Earnings Call Transcript - ABM Q3 2023

Operator, Operator

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

Paul Goldberg, Senior Vice President, Investor Relations

Good morning, everyone, and welcome to ABM's Third Quarter 2023 Earnings Call. My name is Paul Goldberg, and I'm the Senior Vice President of Investor Relations at ABM. With me today are Scott Salmirs, our President and Chief Executive Officer; and Earl Ellis, our Executive Vice President and Chief Financial Officer. Please note that earlier this morning, we issued our press release announcing our third quarter 2023 financial results. A copy of that release and accompanying slide presentation can be found on our website abm.com. After Scott and Earl's prepared remarks, we will host the Q&A session. But before we begin, I would like to remind you that our call and presentation today contain predictions, estimates, and other forward-looking statements. Our use of the words, estimates, expects, and similar expressions are intended to identify these statements and they represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially. These factors are described in the slide that accompanies our presentation as well as in our filings with the SEC. During the course of this call, certain non-GAAP financial information will be presented. A reconciliation of historical non-GAAP numbers to GAAP financial measures is available at the end of the presentation and on the company's website under the Investor tab. And with that, I would like to now turn the call over to Scott.

Scott Salmirs, President and Chief Executive Officer

Thanks, Paul. Good morning and thank you all for joining us today to discuss our third quarter results. Third quarter revenue grew 3.4% to $2 billion, including 2.5% organic growth. Our aviation, education, and manufacturing and distribution segments performed well, driven by robust air travel, new education clients, and our strong market positioning in M&D. These solid results were partially offset by lower activity in bundled energy solutions and delayed project starts in our Technical Solutions group and by the softening market conditions for janitorial services in business and industry. Our teams are acting to resolve project delays in Technical Solutions, which we believe to be transient, and we've also proactively adjusted our cost structure to better match the current demand environment in B&I. In addition to our cost management efforts, we have aggressively pursued price increases to cover the inflationary labor environment and reflect the value of the essential services we provide. I'll now discuss the demand environment for each of our industry groups. Let's begin with B&I. Office density rates remain relatively static in the third quarter at around 50% on a blended basis. Although the hybrid work model remains prevalent, we expect to see a gradual increase in the number of days per week employees spend at their office. In fact, many of our clients plan to mandate employees work an additional day per week in the office starting sometime after Labor Day. Accordingly, office density is likely to gradually improve, which should help stabilize our volume of work orders over time. However, we are beginning to see what has been so prevalent in the media that as office leases expire, many clients are downsizing their office footprint given hybrid work models and the macroeconomic environment. This puts pressure on the demand side for us until vacant floors are re-leased and reoccupied. This trend will likely continue into 2024. We remain well positioned to navigate the challenges in commercial real estate given our flexible labor model. Also importantly, our multi-tenant commercial real estate profile largely consists of Class A and newer buildings. These properties have been less impacted than Class B and Class C properties and should be leased up fairly quickly. In addition, Engineering services constitute a sizable portion of our revenue in B&I. This revenue stream is less impacted than janitorial services as HVAC and electrical systems must be maintained regardless of occupancy density. Finally, I would note that our B&I segment includes a large portion of non-multi-tenant locations such as corporate office towers and corporate campuses. This portion of B&I has seen more stability from a vacancy perspective. Summing it all up, we see the pressures on commercial real estate modestly impacting our revenue line but allowing us to protect margin through our labor model and the ability to manage our cost structure. Moving to Aviation. The leisure and business travel markets, including international travel, continue to be quite strong given pent-up demand. Our aviation team has executed well in this environment, managing through a historically tight labor market while ramping up service volumes to above pre-pandemic levels. They've also done a great job winning new business, such as a significant recent expansion of one of the country's busiest airports that included multiple service lines through our ABM Performance Solutions integrated offering, which is known as APS in the marketplace. Demand within our manufacturing and distribution segment has remained solid benefiting from our core e-commerce and logistics clients and from our diversification efforts, including expanded business with clients in the manufacturing, semiconductor, and biopharma markets. These newer end markets continue to offer strong growth opportunities as clients increasingly outsource support services so they can focus on their core business operations and the momentum for onshoring manufacturing is continuing. Of note, we booked a significant contract with a leading energy company in the third quarter, further diversifying our client base. We will continue to focus on new growth opportunities as we prepare for a large client of ours to rebid and rebalance their work needs over the next year. This is part of their normal business process, and even after the bid, while we expect some revenue pressure, we also expect to maintain a disproportionate share of their business, having provided stellar service to them through a strong growth period. Moving to education. We continue to post mid-single-digit organic revenue growth, driven by 100% in-class learning and by the addition of new clients. We executed well on our sales pipeline and won several new contracts during the third quarter, including a sizable win with the Providence Rhode Island Public School District. We are pleased that Providence has opted to utilize our APS offering, which, as I noted earlier, combines multiple service offerings into one comprehensive solution. Other notable education wins in the third quarter included the Prosper Texas Independent School District and Palm Beach State College in Florida. Our pipeline of new business opportunities remains strong, and we expect to continue to win our fair share going forward. Moving to Technical Solutions. The global demand environment for EV charging infrastructure and microgrids, particularly battery storage systems, remains strong. Our ATS backlog now exceeds $450 million, with EV and microgrid services representing over 60% of the total. At the same time, we are experiencing soft market conditions and bundled energy solutions, which includes HVAC, lighting, and electrical system retrofits. This is driven by reduced investment spending especially in K through 12 schools, primarily due to higher interest rates and the pressure that puts on project ROIs. ATS did not perform as we anticipated in the third quarter for two key reasons. First, we expected to complete a greater number of booked microgrid projects at multiple locations, specifically large battery systems for a large industrial client. This project was initially impacted by supply chain constraints in the first half of the year. With the supply chain having largely stabilized, we faced new delays relating to local permitting and utility issues. Because the deployment of large-scale battery storage systems is relatively new, many local governments are not accustomed to dealing with the unique and complex requirements of these projects, and permitting gets protracted. We continue to work closely with our clients, and we are executing a plan to address near-term hurdles, including targeting alternative sites where appropriate. Turning to e-mobility. As we discussed on our last call, we expected the pace of EV charger installations to materially accelerate in the second half of the year as we began to deliver on several new programs, including one for a large automotive dealer network. Because of this particular auto OEM's recent announcement of a change in its EV production goals, the dealerships have slowed their rollout in EV infrastructure to match the production schedule. We view the battery storage system delays, as well as the project pushouts on EV, as transitory and reflective of rapidly evolving markets experiencing disruptive change. While we address the near-term challenges in this market, ABM remains well positioned in the EV charging space, given our track record of over 22,000 EV installations as well as our innovative technical capabilities that include end-to-end solutions. Also, the level of interest and bidding activity for EV infrastructure and microgrid has never been higher, so we remain really encouraged. Turning now to our ELEVATE initiative. We have continued to make important progress in reaching our long-term technology objectives. During the third quarter, we utilized our new cloud-based ERP system to complete our quarterly close for the Education segment. This platform, which provides significant efficiency and operational improvements, will be rolled out to the remainder of ABM over the next two years as planned. We also continue to leverage our workforce productivity and optimization tool, which provides our operations teams with advanced analytics into productivity levels across their portfolios. In fact, we've seen about a 10% improvement in gross margins on the jobs where the tool has been piloted. This capability will become even more critical going forward to effectively manage our labor utilization as we navigate the commercial office landscape. Additionally, we now have over 200 digital client dashboards deployed at sites across the country, and feedback has been exceptionally positive. As we manage through some specific challenges, ABM remains resilient, supported by our leading market position, diversified industry groups, and financial strength. We continue to be the clear leader in facility services, and we have expanded our long-term growth opportunity through strategic investments in fast-growing markets and will continue to do so. We've done a terrific job winning large new contracts in aviation and education, as well as in manufacturing and distribution where we continue to expand. And although we've experienced some delays in ATS, we are confident our performance will improve as the market matures. In B&I, we are fortunate that our portfolio remains heavily weighted towards better performing Class A commercial real estate and more stable engineering services, combined with our flexible labor model. Given the recent challenges in ATS and B&I, we expect full-year 2023 adjusted EPS to come in at the bottom half of our prior outlook range. Looking further ahead to next year, although our forecasting and budget process is in its early stages, it wouldn't surprise me if fiscal 2024 adjusted EPS was slightly down from 2023 given the softness in the commercial office sector. We will share our more formal 2024 outlook on our Q4 earnings call in December. We are laser-focused on overcoming these near-term challenges including tightly managing costs and making tough decisions to adjust our cost structure across the organization. Beyond that, we are building for the future by winning new business in attractive markets, leveraging our ELEVATE technology, and using our strong free cash flow to enhance shareholder returns. We will also continue to invest for the long-term to position ABM for sustainable success.

Earl Ellis, Executive Vice President and Chief Financial Officer

Thank you, Scott, and good morning, everyone. For those of you following along with our earnings presentation, please turn to slide five. Third quarter revenue increased 3.4% to $2 billion, comprised of organic revenue growth of 2.5% and acquisition contribution of roughly 1%. Moving onto slide six. Net income in the third quarter was $98.1 million or $1.47 per diluted share, both up 73% as compared to last year. The increase in GAAP net income was driven by a gain from employee retention credits of $22.4 million, the adjustment of the fair value of contingent consideration of $37.2 million, and tight expense controls, partially offset by higher interest expense, labor costs, project delays in ATS, and lower commercial office space-related volume. Adjusted net income of $52.8 million and adjusted earnings per diluted share of $0.79 were both down 16% from the prior year period. The year-over-year changes in adjusted net income and adjusted EPS primarily reflected higher interest expense and slightly lower income from operations, partially offset by cost management and benefits from price increase. Adjusted EBITDA was essentially flat with the prior year at $125.3 million, and adjusted EBITDA margin was 6.4% versus 6.6% last year. The margin decline was largely reflective of inefficiencies related to project delays in ATS and the impact of lower volumes in B&I, partially offset by cost initiatives. Now turning to our segment results beginning on slide seven. B&I revenue declined 1% year-over-year to $1 billion, mainly due to reduced demand in the commercial office market. Operating profit in B&I decreased to $78.9 million and operating margin declined to 7.7% as the impact of lower volume was partially offset by price increases and cost actions. Aviation revenue grew 17% to $238 million, marking the ninth consecutive quarter of year-over-year revenue growth. This increase was driven by strong demand for leisure and business travel. We expect demand within our Aviation segment to remain constructive going forward. Aviation's operating profit was $11.7 million versus $9.5 million in the prior year period. And operating margin expanded 20 basis points to 4.9%. The increase in profit and margin primarily reflected higher volume and price increases, partially offset by increased labor costs. Turning to slide eight. Manufacturing and distribution revenue grew 7% to $381.9 million, reflecting broad-based demand. Operating profit increased to $38.1 million while operating margin declined 60 basis points to 10%. Profit and margin performance was largely due to mix as new wins came in slightly below our historical margin in this segment. Education revenue increased 6% to $219.1 million, benefiting from the addition of new clients. Education operating profit was $15.9 million, up 10% over the prior year period, while margin increased 30 basis points to 7.3%. These increases were largely attributable to increased organic revenue growth and labor efficiencies. Technical Solutions revenue grew 6% to $167.9 million, which was below our expectations heading into the quarter. Revenue growth was comprised of 12% growth from RavenVolt, partially offset by a 6% organic decline. As Scott mentioned, ATS revenue was negatively impacted by three factors, namely delays in certain RavenVolt battery storage projects, ongoing softness in our bundled energy solutions markets as investment decisions are being impacted by the higher interest rate environment, and thirdly, the pushout of a large EV charging installation program. Backlog in ATS is now over $450 million, much of which is scheduled to convert to revenue in 2024. Also of note, supply chain issues in ATS have stabilized, which will be helpful as we move forward. ATS operating profit was $11.4 million and margin was 6.8% compared to operating profit of $15.4 million and margin of 9.7% last year. The decrease in margin and profit were largely driven by inefficiency associated with project delays, changes in business mix, and the amortization of intangibles related to the RavenVolt acquisition. Moving on to slide nine. We ended the third quarter with total debt of $1.4 billion including $58.4 million in standby letters of credit, resulting in total debt to pro forma adjusted EBITDA ratio of 2.3 times. At the end of Q3, we had available liquidity of $582.6 million, including cash and cash equivalents of $97.7 million. Free cash flow in the third quarter was still strong at $138 million. During the third quarter, we repurchased 644,000 shares of common stock at an average price of $42.10 for a total cost of $27.1 million. Interest expense was $20.9 million, up approximately $10 million from the prior year period, but down slightly on a sequential basis. The year-over-year increase was primarily attributable to higher interest rates. Now let's move on to our full-year fiscal 2023 outlook as shown on slide 10. On a GAAP basis, we now expect EPS to be in the range of $3.52 to $3.62, up from our prior outlook, driven by gains from changes in items impacting comparability occurring in the third quarter, namely $0.26 related to employee retention credits and an incremental $0.59 related to an adjustment to the fair value of contingent consideration. As for the adjusted EPS, we are tightening to the lower end of our prior range, largely reflecting project pushouts in ATS and ongoing softness in the commercial real estate market. As a result, we now expect full-year 2023 adjusted EPS to be $3.40 to $3.50. Our full-year outlook for adjusted EBITDA margin, interest expense, and tax rate before discrete items are all unchanged. Adjusted EBITDA margin is expected to be 6.5% to 6.8%. Interest expense is expected to be approximately $80 million, and the tax rate before discrete items is expected to be between 29% and 30%. We also continue to expect to grow full-year adjusted EBITDA in the mid-single digits, and for full-year free cash flow to be in the range of $240 million to $270 million before the CARES Act repayment of $66 million, which was made in Q1, and combined full-year integration and ELEVATE expenses of approximately $75 million to $80 million. With that, let me turn it back to Scott for closing comments.

Scott Salmirs, President and Chief Executive Officer

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

Operator, Operator

Thank you. The floor is now open for questions. Today's first question is coming from Tim Mulrooney of William Blair. Please go ahead.

Samuel Kusswurm, Analyst

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

Scott Salmirs, President and Chief Executive Officer

Hey, thanks.

Samuel Kusswurm, Analyst

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

Scott Salmirs, President and Chief Executive Officer

Yes. Thanks for the question. Look, I think for us, I think we have to talk about 2021 when we set our ELEVATE goals and how much the market has changed, right? I mean we have this multigenerational structural shift in commercial real estate between hybrid work and the macroeconomic environment which is certainly going to put short-term pressure on us. And the interest rate environment has significantly changed since then, right? Not to mention what's happened with wage inflation, especially in the blue-collar segment. So that's definitely going to put pressure on us and we could see that pushing out our goals maybe a couple of years. But at the end of the day, we are firmly committed to these metrics and feel strongly we're going to hit our 7.2% margin, our free cash flow targets. The investments that we're making in ELEVATE. The ROI that we're seeing early on is so compelling between the hyper-targeting tool and probably, although the year is not over, we believe we're going to hit a fifth consecutive year in sales growth. So we're excited about that. I mentioned in my prepared remarks that we're seeing the labor productivity tool and the pilots, having 10% gross margin uplift. So we're absolutely firmly committed to our targets. It's just, again, maybe extended a couple of years.

Samuel Kusswurm, Analyst

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

Scott Salmirs, President and Chief Executive Officer

Yes, that's a great question. There have been no cancellations. This is all part of our backlog, which consists of signed contracts. These are significant projects, particularly in battery storage. Initially, we faced delays due to supply chain issues, but we've overcome those challenges. To get these installations completed, we must go through permitting and coordinate with utilities. For context, the battery farms we're installing are as large as one, two, or sometimes three football fields. This market is still developing, and local governments are also adjusting to the permitting process, which is causing some delays. Of our nine projected projects, two are set to occur this year, so progress is being made, although starts are delayed, reflecting the market's maturity. Regarding the RavenVolt acquisition and the microgrid space, we've become even more convinced that this was a valuable acquisition for us and that we're in the right sector. Alternative energy is certainly the future of this country. In Denmark, for example, weather forecasts include details about how much of the country is powered by alternative energy, often reaching 100% or more on some days. This is the direction we're headed, and we're enthusiastic about it. However, we need to adapt to the nature of these large projects, as their timing can be inconsistent, influencing our quarter-to-quarter performance. We're learning this as we progress.

Samuel Kusswurm, Analyst

Got you. Thanks for the insights, Scott.

Operator, Operator

Thank you. The next question is coming from Faiza Alwy of Deutsche Bank. Please go ahead.

Faiza Alwy, Analyst

Yes, hi. Good morning. So I wanted to follow up on that line of questioning. You mentioned a few things, Scott, as it relates to the ATS delays. You mentioned sort of higher interest rates and potentially lower ROI, the government permitting issues and the delay around EV charging installations. Can you help us think through sort of each of those factors, like how much has that been an impact this year? And when do you expect each of these to resolve, so I have a follow-up after that.

Scott Salmirs, President and Chief Executive Officer

Yes, let me focus on electric vehicles, which may be beneficial since I just talked about RavenVolt and microgrids. We previously mentioned that we are shifting our strategy from dealerships to larger fleet and infrastructure projects, and our pipeline for these projects is very strong. We anticipate developments in 2024. However, we were relying on a dealership partnership with a major original equipment manufacturer, which has adjusted its production goals for this year. As a result, our connection to that partnership has been somewhat disrupted for the remainder of this year due to their postponed rollout plans. We expect to see progress in 2024, and this is why we are optimistic about ATS in 2024. With the microgrid projects moving to next year and the expected ramp-up in the dealership program for electric vehicles, we are feeling confident. That said, this situation has created pressure for the remainder of 2024, which is reflected in our Q3 results. So, that's the situation with electric vehicles.

Earl Ellis, Executive Vice President and Chief Financial Officer

And if I just add to that. If you look at our longer-term financial goals, which Scott just mentioned, will probably get pushed out a couple of years. A lot of what was driving those benefits were really driven by our ELEVATE initiatives. And the good news is the benefits associated with ELEVATE are still very well intact. In fact, we've already probably reaped about 50% of those benefits to date. Now some of the headwinds we've actually seen in the business that Scott alluded to, so the interest rates, the softness that we're seeing in CRE, the continued wage inflation that we're experiencing, some of those things will continue. So if I break it down, the interest rates, we believe, have kind of plateaued, and we've now built that we're going to be building that into our projections to come. CRE, we expect softness to continue into 2024. And the wage inflation, the teams have really done a great job in counteracting that with price increases. So the good news is that some of these headwinds that we've seen that have actually offset the benefits with regards to ELEVATE will subside. Therefore, we still are expecting to hit those long-term ELEVATE benefits, however, probably two years out.

Faiza Alwy, Analyst

Okay. That's really helpful. I was going to follow up on that. I guess if I think about then your comment that 2024 EPS might be below $23 million, if ATS is going to sort of see this recovery and interest rates have stabilized, it seems like it's more around wages in the commercial real estate market. I guess, what is your opinion on the commercial real estate market? And sort of what inning are we in, in your opinion?

Scott Salmirs, President and Chief Executive Officer

Yes, this situation is primarily related to commercial real estate. A significant portion of our revenue, about 50%, comes from Business and Industrial. With the ongoing compression, tenants are now occupying roughly 19% less space on average. This reduction in demand will impact our earnings per share next year, particularly since Business and Industrial is one of our highest-margin areas. However, we do have some resilience, as one-third of our revenue in this sector comes from engineering, which remains more stable and isn't affected by demand compression due to consistent air conditioning needs, regardless of occupancy. The remaining two-thirds is linked to commercial real estate, and we anticipate experiencing pressure there. We wanted to communicate this outlook for next year ahead of our guidance, noting that we usually see growth of 2% to 3% in Business and Industrial. Given the current compression, it's evident that we might see a decline of about negative 2% to 3%. In light of the significant structural changes in commercial real estate, it's worth noting that if we only experience a low single-digit decline in Business and Industrial, it demonstrates the resilience of our business model. Coupled with our flexible labor approach and our ability to maintain margins, we believe our situation is still compelling, though we cannot overlook that we will be affected by the demand decrease resulting from ongoing compression.

Faiza Alwy, Analyst

Got it. Thank you so much.

Scott Salmirs, President and Chief Executive Officer

Sure.

Operator, Operator

Thank you. The next question is coming from Andy Wittmann of Baird. Please go ahead.

Andrew Wittmann, Analyst

Okay. Thanks for taking my question guys and good morning. Your response so far to the questions has been helpful for the context in '24. I just wanted to touch on one other thing regarding that outlook that I think would be incremental. In your prepared remarks, Scott, you kind of talked about in the M&D segment, which has been a very good segment for you over the last several years, very good growth. Obviously, very good margins here. But here you said that there's a large client that's got a rebid, and this is an area that you're going to see some revenue pressure here. Do you still expect that the M&D segment margin can show some growth even with some potential revenue pressure that you might be looking at there? I guess because as I go through the segments here, you made it very clear in the last response, B&I is the area where you're seeing the most pressure. These other areas seem like pretty good with ATS maybe being very good on a year-over-year basis next year. So I guess the one area that I want to get a better sense on is this M&D segment. Please?

Scott Salmirs, President and Chief Executive Officer

Yes, that's great. I'm in a unique position as we're finalizing our budgets and preparing guidance, but I want to provide some insight. Let me start by saying that M&D is one of the best initiatives from our management team in recent years, and it's been beneficial. However, we face some challenges due to our success, particularly with a large client we've grown alongside. They are currently going through a rebid process, which we anticipate will lead to revenue compression. We'll still maintain a significant share of their work, but this situation will apply pressure on the M&D segment. However, excluding this issue, M&D as a whole is expected to grow in the high single-digit to low double-digit range and retains its appealing qualities. We just need to consider the challenges posed by this rebid. While it's too soon to determine if margins will increase next year, we expect them to remain stable, though there will likely be some revenue pressure. Overall, M&D remains a valuable area for us, and I believe this is more of a temporary situation than a fundamental shift.

Andrew Wittmann, Analyst

That makes sense. For my follow-up, let's discuss ATS. The early COVID funding from the federal government affected schools in several ways, particularly regarding capital projects for ventilation and air conditioning. Many schools have moved forward with those projects, and I believe your business benefited from that. How much of the challenges you're observing in this area, specifically in the education sector, is related to the federal funds that have supported that market for the past couple of years? I know you mentioned interest rates, but is there another impact influencing the pressures you're experiencing today?

Scott Salmirs, President and Chief Executive Officer

Yes, I don't want to oversimplify, but much of this is influenced by interest rates. These projects are almost entirely financed. When a school considers its infrastructure and major projects, they evaluate them based on the interest rate environment and the return on investment. Rising interest rates pressure those returns. As a result, some schools must upgrade their air conditioning and lighting systems despite the return on investment, so they continue to move forward with those changes. That's why our BES segment isn't at a standstill; it's under pressure, but projects are still occurring. The real pressure is on optional projects that are more marginal. Many of these aren't being canceled; they are just being delayed. We don't expect the interest rate environment to improve significantly soon, so we anticipate continued pressure in 2024. However, the BES segment is doing reasonably well. Looking ahead five years, we remain optimistic. Until interest rates provide some relief and returns become more attractive, there will be pressure. As we pursue new opportunities, we are focusing on projects that schools must complete, but that requires time for planning and preparation. The influence of interest rates is the main factor.

Andrew Wittmann, Analyst

Okay. Thanks for the commentary, guys. Have a good day.

Scott Salmirs, President and Chief Executive Officer

Appreciate it.

Earl Ellis, Executive Vice President and Chief Financial Officer

Thanks.

Operator, Operator

Thank you. The next question is coming from Sean Eastman of KeyBanc Capital Markets. Please go ahead.

Nicholas Breckenridge, Analyst

Hey, guys. This is Nick Breckenridge for Sean today. Yes, I just wanted to sort of ask more about some of those prepared remarks you made, Scott, particularly that comment about how the CRE conditions are going to flow through in the model in '24. Just if you could give more color into the sort of how that labor market tightness would that improve visibility on the out-year margin trends with just being sort of less, I mean, less occupancy rates are going to drive. I mean, maybe less more, I guess, more flexibility. Could you just provide more color on that, please?

Scott Salmirs, President and Chief Executive Officer

Sure. The core of our B&I segment lies in our flexible labor model. To put it simply, if a tenant reduces their space from five floors to four, we can release the staff from the vacated floor. This flexibility helps us maintain our margins. We see some encouraging trends with people returning to work, despite the ongoing macroeconomic challenges and clients taking up less space, which will lead to reduced demand. However, we appreciate the flexibility we have on the cost side, and this is crucial for B&I’s continued success over the years.

Nicholas Breckenridge, Analyst

Thank you for that. I have one more follow-up regarding ATS. Looking ahead, if projects start moving out of backlog and the BES returns, will you have more clarity on whether ATS can maintain a positive growth trend in operating income? Would that be an accurate assessment?

Scott Salmirs, President and Chief Executive Officer

Absolutely, absolutely. As we look out over the next year or two, ATS we see going back to what it's historically been over many years, which is top line double-digit growth and bottom line double-digit growth there as well. So this is one of our most exciting segments and will continue to be so.

Nicholas Breckenridge, Analyst

Awesome. Thanks, guys.

Scott Salmirs, President and Chief Executive Officer

Thank you.

Operator, Operator

Thank you. The next question is coming from Marc Riddick of Sidoti. Please go ahead.

Marc Riddick, Analyst

Hey, good morning.

Scott Salmirs, President and Chief Executive Officer

Good morning.

Earl Ellis, Executive Vice President and Chief Financial Officer

Good morning.

Marc Riddick, Analyst

So a lot of my questions have been answered. I was sort of curious as to whether you can sort of give us a bit of an update as to maybe some of the opportunities that you might see in the acquisition pipeline, valuations that you're seeing and maybe sort of your appetite as far as if there are some things out there that might make sense in this environment?

Scott Salmirs, President and Chief Executive Officer

Yes. One of our biggest opportunities is our capital structure, right? I mean we're at 2.3 times leverage. So we have plenty of powder not only from an M&A standpoint, but share buyback from our dividend standpoint. We have a lot of levers to pull in '24, Mark, which we're excited about. And the M&A pipeline is probably not as robust as it was a couple of years ago just because of the financial markets, right? But we still have a pipeline there is stuff that we're working on, and we'll update you as that happens. But thankfully our capital structure and our strong free cash flow is one of the accelerators for ABM as we move forward.

Marc Riddick, Analyst

Excellent. And along those lines, with the investment spending for be it technology personnel and the like I know there's been really some of that as you prepare for future opportunities. Are there any areas that you feel as though as the timing or being able to pull the trigger on some of those types of investments? Has that changed at all? Or are there any areas that actually might need to be accelerated more so than maybe what you may have thought a year ago?

Scott Salmirs, President and Chief Executive Officer

No, I think we still have our ELEVATE plan and our CADENCE. Most of the funds for ELEVATE have already been deployed, which is positive. As a result, you can expect an increase in free cash flow over the next couple of years. We are on track with our plans. There’s a lot happening here, and I must say that the return on investment is proving to be exactly what we anticipated, if not better.

Marc Riddick, Analyst

Okay. Lastly, regarding labor availability, I know it can be somewhat challenging. I want to discuss whether there has been much change in this area over the last six months, particularly if there are specific regions where the situation has improved or if there are areas where it has become more difficult.

Scott Salmirs, President and Chief Executive Officer

I'm glad you asked that question because I should have addressed it. We are seeing positive signs in the labor markets regarding participation rates and applicant flow. This has allowed us to reduce our overtime as we've been able to hire more effectively. However, wage inflation remains a challenge, currently in the 5% range, which is a significant headwind. We initially anticipated it to be around 3%. Being at 5% now is a big deal, but our operations team has done an excellent job with price increases and recovery, and we're operating in the 75% to 80% recovery range, which is best-in-class. The good news is that candidate flow is improving, with more people coming in. We just need to address wage inflation, but we don't currently have a solution for that.

Marc Riddick, Analyst

Great. Thank you very much.

Scott Salmirs, President and Chief Executive Officer

Thanks, Marc.

Operator, Operator

Thank you. The next question is coming from Josh Chan of UBS. Please go ahead.

Joshua Chan, Analyst

Hi. Good morning Scott, Earl and Paul. Thanks for taking my questions. Yes, I guess on your comments about 2024 EPS being slightly down, I guess, does that scenario require total revenue to be down? Because otherwise, I would have thought that the ATS recovery and a couple of small items could at least give you some EPS growth next year.

Scott Salmirs, President and Chief Executive Officer

Yes, I don't believe that our total revenue as an enterprise will necessarily decline. It will face some challenges, but the key focus, Josh, is on the business mix. The B&I segment may potentially drop by two or three points, and it's important to remember that B&I is one of our highest margin segments. So, the issue is really about the mix, and since B&I constitutes 50% of our business, its decline affects our EPS. This situation reflects a shift in the business mix, but it shouldn't suggest that the firm as a whole will experience organic decline. We have other segments performing very well right now, although it's challenging to offset the impact of one segment that represents half of our revenue and is high margin.

Joshua Chan, Analyst

That's right. That's good color there. Thank you. And then my follow up. So I guess in the past, you've been able to do a good job of maintaining margins flattish to maybe even higher during downturn. You mentioned the flexible labor model. Could you talk about the ability to do that again in this downturn within B&I? What are the pluses and minuses of achieving that next year?

Scott Salmirs, President and Chief Executive Officer

It's still too early to determine our guidance for 2024. However, our flexible labor model has been effective in protecting margins across all segments. While I hesitate to provide specific margin guidance at this stage, I want to emphasize that we have the capability for structural cost adjustments at an enterprise level. We still have sufficient labor resources, and we remain confident in our target of achieving 7.2% as stated in our ELEVATE call for the future. We have always acknowledged that this is not going to be a straight path, and while we couldn't have anticipated the significant structural changes in commercial real estate, we are committed to reaching our 7.2% goal.

Joshua Chan, Analyst

Okay. Great. Thanks for the color and thanks for the time spent.

Scott Salmirs, President and Chief Executive Officer

Thanks.

David Silver, Analyst

Good morning. I want to begin with a couple of questions for Earl. In this quarter, there were significant positive nonrecurring items, specifically the employee retention credit and the contingent consideration adjustment. First, regarding the $22 million employee retention credit, is that the total amount, or will there be adjustments or potential for additional credits in the future? Secondly, could you explain the adjustment to the RavenVolt purchase price? It has an incentive-driven purchase structure. I previously asked this question when the adjustment was smaller, but I'm curious if the revenues are somewhat lower along with the adjusted EBITDA and how the project delays might factor in. Is it possible that these delays could provide an unanticipated benefit? In other words, while the business maintains its full value long-term, could these permitting issues actually work in our favor during the incentive period? I'd appreciate any insights on both of these points.

Earl Ellis, Executive Vice President and Chief Financial Officer

Sure. Yes. Let me start with the question about the ERC. The majority of the credit has come in, as we applied for all eligible credits. We'll see some more trickling in, but nothing significant. Regarding the contingent liability, as Scott mentioned earlier, much of what we've seen with RavenVolt this year is due to delays, particularly in permitting. This means that for the first year, we will see virtually no consideration or earn-out. Looking ahead at the forecast and adjusting for risk from an accounting perspective, it results in a lower contingent liability. However, our teams are more committed and motivated than ever to drive as much EBITDA and profit as possible. Long-term, we remain very optimistic about the value this acquisition will create. I also want to note that when we modeled the deal for RavenVolt, it did not assume an earn-out, and it actually has a significant payback. So in the long run, I believe it will still be value accretive, and we see great opportunities ahead.

David Silver, Analyst

I'd like to revisit the comment about the ATS backlog, which stands at $450 million as of the end of July. Can you provide some context on that? How does it compare to the backlog at the beginning of this fiscal year or a year ago? What should we consider regarding the growth of that backlog in the medium term? Thank you.

Scott Salmirs, President and Chief Executive Officer

Yes. I mean it's as high as it's been. This backlog is so strong. And I think the significant part of the backlog is that it's happening in EV and microgrids. And that's what's compelling because, as you know, that's been the areas of investment for the firm over the last couple of years. So I think it validates that we're playing in the right space. So backlog is strong.

David Silver, Analyst

Okay. I want to follow up on Scott's earlier comment about certain segments of your business performing exceptionally well. I understand there may be some concerns affecting sentiment today. However, I noticed the organic growth figures in aviation, manufacturing, distribution, and education are historically impressive. Could you elaborate on any common themes driving this growth? Is it due to improvements in labor procurement and evaluation, or perhaps a bundled service offering? In your core segments, unaffected by commercial real estate issues, what factors are contributing to this above-average organic growth?

Scott Salmirs, President and Chief Executive Officer

Yes. Our success is largely due to a strong emphasis on business development. We have dedicated resources for sales effectiveness, employing tools like Salesforce and a CRM model, along with our hypertargeting tool developed with ELEVATE that allows us to pinpoint opportunities and pursue them strategically. This has led to a focused and strategic approach to business development, helping us determine where we have a competitive advantage, and it has been very rewarding for us. I believe this is the key to our success.

Operator, Operator

Thank you. At this time, I would like to turn the floor back over to management for closing comments.

Scott Salmirs, President and Chief Executive Officer

Yes. I just want to thank everybody for participating today. Again, we've talked about some of the impediments, but we are as confident as ever about what's going on at ABM and excited to come back to you next quarter with our results and our full year guidance. But have a good fall and we'll see you in December. Thanks, everybody.

Operator, Operator

Ladies and gentlemen this concludes today's event. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.