Earnings Call Transcript - ABM Q2 2022

Operator, Operator

Greetings, and welcome to the ABM Industries, Inc. Q2 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Paul Goldberg, Investor and Media Relations. Please go ahead.

Paul Goldberg, Senior Vice President of Investor Relations

Good afternoon, everyone, and welcome to our second quarter 2022 earnings call. My name is Paul Goldberg, and I’m the Senior Vice President of Investor Relations at ABM. With me today are Scott Salmirs, our President and Chief Executive Officer; and Earl Ellis, our Executive Vice President and Chief Financial Officer. Please note that earlier this afternoon, we issued our press release announcing our second quarter fiscal 2022 financial results. A copy of this release and an accompanying slide presentation can be found on our website. After Scott and Earl’s prepared remarks, we will host a Q&A session. But before I begin, I would like to remind you that our call and presentation today contain predictions, estimates and other forward-looking statements. Our use of the words estimate, expect or similar expressions are intended to identify these statements, and they represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially. These factors are described in a slide that accompanies our presentation as well as our filings with the SEC. During the course of this call, certain non-GAAP financial information will be presented. A reconciliation of historical non-GAAP numbers to GAAP financial measures is available at the end of the presentation and on the Company’s website under the Investor tab. With that, I’d like to now turn the call over to Scott.

Scott Salmirs, President and Chief Executive Officer

Thanks, Paul. Good afternoon, and thank you all for joining us today to discuss our second quarter results. ABM posted strong results in our second quarter, following the excellent results we recorded in our first quarter. Organic revenue growth of 7.5% was driven by solid demand in Business & Industry, Aviation, Manufacturing & Distribution and Technical Solutions, which benefited from robust growth in our e-mobility business. Our teams executed well in a challenging environment, driving high single-digit organic revenue growth while largely mitigating the impacts of labor availability and wage inflation. We generated an adjusted EBITDA margin of 6.5%, which represents a significant improvement over pre-pandemic levels and reflects our ability to protect profitability in the current inflationary environment. Our solid results underscore the strength of our client relationships and our broad capabilities to meet their evolving needs. Overall, our second quarter performance largely reflected healthy demand for our core janitorial services, contributions from acquisitions and the ongoing recovery in the aviation market. These positive factors were partially offset by the expected decline in disinfection-related work orders and enhanced clean services from the heightened levels in last year’s second quarter. As Earl will discuss later, we are reaffirming our previous guidance ranges for full year adjusted earnings per share and adjusted EBITDA margin, reflecting continued favorable market demand trends for our core janitorial services as well as our solutions that enable our clients to achieve their sustainability and energy efficiency objectives. Our strong market positioning is evidenced in our new sales bookings, which increased 11% year-over-year to $795 million through the first 6 months of the year. Let me now discuss the demand environment for each of our industry groups. Beginning with Business & Industry, office occupancy rates remain at relatively low levels but continue to gradually increase, especially on the East and West Coast, where occupancy rates have risen to approximately 35% to 40%, while occupancy in the central part of the U.S. is at approximately 60%. We continue to anticipate a measured pace of rising office occupancy for the balance of 2022. This slower pace of reopening is generally beneficial for our business, enabling us to effectively manage labor costs in today’s tight labor market. At the same time, demand continues to rebound for special events such as concerts and sporting events as essentially all venues have reopened to the public. One notable development in the office market is that occupancy levels are generally higher midweek with lower occupancies on Mondays and Fridays. This trend suggests that even though occupancy levels may not soon return to pre-pandemic levels, clients still must plan for high occupancy days when they think about their future space requirements. Moving to Aviation. Travel rebounded significantly from the prior year, with U.S. passenger volumes now at approximately 90% of pre-pandemic levels, mostly driven by leisure travel. Business travel is also improving, although at a more measured pace. We expect travel demand to continue to trend higher and to approximate pre-pandemic levels in the U.S. in the third quarter. Given the recovery in the travel market, margins in our Aviation business have rebounded strongly, aided by our efforts to optimize our service mix and by our effective management of labor costs in tight markets. Demand in Manufacturing & Distribution continues to be solid as this segment has been largely unaffected by reduced occupancy levels. As a result, our organic revenue growth reflects the health of these end markets. Supported by our strong relationships with many of our country's leading e-commerce, logistics and manufacturing companies, we have expanded our book of business with these clients, benefiting from their continued growth. To further accelerate our growth in Manufacturing & Distribution, we are working to broaden our exposure in attractive markets such as life sciences. With our industry-leading geographic footprint, ABM remains uniquely positioned to serve our clients’ Mechanical & Engineering needs who value our ability to provide consistent service across their numerous site locations. In Education, demand remained stable as K-12 and colleges and universities continued to operate with 100% in-person learning. Although the roll-off of two education accounts in the back half of fiscal 2021 and a reduction in disinfection-related work orders continued to impact revenue in Q2, we expect that the addition of new clients starting in Q3 of this year will drive year-over-year revenue growth in the fourth quarter. In Q2, segment margins were impacted by the labor ramp-up required to service nearly full in-person learning versus the hybrid model from a year ago. Additionally, we did experience labor inflation costs in certain nonunionized markets, especially in the southern regions of the U.S., but we effectively mitigated a large portion of them through price escalations. In Technical Solutions, we continue to see robust demand for our e-mobility charging solutions where revenue quadrupled compared to the prior year, despite some of the supply chain constraints on growth. We expect our e-mobility business to continue to accelerate, driven by the U.S. infrastructure bill and strong demand for electric and hybrid vehicles. On top of that, we recently booked a large bundled energy solutions project that will commence in the coming quarters. Interest in our bundled energy solutions continues to build, and we are optimistic that we will book additional new business in the back half of the year. Going forward, Technical Solutions is poised to benefit from long-term secular trends like electric vehicles, sustainability and energy efficiency. In addition to the constructive demand environment, we continued to make important progress with respect to the ELEVATE program in Q2. The focus of our second quarter efforts was on designing and testing our core cloud-based ERP system and further refining our cloud-based recruiting and tracking system. While there is still plenty of work ahead of us, our teams are well aligned on advancing our ELEVATE strategy. Driving growth through strategic acquisitions is a fundamental component of ELEVATE, and I’m pleased with our progress. During the second quarter, we completed the purchase of Ireland-based Momentum Support. The acquisition expands ABM’s footprint to the attractive Irish market and provides us with cross-selling opportunities to existing ABM clients with operations in Ireland. We further advanced our ELEVATE strategy through the establishment of ABM Ventures, our Business Ventures Program. As our first transaction under the program, we acquired a minority investment in Recycle Track Systems, a leader in cutting-edge traceability and sustainability solutions utilized in the materials waste and recycling industry. Through this partnership, ABM clients will have access to RTS’ full suite of on-demand waste removal and materials management solutions. Before I turn it over to Earl to discuss the financials, let me provide a quick update on the labor environment. As I mentioned last quarter, ABM’s wage inflation risk is largely mitigated by the composition of our direct labor workforce. As a percentage of our contract revenue, roughly two-thirds of our direct labor is subject to collective bargaining agreements or part of a cost-plus arrangement or part of some other arrangement where wage rates can be predicted more easily and passed through. The transparency of these contractual arrangements makes capturing labor cost increases less difficult as clients know that our increases are a direct result of stated or contractual wage increases. That being said, we have definitely been experiencing meaningful wage inflation in the portion of our labor spend that is not subject to the contracts I just mentioned. This wage inflation is most evident in the southern region of the U.S. where unions are less prevalent and hourly wages are generally lower than in the rest of the country. In these instances, we have proactively sought escalations to cover wage cost increases when appropriate. Our success in obtaining price escalation speaks to the high value our clients place on our services, especially during the most challenging of times and to the fact that wage inflation is widespread and affecting our competitors similarly. We also continue to experience these effects of labor shortages when businesses are quickly ramping such as in Education when we went to full in-person learning, virtually overnight, and what we are now seeing in Aviation. Though not expected in the next few quarters, we believe labor shortages will somewhat subside over time, especially as inflation continues, driving more people to reenter the workforce. In the meantime, we continue to aggressively and proactively recruit using all the tools and technology at our disposal. With that, let me turn it over to Earl for the financials.

Earl Ellis, Executive Vice President and Chief Financial Officer

Thank you, Scott, and good afternoon, everyone. For those of you following along with our earnings presentation, please turn to slide 5. Second quarter revenue increased 26.7% to $1.9 billion, largely driven by acquisitions, continued recovery from the pandemic, especially in Aviation and solid demand for our janitorial services. Organic growth of 7.5% was broad-based across all segments with the exception of Education. Moving on to slide 6. Net income in the second quarter was $48.8 million, or $0.72 per diluted share, both up 57% over the same period last year when we posted net income of $31.1 million or $0.46 per diluted share. The increase in GAAP income primarily reflects higher segment earnings and the absence of a litigation reserve taken in the prior year period, partially offset by ELEVATE-related investments. Adjusted net income for the second quarter increased 8% to $60.2 million or $0.89 per diluted share compared to $55.5 million or $0.82 per diluted share in the second quarter of last year. The increase primarily was due to higher segment earnings and one less work day compared to the prior year period. Adjusted EBITDA increased 12% to $118.9 million compared to $106.6 million in the prior year period. Adjusted EBITDA margin for the quarter was solid at 6.5% versus 7.4% last year, largely reflecting the anticipated decline in work orders, which include higher-margin disinfection services. Corporate expenses, excluding items impacting comparability, were essentially flat to the prior year period. Now, turning to our segment results beginning on slide 7. Business & Industry revenue increased 48.9% to over $1 billion, driven primarily by contributions from acquisitions. The period included a full quarter of Able and three weeks of contribution from the Momentum deal. Excluding acquisitions, organic revenue growth was a robust 6.2%, reflecting increased office occupancy, growth in special events, and business expansion with existing customers. Operating profit in Business & Industry increased 6.5% to $76.7 million, driven by significantly higher revenue, especially related to core services, such as janitorial. Operating margin of 7.6% was lower than the prior year and reflected lower enhanced clean and disinfection-related work orders, which we anticipated. Aviation revenue increased 27.4% to $185.9 million, marking the fourth consecutive quarter of robust year-over-year revenue growth. The improvement was largely driven by increased leisure and business airline traffic. Aviation operating profit increased 69% to $9.6 million versus $5.7 million in last year’s second quarter, driven by the significant increase in revenue as well as growth in our higher-margin airport facility services business. The year-over-year operating margin improvement of 130 basis points reflects greater economies of scale on higher volume with existing clients, partially offset by the impact of wage inflation. Turning to slide 8. Revenue within our Manufacturing & Distribution industry group grew 4.9% to $356.9 million. Solid organic growth in this segment was driven by expanded business with existing clients and several new customer wins. Operating profit increased 4.6% to $41.9 million on higher sales volume. Operating margin was essentially flat as service mix was unfavorably impacted by lower levels of enhanced clean and disinfection-related work orders compared to the prior year. Education revenue declined 3.9% to $204.4 million, largely due to lower work orders versus the prior year and the roll-off of two accounts. As Scott mentioned earlier, we believe that the new clients we have coming on board in Q3 will drive year-over-year revenue growth in Education, starting in Q4. Operating profit was $11.7 million, down from $13.8 million in last year’s second quarter due to lower revenue as well as higher wage costs, especially in the southern regions of the U.S. Operating margin remained elevated from pre-pandemic levels and finished at 5.7%. Technical Solutions revenue grew 18.1% to $147 million, largely driven by extremely strong growth in our e-mobility service offering. Operating profit was $10.6 million compared to $10.2 million last year. Operating margin decreased 100 basis points to 7.2%, primarily reflecting a service mix that was more heavily weighted to our e-mobility service line versus the prior year. Moving on to slide 9. We ended the second quarter with total debt of $1.3 billion, including $162 million in standby letters of credit, resulting in a total debt to pro forma adjusted EBITDA ratio of 2.4 times. Debt was up $159 million versus the first quarter and largely reflects the litigation settlement payment of $144 million completed in the second quarter. At the end of Q2, we had available liquidity of $781 million, including cash and cash equivalents of $48.9 million. Turning to capital allocation. We repurchased roughly 700,000 shares in the second quarter at an average price of $43.50 per share for a total cost of $30 million. In total, for the first six months of fiscal 2022, we repurchased approximately 1 million shares for $43.3 million. Lastly, we are proud to have paid our 224th consecutive dividend in the second quarter. Now, let me briefly touch on guidance, as shown on slide 10. As Scott mentioned earlier, we are reaffirming our prior guidance for full year 2022 adjusted EPS to be in the range of $3.50 to $3.70 and for adjusted EBITDA margin to be in the range of 6.4% to 6.8%. Guidance for the full year 2022 GAAP EPS is now expected to be in the range of $2.91 to $3.11, up $0.26 from our prior guidance, reflecting benefits from changes in items impacting comparability.

Scott Salmirs, President and Chief Executive Officer

With that, let me now turn it back to Scott for some closing comments. Thanks, Earl. In an evolving and dynamic market environment, ABM continues to operate from a position of strength, supported by the industry’s best team, the breadth and scale of our operations, and the strength of our balance sheet. We are well-positioned strategically with exposure to secular trends like healthy buildings, sustainability and energy efficiency. We also serve high-growth markets, including e-mobility and e-commerce. These growth opportunities, coupled with the resilience of our janitorial and engineering business, underscore our confidence in our outlook. At the same time, we continue to make important progress with respect to our ELEVATE initiative, enhancing our efficiency to create long-term sustainable value for all of our stockholders and stakeholders. With that, let’s take some questions.

Operator, Operator

Your first question comes from Faiza Alwy with Deutsche Bank.

Faiza Alwy, Analyst

Yes, hi. How are you? I have a lot of questions. First, Scott, could you discuss the overall picture of this quarter, specifically what met your expectations from a few months ago and what might have surprised you or differed from your previous thoughts about the business?

Scott Salmirs, President and Chief Executive Officer

First of all, thanks for the question. Interestingly, we think everything is kind of right in line with what we’re saying if you go back a couple of quarters. We’re performing as expected. Really pleased with everything we’ve done. And I think the thing I would point out is that what was probably unexpected, even from the start of planning for the year, is inflation and the recessionary effects that we’re seeing out there because that certainly has a knock-on effect on wage rates and ability to get labor, and we fought through it. And you see that in our margins and in our bottom line. So, super proud of the team for how they’ve come through in a quarter where if there was anything that was unexpected, it would be how significant the wage pressures are.

Faiza Alwy, Analyst

Okay, understood. Maybe if we could focus on just the Aviation segment, you’ve seen quite a bit of margin improvement there on a year-over-year basis and also sequentially, but I think sequentially was expected. Maybe talk a little bit about how we should think about the long-term margins in Aviation? And how do you expect maybe back-half margins to trend in that business?

Scott Salmirs, President and Chief Executive Officer

Sure. So look, we’re enthusiastic about this segment for sure. One of the things we’ve done through the good work of our Chief Operating Officer, Rene Jacobsen, is reposition how we go to market, and we’ve shifted our mix from predominantly airlines to airports, and that’s helped increase our margins and the trajectory is incredible. We were very, very low operating margin at pre-pandemic. And now we’re at 5%, as you saw, and no reason it shouldn’t continue in the back half of the year at the same rate. And I’d like to believe that as we talk to you in 2023 and 2024, you’re going to continue to see improvement and ultimately get this in line with our other segments. So, we’re on a journey, no pun intended.

Operator, Operator

Your next question comes from Sean Eastman with KeyBanc.

Sean Eastman, Analyst

It’d be great to get some context for the decline in disinfection-related work orders and enhanced clean, maybe year-on-year or sequentially versus the first quarter? Just trying to flesh out how much of that sort of margin tailwind is still in the system.

Scott Salmirs, President and Chief Executive Officer

Sure. So, we still have margin accretion for disinfection, but it is starting to normalize as we projected. Now, high level, we still have a couple of points of revenue tailwind, which is great. And we think some of it will remain, but it’s certainly tailing off as we get more normalized with the pandemic. So, a little bit less, but not significant. So, essentially in line with what we’ve been saying for the past few quarters.

Sean Eastman, Analyst

Okay. And by a couple of points, what exactly do you mean there, Scott, I mean, just versus normalized level?

Scott Salmirs, President and Chief Executive Officer

Sure. When we discuss work orders, it's important to note that during the pandemic, our work orders increased significantly. We were around 5% of pre-pandemic levels, and now we’ve risen to approximately 7%. We don’t anticipate returning to 5%, but we might not maintain 7% either. There’s potential for adjustment, but overall, the levels will still be higher than before. Additionally, in our business, work orders are part of a higher margin segment, which is beneficial for us.

Sean Eastman, Analyst

Okay. That's helpful. Were you going to say something, Earl?

Earl Ellis, Executive Vice President and Chief Financial Officer

Yes. I was just going to add to that, Sean. When you actually look at the margin this past quarter, I would say that if you look at the 90 basis points that we actually shed year-over-year, probably 200 basis points was really the disinfection-related. Just to give some perspective on disinfection in and of itself.

Sean Eastman, Analyst

Okay. Very helpful CFO perspective there. Okay. And then, you called out the wage inflation. Obviously, a big topic there. Could you give us any color on where that’s running, whether it’s ramping or plateauing? And I kind of wondered if the CBAs maybe mean that wage escalations are going to hit ABM with a lag. And I’m not sure if that matters, but any color there would be helpful.

Scott Salmirs, President and Chief Executive Officer

No, no, that’s the right question. And from a risk protection standpoint, we’re in such good shape. I have to tell you, Sean, because as you know, three quarters of our revenue is from collective bargaining agreements. And virtually all of them got done in the last year or so. So, we have line of sight to the next two or three years of escalations. And on average, it’s going to be about 4.5% for wage and benefits, which is really sustainable for us and something that is less difficult to pass on to clients. On the nonunion side, which is call it, a third of our business, you’re definitely seeing elevated levels running anywhere from 5% to 10% increases depending on different geographies. And that’s where we look at a segment like Education, where 75% of the labor is nonunion. And that’s why you see a little bit more pressure in the Education segment. So, it affects every segment differently, but it’s based on geography, so. But I will say the silver lining for us is how much can you recapture in escalations. Last year, we had a record year of price escalation recapture, and we’re probably running close to 2x that right now. So, the team is doing an unbelievable job of recapturing that wage inflation.

Operator, Operator

Your next question comes from David Silver with CL King.

David Silver, Analyst

Scott or Earl, I think maybe I was just going to ask if you could give us an update on the Able Services acquisition. A couple of things. I mean maybe if you could talk about the integration overall? And then secondly, if you could talk about the financial impacts, the accretive nature of Able in your current quarter results? Thanks.

Scott Salmirs, President and Chief Executive Officer

Sure. That’s great. So look, we’re really proud of how Able is going from an integration standpoint. On the operational side, we’re, in my mind, fully integrated operationally. We’re on track with our synergy targets, which is great. And as we modeled out how we wanted this to perform internally, we’re just right on track. So, really pleased with how it’s going. I’ll let Earl talk about the accretive nature, but I will tell you, David, what is really powerful about this as well is the fact from a brand standpoint in the industry, the fact that we’ve combined with Able and what it means for, again, the ABM brand because they’re such a valuable asset and had such a great reputation. It’s been wonderful beyond the pure financials of the transaction. So, couldn’t be more pleased. And Earl, if you want to give some commentary on the accretive nature of it?

Earl Ellis, Executive Vice President and Chief Financial Officer

Yes. Just to reiterate, when we announced this acquisition last year in September, we talked about the presumption that we actually had with regards to revenues as well as the EBITDA that it would accrete. And like Scott just mentioned, everything is on track, including both customer revenue retention as well as the synergies. We also talked about generating about $0.25 in EPS, and we are well on track to deliver that in the first year.

David Silver, Analyst

Okay, that’s great. My next question focuses on the growth in new sales bookings, which is in the low double digits year-to-date. I'm curious about your thoughts on the value proposition that ABM brings in the post-pandemic environment that has contributed to this strong bookings performance. I recognize that your company offered a highly differentiated service during the peak of the pandemic compared to many smaller or regional competitors. However, in this post-pandemic period, the differentiation might not be as apparent to customers. If Rene were present, or if you could share your insights, what aspects of your value proposition do you believe are driving the double-digit growth in sales bookings? Thank you.

Scott Salmirs, President and Chief Executive Officer

I believe a significant part of our success comes from the momentum we've built through the resources we have, our scale, and our expertise. This was particularly evident during COVID. It's widely recognized in the industry that we were among the first to provide solutions like EnhancedClean, which has elevated our brand. When we pitch for new business and discuss our performance over the past couple of years, especially after merging with Able, we all sense that there is a strong momentum at ABM contributing to another record-breaking sales growth in the first half. It's difficult to pinpoint just one factor, but there's a palpable energy around presenting our brand and capabilities to clients, influenced by the experiences of the last few years.

Operator, Operator

Your next question comes from Marc Riddick with Sidoti.

Marc Riddick, Analyst

I was wondering if you could discuss the pace at which people are returning to the office, especially in different regions of the country. Could you update us on how this is affecting staffing visibility and the ramp-up process? It would be helpful to hear how this is unfolding so far.

Scott Salmirs, President and Chief Executive Officer

Yes, office occupancy has increased slightly. About six months ago, we mentioned occupancy levels of 10% to 20% on the coast and 40% in the central part of the country. Currently, those figures are around 35% to 40% on the coast and approximately 60% in the central region. However, not all weekdays see the same occupancy levels. On Mondays and Fridays, occupancy is likely between 5% and 10%, while Tuesdays, Wednesdays, and Thursdays see higher rates, contributing to the average. It’s a gradual return, and we anticipate that trend to continue, but it's clear that a full return to five days a week in the office is unlikely. The return will be more gradual, which aligns with ABM’s strengths in labor efficiency and effective staff deployment, as we've observed in our margins.

Marc Riddick, Analyst

It seems as though then the pace of how this has played out so far has been relatively at least slightly positive, if not more so compared to maybe if it was rushed or the like. Is that a fair way to look at that?

Scott Salmirs, President and Chief Executive Officer

Yes, it is, Marc. When we consider the current labor environment, it's not just about wages. The Business & Industry office segment is mainly unionized, which allows for more controllable costs, but it's also about the availability of labor and staffing without needing to rely on overtime. The gradual pace of returning to the office has actually been beneficial for us. While we hope to see stronger numbers eventually for the overall economy, at this moment, it aligns well with ABM’s strengths.

Operator, Operator

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to Mr. Scott Salmirs for closing remarks.

Scott Salmirs, President and Chief Executive Officer

I just want to thank everyone for participating this afternoon. We’re excited about everything we’re doing here at ABM. And just really pleased with our performance and look forward to speaking to you in the fall. Have a good, safe, healthy summer. Take care, everybody.

Operator, Operator

This concludes today’s conference. You may disconnect your line at this time. Thank you all for your participation.