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 þ     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.  o

 

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, 2010 (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 $1,100,912,951 computed by reference to the price at which the common stock was last sold.

 

Number of shares of common stock outstanding as of December 10, 2010: 52,659,190.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Proxy Statement to be used by the Company in connection with its 2011 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, 2010

TABLE OF CONTENTS

 

 

 

 

Introduction

 

ABM Industries Incorporated (“ABM”), through its subsidiaries (collectively, the “Company”), is a leading provider of facility services in the United States. With 2010 revenues of approximately $3.5 billion, the Company provides janitorial, parking, security and engineering services for thousands of commercial, industrial, institutional, governmental and retail client facilities in hundreds of cities, primarily throughout the United States. The Company employed approximately 96,000 employees at October 31, 2010, the vast majority of whom are service employees.

 

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.

 

Acquisitions

 

On December 1, 2010, the Company acquired The Linc Group, LLC (“Linc”) pursuant to an Agreement and Plan of Merger, dated as of December 1, 2010 (the “Merger Agreement”), by and among ABM, Linc, GI Manager LP, as the Members Representative, and Lightning Services, LLC, a wholly-owned subsidiary of ABM (“Merger Sub”). Pursuant to the Merger Agreement, Merger Sub merged with and into Linc, and Linc continued as the surviving corporation and as a wholly owned subsidiary of ABM. The aggregate purchase price for all of the outstanding limited liability company interests of Linc was approximately $301.0 million, subject to certain adjustments as set forth in the Merger Agreement. With annual revenues of approximately $579 million and approximately 3,000 employees, Linc provides end-to-end integrated facilities management services that improve operating efficiencies, reduce energy consumption and lower overall operational costs for more than 25,000 facilities in the government, commercial and residential markets throughout the United States and select international markets. The operations of Linc will be included in the Engineering segment as of the acquisition date. Except where specifically indicated, the information contained in the Annual Report on Form 10-K does not include information related to Linc.

 

On October 1, 2010, the Company acquired select assets of Five Star Parking, Network Parking Company Ltd., and System Parking, Inc. (“L&R”) from the L&R Group of Companies for an aggregate purchase price of $34.7 million, including $0.2 million of assets distributed as consideration. The Company incurred $0.4 million of direct acquisition costs, which were expensed as incurred. L&R employs approximately 2,500 people and services more than 450 client accounts across the United States. The acquisition extends and expands the Company’s parking business in major cities. The acquisition also expands the Company’s presence at airports. The results of operations of L&R are included in the Company’s Parking segment as of the acquisition date. The amounts of L&R revenues and operating profit included in the Company’s consolidated statements of income for fiscal year 2010 were $14.9 million and $0.4 million, respectively.

 

On June 30, 2010, the Company acquired all of the outstanding shares of Diversco, Inc. (“Diversco”) from DHI Holdings, Inc. for $30.6 million in cash and incurred direct acquisition costs of $0.2 million, which were expensed as incurred. The purchase price was subsequently adjusted to $30.4 million in connection with a working capital adjustment. Diversco is a national provider of outsourced facility services. The acquisition expands the geographic reach of the Company’s janitorial and security businesses, particularly in the Southeast, Midwest and Mid-Atlantic regions of the United States. The results of operations of Diversco are included in the Company’s Janitorial and Security segments as of the acquisition date. The amounts of Diversco’s revenues and operating profit included in the Company’s consolidated statements of income for fiscal year 2010 were $28.1 million and $1.2 million, respectively.

Segment Information

 

The Company conducts business through a number of subsidiaries that are grouped into four segments based on the nature of their business operations. At October 31, 2010, the four reportable operating segments were:

 

 

The business activities of the Company by reportable operating 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, educational institutions, stadiums and arenas, and government buildings. These services include 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 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 actual 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 cleanup after tenant moves, construction cleanup 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 Janitorial segment’s 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 in 38 states and the District of Columbia through 32 offices. The Company operates parking lots and garages at many facilities, including office buildings, hotels, medical centers, retail centers, sports and entertainment arenas, educational institutions, municipalities, and 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 managed arrangements, the Company manages the underlying parking facility for the owner in exchange for a management fee. Contract terms for managed arrangements are generally from one to three years, can usually be terminated 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 contract. Under leased location arrangements, the Company leases parking facilities from the owner and is responsible for a majority of the operating expenses incurred. Under these arrangements, 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 that 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 and is then responsible for the agreed-upon operating expenses based upon the agreement terms. Allowance contract terms are generally from one to three years, can usually be terminated 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 proprietary revenue control software, SCORE⁴; 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 in 37 states and the District of Columbia through 48 offices. Security services include: staffing of security officers, mobile patrol services, and 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 clients 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 SAFETY Act Certification from The U.S. Department of Homeland Security in 2008.

 

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 operate in 36 states and the District of Columbia through 9 branches and maintain national ISO 9000 Certification (“ISO”). ISO is a family of standards for quality management comprising 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 that provide comprehensive, cost-efficient solutions to help curb rising utility costs 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 Engineering segment’s contracts are cost-plus arrangements 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 14 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplemental Data,” for the operating results of the reportable operating segments.

 

Trademarks

 

The Company believes that it owns or is licensed to use all corporate names, trade names, 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 results in a very competitive market, and the Company experiences competition from a large number of mostly regional and local owner-operated companies, primarily located in major cities throughout the United States. The Company also competes on a national basis with the operating divisions of a few large, diversified facility services and manufacturing companies. 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, educational institutions, stadiums and arenas, and government buildings. No client accounted for more than 5% of the Company’s consolidated revenues during 2010, 2009 or 2008.

 

Employees

 

As of October 31, 2010, the Company employed approximately 96,000 employees. Over 40,000 of these employees are covered under collective bargaining agreements. Approximately 5,700 of the Company’s employees have 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 23, 2010 were as follows:

 

 

 

Risks Relating to our Operations

 

Risks relating to our acquisition of Linc and our acquisition strategy may adversely impact our results of operations.  On December 1, 2010, we acquired Linc, a global provider of technical building services that has significant domestic and international operations. The Linc acquisition effectively increased the Company’s engineering segment by approximately 165% when measured by revenues. Realization of the anticipated benefits of the acquisition will depend, among other things, upon our ability to timely integrate the Linc business successfully with our operations and to achieve the anticipated savings associated with reductions in offices, staffing and other costs. There can be no assurance that the acquisition of Linc or any acquisition that we make in the future will provide the benefits that were anticipated 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:

 

 

Portions of our historic growth have been 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 revenue 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, those described above in relationship to the Linc acquisition.

 

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 who 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 Services, Inc. (“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.

 

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. Additionally, adverse changes in occupancy rates 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. 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 on 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. 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. We have standby letters of credit collateralizing self-insurance claims and insurance deposits that represent amounts collateralizing self-insurance claims that we cannot access for operations. In addition, $25.0 million original principal amount of our investment portfolio is invested in auction rate securities that 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. In the past, we have experienced declines in the fair value of our investments in auction rate securities that we have determined to be other-than-temporary. If at any time in the future we determine that a further 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 clients to obtain financing, which could adversely impact our ability to collect amounts due from such clients or result in a decrease, or cancellation, of our services under our client contracts. Declines in our ability to collect receivables or in the level of client 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 or 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 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 businesses. 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 any 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.

 

Federal health care reform legislation may adversely affect our business and results of operations.  In March 2010, the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 were signed into law in the United States (collectively, the “Health Care Reform Laws”). The Health Care Reform Laws include a large number of health-related provisions that become effective over the next four years, including requiring most individuals to have health insurance and establishing new regulations on health plans. Although the Health Care Reform Laws do not mandate that employers offer health insurance, beginning in 2014 penalties will be assessed on large employers who do not offer health insurance that meets certain affordability or benefit requirements. Providing such additional health insurance

benefits to our employees, or the payment of penalties if such coverage is not provided, would increase our expense. If we are unable to raise the rates we charge our clients to cover this expense, such increases in expense could reduce our operating profit.

 

In addition, under the Health Care Reform Laws employers will have to file a significant amount of additional information with the Internal Revenue Service and will have to develop systems and processes to track requisite information. We will have to modify our current systems, which could increase our general and administrative expense.

 

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, 2010, approximately 43% 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 that, 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, 2010, the Company had corporate, subsidiary, regional, branch or district offices in approximately 296 locations throughout the United States, the Commonwealth of Puerto Rico and in British Columbia and Ontario, Canada. At October 31, 2010, the Company owned 11 facilities having an aggregate net book value of $3.6 million and which were located in: (1) Jacksonville and Tampa, Florida; (2) Portland, Oregon; (3) Houston, Texas; (4) Lake Tansi, Tennessee; (5) Kennewick, Spokane and Tacoma, Washington; and (6) Spartanburg, South Carolina.

 

Rental payments under long- and short-term lease agreements amounted to $106.2 million in 2010. Of this amount, $69.1 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 for the Company’s businesses.

 

 

The Company is involved in various claims and legal proceedings of a nature considered normal to its business, as well as in additional matters from time to time. The Company records accruals for contingencies when it is probable or known 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, among others, 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 subsidiaries of ABM 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.

 

On January 8, 2009, the Augustus case was certified as a class action by the Superior Court of California, Los Angeles County. On October 6, 2010, the Company moved to decertify the class and for summary judgment. The case has been stayed pending a decision by the court.

 

On September 29, 2010, the Batiz case was decertified as a class action by the United States District Court of California, Central District, and all opt-in plaintiffs were dismissed without prejudice.

 

On February 19, 2010, the United States District Court granted conditional certification of the class in the Khadera case as a federal “opt-in” class action. The Simpson case, which is a purported class action brought under state law, was filed in Washington State court subsequent to the decision of the federal court in the Khadera case and contains allegations generally similar to those made in the Khadera case.

 

On January 15, 2009, a federal court judge denied with prejudice class certification status in the Villacres case. That case, and the companion state court case filed April 3, 2008, in Los Angeles Superior Court were both subsequently dismissed with prejudice on summary judgment. On June 17, 2010, the United States Court of Appeals for the Ninth Circuit affirmed the decision of the district court, which had summarily dismissed with prejudice the Villacres case. The state court companion case, filed April 3, 2008 in Los Angeles Superior Court,

has also been dismissed with prejudice by the judge of the Los Angeles Superior Court. On October 22, 2010, the State Appellate Court affirmed the decision of the judge of the Los Angeles Superior Court.

 

The Company was a defendant in a lawsuit filed July 19, 2007 in the United States District Court, Eastern District of California, entitled U.S. Equal Employment Opportunity Commission, Plaintiff Erika Morales and Anonymous Plaintiffs One through Eight v. ABM Industries Incorporated et. al. (the “Morales case”). The plaintiffs in the Morales case alleged sexual harassment, discrimination and retaliation. In 2009, fourteen claimants joined the lawsuit alleging various claims against the Company. The case involved both Title VII federal law claims and California state law claims. In June 2010, the Company agreed to a settlement of $5.8 million for the Morales case. On September 27, 2010, the court accepted the settlement agreement and dismissed the case. Under the terms of the settlement, ABM also agreed to enter into a consent decree requiring a subsidiary to, among other things, track sexual harassment claims and monitor compliance with certain applicable laws.

 

 

 

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 December 10, 2010, there were 2,883 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, 2005 with a $100 investment in each of the Standard & Poor’s 500 Index ( “S&P 500 Index”) and the Russell 2000 Value Index, also made on October 31, 2005. The graph portrays total return, 2005 – 2010, 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.

 

COMPARISON OF CUMULATIVE FIVE YEAR TOTAL RETURN

 

 

 

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, 2010. 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, the financial results of this segment 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) Revenues in 2010 include revenues associated with the acquisitions of L&R and Diversco, which were acquired on October 1, 2010 and June 30, 2010, respectively, totaling $43.0 million. Beginning in 2008, includes revenues associated with the acquisition of OneSource, which was acquired on November 14, 2007. Revenues in 2007 included a $5.0 million gain 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 consist of total gains in connection with World Trade Center insurance claims of $80.0 million in 2006. Of the $80.0 million, $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 2010 and 2009 include adjustments to increase self-insurance reserves related to prior year claims by $1.2 million and $9.4 million, respectively, while 2008, 2007 and 2006 included adjustments to reduce self-insurance reserves related to prior years by $22.8 million, $1.8 million and $14.1 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 2010, 2009, 2008 and 2007 included $5.7 million, $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 2008.

 

Selling, general and administrative expense in 2010 included a $5.8 million litigation settlement related to the Morales case and a $3.4 million reversal of previously recorded share-based compensation expense, due to a change in the probability of achieving the financial performance targets established in connection with certain performance share grants.

 

Selling, general and administrative expense in 2008 included $68.0 million of integration related 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” sub-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 during 2009. The other-than-temporary impairment approximated $3.7 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 2009. (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 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, 2010, the Company had outstanding borrowings under its line of credit of $140.5 million, which is primarily associated with acquisitions.

 

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 other 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 2010, 2009, 2008 and 2007, unless otherwise indicated, are to fiscal years 2010, 2009, 2008 and 2007, respectively. The Company’s fiscal year is the period from November 1 through October 31. Except where specifically indicated, this discussion does not include the operations of Linc, which the Company acquired on December 1, 2010.

 

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 industrial activity, commercial office building occupancy and rental rates, air travel levels, tourism, and transportation needs at educational institutions and health care service facilities, among others.

 

On December 1, 2010, the Company acquired Linc pursuant to the Merger Agreement, dated as of December 1, 2010, by and among ABM, Linc, GI Manager LP, as the Members Representative, and Lightning Services, LLC, a wholly-owned subsidiary of ABM (“Merger Sub”). Pursuant to the Merger Agreement, Merger Sub merged with and into Linc, and Linc continued as the surviving corporation and as a wholly owned subsidiary of ABM. The aggregate purchase price for all of the outstanding limited liability company interests of Linc was approximately $301.0 million, subject to certain adjustments as set forth in the Merger Agreement. With annual revenues of approximately $579 million and approximately 3,000 employees, Linc provides end-to-end integrated facilities management services that improve operating efficiencies, reduce energy consumption and lower overall operational costs for more than 25,000 facilities in the government, commercial and residential markets throughout the United States and select international markets. The operations of Linc will be included in the Engineering segment as of the acquisition date.

 

On October 1, 2010, the Company acquired select assets of L&R from the L&R Group of Companies for an aggregate purchase price of $34.7 million, including $0.2 million of assets distributed as consideration. The Company incurred $0.4 million of direct acquisition costs, which were expensed as incurred. L&R employs approximately 2,500 people and services more than 450 client accounts across the United States. The acquisition extends and expands the Company’s parking business in major cities. The acquisition also expands the Company’s presence at airports. The results of operations of L&R are included in the Company’s Parking segment as of the acquisition date. The amounts of L&R revenues and operating profit included in the Company’s consolidated statements of income for 2010 were $14.9 million and $0.4 million, respectively.

 

On June 30, 2010, the Company acquired all of the outstanding shares of Diversco from DHI Holdings, Inc. for $30.6 million in cash and incurred direct acquisition costs of $0.2 million, which were expensed as incurred. The purchase price was subsequently adjusted to $30.4 million in connection with a working capital adjustment. Diversco is a national provider of outsourced facility services. The acquisition expands the geographic reach of the Company’s janitorial and security businesses, particularly in the Southeast, Midwest and Mid-Atlantic regions of the United States. The results of operations of Diversco are included in the Company’s Janitorial and Security segments as of the acquisition date. The amounts of Diversco’s revenues and operating

profit included in the Company’s consolidated statements of income for 2010 were $28.1 million and $1.2 million, respectively.

 

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 that 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.

 

Total revenues increased $13.9 million, or 0.4%, to $3,495.7 million in 2010 from $3,481.8 million in 2009. The Company’s growth in total revenues includes approximately $43.0 million of revenues attributable to the L&R and Diversco acquisitions described above. Excluding the L&R and Diversco acquisitions, revenues decreased $29.1 million, or 0.8%, in 2010, as compared to 2009. During 2009, the Company experienced losses of client contracts that exceeded new business, reductions in the level and scope of client services, contract price compression and declines in the level of tag work, primarily in the Janitorial segment. These losses and reductions continued to influence results throughout 2010. In addition, during 2010 the Janitorial segment continued to experience some additional reductions in the level and scope of client services and contract price compression. These revenue decreases in the Janitorial segment were partially offset by additional revenues from new clients and the expansion of services to existing clients in the Engineering segment.

 

Despite the reductions in revenues, the Company’s operating profit, excluding Corporate, increased $5.1 million, or 2.7%, to $193.1 million in 2010 from $188.0 million in 2009. This increase primarily related to increases in operating profit in the Engineering and Parking segments as a result of additional revenues from new clients and the expansion of services to existing clients and cost control measures in all segments, including lower compensation costs.

 

The Company’s largest operating segment is the Janitorial segment, which generated approximately 66.9% of the Company’s revenues and approximately 73.0% of the Company’s operating profit, excluding the Corporate segment, for 2010.

 

In addition to revenues and operating profit, the Company’s management views operating cash flows as a good indicator of financial performance, as strong operating cash flows provide opportunities for growth both organically and through acquisitions. Operating cash flows primarily depend on revenue levels, the timing of collections and payments to suppliers and other vendors, the quality of receivables, the timing and amount of income tax payments and the timing and amount of payments on self-insured claims. The Company’s cash flows provided by continuing operating activities were $140.7 million, $121.3 million and $62.3 million for 2010, 2009 and 2008, respectively.

 

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 third-party claims administrators. The Company compares actual trends to expected trends and monitors claims developments. 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 the findings with the Company, the specific case reserves estimated by the third-party claims administrators are provided to an 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 statements.

 

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 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 were reduced in 2008. Reduced claim costs, which the Company believes 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 $22.8 million reduction in the related self-insurance reserves, that was recorded in the Corporate segment.

 

During 2009, favorable trends observed during recent years did not continue. Specifically, the Company noticed the effects of (i) unfavorable developments (primarily affecting workers’ compensation in California and other states where the Company has 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 earlier 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 its expected losses for prior year claims, which resulted in an increase in the related self-insurance reserves of $9.4 million in 2009, that was recorded in the Corporate segment.

 

During 2010, the Company increased its reserves related to prior year claims by approximately $1.2 million, which was recorded in the Corporate segment. The increase resulted mostly from higher than expected losses in general liability claims. While expenses related to workers’ compensation claims were observed to be coming in higher for New York and Illinois, the impact of certain 2009 case law decisions in California was less than previously expected, offsetting the increases in the other states.

 

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 is focused on integrating recent acquisitions and 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 will continue to seek 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.

 

Liquidity and Capital Resources

 

 

 

At October 31, 2010, the Company had a $450 million syndicated line of credit (the “old Facility”). As of October 31, 2010, the total outstanding amounts under the old Facility in the form of cash borrowings and standby letters of credit were $140.5 million and $100.8 million, respectively.

 

In connection with the acquisition of Linc, the Company terminated the old Facility on November 30, 2010 and replaced it with a new $650 million five year syndicated line of credit (the “new Facility”). The new Facility is scheduled to expire on November 30, 2015, with the option to increase the size of the new Facility to $850 million at any time prior to the expiration. Borrowings under the new Facility were used to acquire Linc on December 1, 2010, as well as pay down the outstanding balances under the old Facility. The new Facility is available for working capital, the issuance of standby letters of credit, the financing of capital expenditures and other general corporate purposes, including acquisitions. The Company’s ability to draw down available amounts under the new Facility is subject to compliance with certain financial covenants, including covenants relating to consolidated net worth, a fixed charge coverage ratio and a leverage ratio. In addition, other covenants under the line of credit include limitations on liens, dispositions, fundamental changes, investments and certain transactions and payments. See Note 16 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information.

 

As of November 30, 2010, the Company was in compliance with all covenants under the new Facility and expects to be in compliance in the foreseeable future.

 

The Company believes that the cash generated from operations and amounts available under the new Facility will be sufficient to fund the Company’s operations and cash requirements, except to the extent cash is required for significant acquisitions, if any.

 

Working Capital.  Working capital decreased by $3.4 million to $274.9 million at October 31, 2010 from $278.3 million at October 31, 2009. Excluding the effects of discontinued operations, working capital increased by $2.1 million to $270.7 million at October 31, 2010 from $268.6 million at October 31, 2009.

 

Cash Flows from Operating Activities.  Net cash provided by operating activities was $149.9 million, $140.9 million and $68.3 million in 2010, 2009 and 2008, respectively.

 

The $9.0 million increase in 2010 compared to 2009 was primarily related to:

 

 

partially offset by:

 

 

 

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

 

 

Cash Flows from Investing Activities.  Net cash used in investing activities was $87.9 million, $37.5 million and $421.5 million in 2010, 2009 and 2008, respectively.

 

The $50.4 million increase in net cash used in investing activities in 2010, compared to 2009, was primarily related to a $44.4 million increase in cash paid for asset and business acquisitions and additional consideration paid for prior years acquisitions in 2010, compared to 2009.

 

In 2010 the Company paid $62.3 million for the L&R and Diversco acquisitions, net of cash acquired, and $3.3 million of additional consideration for the achievement of certain financial performance targets in connection with prior years acquisitions.

 

In 2009, the Company paid $15.1 million for the Control Building Services, Inc., Control Engineering Services, Inc., and TTF, Inc. (“Control”) acquisition and $6.0 million of additional consideration for the achievement of certain financial performance targets in connection with prior years acquisitions (excluding $1.2 million related to contingent amounts settled in stock issuances).

 

The $384.1 million decrease in 2009 compared to 2008 was primarily related to a $401.8 million decrease in cash paid for acquisitions and additional consideration paid for prior years acquisitions and a $15.5 million decrease in capital expenditures, partially offset by $33.4 million of proceeds received for the sale of the Lighting business in 2008.

 

In 2009, the Company paid $15.1 million for the Control acquisition and $6.0 million of additional consideration for the achievement of certain financial performance targets in connection with prior years acquisitions (excluding $1.2 million related to additional consideration settled in stock issuances).

 

In 2008, the Company paid $390.5 million and $27.3 million for the acquisition of OneSource and the remaining 50% equity of Southern Management Company (“Southern Management”), respectively, and $5.1 million of additional consideration paid for the achievement of certain financial performance targets in connection with prior years acquisitions (excluding $0.6 million related to contingent amounts settled in stock issuances).

 

Cash Flows from Financing Activities.  Net cash used in financing activities was $56.7 million and $96.0 million in 2010 and 2009, respectively, and net cash provided by financing activities was $232.2 million in 2008.

 

The $39.3 million decrease in net cash used in financing activities in 2010 compared to 2009 was primarily related to $25.5 million of net repayments on borrowings from the line of credit (which included the financing of the L&R and Diversco acquisitions for $64.9 million, excluding acquisition costs).

 

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

 

Commitments

 

As of October 31, 2010, 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.

 

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, 2010, the aggregate employee benefit plan liability, including the Company’s deferred compensation plans, was $28.5 million. Future benefits expected to be paid over the next 20 years are approximately $39.7 million.

 

The defined benefit and post-retirement plan liabilities as of October 31, 2010 assume future annual compensation increases of 3.5%, a rate of return on plan assets of 8.0% (when applicable), and discount rates in the range of 4.50% to 4.98%. The discount rates were determined using the individual cash flows of each plan. In determining the long-term rate of return for a plan, the Company considers the nature of the plan’s investments, historical rates of return, and an expectation for the plan’s investment strategies. The Company believes changes in assumptions will not have a material impact on the Company’s financial position and operating performance. The Company expects 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 $28.5 million as of October 31, 2010 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 $58.2 million, $47.9 million and $47.7 million in 2010, 2009 and 2008, respectively.

 

Line of Credit

 

As of October 31, 2010, the total outstanding amount under the old Facility in the form of cash borrowings was $140.5 million. The old Facility was scheduled to expire on November 14, 2012.

 

In connection with the acquisition of Linc, the Company terminated the old Facility on November 30, 2010 and replaced it with the new Facility. The new Facility is scheduled to expire on November 30, 2015. See Note 16 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information.

 

Standby Letters of Credit

 

The Company had $100.8 million of standby letters of credit as of October 31, 2010, primarily related to its general liability, automobile, property damage, and workers’ compensation self-insurance programs.

 

In connection with the Linc acquisition on December 1, 2010, the Company acquired $11.9 million of standby letters of credit as of the acquisition date.

 

Surety Bonds

 

The Company uses surety bonds, principally performance and payment bonds, to guarantee performance under various client 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, 2010, outstanding surety bonds totaled $112.5 million. The Company does not believe it will be required to draw upon these bonds.

 

In connection with the Linc acquisition on December 1, 2010, the Company acquired $98.4 million of outstanding surety bonds as of the acquisition date.

 

Unrecognized Tax Benefits

 

As of October 31, 2010, the Company had $101.7 million of unrecognized tax benefits. 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 13 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 Operations

 

COMPARISON OF 2010 TO 2009

 

 

Net Income.  Net income in 2010 increased by $9.8 million, or 18.1%, to $64.1 million ($1.21 per diluted share) from $54.3 million ($1.05 per diluted share) in 2009. Net income included income from discontinued operations of $0.3 million and a loss from discontinued operations of $1.2 million ($0.02 per diluted share) in 2010 and 2009, respectively.

 

Income from Continuing Operations.  Income from continuing operations in 2010 increased by $8.4 million, or 15.1%, to $63.9 million ($1.21 per diluted share) from $55.5 million ($1.07 per diluted share) in 2009.

 

The increase in income from continuing operations was primarily related to:

 

 

 

partially offset by:

 

 

Revenues.  Total revenues increased $13.9 million, or 0.4%, in 2010, as compared to 2009. The Company’s growth in total revenues includes approximately $43.0 million of revenues attributable to the L&R and Diversco acquisitions described above. Excluding the L&R and Diversco acquisitions, revenues decreased $29.1 million, or 0.8%, in 2010, as compared to 2009. During 2009, the Company experienced losses of client contracts that exceeded new business, reductions in the level and scope of client services, contract price compression and declines in the level of tag work, primarily in the Janitorial segment. These losses and reductions continued to influence results throughout 2010. In addition, during 2010 the Janitorial segment continued to experience some additional reductions in the level and scope of client services and contract price compression. These revenue decreases in the Janitorial segment were partially offset by additional revenues from new clients and the expansion of services to existing clients in the Engineering segment.

 

Operating Expenses.  As a percentage of revenues, gross margin was 10.3% and 10.5% in 2010 and 2009, respectively.

 

The gross margin percentages were affected by the following:

 

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses decreased $22.1 million, or 8.4%, in 2010 compared to 2009.

 

The decrease in selling, general and administrative expenses was primarily related to:

 

 

partially offset by:

 

 

Interest Expense.  Interest expense in 2010 decreased $1.2 million, or 21.1%, to $4.6 million from $5.9 million in 2009. The decrease was primarily related to a lower average outstanding balance and a lower average interest rate under the line of credit in 2010 compared to 2009. The average outstanding balance under the Company’s line of credit was $156.7 million and $212.9 million in 2010 and 2009, respectively.

 

Provision for Income Taxes.  The effective tax rates on income from continuing operations for 2010 and 2009 were 38.6% and 34.5%, respectively. The effective tax rates for 2010 and 2009 include $0.2 million of discrete tax costs and $4.4 million of discrete tax benefits, respectively. The tax benefits in 2009 were principally driven by the benefits of state tax rate increases on the carrying value of the Company’s state deferred tax assets and employment based tax credits.

 

Segment Information

 

The Company determined Janitorial, Parking, Security and Engineering to be its reporting segments in accordance with Accounting Standards Codification^tm (“ASC”) Topic 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, certain legal costs and settlements, certain information technology costs, share-based compensation costs, severance costs associated with acquisitions and certain chief executive officer and other finance and human resource departmental costs. Segment Revenues and operating profits of the continuing reportable operating segments (Janitorial, Parking, Security, and Engineering) for 2010 and 2009 were as follows:

 

 

 

Janitorial.  Janitorial revenues decreased $44.1 million, or 1.9%, during 2010 compared to 2009. Excluding the revenues associated with the Diversco acquisition, Janitorial revenues decreased $68.1 million, or 2.9%, during 2010, as compared to 2009. During 2009, Janitorial experienced losses of client contracts that exceeded new business, reductions in the level and scope of client services, contract price compression and declines in the level of tag work, which continued to influence results throughout 2010. In addition, during 2010, Janitorial continued to experience some reductions in the level and scope of client services and contract price compression as a result of decreases in client discretionary spending, partially offset by additional revenues from new clients.

 

Despite the reduction in revenues, operating profit increased $1.1 million, or 0.8%, during 2010 compared to 2009. The increase was primarily related to cost control measures, including a reduction in payroll and payroll related expenses, and $1.1 million of operating profit contributed by the Diversco acquisition.

 

Parking.  Parking revenues increased $11.9 million, or 2.6%, during 2010 compared to 2009. Excluding the revenues associated with the L&R acquisition, Parking revenues decreased $3.0 million, or 0.7%. The decrease in revenues, excluding the L&R acquisition, was primarily related to a $5.7 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 $2.7 million increase in lease and allowance revenues from new clients and the expansion of services to existing clients.

 

Operating profit increased $2.5 million, or 12.1%, during 2010 compared to 2009. The increase was primarily related to the increase in lease and allowance revenues, cost control measures and $0.4 million contributed by the L&R acquisition.

 

Security.  Security revenues increased $1.6 million, or 0.5%, during 2010 compared to 2009. Excluding the revenues associated with the Diversco acquisition, Security revenues decreased $2.4 million, or 0.7%. The decrease in revenues was primarily related to reductions in the level and scope of client services and contract price compression as a result of decreases in client discretionary spending.

 

Operating profit decreased $0.7 million, or 8.9%, in 2010 compared to 2009. The decrease was primarily related to margin compression.

 

Engineering.  Engineering revenues increased $45.1 million, or 14.8%, during 2010 compared to 2009. The increase was primarily related to additional revenues from new clients and the expansion of services to existing clients.

 

Operating profit increased by $2.3 million, or 11.7%, in 2010 compared to 2009, primarily related to the increase in revenues.

 

Corporate.  Corporate expense decreased $11.6 million, or 12.1%, in 2010 compared to 2009.

 

The decrease in Corporate expense was primarily related to:

 

 

partially offset by:

 

 

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 related 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 related to:

 

 

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 continued to feel the negative impact of the weak economic environment which resulted in reductions in the level and scope of services provided to 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 was due to the reduction of expenses incurred on the behalf of managed parking facilities, which were reimbursed to the Company. These reimbursed expenses were recognized as parking revenues and expenses and had 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 were 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 related to:

 

 

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.

 

Provision for Income Taxes.  The effective tax rate on income from continuing operations for 2009 was 34.5%, compared to 37.5% for 2008. The effective tax rates for 2009 and 2008 include $4.4 million and $0.9 million of discrete 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 the 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. 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, certain legal costs and settlements, certain information technology costs, share-based compensation costs, severance costs associated with acquisitions and certain chief executive officer and other finance and human resource departmental costs. 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 primarily related to reductions in the level and scope of services provided to

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 related 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 related 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 primarily related 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 primarily related 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 related 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 related 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 related to:

 

 

partially offset by:

 

 

Adoption of Accounting Standards

 

Effective November 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) updated authoritative standard for accounting for business combinations, which is included in ASC Topic 805 “Business Combinations” (“ASC 805”). Upon adoption, on November 1, 2009, the Company expensed approximately $1.0 million of deferred acquisition costs for acquisitions then being pursued. In addition, during 2010 the Company incurred an additional $1.3 million of acquisition costs related to the acquisitions of L&R and Diversco and other acquisitions currently being pursued.

 

Effective November 1, 2009, the Company adopted the FASB updated authoritative standard for determining the useful life of intangible assets, which is included in ASC Topic 350-30 “General Intangibles Other than

Goodwill” (“ASC 350-30”). This authoritative standard amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset and requires additional disclosures. This authoritative standard must be applied prospectively to all intangible assets recognized as of the effective date. This authoritative standard had no impact on the Company’s consolidated financial statements, but could impact the way in which the useful lives of intangible assets acquired in business combinations will be determined, if renewal or extension terms are apparent.

 

Effective November 1, 2009, the Company adopted the FASB updated authoritative standard on employers’ disclosures about post-retirement benefit plan assets, which is included in ASC Topic 715 “Compensation — Retirement Benefits” (“ASC 715”). The authoritative standard expands the annual disclosures by requiring additional disclosures about how investment allocation decisions are made by management, major categories of plan assets and significant concentrations of risk. Additionally, an employer is now required to disclose information about the valuation of plan assets similar to the disclosure required under ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC 820”). This authoritative standard did not have an impact on the Company’s consolidated financial statements as it only amended required annual disclosures. See Note 10 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for the required disclosures.

 

Effective November 1, 2009, the Company adopted the FASB authoritative standard on fair value measurements for non-financial assets and non-financial liabilities measured on a non-recurring basis, which is included in ASC 820. The Company’s non-financial assets and non-financial liabilities principally consist of intangible assets acquired through business combinations and long-lived assets. During 2010, the Company did not re-measure any non-financial assets or non-financial liabilities to fair value, therefore, this authoritative standard did not have any impact on the Company’s consolidated financial statements.

 

Effective February 1, 2010, the Company adopted FASB accounting standard update No. 2010-6, “Improving Disclosures about Fair Value Measurements,” issued in January 2010 related to fair value measurements and disclosures, except for the additional gross presentation disclosure requirements for Level 3 changes which will be adopted in the first quarter of 2012. The update requires entities to make new disclosures about recurring or non-recurring fair value measurements of assets and liabilities, including: (1) the amounts of significant transfers between Level 1 and Level 2 fair value measurements and the reasons for the transfers; (2) the reasons for any transfers in or out of Level 3; and (3) information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of recurring Level 3 fair value measurements. The FASB also clarified existing fair value measurement disclosure guidance about the level of disaggregation of assets and liabilities, and information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The Company did not have transfers of assets and liabilities between Level 1, Level 2 and/or Level 3 during 2010 and the required additional disclosures had no impact on the Company’s financial position or results of operations. See Notes 4 and 5 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for the required disclosures.

 

Critical Accounting Policies and Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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, estimates 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; 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 cost basis; (3) expected defaults; (4) available ratings for the 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 security’s amortized cost basis. Significant assumptions used in estimating credit losses include: (1) default rates for the security and the mono-line insurer, if any (which were based on published historical default rates of similar securities and consideration of current market trends) and (2) the expected life of the security (which represents the Company’s view of when market efficiencies for securities may be restored).

 

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. 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 $231.5 million, $231.0 million and $253.7 million in 2010, 2009 and 2008, 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 some of the Company’s management and service contracts, the Company allocates a portion of its insurance-related costs to certain clients, including workers’ compensation insurance. A material change in the Company’s insurance costs due to a change in the number of claims, costs or premiums, or changes in laws or other factors 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 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 their underlying exposures.

 

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 a client’s 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), 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. 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 assets are expected to be realized.

 

Goodwill.  Goodwill represents the excess of costs over the fair value of net assets of 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 each reporting unit with its 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. The estimated fair value of each reporting unit was significantly in excess of their respective carrying amounts as of the measurement date.

 

Income Taxes.  The Company’s deferred tax assets and liabilities are determined based on temporary differences between financial reporting and tax bases of assets and liabilities, and applying enacted tax rates expected to be in effect for the year in which the differences are expected to reverse. 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. The provision for income taxes is based on domestic (including federal and state) and international statutory income tax rates in the tax jurisdictions where the Company operates, permanent differences between financial reporting and tax reporting, and available credits and incentives. Interest and penalties related to uncertain tax positions are recognized in income tax expense. The U.S federal government is the Company’s most significant income tax jurisdiction.

 

Significant judgment is required in determining income tax provisions and tax positions. The Company may be challenged upon review by the applicable taxing authorities and positions taken may not be sustained. All, or a portion of, the benefit of income tax positions are recognized only when the Company has made a determination that it is more-likely-than-not that the tax position will be sustained upon examination, based upon the technical merits of the position and other factors. For tax positions that are determined as more-likely-than-not to be sustained upon examination, the tax benefit recognized is the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement. The development of reserves for income tax positions requires consideration of timing and judgments about tax issues and potential outcomes, and is a subjective critical estimate. In certain circumstances, the ultimate outcome of exposures and risks involves significant uncertainties. If actual outcomes differ materially from these estimates, they could have a material impact on the Company’s results of operations and financial condition.

 

Contingencies and Litigation.  Loss contingencies are recorded as liabilities when they are 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. If 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 include 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

 

At October 31, 2010, the Company’s exposure to interest rate risk related primarily to its cash equivalents and London Interbank Offered Rate (“LIBOR”) and Interbank Offered Rate (“IBOR”) based borrowings under the old Facility. At October 31, 2010, outstanding LIBOR and IBOR based borrowings of $140.5 million represented 100% of the Company’s total debt obligations. A hypothetical 1% increase or decrease in interest rates during 2010 on the average outstanding borrowings under the old Facility, net of the interest rate swap agreements, would have added to or reduced interest expense by approximately $0.6 million in 2010.

 

In connection with the acquisition of Linc, the Company terminated the old Facility on November 30, 2010 and replaced it with the new Facility. The new Facility is scheduled to expire on November 30, 2015. See Note 16 of the Notes to the Consolidated Financial Statements contained in Item 8, “Financial Statements and Supplementary Data,” for additional information.

 

Interest Rate Swaps

 

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%.

 

On October 19, 2010, the Company entered into a three-year forward starting interest rate swap agreement with an underlying notional amount of $25.0 million, pursuant to which the Company receives variable interest payments based on LIBOR and pays fixed interest at a rate of 0.89%. The effective date of the hedge is February 24, 2011.

 

These swaps are intended to hedge the interest risk associated with the Company’s forecasted floating-rate, LIBOR-based debt. As of October 31, 2010, the critical terms of the swaps 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 counterparties, when determining the fair value of the swaps.

 

As of October 31, 2010, the fair value of the interest rate swaps was a $0.4 million liability, of which $0.3 million and $0.1 million were included in Other accrued liabilities and Retirement plans and other, respectively, on the accompanying consolidated balance sheet. The effective portion of these cash flow hedges 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 transactions affect earnings. Any ineffective portion of the hedges is recorded immediately to interest expense. No ineffectiveness existed at October 31, 2010. The amount included in accumulated other comprehensive loss is $0.4 million ($0.3 million, net of taxes).

 

Investment in Auction Rate Securities

 

At October 31, 2010, 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 2010 would have added approximately $0.3 million of additional interest income in 2010.

 

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.

 

 

Report of Independent Registered Public Accounting Firm

 

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, 2010 and 2009, 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, 2010. 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, 2010, 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, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 2010, 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, 2010, 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 23, 2010

 

ABM Industries Incorporated and Subsidiaries

 

CONSOLIDATED BALANCE SHEETS

 

     See accompanying notes to the consolidated financial statements.

ABM Industries Incorporated and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME