill for impairment between annual tests if events occur or circumstances change that would more likely than not reduce the fair value of any reporting unit below its carrying amount. In addition, we test certain intangible assets for impairment annually or if events occur or circumstances change that would indicate the remaining carrying amount of these intangible assets might not be recoverable. These events or circumstances could include, but are not limited to, a significant change in the business climate, legal factors, operating performance indicators, competition, and sale or disposition of a significant portion of one of our business. If the fair market value of one of our businesses is less than its carrying amount, we could be required to record an impairment charge. The valuation of the businesses requires judgment in estimating future cash flows, discount rates and other factors. In making these judgments, we evaluate the financial health of our businesses, including such factors as market performance, changes in our client base and operating cash flows. The amount of any impairment could be significant and could have a material adverse effect on our reported financial results for the period in which the charge is taken.

 

Risks Related to Labor, Legal Proceedings and Compliance

 

We are defendants in several class and representative actions or other lawsuits alleging various claims that could cause us to incur substantial liabilities.  We are defendants in several class and representative action lawsuits brought by or on behalf of our current and former employees alleging violations of federal and state law, including with respect to certain wage and hour matters. It is not possible to predict the outcome of these lawsuits or in other litigation or arbitration to which we are subject. These lawsuits and other proceedings may consume substantial amounts of our financial and managerial resources, regardless of the ultimate outcome of the lawsuits and other proceedings. In addition, we may become subject to similar lawsuits in the same or other jurisdictions. An unfavorable outcome with respect to these lawsuits and any future lawsuits could, individually or in the aggregate, cause us to incur substantial liabilities that may have a material adverse effect upon our business, financial condition or results of operations.

 

Changes in immigration laws or enforcement actions or investigations under such laws could significantly adversely affect our labor force, operations and financial results.  Because many jobs in our Janitorial segment do not require the ability to read or write English, we are an attractive employer for recent émigrés to this country and many of our jobs are filled by such. Adverse changes to existing laws and regulations applicable to employment of immigrants, enforcement requirements or practices under those laws and regulations, and inspections or investigations by immigration authorities or the prospects or rumors of any of the foregoing, even if no violations exist, could negatively impact the availability and cost of personnel and labor to the Company and the Company’s reputation.

 

Labor disputes could lead to loss of revenues or expense variations.  At October 31, 2009, approximately 42% of our employees were subject to various local collective bargaining agreements, some of which will expire or become subject to renegotiation during the year. In addition, at any given time, we may face a number of union organizing drives. When one or more of our major collective bargaining agreements becomes subject to renegotiation or when we face union organizing drives, we and the union may disagree on important issues which, in turn, could lead to a strike, work slowdown or other job actions at one or more of our locations. In a market where we and a number of major competitors are unionized, but other competitors are not unionized, we could lose clients to competitors who are not unionized. A strike, work slowdown or other job action could in some cases disrupt us from providing services, resulting in reduced revenues. If declines in client service occur or if our clients are targeted for sympathy strikes by other unionized workers, contract cancellations could result. The result of negotiating a first time agreement or renegotiating an existing collective bargaining agreement could result in a substantial increase in labor and benefits expenses that we may be unable to pass through to clients. In addition, proposed legislation, known as The Employee Free Choice Act, could make it significantly easier for union organizing drives to be successful and could give third-party arbitrators the ability to impose terms of collective bargaining agreements upon us and a labor union if we and such union are unable to agree to the terms of a collective bargaining agreement.

 

We participate in multi-employer defined benefit plans which could result in substantial liabilities being incurred.  We contribute to multi-employer benefit plans that could result in our being responsible for unfunded liabilities under such plans that could be material.

Other

 

Natural disasters or acts of terrorism could disrupt services.  Storms, earthquakes, drought, floods or other natural disasters or acts of terrorism may result in reduced revenues or property damage. Disasters may also cause economic dislocations throughout the country. In addition, natural disasters or acts of terrorism may increase the volatility of financial results, either due to increased costs caused by the disaster with partial or no corresponding compensation from clients, or, alternatively, increased revenues and profitability related to tag jobs, special projects and other higher margin work necessitated by the disaster.

 

Other issues and uncertainties may include:

 

 

 

None.

 

 

As of October 31, 2009, the Company had corporate, subsidiary, regional, branch or district offices in approximately 270 locations throughout the United States (including Puerto Rico) and in British Columbia and Ontario, Canada. At October 31, 2009, the Company owned 10 facilities which had an aggregate net book value of $2.2 million which were located in: (1) Jacksonville and Tampa, Florida; (2) Portland, Oregon; (3) Houston, Texas; (4) Lake Tansi, Tennessee and (5) Kennewick, Seattle, Spokane and Tacoma, Washington.

 

Rental payments under long and short-term lease agreements amounted to $102.3 million in 2009. Of this amount, $65.0 million in rental expense was attributable to parking lots and garages leased and operated by Parking. The remaining expense was for the rental or lease of office space, computers, operating equipment and motor vehicles amongst our businesses.

 

 

The Company is involved in various claims and legal proceedings of a nature considered normal to its business, as well as, from time to time, in additional matters. The Company records accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available.

 

The Company is a defendant in the following class action or purported class action lawsuits related to alleged violations of federal and/or state wage-and-hour laws:

 

 

The named plaintiffs in the lawsuits described above are current or former employees of ABM subsidiaries who allege, among other things, that they were required to work “off the clock,” were not paid proper minimum wage or overtime, were not provided work breaks or other benefits, and/or that they received pay stubs not conforming to state law. In all cases, the plaintiffs generally seek unspecified monetary damages, injunctive relief or both. The Company believes it has

meritorious defenses to these claims and intends to continue to vigorously defend itself.

 

On January 8, 2009, a judge of the L.A. Superior Court certified the Augustus case as a class action. The previously reported case of Chen v. Ampco System Parking and ABM Industries filed on March 6, 2008, in the U.S. District Court of California, Southern District was settled on November 23, 2009. On January 15, 2009, a federal court judge denied with prejudice class certification status in the Villacres case. That case as well as the companion state court case filed April 3, 2008, in L.A. Superior Court, were both subsequently dismissed with prejudice on summary judgment. Both dismissals have been appealed by the plaintiff.

 

As described in Note 2 and 8 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplemental Data,” the Company self-insures certain insurable risks and, based on its periodic evaluations of estimated claim costs and liabilities, accrues self-insurance reserves to the Company’s best estimate. One such evaluation, completed in November 2004, indicated adverse developments in the insurance reserves that were primarily related to workers’ compensation claims in the State of California during the four-year period ended October 31, 2003 and resulted in the Company recording a charge of $17.2 million in the fourth quarter of 2004. In 2005, the Company, believing a substantial portion of the $17.2 million, as well as other costs incurred by the Company in its insurance claims, was related to poor claims management by a third party administrator that no longer performs these services for the Company, filed an arbitration claim against this third party administrator for damages related to claims mismanagement. In November 2008, the Company and its former third party administrator settled the claim for $9.8 million ($9.6 million, net of expenses). The Company received the $9.8 million settlement amount in January 2009.

 

 

None.

 

 

 

Market Information and Dividends

 

The Company’s common stock is listed on the New York Stock Exchange (NYSE: ABM). The following table sets forth the high and low intra-day prices of the Company’s common stock on the New York Stock Exchange and quarterly cash dividends declared on shares of common stock for the periods indicated:

 

 

To our knowledge, there are no current factors that are likely to materially limit the Company’s ability to pay comparable dividends for the foreseeable future.

 

Stockholders

 

At November 30, 2009, there were 3,137 registered holders of the Company’s common stock.

Performance Graph

 

The following graph compares a $100 investment in the Company’s stock on October 31, 2004 with a $100 investment in the Standard & Poor’s 500 ( “S & P 500”), the Standard & Poor’s 1500 Environmental & Facilities Services Index ( “S & P 1500”) and the Russell 2000 Value Index, also made on October 31, 2004. The graph portrays total return, 2004 – 2009, assuming reinvestment of dividends. The comparisons in the following graph are based on historical data and are not indicative of, or intended to forecast, the possible future performance of the Company’s common stock. This graph shows returns based on fiscal years ended October 31.

 

RETURN ON $100 INVESTMENT ON OCTOBER 31, 2004

 

 

 

The Company believes that the Russell 2000 Value Index is a more appropriate index to use than the S & P 1500 for purposes of the performance graph and future disclosures will not include a comparison to the S & P 1500. The S & P 1500 can be disproportionately influenced by the performance of one or more of the eight companies that are included in the index while the Russell 2000 Value Index includes over 1,300 companies with investment characteristics that are similar to the Company’s investment characteristics. The Company is a member of the Russell 2000 Value Index and the S & P 1500.

 

The performance graph shall not be deemed “soliciting material,” be “filed” with the Commission or subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.

 

The following selected financial data is derived from the Company’s consolidated financial statements as of and for each of the five years ended October 31, 2009. This information should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8, “Financial Statements and Supplementary Data”. As a result of the sale of substantially all of the assets of the Lighting segment on October 31, 2008 and our Mechanical segment in June 2005, the financial results of these segments have been classified as discontinued operations in the following selected financial data and in the Company’s accompanying consolidated financial statements and notes for all periods presented. Additionally, acquisitions made in recent years (most significantly, the Company’s acquisition of OneSource on November 14, 2007) have impacted comparability among the periods presented.

 

 

(1) Beginning in 2008, includes revenues associated with the acquisition of OneSource Services, Inc., (“OneSource,”) which was acquired on November 14, 2007. Revenues in 2007 and 2005 included a $5.0 million gain and a $4.3 million gain, respectively, from the termination of off-airport parking garage leases.

 

(2) The World Trade Center formerly represented the Company’s largest job-site; its destruction on September 11, 2001 has directly and indirectly impacted subsequent operating results. Amounts for 2006 and 2005 consist of total gains in connection with World Trade Center insurance

claims of $80.0 million and $1.2 million in 2006 and 2005, respectively. Of the 2006 amount, $14.0 million related to the recovery of the Lighting segment’s loss of business profits and has been reclassified to discontinued operations.

 

(3) Operating expenses in 2009 included a $9.4 million adjustment to increase self-insurance reserves related to prior year claims while 2008, 2007, 2006 and 2005 included adjustments to reduce self-insurance reserves related to prior years by $22.8 million, $1.8 million, $14.1 million, and $8.2 million, respectively. Additionally, operating expenses for 2009 includes a net benefit of a $9.6 million legal settlement received from the Company’s former third party administrator.

 

(4) Selling, general and administrative expenses in 2009, 2008 and 2007 included $21.8 million, $24.3 million and $4.6 million of costs, respectively, associated with (a) the implementation of a new payroll and human resources information system, and the upgrade of the Company’s accounting systems; (b) the transition of certain back office functions to the Company’s Shared Services Center in Houston, Texas; (c) the move of the Company’s corporate headquarters to New York; and (d) integration costs associated with the acquisition of OneSource in fiscal 2008.

 

Selling, general and administrative expense in 2008 included $68.0 million of expenses associated with the OneSource acquisition and a $6.3 million write-off of deferred costs related to the Company’s Master Professional Services Agreement between the Company and International Business machines Corporation (“IBM,”) (see the “Commitments” section of the “Liquidity and Capital Resources” section below).

 

Selling, general and administrative expenses in 2006 included $3.3 million of transition costs associated with the outsourcing of the Company’s information technology infrastructure and support services to IBM.

 

(5) The Company determined that one of its auction rate securities was other-than-temporarily impaired at July 31, 2009. The other-than-temporary impairment approximated $3.6 million, of which $1.6 million was recognized in earnings as a credit loss, with a corresponding reduction in the cost basis of that security during the third quarter of 2009. No further other-than-temporary impairments were identified. (See Note 5 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.”)

 

(6) In connection with the OneSource acquisition, the Company acquired $42.5 million in insurance deposits that represent amounts collateralizing OneSource’s self-insurance claims. The Company recorded $273.8 million of goodwill representing the excess of the cost of the acquisition over the fair value of net assets acquired in the acquisition of OneSource. As of October 31, 2009, the Company had outstanding borrowings under its line of credit of $172.5 million which primarily resulted from the OneSource acquisition.

 

Forward-Looking Statements

 

Certain statements in this Annual Report on Form 10-K, and in particular, statements found in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, that are not historical in nature, constitute forward-looking statements. These statements are often identified by the words, “will,” “may,” “should,” “continue,” “anticipate,” “believe,” “expect,” “plan,” “appear,” “project,” “estimate,” “intend,” and words of a similar nature. Such statements reflect the current views of the Company with respect to future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these statements. In Item 1A, we have listed specific risks and uncertainties that you should carefully read and consider. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

 

The following discussion should be read in conjunction with the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.” All information in the discussion and references to years are based on the Company’s fiscal year that ends on October 31. All references to 2009, 2008, 2007 and 2006, unless otherwise indicated, are to fiscal years 2009, 2008, 2007 and 2006, respectively. The Company’s fiscal year is the period from November 1 through October 31.

 

Overview

 

ABM Industries Incorporated (“ABM”), through its subsidiaries (collectively, the “Company,”) provides janitorial, parking, security and engineering services for thousands of commercial, industrial, institutional and retail client facilities in hundreds of cities, primarily throughout the United States. The Company’s business is impacted by, among other things, industrial activity, commercial office building occupancy and rental rates, air travel levels, tourism and transportation needs at colleges, universities and health care service facilities. Consistent with the continued weakness in the U.S. economic climate in 2009, the Company continued to experience reductions in the level and scope of services demanded by its clients, contract price compression, loss of client contracts and a decline in the level of tag work. Despite the weak economic climate, the Company’s operating profit increased in all segments during 2009 compared to 2008, primarily due to successful execution of the Company’s operating strategies around cost control and the strategic reduction of less profitable client relationships.

 

The Company’s largest operating segment is the Janitorial segment, which generated approximately 68.4% of the Company’s revenues and approximately 74.4% of the Company’s operating profit, excluding the Corporate segment, for 2009.

 

Revenues at the Company’s Janitorial, Security and Engineering segments are primarily based on the performance of labor-intensive services at contractually specified prices. Revenues generated by the Parking segment relate to parking and transportation services, which are less labor-intensive. In addition to services defined within the scope of client contracts, the Janitorial segment also generates revenues from extra services (or tags) such as, but not limited to, flood cleanup services and snow removal, which generally provide higher margins.

 

In addition to revenues and operating profit, the Company’s management views operating cash flows as an indicator of financial performance, as strong operating cash flows provide opportunities for growth both organically and through acquisitions. The Company’s cash flows from operating activities, including cash flows from discontinued operating activities, increased by $72.6 million in 2009, compared to 2008, primarily due to improved collections. Net cash provided by discontinued operating activities increased $13.6 million in 2009, compared to 2008. Operating cash flows primarily depend on revenues levels, the timing of collections and payments to suppliers and other vendors, the quality of receivables, and the magnitude of self-insured claims. The Company’s trade accounts receivable, net, balance was $445.2 million at October 31, 2009.

 

The Company self-insures certain insurable risks such as workers’ compensation, general liability, automobile and property damage. The Company periodically performs a thorough review, with the assistance of external professionals, of its estimate of the ultimate cost for self insurance reserves. As part of this evaluation, the Company reviews the status of existing and new claims and coordinates this review with our third party claims administrators. We compare actual trends

to expected trends and monitor claims development. The third party claims administrators that manage the claims for the Company project their estimates of the ultimate cost for each claim based upon known factors related to the management of the claims, legislative matters and case law. After reviewing with the Company, the specific case reserves estimated by the third party claims administrators are provided to an external actuary who assists the Company in projecting an actuarial estimate of the overall ultimate cost for self insurance, which includes the case reserves plus an actuarial estimate of reserves required for additional developments, including “incurred but not reported” claim costs. The independent third party’s actuarial estimate of the reserves is reviewed by management, and forms the basis for management’s best estimate of the reserves, as recorded in the Company’s financial statement.

 

Although the Company engages third-party experts to assist in estimating appropriate self-insurance reserves, the determination of those reserves is dependent upon significant actuarial judgments that have a material impact on the Company’s reserves. The interpretation of trends requires knowledge of many factors that may or may not be reflective of adverse or favorable developments (e.g., changes in regulatory requirements). Trends may also be impacted by changes in safety programs or claims handling practices. If analyses of losses suggest that the frequency or severity of claims incurred has changed, the Company would be required to record increases or decreases in expenses for self-insurance liabilities.

 

During 2008, favorable developments in the claims management process as well as the effects of favorable legislation in certain states continued to be observed. Specifically, the Company also continued to experience the favorable impact of prior workers compensation reforms in California. Prior to the reforms of 2003 and 2004, the California workers’ compensation system was characterized by high insurances rates to employers and variability in benefits to injured workers. To address rising costs, a series of reforms were passed by the California Legislature. The reforms focused on, among other things, revising medical fee schedules, improving quality of care, encouraging medical utilization review, capping temporary disability benefits, and reducing the number and size of permanent disability awards. Following the implementation of reforms, from 2004 to 2008, the industry workers’ compensation claims cost benchmark was reduced by 65%. The reforms not only favorably affected claims incurred after 2004, but also favorably affected certain claims open at the time the reforms were enacted. Accordingly, as benefits of the reforms had become more readily measurable in 2008, estimates of the cost of settling these older claims had been reduced in 2008. Reduced claim costs, which the Company believe were driven by the continuing effects of California workers’ compensation reform and internal loss control efforts, were observed during 2008 in both the Company’s general liability and workers’ compensation program claims in 2008. After analyzing the historical loss development patterns, comparing the loss development against benchmarks, and applying actuarial projection methods, in 2008 the Company lowered its expected losses for prior year claims, which resulted in a reduction in the related self-insurance reserves of $22.8 million. This reduction in self-insurance reserves was recorded in the Corporate segment.

 

During 2009, the favorable trends observed during 2008 were no longer continuing . Specifically, the Company noticed the effects of (i) unfavorable developments (primarily affecting workers compensation in California and other states where we have a significant presence), (ii) certain case law decisions during 2009 resulting in a more favorable atmosphere for injured workers regarding their disability rating in California, and (iii) existing claims in California being updated by injured workers to add additional medical conditions to their original claims, resulting in additional discovery costs and likely higher medical and indemnity costs. Further, during 2009, certain general liability claims related to older policy years experienced losses significantly higher than were previously estimated. After analyzing the historical loss development patterns, comparing the loss development against benchmarks, and applying actuarial projection methods, the Company increased the expected losses for prior year claims, which resulted in an increase in the related self-insurance reserves of $9.4 million in 2009. This increase in self-insurance reserves was recorded in the Corporate segment.

 

The Company believes that achieving desired levels of revenues and profitability in the future will depend upon, among other things, its ability to attract and retain clients at desirable profit margins, to pass on cost increases to clients, and to keep overall costs low. In the short term, the Company plans to remain competitive by, among other things, continued cost control strategies. The Company will continue to monitor, and in some cases exit client arrangements where the Company believes the client is at high risk of bankruptcy or which produce low profit margins and focus on client arrangements that may generate less revenues but produce higher profit margins. Additionally, the Company

is aggressively seeking acquisitions, both domestically and internationally. In the long term, the Company expects to continue to grow organically and through acquisitions (including international expansion) in response to the growing demand for a global integrated facility services solution provider.

 

On November 14, 2007, the Company acquired OneSource Services, Inc. (“OneSource”), a provider of outsourced facilities services including janitorial, landscaping, general repair and maintenance and other specialized services for commercial, industrial, institutional and retail client facilities, primarily in the United States, for an aggregate purchase price of $390.5 million. OneSource’s operations are included in the Janitorial segment since the date of its acquisition.

 

On October 31, 2008, the Company completed the sale of substantially all of the assets of its Lighting segment, excluding accounts receivable and certain other assets, to Sylvania Lighting Services Corp (“Sylvania.”) for approximately $34.0 million in cash, which included certain adjustments and payment to the Company of $0.6 million pursuant to a transition services agreement. Sylvania assumed certain liabilities under certain contracts and leases relating to the period after the closing. The remaining assets and liabilities associated with the Lighting segment have been classified as assets and liabilities of discontinued operations for all periods presented. The results of operations of the Lighting segment for all periods presented are classified as “(Loss) income from discontinued operations, net of taxes.”

 

Effective May 1, 2009, the Company acquired certain assets (primarily customer contracts and relationships) of Control Building Services, Inc., Control Engineering Services, Inc., and TTF, Inc. (“Control acquisition”), for $15.1 million in cash, plus additional consideration of up to $1.6 million, contingent upon the achievement of certain revenue targets during the three year period commencing on May 1, 2009. The acquisition expands the Company’s janitorial and engineering service offerings to clients in the Northeast. The Company has finalized the allocation of the purchase price to assets acquired during the three months ended October 31, 2009. See Note 3 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplement Data,” for additional information.

Liquidity and Capital Resources

 

 

 

As of October 31, 2009, the Company’s cash and cash equivalents balance was $34.2 million. The increase in cash was principally due to the timing of net borrowings under the Company’s line of credit, collections of accounts receivable and payments made on vendor invoices.

 

The Company believes that the cash generated from operations and amounts available under its $450.0 million line of credit will be sufficient to meet the Company’s cash requirements for the long-term, except to the extent cash is required for significant acquisitions, if any. As of October 31, 2009, the total outstanding amounts under the Company’s line of credit in the form of cash borrowings and standby letters of credit were $172.5 million and $118.6 million, respectively. Available credit under the line of credit was up to $158.9 million as of October 31, 2009, subject to limitations related to compliance with certain covenants under the Company’s line of credit. The covenants include limitations on liens, dispositions, fundamental changes, investments, indebtedness and certain transactions and payments. As of October 31, 2009, the Company was in compliance with all covenants.

 

Working Capital.  Working capital increased by $4.3 million to $278.3 million at October 31, 2009 from $274.0 million at October 31, 2008. Excluding the effects of discontinued operations, working capital increased by $19.0 million to $268.6 million at October 31, 2009 from $249.6 million at October 31, 2008.

 

The increase was primarily due to:

 

 

partially offset by:

 

 

Cash Flows from Operating Activities.  Net cash provided by operating activities was $140.9 million, $68.3 million and $54.3 million in 2009, 2008 and 2007, respectively.

 

The $72.6 million increase in 2009 compared to 2008 was primarily due to:

 

 

The $14.0 million increase in 2008 compared to 2007 was primarily due to:

 

 

 

Cash Flows from Investing Activities.  Net cash used in investing activities was $37.5 million, $421.5 million and $54.8 million in 2009, 2008 and 2007, respectively.

 

The $384.1 million decrease in 2009 compared to 2008 was primarily due to:

 

 

partially offset by:

 

 

The $366.7 million increase in 2008 compared to 2007 was primarily due to:

 

 

partially offset by:

 

 

No significant cash flows were provided by discontinued investing activities in 2009, 2008 or 2007.

 

Cash Flows from Financing Activities.  Net cash used in financing activities was $96.0 million in 2009 and net cash provided by financing activities was $232.2 million and $7.0 million in 2008 and 2007, respectively.

 

The $328.2 million decrease in 2009 compared to 2008 was primarily due to:

 

 

The $225.3 million increase in 2008 compared to 2007 is primarily due to the Company’s net borrowings related to the acquisition of OneSource and the purchase of the remaining 50% of the equity of Southern Management in 2008.

 

No cash flows were provided by discontinued financing activities for the year ended October 31, 2009, 2008 or 2007.

Commitments

 

As of October 31, 2009, the Company’s future contractual payments, commercial commitments and other long-term liabilities were as follows:

 

 

Operating Leases

 

The amounts set forth under operating leases represent the Company’s contractual obligations to make future payments under non-cancelable operating lease agreements for various facilities, vehicles and other equipment.

 

IBM Master Professional Services Agreement

 

On September 29, 2006, the Company entered into a Master Professional Services Agreement (the “Services Agreement”) with International Business Machines Corporation (“IBM”) that became effective October 1, 2006. Under the Services Agreement, IBM was responsible for substantially all of the Company’s information technology infrastructure and support services. In 2007, the Company entered into additional agreements with IBM to provide assistance, support and post-implementation services relating to the upgrade of the Company’s accounting systems and the implementation of a new payroll system and human resources information system. In connection with the OneSource acquisition in 2008, the Company entered into additional agreements with IBM to provide information technology systems integration and data center support services through 2009. During the fourth quarter of 2008, the Company assessed the services provided by IBM to determine whether the services provided and the level of support was consistent with the Company’s strategic objectives. Based on this assessment, the Company determined that some or all of the services provided under the Services Agreement would be transitioned from IBM. In connection with this assessment, the Company wrote-off $6.3 million of deferred costs in 2008.

 

On January 20, 2009, the Company and IBM, entered into a binding Memorandum of Understanding (the “MOU”), pursuant to which the Company and IBM agreed to: (1) terminate certain services then provided by IBM to the Company under the Services Agreement; (2) transition the terminated services to the Company and/or its designee; (3) resolve certain other disputes arising under the Services Agreement; and (4) modify certain terms applicable to services that IBM would continue to provide to the Company. In connection with the execution of the MOU, the Company delivered to IBM a formal notice terminating for convenience certain information technology and support services effective immediately (the “Termination”). Notwithstanding the Termination, the MOU contemplated (1) that IBM would assist the Company with the transition of the terminated

services to the Company or its designee pursuant to an agreement (the “Transition Agreement”) to be executed by the Company and IBM and (2) the continued provision by IBM of certain data center support services. On February 24, 2009, the Company and IBM entered into an amended and restated agreement, which amended the Services Agreement (the “Amended Agreement”), and the Transition Agreement, which memorializes the termination-related provisions of the MOU as well as other terms related to the transition services. Under the Amended Agreement, the base fee for the provision of the defined data center support services is $18.8 million payable over the service term (March 2009 through December 2013).

 

In connection with the Termination, the Company agreed to: (1) reimburse IBM for certain actual employee severance costs, up to a maximum of $0.7 million, provided the Company extended comparable offers of employment to a minimum number of IBM employees; (2) reimburse IBM for certain early termination costs, as defined, including third party termination fees and/or wind down costs totaling approximately $0.4 million associated with software, equipment and/or third party contracts used by IBM in performing the terminated services; and (3) pay IBM fees and expenses for requested transition assistance which were estimated to be approximately $0.4 million. Payments made in connection with the Termination were $0.7 million in 2009.

 

Employee Benefit Plans

 

The Company has defined benefit, post-retirement and deferred compensation plans. All defined benefit and post-retirement plans have been amended to preclude new participants. These plans are described in further detail in Note 10 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.” As of October 31, 2009, the aggregate employee benefit plan liability, including the Company’s deferred compensation plans, was $28.3 million. Future benefits expected to be paid over the next 20 years are approximately $40.0 million.

 

The defined benefit and post retirement plan liabilities as of October 31, 2009 assume future annual compensation increases of 3.5% and a rate of return on plan assets of 8.0% (when applicable); and a discount rate of 5.5%. The discount rate is estimated considering a long-term AA/Aa rated bond portfolio. In determining the long-term rate of return for a plan, the Company considers the nature of the plans investments, historical rates of return, and an expectation for the plan’s investment strategies. We believe changes in assumptions would not have a material impact on the Company’s financial position and operating performance. We expect to fund payments required under the plans with cash flows from operating activities when due in accordance with the plan.

 

The employee benefit plan obligation of $28.3 million as of October 31, 2009 does not include the union-sponsored multi-employer defined benefit plans. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. Contributions made to these plans were $47.9 million, $47.7 million and $37.1 million in 2009, 2008 and 2007, respectively.

 

Line of Credit

 

The Company had $172.5 million of outstanding borrowings under the line of credit as of October 31, 2009, which was primarily used to finance the OneSource acquisition. The line of credit is scheduled to expire on November 14, 2012.

 

Standby Letters of Credit

 

The Company had $118.6 million of standby letters of credit as of October 31, 2009, primarily related to its general liability, automobile, property damage, and workers compensation self-insurance programs.

 

Surety Bonds

 

The Company uses surety bonds, principally performance and payment bonds, to guarantee performance under various customer contracts in the normal course of business. These bonds typically remain in force for one to five years and may include optional renewal periods. At October 31, 2009, outstanding surety bonds totaled $103.2 million. The Company does not believe these bonds will be required to be drawn upon.

 

Unrecognized Tax Benefits

 

As of October 31, 2009, we had $102.3 million of unrecognized tax benefits, primarily related to the acquisition of OneSource. This represents the tax benefits associated with various tax positions taken on tax returns that have not been recognized in our financial statements due to uncertainty regarding their resolution.

The resolution or settlement of these tax positions with the taxing authorities is subject to significant uncertainty, and therefore, we are unable to make a reliable estimate of the eventual cash flows by period that may be required to settle these matters. In addition, certain of these matters may not require cash settlements due to the exercise of credit and net operating loss carryforwards as well as other offsets, including the indirect benefit from other taxing jurisdictions that may be available. (See Note 14 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.”)

 

Environmental Matters

 

The Company’s operations are subject to various federal, state and/or local laws regulating the discharge of materials into the environment or otherwise relating to the protection of the environment, such as discharge into soil, water and air, and the generation, handling, storage, transportation and disposal of waste and hazardous substances. These laws generally have the effect of increasing costs and potential liabilities associated with the conduct of the Company’s operations. In addition, from time to time the Company is involved in environmental matters at certain of its locations or in connection with its operations. Historically, the cost of complying with environmental laws or resolving environmental issues relating to United States locations or operations has not had a material adverse effect on the Company’s financial position, results of operations or cash flows. The Company does not believe that the resolution of known matters at this time will be material.

 

Effect of Inflation

 

The rates of inflation experienced in recent years have had no material impact on the financial statements of the Company. The Company attempts to recover increased costs by increasing prices for its services, to the extent permitted by contracts and competition.

 

Results of Continuing Operations

 

COMPARISON OF 2009 TO 2008

 

 

Net Income.  Net income in 2009 increased by $8.9 million, or 19.5%, to $54.3 million ($1.05 per diluted share) from $45.4 million ($0.88 per diluted share) in 2008. Net income included a loss from discontinued operations of $1.2 million ($0.02 per diluted share) and $7.3 million ($0.15 per diluted share) in 2009 and 2008, respectively. The loss from discontinued operations in 2008 is primarily due to a pre-tax goodwill impairment charge of $4.5 million and a $3.5 million loss, net of taxes, on the sale of substantially all the assets of the Lighting segment.

 

Income from Continuing Operations.  Income from continuing operations in 2009 increased by $2.8 million, or 5.2%, to $55.5 million ($1.07 per diluted share) from $52.7 million ($1.03 per diluted share) in 2008.

 

The increase in income from continuing operations was primarily a result of:

 

 

 

partially offset by:

 

 

Revenues.  Revenues in 2009 decreased $141.8 million, or 3.9%, to $3,481.8 million from $3,623.6 million in 2008. The Company and its clients continue to feel the negative impact of the weak economic environment resulting in reductions in the level and scope of services provided to its clients, contract price compression, the reduction of less profitable client contracts, loss of client contracts and a decline in the level of tag work as a result of decreases in client discretionary spending. However, approximately $22.8 million, or 16.1%, of the decrease in revenues is due to the reduction of expenses incurred on the behalf of managed parking facilities, which are reimbursed to the Company. These reimbursed expenses are recognized as parking revenues and expenses and have no impact on operating profit.

 

Operating Expenses.  As a percentage of revenues, gross margin was 10.5% and 11.0% in 2009 and 2008, respectively.

 

The gross margin percentages are affected by the following:

 

 

Selling General and Administrative Expenses.  Selling, general and administrative expenses in 2009 decreased $24.0 million, or 8.3%, to $263.6 million from $287.6 million in 2008.

 

The decrease in selling, general and administrative expenses was primarily a result of:

 

 

partially offset by:

 

 

Interest Expense.  Interest expense in 2009 decreased $9.3 million, or 61.3%, to $5.9 million from $15.2 million in 2008. The decrease was primarily related to a lower average outstanding balance and a lower average interest rate under the line of credit in 2009 compared to 2008. The average outstanding balance under the Company’s line of credit was $212.9 million and $294.4 million in 2009 and 2008, respectively.

 

Income Taxes.  The effective tax rate on income from continuing operations for 2009 was 34.5%, compared to the 37.5% for 2008. The effective tax rate for 2009 and 2008 includes $4.4 million and $0.9 million of non-recurring tax benefits, respectively. These tax benefits include the benefits of state tax rate increases on the carrying value of the Company’s state deferred tax assets and employment based tax credits.

 

Discontinued Operations.  The Company recorded a loss from discontinued operations of $1.7 million ($1.2 million, net of income tax benefits), or $0.02 per diluted share, in 2009. The losses recorded were due to severance related costs and general and administrative transition costs. The effective tax rate on loss from discontinued operations for 2009 was 30.6%, compared to 6.8% for 2008.

 

Segment Information

 

The Company determined Janitorial, Parking, Security and Engineering to be its reporting segments in accordance with ASC 280 “Segment Reporting” (“ASC 280”). In connection with the discontinued operation of the Lighting segment, the operating results of Lighting are classified as discontinued operations and, as such, are not reflected in the tables below.

 

Most Corporate expenses are not allocated. Such expenses include the adjustments to the Company’s self-insurance reserves relating to prior years, severance costs associated with the integration of OneSource’s operations into the Janitorial segment, the Company’s share-based compensation costs, the completion of the corporate move to New York, and certain information technology costs. Until damages and costs are awarded or a matter is settled, the Company also accrues probable and estimable losses associated with pending litigation in Corporate. Segment Revenues and operating profits of the continuing reportable segments (Janitorial, Parking, Security, and Engineering) for 2009 and 2008 were as follows:

 

 

 

Janitorial.  Janitorial revenues decreased $110.2 million, or 4.4%, during 2009 compared to 2008. The decrease in revenues was due to reductions in the level and scope of services provided to its clients, contract price compression, loss of client contracts and a decline in the level of tag work as a result of decreases in client discretionary spending.

 

Despite the reductions in revenue, operating profit increased $21.3 million, or 18.0%, during 2009 compared to 2008. The increase was primarily attributable to cost control measures and lower labor expenses resulting from two less working days in 2009 compared to 2008.

 

Parking.  Parking revenues decreased $17.9 million, or 3.8%, during 2009 compared to 2008. The decrease was primarily a result of a $22.8 million reduction of expenses incurred on the behalf of managed parking facilities, which are reimbursed to the Company. These

reimbursed expenses are recognized as parking revenues and expenses, which have no impact on operating profit. The decrease in management reimbursement revenues was offset by a $4.9 million increase in lease and allowance revenues from new clients and an increased level of service to existing clients.

 

Operating profit increased $0.8 million, or 4.4%, during 2009 compared to 2008. The increase was primarily attributable to additional profit from the increase in lease and allowance revenues and decreases in discretionary and overhead costs.

 

Security.  Security revenues increased $1.1 million, or 0.3%, during 2009 compared to 2008. The increase in revenues was due to additional revenues from new clients and the expansion of services to existing clients, partially offset by loss of certain client contracts.

 

Operating profit increased $0.5 million, or 6.4%, during 2009 compared to 2008 due to an increase in revenues and a decrease in discretionary and overhead costs partially offset by loss of certain client contracts.

 

Engineering.  Engineering revenues decreased $14.2 million, or 4.4%, during 2009 compared to 2008, primarily due to the loss of client contracts, principally those with low gross profit margins, and the effects of two less working days in 2009 compared to 2008.

 

Despite the reduction in revenues, operating profit increased $0.5 million, or 2.8%, during 2009 compared to 2008, primarily due to higher margins generated from contracts with new clients and decreases in discretionary and overhead costs.

 

Corporate.  Corporate expense increased $30.6 million, or 46.8%, during 2009 compared to 2008.

 

The increase in Corporate expense was primarily a result of:

 

 

partially offset by:

 

 

COMPARISON OF 2008 TO 2007

 

 

 

Net Income.  Net income in 2008 decreased by $7.0 million, or 13.4%, to $45.4 million ($0.88 per diluted share) from $52.4 million ($1.04 per diluted share) in

2007. Net income includes a loss of $7.3 million ($0.15 per diluted share) and income of $1.8 million ($0.04 per diluted share) from discontinued operations in 2008 and 2007, respectively. The loss from discontinued operations in 2008 was primarily due to a pre-tax goodwill impairment charge of $4.5 million and a $3.5 million loss, net of taxes, on the sale of substantially all the assets of the Lighting segment.

 

Income from continuing operations.  Income from continuing operations in 2008 increased by $2.1 million, or 4.1%, to $52.7 million from $50.6 million in 2007. The increase was mainly attributable to an increase in operating profit from the acquisition of OneSource and favorable developments in self-insurance reserves during 2008, which were offset by an increase in interest expense and certain corporate expenses. Specifically, the Janitorial segment’s operating profit increased by $31.1 million due to the acquisition of OneSource combined with an organic increase in Janitorial revenues. In addition, the Parking, Security and Engineering segments experienced a combined operating profit increase of $5.1 million primarily due to growth in revenues from new clients and the expansion of services to existing clients. As a result of the integration of OneSource’s operations into the Janitorial segment, the Company has achieved synergies through (1) a reduction in duplicative positions and back office functions, (2) the consolidation of facilities and (3) a reduction in professional fees and other services. Self-insurance expense was $24.5 million lower primarily due to a decrease in self-insurance reserves ($22.8 million) in 2008, related to major and minor programs, as a result of the net favorable developments in the California workers compensation and general liability claims attributable to prior years. (See Note 8 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data.”)

 

The favorable impact of these items was partially offset by:

 

 

Revenues.  Revenues in 2008 increased $917.5 million, or 33.9%, to $3,623.6 million from $2,706.1 million in 2007, primarily due to $817.5 million and $19.1 million of additional revenues from the OneSource and Healthcare Parking Services America, (“HPSA”) acquisitions, which closed on November 14, 2007 and April 2, 2007, respectively. Excluding the OneSource and HPSA revenues, revenues increased by $80.9 million, or 3.0%, in 2008 compared to 2007, which was primarily due to new business and expansion of services in all operating segments. The 2007 Parking revenues included a $5.0 million gain in connection with a termination of an off-parking garage lease during 2007.

 

Operating Expenses.  As a percentage of revenues, gross margin (revenues minus operating expenses) was 11.0% in 2008 compared to 10.2% in 2007. The increase in gross margin percentage was primarily due to the $24.5 million reduction in insurance expense previously discussed, partially offset by the absence of the 2007 $5.0 million lease termination gain in Parking in connection with the termination of an off-airport parking garage lease recorded in 2007.

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses increased $94.0 million, or 48.5%, in 2008 compared to 2007, primarily due to the inclusion of $68.0 million of OneSource expenses in 2008.

 

Excluding OneSource, selling, general and administrative expenses increased $26.0 million, which was primarily due to the following:

 

 

 

partially offset by:

 

 

Income Taxes.  The effective tax rate on income from continuing operations was 37.5% and 34.0% in 2008 and 2007, respectively. The year ended October 31, 2008 included a $0.9 million tax benefit for miscellaneous federal and state tax adjustments, settlements and release of state valuation allowances. The 2007 income tax provision included a $0.9 million tax benefit in 2007 due mostly to the increase in the Company’s net deferred tax assets that resulted primarily from the State of New York requirement to file combined returns effective in 2008. This new regulatory requirement will result in an increase in the future effective state tax rate. An additional $0.9 million tax benefit was recorded in 2007 mostly from the elimination of state tax liabilities for closed years. Income tax expense in 2007 had a further $0.6 million benefit primarily due to the inclusion of Work Opportunity Tax Credits attributable to 2006, but not recognizable in 2006 because the program had expired and was not extended until the first quarter of 2007.

 

Discontinued Operations.  Revenues from discontinued operations increased $2.5 million, or 2.2%, during 2008 compared to 2007, primarily due to increased contract revenues mainly due to the recognition of $8.0 million of deferred revenues in connection with the sale of Lighting, offset by a decrease in time and material, and special project business.

 

The Company recorded a loss from discontinued operations of $6.6 million ($7.3 million, net of income tax benefits) in October 31, 2008 compared to net income of $3.1 million ($1.8 million, net of income tax provision) in October 31, 2007. The difference was primarily due to a pre-tax goodwill impairment charge of $4.5 million recorded in the second quarter ended April 30, 2008 and a $3.5 million loss, net of taxes, on the sale of the assets associated with the Lighting segment. In response to objective evidence about the implied value of goodwill relating to the Company’s Lighting segment, the Company performed an assessment of goodwill for impairment. The goodwill in the Company’s Lighting segment was determined to be impaired and a non-cash, pre-tax goodwill impairment charge of $4.5 million was recorded, which is included in discontinued operations in the accompanying consolidated statements of income.

 

The effective tax rate from discontinued operations for the year ended October 31, 2008 was 6.8%, compared to the 41.3% for the year ended October 31, 2007. The effective tax rate for 2008 was a lower benefit than the expected annual rate primarily due to a portion of the goodwill impairment charge being a non-deductible for tax purposes, which reduced the expected tax benefit by $1.3 million.

 

Segment Information

 

The Company determined Janitorial, Parking, Security and Engineering to be its reporting segments in accordance with ASC 280 “Segment Reporting” (“ASC 280”). In connection with the discontinued operation of the Lighting segment, the operating results of Lighting are classified as discontinued operations and, as such, are not reflected in the tables below.

 

Most Corporate expenses are not allocated. Such expenses include the adjustments to the Company’s self-insurance reserves relating to prior years, severance costs associated with the integration of OneSource’s operations into the Janitorial segment, the Company’s share based compensation costs, the completion of the corporate move to New York, and certain information technology costs. Until damages and costs are awarded or a matter is settled, the Company also accrues probable and estimable losses associated with pending litigation in Corporate. Segment revenues and operating profits of the continuing reportable

segments (Janitorial, Parking, Security, and Engineering) for 2008 and 2007 were as follows:

 

 

Janitorial.  Janitorial revenues increased $870.7 million, or 53.7%, during 2008 compared to 2007 primarily due to $817.5 million of additional revenues contributed by OneSource. Excluding the impact of the OneSource acquisition, Janitorial revenues increased by $53.2 million. All Janitorial regions, except the Northeast and Southeast regions, experienced revenues growth which was due to increased business from new clients and price increases to pass through union wage and benefit increases. The decreases within the Northeast and Southeast regions were mainly due to reduced discretionary revenues from the Company’s financial institution clients.

 

Operating profit increased $31.1 million, or 35.5%, during 2008 compared to 2007. The increase was primarily attributable to the acquisition of OneSource, increased revenues as noted above and a reduction in insurance expense. The increase in operating profit includes synergies generated from the integration of OneSource’s operations into the Janitorial segment. The synergies were achieved through a reduction of duplicate positions and back office functions, the consolidation of facilities, and the reduction in professional fees and other services.

 

Parking.  Parking revenues increased $20.4 million, or 4.5%, during 2008 compared to 2007, primarily due to a $19.1 million increase in revenues contributed by HPSA and a $6.1 million increase in lease and allowance revenues. These increases to Parking revenues were partially offset by the absence of the $5.0 million gain recorded in 2007 associated with the termination of an off-airport parking garage lease in Philadelphia.

 

Operating profit decreased $1.4 million, or 6.6%, during 2008 compared to 2007 due to the absence of the $5.0 million lease termination gain recorded in 2007, partially offset by $2.2 million of additional profit earned on increased lease and allowance revenues, $1.4 million of additional operating profit contributed by HPSA and a reduction in insurance expense.

 

Security.  Security revenues increased $12.0 million, or 3.7%, during 2008 compared to 2007, primarily as a result of new clients and the expansion of current clients in the Northwest and Midwest regions.

 

Operating profit increased by $3.0 million, or 62.4% in 2008 compared to 2007, primarily due to the absence of a $1.7 million litigation settlement recorded in 2007, increased revenues and a reduction in insurance expense.

 

Engineering.  Engineering revenues increased $18.2 million, or 6.1%, during 2008 compared to 2007, primarily due to growth in revenues from new clients, expansion of services and the cross selling of services to existing clients throughout the Company.

 

Operating profit increased by $3.5 million, or 22.6%, in 2008 compared to 2007, primarily due to increased revenues, higher profit margins on the new business compared to business replaced, and a reduction in insurance expense.

 

Corporate.  Corporate expense increased $13.9 million, or 26.9%, in 2008 compared to 2007.

 

The increase in Corporate expense was primarily a result of:

 

 

 

partially offset by:

 

 

Adoption of Accounting Standards

 

Effective October 31, 2009, the Company adopted ASC105 “GAAP” (“ASC 105”) issued by the Financial Accounting Standards Board (“FASB”) that establishes the ASC as the source of authoritative accounting principles to be applied in the preparation of financial statements in conformity with the Generally Accepted Accounting Principles (“GAAP”). Upon adoption, all existing accounting standards were superseded and all other accounting literature not included in the ASC is now considered non-authoritative. The adoption of ASC 105 had no impact on the Company’s financial position or operating results as it only amends the referencing to existing accounting standards (other than the Securities and Exchange Commission (“SEC”) guidance).

 

Effective November 1, 2008, the Company adopted the FASB guidance for measurements and disclosures of assets and liabilities that are recognized or disclosed at fair value on a recurring basis (at least annually). Further FASB guidance delayed the effective date of the fair value guidance for non-financial assets and liabilities. The Company will adopt the fair value guidance for its non-financial assets and liabilities in fiscal year 2010. On May 1, 2009, the Company adopted the FASB guidance on determining fair value when the volume and level of activity for the asset or liability have significantly decreased and identifying transactions that are not orderly. This guidance further reemphasizes that the objective of a fair value measurement remains the determination of an exit price. This fair value guidance adopted is included in ASC 820 “Fair Value Measurements and Disclosures” (“ASC 820”). See Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for the required disclosures and additional information. The Company’s non-financial assets and liabilities consists of intangible assets acquired through business combinations and long-lived assets when assessing potential impairment.

 

Effective February 1, 2009, the Company adopted the new FASB guidance related to disclosures about derivative instruments and hedging activities. This guidance, included in ASC 815 “Derivatives and Hedging” (“ASC 815,”) requires additional disclosures for derivative instruments and hedging activities. This guidance requires entities to disclose how and why they use derivatives, how these instruments and the related hedged items are accounted for and how derivative instruments and related hedged items affect the entity’s financial position, results of operations and cash flows. See Note 9 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for the required disclosures.

 

Effective May 1, 2009, the Company adopted the FASB guidance on interim disclosures about fair value of financial instruments. The updated guidance requires entities to include disclosures regarding the fair value of financial instruments and methods and significant assumptions used to estimate the fair value in their interim financial statements. There were no changes to the required annual disclosures. The fair value guidance regarding the interim disclosures about fair value of financial instruments and the fair value option for financial assets and liabilities is included in ASC 825 “Financial Instruments” (“ASC 825”). See Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for the required annual disclosures. Additionally, effective November 1, 2008, the Company adopted the FASB guidance regarding the fair value option for financial assets and liabilities, which permits entities to measure eligible financial instruments at fair value. As the Company did not elect the fair value option for its financial instruments (other than those already

measured at fair value in accordance with ASC 820), the adoption of this guidance did not have an impact on the Company’s accompanying consolidated financial statements.

 

Effective May 1, 2009, the Company adopted the new FASB guidance on recognition and presentation of other-than-temporary impairments. The guidance amends the requirements for recognizing other-than-temporarily impaired debt securities and revises the existing impairment model for such securities by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporary impaired. This guidance is included in ASC 320 “Investments — Debt and Equity Securities” (“ASC 320”). It also modifies the presentation of other-than-temporary impairment losses and increases the frequency of and expands required disclosures about other-than-temporary impairment for debt and equity securities. See Note 5 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information and required disclosures.

 

Effective July 31, 2009, the Company adopted the new FASB guidance on subsequent events, which is included in ASC 855 “Subsequent Events” (“ASC 855”). The objective of this guidance is to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. This statement introduces the concept of financial statements being available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. See Note 2 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information.

 

Recent Accounting Pronouncements

 

In December 2007, the FASB issued updated guidance for accounting for business combinations, which is included in ASC 805 “Business Combinations” (“ASC 805”). The updated guidance better represents the economic value of a business combination transaction. The changes to be effected with the new guidance include, but are not limited to: (1) acquisition costs will be recognized separately from the acquisition; (2) known contractual contingencies at the time of the acquisition will be considered part of the liabilities acquired measured at their fair value and all other contingencies will be part of the liabilities acquired measured at their fair value only if it is more likely than not that they meet the definition of a liability; (3) contingent consideration based on the outcome of future events will be recognized and measured at the time of the acquisition; (4) business combinations achieved in stages (step acquisitions) will need to recognize the identifiable assets and liabilities, as well as noncontrolling interests, in the acquiree, at the full amounts of their fair values; and (5) a bargain purchase (defined as a business combination in which the total acquisition-date fair value of the identifiable net assets acquired exceeds the fair value of the consideration transferred plus any noncontrolling interest in the acquiree) will require that excess to be recognized as a gain attributable to the acquirer. In April 2009, the FASB amended the guidance related to contingencies in a business combinations, which is included in ASC 805-20 “Identifiable Assets and Liabilities, and Any Noncontrolling Interest” (“ASC 805-20”). The amendment changes the provisions in ASC 805 for the initial recognition and measurement, subsequent measurement and accounting, and disclosures for assets and liabilities arising from contingencies in business combinations. It further eliminates the distinction between contractual and non-contractual contingencies, including the initial recognition and measurement criteria in the updated business combinations guidance and instead carries forward most of the provisions of the previous business combinations guidance for acquired contingencies. The Company anticipates the adoption of the updated business combinations guidance and the subsequent amendment will have an impact on the way in which business combinations will be accounted for compared to current practice. Both pronouncements will be effective beginning with any business combinations that close in fiscal year 2010. Upon adoption on November 1, 2009, the Company will write-off, through earnings, approximately $1.0 million of deferred acquisition costs for acquisitions currently being pursued.

 

In April 2008, the FASB issued updated guidance about determining the useful life of intangible assets. This guidance is included in ASC 350-30 “General Intangibles Other than Goodwill” (“ASC 350-30”). The guidance amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. The objective of the guidance is to improve the consistency between the useful life of a recognized intangible asset determined under ASC 350 “Intangibles — Goodwill and Other” (“ASC 350”) and the period of expected cash flows used to measure the fair value of the asset under ASC 805 and other GAAP. This guidance will be effective beginning in fiscal year 2010.

The Company anticipates that its adoption will have an impact on the way in which the useful lives of intangible assets acquired in a business combination will be determined compared to current practice, if renewal or extension terms are apparent.

 

In December 2008, the FASB issued updated guidance on employers’ disclosures about postretirement benefit plan assets, which is included in ASC 715 “Compensation — Retirement Benefits” (“ASC 715”). The guidance expands the disclosures set forth in the initial guidance by adding required disclosures about how investment allocation decisions are made by management, major categories of plan assets, and significant concentrations of risk. Additionally the updated guidance requires an employer to disclose information about the valuation of plan assets similar to that required under ASC 820. The updated guidance intends to enhance the transparency surrounding the types of assets and associated risks in an employer’s defined benefit pension or other postretirement plan and will be effective beginning in fiscal year 2010. Its adoption will not have an impact on the Company’s consolidated financial position or results of operations as it only amends the required disclosures.

 

Critical Accounting Policies and Estimates

 

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, the Company evaluates its estimates, including those related to self-insurance reserves, allowance for doubtful accounts, sales allowances, deferred income tax assets and valuation allowances, estimate of useful lives of intangible assets, impairment of goodwill and other intangibles, fair value of auction rate securities, cash flow forecasts, share-based compensation expense, and contingencies and litigation liabilities. The Company bases its estimates on historical experience, known or expected trends, independent valuations and various other assumptions that are believed to be reasonable under the circumstances based on information available as of the date of the issuance of these financial statements. The results of such assumptions form the basis for making estimates about the carrying amounts of assets and liabilities that are not readily apparent from other sources. The current economic environment and its potential effect on the Company and its clients have combined to increase the uncertainty inherent in such estimates and assumptions. Future results could be significantly affected if actual results were to be different from these estimates and assumptions.

 

The Company believes the following critical accounting policies govern its more significant judgments and estimates used in the preparation of its consolidated financial statements.

 

Investments in Auction Rate Securities.  The Company considers its investments in auction rate securities as “available for sale.” Accordingly, auction rate securities are presented at fair value with changes in fair value recorded within other comprehensive income, unless a decline in fair value is determined to be other-than-temporary. The credit loss component of an other-than-temporary decline in fair value is recorded in earnings in the period identified. Fair value is estimated by considering, among other factors, assumptions about: (1) the underlying collateral; (2) credit risks associated with the issuer; (3) contractual maturity; (4) credit enhancements associated with any financial insurance guarantee, if any, which includes the rating of the associated guarantor, (where applicable); and (5) assumptions about when, if ever, the security might be re-financed by the issuer or have a successful auction.

 

The Company’s determination of whether impairments of its auction rate securities are other-than-temporary is based on an evaluation of several factors, circumstances and known or reasonably supportable trends including, but not limited to: (1) the Company’s intent to not sell the securities; (2) the Company’s assessment that it is not more likely than not that the Company will be required to sell the securities before recovering its costs; (3) expected defaults; (4) the decline in ratings for the auction rate securities or the underlying collateral; (5) the rating of the associated guarantor (where applicable); (6) the nature and value of the underlying collateral expected to service the investment; (7) actual historical performance of the security in servicing its obligations; and (8) actuarial experience of the underlying re-insurance arrangement (where applicable) which in certain circumstances may have preferential rights to the underlying collateral. The Company’s determination of whether an other-than-temporary impairment represents a credit loss is calculated by evaluating the difference between the present value of the cash flows expected to be collected and the securities amortized cost basis. Significant assumptions used in estimating credit losses include: (1) default rates (which are based on published historical default rates of similar securities and consideration of current market trends) and (2) the expected term of the security.

Revenue Recognition.  The Company earns revenues primarily under service contracts that are either fixed price, cost-plus or time and materials based. Revenues are recognized when earned, normally when services are performed. In all forms of service provided by the Company, revenue recognition follows the guidelines under Staff Accounting Bulletin (“SAB”) No. 104, unless another form of guidance takes precedence over SAB No. 104 as mentioned below. Revenues are reported net of applicable sales and use tax imposed on the related transaction.

 

The Janitorial segment primarily earns revenues from the following types of arrangements: fixed price, cost-plus, and tag (extra service) work. Fixed price arrangements are contracts in which the client agrees to pay a fixed fee every month over the specified contract term. A variation of a fixed price arrangement is a square-foot arrangement. Square-foot arrangements are ones in which monthly billings are fixed, however, the client is given a credit calculated based on vacant square footage that is not serviced. Cost-plus arrangements are ones in which the client agrees to reimburse the Company for the agreed upon amount of wages and benefits, payroll taxes, insurance charges and other expenses plus a profit percentage. Tag revenues are additional services requested by the client outside of the standard contract terms. This work is usually performed on short notice due to unforeseen events. The Janitorial segment recognizes revenues on each type of arrangement when services are performed.

 

The Parking segment earns revenues from parking and transportation services. There are three types of arrangements for parking services: managed lot, leased lot and allowance arrangements. Under managed lot arrangements, the Company manages the parking lot for the owner in exchange for a management fee. The revenues and expenses are passed through by the Company to the owner under the terms and conditions of the management contract. The management fee revenues are recognized when services are performed. The Company reports revenues and expenses, in equal amounts, for costs directly reimbursed from its managed parking lot clients. Such amounts totaled $231.0 million, $253.7 million and $254.0 million in 2009, 2008 and 2007, respectively. Under leased lot arrangements, the Company leases the parking lot from the owner and is responsible for all expenses incurred, retains all revenues from monthly and transient parkers and pays rent to the owner per the terms and conditions of the lease. Revenues are recognized when services are performed. Under allowance arrangements, the Company is paid a fixed or hourly fee to provide parking and/or transportation services. The Company is then responsible for operating expenses. Revenues are recognized when services are performed.

 

The Security segment primarily performs scheduled post assignments under one-year service arrangements. Security services for special events are generally performed under temporary service agreements. Scheduled post assignments and temporary service agreements are billed based on actual hours of service at contractually specified rates. Revenues for both types of arrangements are recognized when services are performed.

 

The Engineering segment provides services primarily under cost-plus arrangements in which the client agrees to reimburse the Company for the full amount of wages, payroll taxes, insurance charges and other expenses plus a profit percentage. Revenues are recognized for these contracts when services are performed.

 

Self-Insurance Reserves.  The Company is subject to certain insurable risks such as workers’ compensation, general liability, automobile and property damage. The Company maintains commercial insurance policies that provide $150.0 million (or $75.0 million with respect to claims acquired from OneSource in 2008) of coverage for certain risk exposures above the Company’s deductibles (i.e., self-insurance retention limits). The Company’s deductibles, currently and historically, have generally ranged from $0.5 million to $1.0 million per occurrence (in some cases somewhat higher in California). The Company is also responsible for claims in excess of its insurance coverage. Pursuant to the Company’s management and service contracts, the Company allocates a portion of its insurance-related costs to certain clients, including workers’ compensation insurance, at rates that, because of the scale of the Company’s operations and claims experience, are believed to be competitive. A material change in the Company’s insurance costs due to a change in the number of claims, costs or premiums, could have a material effect on operating results. Should the Company be unable to renew its umbrella and other commercial insurance policies at competitive rates, it would have an adverse impact on the Company’s business, as would the incurrence of catastrophic uninsured claims or the inability or refusal of the insurance carriers to pay otherwise insured claims. Further, to the extent that the Company self-insures, deterioration in claims management could increase claim costs. Additionally, although the Company engages third-party experts to

assist in estimating appropriate self-insurance accounting reserves, the determination of those reserves is dependent upon significant actuarial judgments that have a material impact on the Company’s reserves. Changes in the Company’s insurance reserves, as a result of periodic evaluations of the related liabilities, will likely cause significant volatility in the Company’s operating results that might not be indicative of the operations of the Company’s ongoing business.

 

Liabilities for claims under the Company’s self-insurance program are recorded on an undiscounted, claims-incurred basis. Associated amounts that are expected to be recovered by insurance are presented as “insurance recoverables.” Assets and liabilities related to the Company’s insurance programs are classified based upon the timing of expected payment or recovery. The Company allocates current-year insurance expense to its operating segments based upon labor dollars and revenue.

 

Trade Accounts Receivable Allowances

 

Allowance for Doubtful Accounts

 

Trade accounts receivable arise from services provided to the Company’s clients and are generally due and payable on terms varying from receipt of the invoice to net thirty days. The Company records an allowance for doubtful accounts to provide for losses on accounts receivable due to clients inability to pay. The allowance is typically estimated based on an analysis of the historical rate of credit losses or write-offs (due to a client bankruptcy or failure of a former client to pay) and specific client concerns, and known or expected trends. Such analysis is inherently subjective. The Company’s earnings will be impacted in the future to the extent that actual credit loss experience differs from amounts estimated. Changes in the financial condition of the Company’s clients or adverse developments in negotiations or legal proceedings to obtain payment could result in the actual loss exceeding the estimated allowance. The Company does not believe that it has any material exposure due to either industry or regional concentrations of credit risk.

 

Sales Allowance

 

Sales allowance is an estimate for losses on client receivables resulting from client credits. Credits result from, among other things, client vacancy discounts, job cancellations and property damage. The sales allowance estimate is based on an analysis of the historical rate of sales adjustments (credit memos, net of re-bills) and considers known current or expected trends. Such analysis is inherently subjective. The Company’s earnings will be impacted in the future to the extent that actual credit experience differs from amounts estimated.

 

Long-Lived Assets Other Than Goodwill.  The Company reviews its long-lived assets for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable. When such events or changes in circumstances occur, a recoverability test is performed comparing projected undiscounted cash flows from the use and eventual disposition of an asset or asset group to its carrying amount. If the projected undiscounted cash flows are less than the carrying amount, an impairment is recorded for the excess of the carrying amount over the estimated fair value, which is generally determined using discounted future cash flows.

 

The Company’s intangible assets primarily consist of acquired customer contracts and relationships, trademarks and trade names, and contract rights. Acquired customer relationship intangible assets are being amortized using the sum-of-the-years-digits method over their useful lives consistent with the estimated useful life considerations used in the determination of their fair values. The accelerated method of amortization reflects the pattern in which the economic benefits of the customer relationship intangible asset are expected to be realized. Trademarks and trade names are being amortized over their useful lives using the straight-line method. Contract rights, are being amortized over the contract periods using the straight-line method.

 

Goodwill.  Goodwill represents the excess of costs over the fair value of net assets of the acquired businesses. The Company assesses impairment of goodwill at least annually as of August 1 at the reporting unit level (which for the Company is represented by each operating segment). The impairment test is performed in two steps: (i) the Company determines whether impairment exists by comparing the estimated fair value of the reporting unit with the carrying amount; and (ii) if an indication of impairment exists, the Company measures the amount of impairment loss by comparing the implied fair value of goodwill with its carrying amount.

 

Income Taxes.  Deferred income taxes reflect the impact of temporary differences between the amount of assets and liabilities recognized for financial reporting

purposes and such amounts recognized for tax purposes. These deferred taxes are measured using enacted tax rates for the years in which those temporary differences are expected to be recovered or settled. If the enacted rates in future years differ from the rates expected to apply, an adjustment of the net deferred tax assets will be required. Additionally, if management determines it is more likely than not that a portion of the Company’s deferred tax assets will not be realized, a valuation allowance is recorded. At October 31, 2009, we had unrecognized tax benefits of $102.3 million , all of which, if recognized, would impact the Company’s effective tax rate.

 

Contingencies and Litigation.  Loss contingencies are recorded as liabilities when it is both: (1) probable or known that a liability has been incurred and (2) the amount of the loss is reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. As long as the Company believes that a loss in litigation is not probable, then no liability will be recorded unless the parties agree upon a settlement, which may occur because the Company wishes to avoid the costs of litigation. Expected costs of resolving contingencies, which includes the use of third-party service providers, are accrued as the services are rendered.

 

 

Market Risk Sensitive Instruments

 

The Company’s primary market risk exposure is interest rate risk. The potential impact of adverse increases in this risk is discussed below. The following sensitivity analysis does not consider the effects that an adverse change may have on the overall economy nor does it consider actions the Company may take to mitigate its exposure to these changes. Results of changes in actual rates may differ materially from the following hypothetical results.

 

Interest Rate Risk

 

Line of Credit

 

The Company’s exposure to interest rate risk relates primarily to its cash equivalents and London Interbank Offered Rate (“LIBOR”) and Interbank Offered Rate (“IBOR”) based borrowings under the $450.0 million five year syndicated line of credit that expires in November 2012. At October 31, 2009, outstanding LIBOR and IBOR based borrowings of $172.5 million represented 100% of the Company’s total debt obligations. While these borrowings mature over the next 60 days, the line of credit extends through November 2012, subject to the terms of the line of credit. The Company anticipates borrowing similar amounts for periods of one week to three months. A hypothetical 1% increase in interest rates during 2009 on the average outstanding borrowings under the Company’s line of credit, net of the interest rate swap agreement, would have added approximately $1.4 million of additional interest expense in 2009.

 

Interest Rate Swap

 

On February 19, 2009, the Company entered into a two-year interest rate swap agreement with an underlying notional amount of $100.0 million, pursuant to which the Company receives variable interest payments based on LIBOR and pays fixed interest at a rate of 1.47%, This swap is intended to hedge the interest risk associated with $100.0 million of the Company’s floating-rate, LIBOR-based debt. The critical terms of the swap match the terms of the debt, resulting in no hedge ineffectiveness. On an ongoing basis (no less than once each quarter), the Company assesses whether its LIBOR-based interest payments are probable of being paid during the life of the hedging relationship. The Company also assesses the counterparty credit risk, including credit ratings and potential non-performance of the counterparty when determining the fair value of the swap.

 

As of October 31, 2009, the fair value of the interest rate swap was a $1.0 million liability, which is included in Retirement plans and other on the accompanying consolidated balance sheet. The effective portion of this cash flow hedge is recorded as accumulated other comprehensive loss in the Company’s accompanying consolidated balance sheet and reclassified into interest expense in the Company’s accompanying consolidated statements of income in the same period during which the hedged transaction affects earnings. Any ineffective portion of the hedge is recorded immediately to interest expense. No ineffectiveness existed at October 31, 2009. The amount included in accumulated other comprehensive loss is $1.0 million ($0.6 million, net of taxes).

 

Investment in Auction Rate Securities

 

At October 31, 2009, the Company held investments in auction rate securities from five different issuers having an aggregate original principal amount of $25.0 million. The investments are not subject to material interest rate risk. These auction rate securities are debt instruments with stated maturities ranging from 2025 to 2050, for which the interest rate is designed to be reset through Dutch auctions approximately every 30 days based on spreads to a base rate (i.e., LIBOR). A hypothetical 1% increase in interest rates during 2009 would have added approximately $0.3 million of additional interest income in 2009.

 

Foreign Currency

 

Substantially all of the operations of the Company are conducted in the United States, and, as such, are not subject to material foreign currency exchange rate risk.

 

 

The Board of Directors and Stockholders

ABM Industries Incorporated:

 

We have audited the accompanying consolidated balance sheets of ABM Industries Incorporated and subsidiaries as of October 31, 2009 and 2008, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended October 31, 2009. In connection with our audits of the consolidated financial statements, we have also audited the related financial statement Schedule II. We have also audited ABM Industries Incorporated’s internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). ABM Industries Incorporated’s management is responsible for these consolidated financial statements, the related financial statement Schedule II, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A(b)). Our responsibility is to express an opinion on these consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ABM Industries Incorporated and subsidiaries as of October 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement Schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, ABM Industries Incorporated maintained, in all material respects, effective internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

 

New York, New York

December 22, 2009

 

ABM Industries Incorporated and Subsidiaries

 

     See accompanying notes to the consolidated financial statements.

ABM Industries Incorporated and Subsidiaries