ABM Industries Inc

NYSE:ABM

Earnings Call Transcript 2020-Q3

[Operator]

Greetings and welcome to the ABM Industries Inc. Q3 2020 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Susan Kim, Vice President of Investor Relations and Treasurer. Thank you, you may begin.

[Susan Kim, Vice President, Investor Relations, Treasurer]

Thank you all for joining us this morning. With us today are Scott Salmirs, our President and Chief Executive Officer, and Dean Chin, our interim Chief Financial Officer.

We issued our press release yesterday afternoon announcing our third quarter and fiscal 2020 financial results. A copy of this release and an accompanying slide presentation can be found on our corporate website.

Before we begin, I would like to remind you that our call and presentation today contain predictions, estimates and other forward-looking statements. Our use of the words estimate, expect, and similar expressions are intended to identify these statements. These statements represent our current judgment of what the future holds. While we believe them to be reasonable, these statements are subject to risks and uncertainties that could cause our actual results to differ materially. These factors are described in the slide that accompanies our presentation as well as in our filings with the SEC.

During the course of this call, certain non-GAAP financial information will be presented. A reconciliation of those numbers to GAAP financial measures is available at the end of the presentation and on the company’s website under the Investor tab.

I would now like to turn the call over to Scott.

[Scott Salmirs, President, Chief Executive Officer]

Thanks Susie. Good morning and thank you for joining us on today’s call to discuss our third quarter results.

As you saw in our press release, we reported revenues of $1.4 billion for the quarter. While this represents a 15% decrease versus last year, the aviation segment contributes more than half of that decline, as you’d probably expect. Excluding aviation, revenue was down less than 8%.

In addition, we saw trends improve as the quarter progressed across all of our other segments, and we saw another record quarter of pandemic-driven work orders particularly within the business and industry and technology and manufacturing segments. This offset some of the scope reductions that occurred with client disruptions and modified operations due to reduced occupancies.

We also expanded with key strategic accounts and other essential operations such as manufacturing facilities. Even within technical solutions, site access improved as the quarter advanced and we were able to restart churning through our strong backlog, so revenue has been resilient for us especially when contrasted against the reduction in commerce during the quarter.

Because of the dynamic nature of how our direct labor is structured, where we experienced scope reductions we aligned staffing to match the work. This preserves margin and can even enhance it as we find efficiencies through labor strategies and other tight controls.

Our quarterly performance also reflected some difficult decisions we made early on to prepare us financially for the uncertainty of the pandemic, which was right in front of us. At the beginning of the quarter in May, we instituted temporary reductions in salary across certain staff and management which included the executive team and the board. We also temporarily furloughed and reduced hours for certain corporate staff. Unlike many firms, we reduced or suspended benefits such as our 401-K matches. These were really hard decisions that had to be made but necessary to potentially protect liquidity and ensure business continuity during very uncertain times.

The combined impact of higher margin work orders, labor efficiencies, and corporate actions led to our significant year-over-year expansion in profit. Income from continuing operations grew to $56 million or $0.83 per share, and on an adjusted basis $50.1 million or $0.75 per share. Adjusted EBITDA margin rose to 7.9% versus 5.6% last year, so we couldn’t be more pleased with our performance.

We continued being disciplined on collections and payables during the quarter. Cash flow from operations was approximately $130 million or $121 million on a free cash flow basis. This was one of our all-time highs and enabled us to achieve leverage of 2.2 times. Our team understood how much of a priority this was and the results speak for themselves.

Now that we’ve successfully managed through the past six months, we’ve reversed many of the temporary cost reductions occurring during the third quarter. Of course, this doesn’t mean our intense focus on managing the business through changing conditions will relax in any way; in fact, much of the discipline we invoked during the past few months is now incorporated into our standard operating procedures.

The health and safety of our team members and our clients has been our top priority, and I’m so proud of the determination our people have shown during this time. We quickly adapted our standard operating practices to follow the guidelines of the CDC and other government authorities, as well as our own advisory council, and as an essential service provider our team members were tasked with being agile and responsive to the rapidly changing needs of our clients as they worked to protect their employees, their customers and their facilities. The feedback has been overwhelming and we believe this will have a lasting impact on retention.

I could spend hours on this call highlighting example after example of how our team members have made a difference during this stressful time. In the northwest independent school district of Fort Worth Texas, our education team members helped the district conduct four modified graduation ceremonies by cleaning and disinfecting throughout the event. Administrators were able to preserve this special occasion for nearly 1,500 students and create a celebratory, safe and sanitized environment.

In the U.K., our ABM team members were among those recognized by Prince Charles and London’s mayor, Sadiq Khan for our contributions in keeping the city’s transit system, the transport to London clean and hygienic, and as you most likely have seen, our frontline workers have been featured by numerous media outlets for our critical disinfection work across airports and airlines as the aviation industry continues to respond to the pandemic. Again, these few examples only touch on the many, many instances of ABM fulfilling our mission of making a difference.

As COVID persists, I continue to be inspired by how our team members face adversity with commitment and pride. These results don’t happen by accident. They happen through dedication to each other, operational excellence, and strong client relationships.

What do these results mean for the full year and beyond? As we stated in our release, we feel it would be imprudent to attempt a guidance outlook at this time. Recent events have redefined the concept of uncertainty and clients are still determining what the next few months will look like for them, and we are all still unsure of how COVID will play out. Dean will go through detail on some of the assumptions that could be considered at this juncture, but understand information continues to come in daily and we are still in a very dynamic period.

More to the point, as I mentioned earlier, we saw top line trends improve throughout the quarter. Is this encouraging? Absolutely; however, we can’t ignore how recoveries, reopening and resurgences are still at different stages across industries and regions. We are not at a point of sustainable clarity yet when it comes to questions like, how long do schools remain open or closed? How quickly will air travel start returning? Will there be a COVID spike this fall or winter, and what does that mean for office re-occupancy?

The diversity within our portfolio means there could be a variety of outcomes as well. Look at the variance between industries like aviation versus technology and manufacturing. As one sector faces headwinds the other is remaining strong, and headwinds don’t necessarily mean lower profitability. Our variable cost structure, especially with fixed fee and performance-driven contracts, has been a particular strength for us, so a lot remains highly unknown and not necessarily linear to results, but more than ever we appreciate the diversity in our portfolio mix.

Longer term, we firmly believe heightened awareness of safe and clean spaces is here to stay and we continue to invest in our EnhancedClean program to meet our clients’ needs. Our EnhancedClean program is a three-step approach that delivers healthy spaces with a certified disinfection process. We have an advisory council consisting of internal and external leading experts in infectious disease and industrial hygiene. This group will advise us on so many different aspects of ABM’s business going forward and provide significant value to our clients as they return to their spaces safely, navigate change, and deliver assurances to their employees, customers and the public by demonstrating trustworthy cleaning and disinfection.

During the quarter, we formally kicked off the first wave of our EnhancedClean deployment plan targeting our top clients and educating them on this unique offering. This will be a cornerstone for sustaining some of the higher margin demand we are currently seeing. Client commitments are spanning terms of six to nine months at a significantly higher margin profile that is reflective of the value we’re providing. Ultimately, the total penetration of work orders plus EnhancedClean can elevate our legacy margin profile regardless of operating environment.

In conjunction with the EnhancedClean launch, we recently unveiled a targeted media campaign called Safety Seen to generate demand. Visit our IR website or go to EnhancedClean.com to watch the video. This is the most comprehensive marketing strategy we have developed at the firm and we couldn’t be more enthusiastic. In fact, I’m thrilled to share that we recently crossed over the $100 million sales mark for our EnhancedClean program.

So many of our prestigious clients have begun to sign up, even clients like United Healthcare who are vested in the healthcare space and understand infection control. They want our services, which is tremendous validation. We are optimistic that we will continue growing our base, especially as we start to return to normalcy across our end markets and re-occupancy accelerates.

The $100 million mark in EnhancedClean was not the only milestone we reached. At the end of August, we crossed the billion dollar mark in new sales. As you know, this is typically our annual target. Normally we would wait until the fourth quarter for a sales update, but to have achieved this in August during such an unusual year where so much of commerce has paused is yet another testament of how remarkably our teams have executed, and we wanted to make sure we mentioned it on the call.

We will continue to build and invest in our sales effort as we’ve seen the powerful results of a well-trained sales force and an ingrained sales culture across the enterprise. Additionally, we will restart projects that were put on hold as the pandemic developed. We intend to revisit areas like our IT road map. We couldn’t be more pleased to have Melanie Kirkwood Ruiz on the team. As our new Chief Information Officer, she will be instrumental in determining how we re-engage these projects and accelerate towards a digital future.

Despite the unpredictability of these extraordinary times, we are committed to driving the momentum we experienced during the third quarter by managing the financial, operational and strategic elements within our control. As our results have demonstrated, our service excellence remains unparalleled and we are focused on leveraging our strengths to enable our organization, our clients and our communities to emerge from this pandemic even stronger.

Before I turn the call over to Dean for our financial results, I wanted to comment on the social and cultural movements that are currently sweeping the country. As a representative of 140,000 team members who work and contribute in communities all across this country, there has never been a more powerful time to live our company’s core values of respect, integrity and trust. We have a responsibility to those who dedicate themselves to ABM every day.

During the quarter, we launched an endeavor that we have been developing since the beginning of the year, ABM’s culture and inclusion council. This committee of our team members will be responsible for aligning our overarching business strategy with diversity at ABM. We will shape our organizational priorities to continue to nurture and advance an inclusive workplace. We also joined other New York City headquartered businesses through the Partnership for New York City to reassert our commitment to diversity and inclusion among our board, executive leadership, and our entire workforce. We will be supporting programs that reinforce and reflect that this is a top priority for ABM.

Fostering diversity is critical to our long term success and our ability to fulfill our vision of being the clear choice through our people. In all respects, we are going to continue to build a stronger ABM both financially and culturally.

I’ll turn the call over to Dean now, but not before thanking him for being our financial steward this quarter and continuing to drive excellence across the enterprise.

Dean?

[Dean Chin, Chief Financial Officer (interim)]

Thanks Scott.

Before I review our financial performance for the quarter, I would like to acknowledge our exceptional finance organization for persisting through another quarter end. Our teams continue to deliver during these complex times and I’ve never been prouder to be a member of this team. In addition, I wanted to express what a pleasure it has been to meet and connect with many of you on this call over these past few months.

Now for our quarterly results.

Revenues for the quarter were $1.4 billion, a total decrease of approximately 15% compared to last year, reflecting a full quarter of COVID-19 decreases in most of our business segments. Partially offsetting this revenue decline was record demand for work orders, which are the higher margin services we have been providing through the pandemic. Work orders were particularly elevated in business and industry and technology and manufacturing.

GAAP income from continuing operations was $56 million or $0.83 per diluted share compared to $36.5 million or $0.55 last year. Our current results reflect an $8.5 million favorable impact related to prior year self insurance reserves. We continue to see improvement in claim trends and we are encouraged by the sustained impact from our risk and safety program.

On an adjusted basis, income from continuing operations for the quarter increased to $50.1 million or $0.75 per diluted share compared to $40.2 million or $0.60 last year. On a GAAP and an adjusted basis, we achieved earnings growth versus last year as a result of higher margin revenue mix due to a significant increase in work orders and our ability to achieve efficiencies by aligning labor with decreased legacy services.

Additionally, as Scott referenced, we implemented temporary salary reductions, furloughs, and reduced hours for certain corporate staff and management. These actions contributed $18 million in the quarter on a pre-tax basis, or approximately $0.18 per share primarily in technical solutions and corporate, and more than offset certain increases in other expenses. This included bad debt related to client receivables primarily in the B&I segment and other expenses, including EnhancedClean. As it relates to bad debt, we will continue to exercise prudence as we monitor client receivables and overall credit conditions, particularly within certain sectors throughout this period.

Our overall performance during the quarter led to adjusted EBITDA of approximately $109.7 million and a margin rate of 7.9% compared to $93 million or 5.6% last year.

Now turning to segment results. As a reminder, these results reflect the full quarterly impact of COVID-19 compression on revenues as well as operating profit expansion due to direct and indirect labor management as revenues decline. Additionally, as I previously mentioned, these results also reflect segment-specific increases in bad debt reserves and investments facilitated with EnhancedClean.

B&I revenues were $756.9 million with operating profit growing more than 58% to $71.6 million at a margin rate of 9.5%. Consistent with last quarter, the decrease in revenue was driven by declines in [indiscernible] and to a lesser extent facility services. Partially offsetting this decline was substantially more demand for higher margin work orders as a result of pandemic-related client needs. This enabled us to generally maintain our janitorial work and created a more favorable mix during the quarter. The loss of certain lower margin contracts at the end of last year as well as new business starts and expansion with key clients further led to our profit growth for the quarter.

T&M reported revenues of $243.2 million, up 7.2% versus last year and even higher than last quarter. Operating profit was $24.5 million at an operating margin of 10.1%. T&M is experiencing strong resilience during the pandemic as many of our clients on the manufacturing side are providing essential services and remain open. This has driven an increase in work order demand particularly within the tech, logistics, and industrial manufacturing end markets. This enabled us to offset the revenue impact of any COVID-related compression and profit impact of higher margin account losses from last year.

Revenue in education was $188.6 million, down $26.8 million from last year, reflecting school closures. However, operating profit of $18.3 million increased considerably versus last year’s $12.6 million as a result of labor related savings associated with reduced revenue as this segment contains a higher degree of fixed fee and performance contracts.

This segment in particular can experience varying results depending on the impact of COVID-19. As schools reopen, revenues will expand but we will also be staffing to meet that demand. Conversely, if schools remain in hybrid states, we will still be performing work and have the ability to calibrate labor accordingly, so for this reason we must continue to monitor our K-12 and higher education portfolio given the sensitivity based on COVID resurgence patterns. Over time, we believe EnhancedClean will be an important part of our offering, and our technical solutions segment can alleviate potential budget constraints for school districts as they deal with the pandemic’s economic impacts.

Aviation reported revenues of $116.4 million and an operating loss of $8.2 million. With a revenue decline of more than 55% for the quarter, aviation continues to be our most impacted segment during the pandemic as global travel declines and flight reductions continue to pervade the industry. Accordingly, we have managed variable costs and expenses to match demand. Our results for the quarter included an approximately $4 million severance accrual unique to the U.K.

Looking ahead, we believe passenger travel will remain uncertain for the foreseeable future. As we outlined last quarter, we are actively pursuing a deliberate shift away from airline and expanding our airport portfolio. Recently we won a contract with the Port Authority of New York and New Jersey for airport shuttle bus services. As this shift continues, we will continue to manage labor and expenses acutely where possible. Through these strategies, our goal is to improve by the fourth quarter towards a breakeven position.

Finally onto technical solutions, technical solutions reported revenues of $119.2 million, down from last year’s $165.7 million. This decline reflects our limited site access which impeded our ability to churn our still strong backlog of approximately $170 million, particularly during the early part of the quarter. Operating profit of $13.2 million enabled us to support expenses and expand operating margin to 11.1% compared to 10.8% last year. Over the medium to long term, we believe our technical solutions business will see more opportunities in the market for budgeting solutions as municipalities and education facilities seek to overcome COVID-19.

We continue to demonstrate our disciplined approach to manage our working capital through our internal liquidity office, which we established last quarter. As a result, we achieved cash flow from operations of $130 million during the quarter and free cash flow of $121 million. This includes $42 million in deferred U.S. payroll taxes as a result of the CARES Act, which will be due in 2021 and 2022.

Due to our strong cash position, we ended the quarter with total debt including standby letters of credit of $916 million and a bank adjusted leverage ratio of 2.2 times. This leverage ratio reflects the substantial pay down of our precautionary revolver borrowings in March. Additionally, we ended the quarter with cash and cash equivalents of approximately $230 million, highlighting our ample liquidity to manage and drive our business during even the most uncertain times.

As we continue to navigate the current operating environment, we need to maintain our prudent approach to liquidity and capital allocation as we monitor client demand. We will prioritize organic endeavors such as our investment in EnhancedClean and our longstanding dividend policy. We will of course be opportunistic should we have greater visibility on what the future holds.

During the quarter, we paid our 217th consecutive quarterly cash dividend for a total distribution of approximately $12.3 million, and as stated in our earnings release, I’m pleased to share that the board of directors approved our 218th consecutive quarterly cash dividend.

Now onto guidance. As we stated in our press release, it remains difficult to provide an accurate range given the variability of outcomes that can occur in this environment; however, I would like to provide some additional context for the fourth quarter based on our current view of the business.

Given the month-to-month top line improvement we saw during Q3 and new business wins, we believe we can continue to offset some of the COVID compression. As a result, we could see flat to modest sequential improvement in organic revenue for the fourth quarter. Additionally, based on what we saw during the quarter, we do not anticipate a material slowdown in our higher margin work, and labor management will also be an ongoing area of focus dependent on demand. As Scott described, depending on the level of work we perform, labor can modulate up and down leading to varying degrees of labor efficiencies.

The fourth quarter will have one less working day, which could lead to approximately $6 million in lower labor expense. As a result of our positive quarterly performance and our ample liquidity position, the temporary staff and management costs I described earlier concluded and therefore under the current circumstances will not materially impact the fourth quarter.

In addition to these operationally driven elements, I also want to discuss our assumptions for interest expense, capital expenditures, and income taxes for the remainder of the year and potentially next year as well.

First on interest, based on the aforementioned operating assumptions and our current cash position, we do not anticipate a significant increase in borrowings for the fourth quarter. As such, we believe interest expense will be approximately $10 million for the quarter.

Next, as I mentioned earlier, we plan to continue managing working capital and liquidity conservatively to ensure we are prepared if conditions rapidly change in the near term. Therefore, we do not anticipate a material increase in capital expenditures to occur during the fourth quarter. As Scott discussed, we will be reviewing our strategic priorities over the next few months to determine which additional investments we will re-engage as we adjust to our new norm.

We are also assuming that any government related benefits in the U.K. and the U.S, such as the CARES Act, will not reoccur. This should be considered when ascertaining free cash flow for next year. Obviously we will continue to drive higher free cash flow conversion through the disciplines we have sharpened over the past few months.

Lastly, related to taxes, I wanted to remind everyone that given the disruptions to traditional hiring practices due to the pandemic, we continue to believe [indiscernible] will be less than our original pre-COVID expectation of $7 million and this could continue into next year as well.

In conclusion, while there are clearly a number of variables that we must consider during these unprecedented times, our results underscore how exceptionally our teams have executed. This foundation has strengthened our ability to navigate towards a profitable future.

Operator, we are now ready for questions.

[Operator]

[Operator instructions]

Our first question comes from the line of Tim Mulrooney of William Blair. Please proceed with your questions.

[Tim Mulrooney, William Blair]

Scott, Dean, good morning. Congrats on a great quarter.

[Scott Salmirs, President, Chief Executive Officer]

Hey, thanks so much.

[Dean Chin, Chief Financial Officer (interim)]

Thank you Tim.

[Tim Mulrooney, William Blair]

Yes, so a couple questions here. First of all, your consolidated EBITDA margin expanded by 230 basis points in the third quarter. Can you talk a little bit about how much of that was from higher margin EnhancedClean work versus labor efficiencies versus furloughs, and as I’m thinking about these three buckets, can you share with us what that implies from a broader perspective when we’re thinking about your longer term EBITDA target margin range of 5.6% to 6%?

[Dean Chin, Chief Financial Officer (interim)]

Thanks Tim. As you would expect, our 230 basis point margin expansion had puts and takes. First, I would like to describe the positive items that drove on a gross basis 320 basis points. During the quarter, as we described, we had temporary salary, furlough and work hour reductions that had an impact of 130 basis points. Also included in the 320 basis point gross was the impact of labor efficiencies as we managed the COVID revenue compression, the significant higher demand that we had from work order demand, and there were also certain fixed overhead costs that we were unable to leverage during the quarter, as you would expect.

Also in this 320 basis points was 100 basis points related to bad debt as we continued to monitor our credit worthiness for certain clients, and also our investment in EnhancedClean.

[Scott Salmirs, President, Chief Executive Officer]

Yes, and what I would add, Tim, too is that when you think of even the medium term now and what this means for us, we’ve talked in the past about the right zone for us, so we would say the golden zone was 5.5% to 6% EBITDA margin, and I think what this does--what COVID’s doing is accelerating that for us. We are really enthusiastic about where we’re heading, and there’s been certain disciplines that have happened within our organization through COVID in terms of SOPs - standard operating practices, so we’ve talked over the last few years of 2020 Vision about how difficult it is to ingrain really foundational changes in terms of getting 300 branch offices to adopt standard operating practices. Well, we’ve done it through COVID, and we talked a little bit about this last quarter, about our pods or our task force that was set up to manage collections, payables, labor, and that rigor has really resonated with our employees and they’re really seeing the benefit of it, so we’re going to continue with that muscle strength. That’s really going to inure to our benefit down the road.

Then with EnhancedClean, there is going to be embedded EnhancedClean going forward. I don’t think anybody can imagine going back to an office and talking to the landlord of the office building or to your head of facilities and them saying, we’re back to normal, there’s no more virus protection. I think that’s going to be completely embedded going forward.

Then even as we re-staff the buildings, we think we’re going to find efficiencies as floor plates expand, so we’re truly optimistic about our ability to maintain the margins in that 5.5% to 6% range. Then the big question will be, do we break out past that 6%, and from our perspective it’s just too early right now to determine that.

[Tim Mulrooney, William Blair]

Okay, good color. Thank you.

Sticking on this subject of EnhancedClean, in your press release you highlighted we had a lot of higher margin work in the quarter. My question is, and now I’m thinking about your B&I and your T&M segments, how much of that higher margin work was emergency work and how much do you think is here to stay? In other words, how much of it do you think was one-time CAG work versus the longer tail EnhancedClean type work?

[Scott Salmirs, President, Chief Executive Officer]

Yes, you may not like this answer but I have to tell you, it’s just too early to tell. I think generally speaking March was the month which was part of Q2, where there was a lot of reactive work, right? I think for this quarter, it was more programmatic in the hope that it would create safety and people wanting to get back.

I think the real test for us, Tim, is how much of this will be embedded into the future, and for us to hit the $100 million sales mark in EnhancedClean--remember, EnhancedClean is different than work orders. EnhancedClean means I want to put a program in place in my property for six to nine months - that’s kind of been what it’s been averaging, so we think it’s the tip of the iceberg. Aspirationally, do I want to see that double next year? I do, so I think the big thing is that virus protection is here to stay, whether you’re educational facility, whether you’re an airport or you’re an office building. You can’t move into the future without a program that’s going to make people feel safe, so we’re optimistic.

I think it’s a little early. I believe by next quarter we’ll have probably a better window into how much of this we’ve gotten embedded into that six to nine-month range of EnhancedClean.

[Tim Mulrooney, William Blair]

Okay, great. That was a great answer. I think I understand how it’s laid out now, more of it--more EnhancedClean type work this quarter than last quarter, so transitioning some of that short emergency CAG work into the longer term, higher margin EnhancedClean. That makes sense.

If I could sneak in one more, Scott, because I really wanted to get your answer to this, or at least hear your thoughts on it. I think the biggest issue with investors right now is trying to gauge how many of your B& customers will remain customers if work from home become a more permanent fixture of our society. I know it’s a debate that everyone’s having right now. We recently heard Netflix’s CEO say he wants everyone back to work as soon as a vaccine is discovered, but others may be thinking differently.

How are you thinking about this dynamic right now and how it might ultimately impact your business? Thank you.

[Scott Salmirs, President, Chief Executive Officer]

Yes, so I am not wish-washy on this. I have very strong opinions. I used to be a facility manager - I ran facilities for Goldman Sachs, for Lehman Brothers, and managed facilities for CBRE, so I have a little bit of background on it. I will tell you I am so optimistic about the future of office. You start looking now online at all the employee surveys that are circulating around. People want to get back to work. People recognize that collaboration is an important part of their work experience and, frankly, their lives. In my CEO networks, from all the different CEOs I’m talking to across the country, we’re all starting to talk about the culture that makes each of our companies so special and how important it is to develop employees.

We want people back, people want to come back, so again--and I’m not sure how you create a strong company with a distributed management team. It doesn’t make sense to me, and I think you combine that with the fact that even if there is a shift--let’s just say there’s a 25% shift in work from home, which I don’t believe will happen, but even if you do that, when you start distancing the floor plates, we have heard tenants talk about having to take 50% more space to get to where they want to be, where they ultimately want to get to for distancing. I can tell you I had a conversation with our internal head of real estate yesterday about whether or not we take some of our sub-tenants’ space in our office so that we can create distancing.

I’m super optimistic about office space and I’ll give you some firm facts. In 2010, the average square foot per person in an office building was 225 square feet per person. It’s migrated down to 150 square feet per person in 2020. I think that’s going to start heading up because of social distancing, and just as a frame of reference with that 150 square feet, in 1990 it was 425 square feet per person, so there is room here to grow.

I think this could end up surprising people and there could end up being expansions, minimally net neutral. But for us, it works for us, and then you think about who’s going to be doing these modifications, who is going to be bringing people back, it’s really the Class A tenants. The Class A office buildings that have better air systems, that invest in technology and have more robust cleaning specs because of their financial wherewithal, that’s ABM’s client base, so I am on the side of not neutral, I am so optimistic about the future of office space. I know I am--if I was in the minority, I think it’s heading in the direction where my thought process is.

I hope that gives you come clarity, but I really feel like what I’m saying in grounded in fact and also from the perspective of a CEO running a 140,000 person company and wants to keep being proficient and accelerating.

[Tim Mulrooney, William Blair]

Yes, it makes sense to me, Scott. I’m really glad I asked. Thanks for your perspective. I’ll hop back in the queue.

[Scott Salmirs, President, Chief Executive Officer]

Thanks Tim.

[Operator]

Thank you. Our next question is coming from the line of Andrew Wittmann of Baird. Please proceed with your question.

[Andrew Wittmann, Baird]

Great, thanks. Good morning and thank you for taking my questions. Maybe just a couple here.

I guess I wanted to start with some of the new sales, Scott, that you mentioned. In your script, you said a billion dollars, you’re basically a quarter ahead of plan, you’re usually a billion by year end, but things are doing well so you gave us a third quarter update here. Can you just talk--I guess maybe give some context on this one, how much of that is recurring work that’s contractual, recurring work in what I’d call your annuity businesses versus work that’s in your technical solutions, which would be a little bit more project focused?

Also, just given that we’re asking about technical solutions, you gave a backlog number for the first time. I was just wondering how that $170 million backlog that you disclosed compares to the backlog a year ago at this time.

[Scott Salmirs, President, Chief Executive Officer]

Yes, so I think a majority of our sales has been on the annuity business--you know, of the billion dollars, by far the majority. The ATF business just started picking up towards the back end of the quarter. We’ve just been seeing great demand. What it really proves, Andy, is that if you make this investment in the sales culture, it really pays off.

You know, we furloughed some of our sales people and we put them on reduced hours. We did all the things that we thought were responsible things to be doing in light of the uncertainty at the start of this pandemic, and even with that we sold because you have to remember that our sales don’t just come from sales people, they come from operators in the field talking with clients and expanding footprints.

I can tell you candidly, I’m blown away that we would hit a billion dollars in sales in August, in this year where so much of commerce--not only has commerce stopped, but the focus hasn’t been on that from facility managers and from landlords. That’s not necessarily been their focus. The focus has been getting people back, so to hit this mark is just--it just speaks volumes to what’s going on at ABM. I just couldn’t be more proud of that.

I think that’s one of the standout statistics for this quarter, is to put on a billion dollars in sales in August in this crazy year, I mean, has to be a standout point.

[Dean Chin, Chief Financial Officer (interim)]

And Andy, I would add to what Scott said, that in the past we’ve talked about a healthy backlog being in between $150 million to $200 million, and I also wanted to remind you that last year at this time, we had two really large deals that closed that extended that healthy range above, so this year slightly down, however with the pandemic and the stoppage and new sales, I really don’t think it’s a comparability--equal comparability over year when you compare where we are today versus last year.

[Andrew Wittmann, Baird]

That’s helpful context on those. I should have asked about your retention rates, Scott, in your annuity businesses. It sounds like the adds are churning very strongly. During COVID, it seems hard to believe that there’d be a lot of churn out of the portfolio, but could you just comment on the retention levels that you have seen in the last three months?

[Scott Salmirs, President, Chief Executive Officer]

Yes, we’ll be really transparent and tell you we’re not taking credit for it, because there hasn’t been a lot of activity, right? It’s all been about stasis of operations, so--but I will say what we’ve done through COVID in terms of our EnhancedClean program and being there for clients, and no small thing, Andy, but our access to supply chain, because you know as well as anybody we’re dealing with smaller competitors in each market, and they just did not have the same access to supply chain.

I think I mentioned on the last call, we put in an order for $15 million worth of electrostatic sprayers, which is the equipment that disperses the disinfection chemicals, we put in an order for $15 million of electrostatic sprayers and chemicals and we had access to supply chain and we did not let our customers down.

When I think of retention, I think the big test will be next year. Did we rise above, did we create such a standout with clients that--again, that our bigger clients say with ABM, one thing we get is surety. We get surety because they have the access, they have the scale, and just having an advisory council. I can’t tell you how many of our clients will call us now and say, I’m reading the CDC, I’m reading the stuff from the World Health Organization, can you help me understand that? When you have your own advisory panel, which we cannot think of another small competitor that has one of these, I just feel like--you know, we’ve always talked about scale and does scale really matter in our business, it’s such a local business. I think the one thing that this pandemic has proved out is that in what we do, scale matters. There’s nothing else from a resource standpoint between supply chain and having an advisory council.

[Andrew Wittmann, Baird]

My last question for now is on the education segment here. I guess in the quarter, it’s mostly the summer season in your third quarter, it’s kind of half in session, half summer, so I want to be careful about extrapolating the decline in revenues - I guess you were down about 12% year-over-year in the quarter, into the fall school season. I’m just curious as to what you’re seeing in terms of the reopening performance so far, recognizing that anything can change with new COVID cases - that point’s not lost on anyone, but a lot of schools are trying to start at least partially in session. What’s the current outlook as it stands today about the revenue performance, and does the revenue performance that you’re seeing today have any implications on what your margins for this segment can be?

[Scott Salmirs, President, Chief Executive Officer]

Yes, that’s a good question. Just to give you kind of a frame of reference, right now within our portfolio, and 50% of it is K-12 and 50% is higher ed, what we would say across the board is--so now with the ABM portfolio, 85% of our business is either hybrid or in-person, and 15% is online only. We’re studying, and literally Andy day-by-day, we’re studying the trends of what’s happening with schools and whether or not they are continuing on in either hybrid or in-person, or they’re gravitating to online.

But you know, we’ve been relatively stable at this rate in terms of revenues because--you know, the analogy I use is at the University of Miami, which has this magnificent campus, lush, we do the landscaping there, we take care of their healthcare buildings, all of the student facilities, even if they go 100% online, they’re not going to padlock the campus, right? You still have to take care of the facilities, and a lot of the online stuff that’s happening, it’s happening where the teachers are going inside the classrooms, so you have to disinfect.

I feel like there’s going to be some stability there, at least through the fourth quarter. The real question is going to be when you look at our fiscal ’21, what is going to happen for that next semester, the spring semester that starts, I guess in January. Will they have lessons learned from this semester as to how they want to approach it, and that could create some variability for us.

But that segment’s been pretty resilient. I mean, to be 12% down in revenue given the fact that most of this quarter, the schools were actually closed, no one was attending, we feel like--we feel really good about that segment.

[Andrew Wittmann, Baird]

Okay, great. Thank you.

[Scott Salmirs, President, Chief Executive Officer]

Sure.

[Operator]

Thank you. Our next question is coming from the line of Sean Eastman with Keybanc Capital Markets. Please proceed with your question.

[Sean Eastman, Keybanc]

Hi team, compliments on another great quarter.

[Scott Salmirs, President, Chief Executive Officer]

Thank you.

[Sean Eastman, Keybanc]

Scott, I just wanted to start on any puts and takes you can walk us through as we think about next year - you know, tough comps, easy comps. I think in particular, it’s clear that you guys have done a terrific job around the labor management piece on the downswing, but as we think about a scenario where the operating environment is returning to some normalcy, we’re getting some recovery in the top line, how to think about your ability to manage labor on the upswing relative to the downswing, and what point we start to need to fold back some of the back office investment programs you guys have talked about over the past several quarters. Any puts and takes around next year in the context of those items would be helpful.

[Scott Salmirs, President, Chief Executive Officer]

Sure, and there’s a lot to unpack there in that question. It’s complicated, right? If you think about ’21, our comps, they’re going to be impossible because Q1 had no COVID, Q2 had just March but it was a crazy March because everyone was trying to figure out if they could keep people, because we didn’t really understand the pandemic then and it was all about a heightened amount of disinfection and oversized work orders, so Q2 was a little funky. Then Q3 and Q4 will have full COVID, so it’s going to be hard to do quarterly comps for next year.

But I do think there is an opportunity for us as tenants, as employees start returning and we start building back our staff, I think we will get efficiencies. You always get efficiencies when you get a chance to rebuild. In our business, we call it re-sectioning the building, because people have sections. That’s what they call an office building with different floors, so that’s the term of ours, so as we re-section the buildings and grow, I think we’ll create some really good labor efficiencies there on the way up.

Then another really important piece of this, Sean, is the labor situation. For the last two years, we’ve been dealing with unemployment at 3% and it’s been impossible to get labor. We’ve told you guy anecdotal stories about how you need to get 10 people through the interview process to find one as a janitor, and with unemployment where it is now, double-digit unemployment, I think what’s going to happen is the supply side will be really good for us in terms of trying to find people.

I think unfortunately for the economy, it really hit the hardest on the people that want to come work for ABM - you know, the restaurant segment, some of the retail segment, so I think it’s going to be opportunistic for us. Then the last piece of it is not only supply but actually the cost of labor, and we don’t see that being a tailwind. We don’t think that labor costs are going to go down because of the unemployment - we think that will kind of stay where we are, but I think it’s going to be a really good tailwind for us in terms of the supply side.

Dean, I don’t know if you have anything you want to share on that, but we’re feeling pretty good about that.

[Dean Chin, Chief Financial Officer (interim)]

Thanks Scott. As a reminder to everyone, in the fourth quarter we will have one less working day, and as we look into fiscal year ’21 on an overall basis, we will also have one more day, but the distribution of that through the quarter will be as follows. In Q1, we’ll have one less day, in Q2 we’ll have one more day, and then in Q3 one less day.

I also wanted to point out that we all read about how states have deficiencies, and so we expect an increase in the [indiscernible] rate for next year. Not quite sure exactly what that rate will be yet, and also we will look to have conversations with our clients as we see an uptick in that rate. More to come on that in our year-end discussion.

[Sean Eastman, Keybanc]

Okay, really helpful responses. Maybe just in a similar vein around free cash flow, clearly really excellent job done getting cash in the door in fiscal ’20. You did call out the $44 million CARES Act tax deferral - I guess half of that becomes a headwind for fiscal ’21, but any other puts and takes around free cash flow generation we should think about for fiscal ’21 relative to fiscal ’20?

[Dean Chin, Chief Financial Officer (interim)]

Yes Sean, I’ll start off with a few comments there. As Scott mentioned, we talked about the pod structures that we established in the pandemic and we will continue to utilize those pod structures to have a disciplined approach utilizing standard operating procedure to collect cash. As you mentioned, we’ll also continue to get the deferral of U.S. payroll taxes during the quarter and would approximate equally about what we had in this quarter.

Then as Scott also mentioned, as we look to align our strategic priorities over the next few months, we wouldn’t expect a material change in capital expenditures from Q3.

[Scott Salmirs, President, Chief Executive Officer]

Yes, and before we let this one go, I have more of an emotional response to this because I am so proud of what this firm has accomplished. To have historic free cash flow in this time where, again, commerce has shut down, I’m sure people or companies around the country are struggling with maybe paying bills - we know what we read, right? For our team to be so vigilant about collecting cash and being on it and just the rigor involved, it’s just incredible. I talk to other companies in our space and even outside of our space, and the first thing they talk about is liquidity and cash flow and how we have to stay on it, and it’s almost embarrassing about how well we’re doing.

So I am so proud of what we’ve done and how seriously our people have taken the concept of collecting cash, and again as Dean mentioned, this is a muscle strength we are not going to let go. I am so enthusiastic about what we’ve done and where we’re going on cash. Another amazing highlight of this quarter.

[Sean Eastman, Keybanc]

All right, I’ll leave it there. Thanks very much for the time.

[Scott Salmirs, President, Chief Executive Officer]

Sure.

[Operator]

Thank you. Our next question comes from the line of Marc Riddick with Sidoti & Company. Please proceed with your questions.

[Marc Riddick, Sidoti & Co.]

Good morning everyone. I wanted to touch on EnhancedClean and get a sense of client receptivity. I was wondering if you could spend a little bit of time on the types of businesses or particular areas or what have you, that were maybe most receptive to the service offerings, as well as maybe if you could touch a little bit on--you mentioned this six to nine month time frame, how should we think about those future renewal or extensions? How should we think about how that might then proceed for a client who’s signed up?

[Scott Salmirs, President, Chief Executive Officer]

Yes, so we’ve seen receptivity across the board on EnhancedClean because when you really strip it back, it’s like are you going to do disinfection work to protect against COVID, so you couldn’t imagine anyone, any landlord or any facility manager saying we’re not going to do anything. Everyone is doing, and it’s a question between--and I may have said this a little earlier, it’s a question between do I want to think about it on a temporary basis, like I’m going to give you a work order for a month, or do I want to make this more programmatic, and the programmatic stuff is the EnhancedClean six to nine months. I think that’s probably for now a proper time horizon to--so here’s the way you should think about it.

Work order, very reactive, let’s think about this on a temporary basis. EnhancedClean, bridge to a vaccine, bridge to getting people back. I want to put a program in place over the next six to nine months to start thinking about getting people back, and then ultimately when we’re talking two or three years from now, we probably won’t be talking about EnhancedClean anymore. We’re going to have specifications when contracts are bid that are going to incorporate regular disinfection, which as you know is a higher margin service for us. It will gravitate from calling it EnhancedClean to say, oh, the specification of the future is going to include doing the things that we used to do in a bathroom and a pantry in general office space.

The reason it’s still kind of in its infancy for us - I mean, $100 million is spectacular right out of the box for a quarter, but not every facility manager understands the plan for re-occupancy yet, so as facility managers, as landlords start getting a sense of the patterns for re-occupancy, that’s when they start saying, all right, I’m in a transition from doing this on a work order to putting this into EnhancedClean, so that’s why we think EnhancedClean is going to accelerate through 2021, because again we’re going to have more of a handle.

We hope that Labor Day was the aspirational trigger to start getting people back to the office, so we may see when we talk to you in the fourth quarter a better handle on EnhancedClean and what’s happened. But then people have also talked about January being the next trigger of when people are coming back to the office, so it may be not until fiscal year ’21 for us to get a better handle on it.

I think Marc, on the highest level, I don’t think any of us can imagine an airport, an educational facility or an office building having ownership saying, we are not doing EnhancedClean. It just doesn’t sound rational, because you have to give your employees and your tenants a feeling of safety. This is the only way to do it, especially with ours because you get a certification. You literally get that sticker on the door that says, this facility is EnhancedClean certified. If you think about schools, parents are going to be, like, I don’t want to send my kids back unless I’m guaranteeing that you’re doing the right disinfection, so we’re super optimistic about the future of EnhancedClean.

[Marc Riddick, Sidoti & Co.]

Okay, great. That’s very helpful. Then I was wondering if you could--I wanted to circle back to education for a moment and get a sense of the--I think you’d mentioned this a bit, but I just wanted to get a sense of maybe the differences of activity around--you touched on K-12 versus higher ed. I wanted to get a sense of are--it seems as though there would be deeper pockets in the higher ed area to maybe be more active on implementing something like this, so I was wondering if you could touch on maybe the funding environment that you’re seeing and whether or not that could have an impact on the timing of when these things are brought onboard. Thanks.

[Scott Salmirs, President, Chief Executive Officer]

Yes, I think within our industry group of education, I think it’s still a little early because on the K-12 side, we’ve seen so much in term of budget cuts. You read about it in the paper all day about how school budgets are being cut, but again, let’s think, right? If school budgets are cut, can you really cut cleaning? That’s the one area that you know is going to be sacrosanct for superintendants. Then same thing with higher ed - how could you cut cleaning? That’s the one area. You may want to cut food service, you may want to cut--you know, there’s so many other places to look at where you’re going to make cuts, other than cleaning, right?

But also, think about our technical solutions space. Our target market is education, so we are seeing so much activity especially on the K-12 side right now with superintendants calling and us actually reaching out to say, look, I know you’re having a budget deficit, we can come in and do a retrofit of your electrical mechanical systems. Typically we find 30% energy savings - that’s enough to save teacher jobs, to save afterschool programs, so the budget cuts interestingly enough are going to be a big tailwind for our technical solutions business as they find ways to save money and save teachers’ jobs.

Those budget cuts for our industry group, education - again, I just will say I can’t imagine a world where they go back to the PTA or the school board and say, we’re making cuts to our cleaning program. I just can’t see it.

[Marc Riddick, Sidoti & Co.]

I appreciate it. Thank you very much.

[Scott Salmirs, President, Chief Executive Officer]

Sure.

[Operator]

Thank you. We have time for one more question. Our next question is coming from the line of David Silver with CL King. Please proceed with your questions.

[David Silver, CL King & Associates]

Yes, hi. Thanks. Just a couple of areas I’m going to ask you maybe to go back on, but I did have a question about the marketing effort or the go-to-market strategy for EnhancedClean. Just me personally, I’ve seen the advertising online and in industrial marketing. You touched on maybe the spend at one point in your remarks for this program. Is there any way that you could characterize, either qualitatively or quantitatively, is the rollout and the marketing for the EnhancedClean service, is it significantly different than other marketing programs that you’ve done, either in the vehicles that you use to disseminate the advertising or the groups you’re reaching out on?

Then just qualitatively, if you could talk about the split between new customers, customers you didn’t do business with that are responding to EnhancedClean, versus maybe cross-selling to your existing client base? Thank you.

[Scott Salmirs, President, Chief Executive Officer]

Sure. This is nothing like anything we’ve ever done at the company in terms of a true product rollout, service rollout. We’ve never been on social media the way we are now, so we’ve hired a proper advertising agency and PR firm. We are doing this the right way. We see so much opportunity in EnhancedClean, and I’ll give you a point of reference which is so interesting.

Tomorrow we’re doing a webinar. Part of the advertising you’ve seen on the social channels is that we’re doing a webinar with our expert panel to tell clients how to get back safely. We view the webinar as something that could be a good resource for clients but, more importantly, it’s part of advertising, right? It’s part of how you position your brand as a knowledgeable brand and we can do a webinar, and we said, you know what? Even if we get 50 people, it will be mission accomplished because it’s really about seeing the advertising, less about the webinar itself.

We are going to have--so we track obviously the registrations, and again at the outset we said if we can get 50 people, 50 important people, that would be great. We’re close to 1,000 people that have registered for this webinar already, which has blown us away. We’re tracking metrics, we’re tracking hits analytically that go to our website for new customers and even existing customers are tracking it through.

I think it’s too early to give you the split now of new customers versus existing customers. We’ll have definitely more insight in Q4 once the campaign has gone through one cycle, one quarter. It’s like nothing we’ve ever done and what we’re really hoping is that taking this approach, really leveraging social channels is going to be game changing for us and really change the demand set. It’s too early to tell, but again to go back to it, we’ve never done anything like this before. We’re so enthusiastic about it.

[David Silver, CL King & Associates]

Okay, thanks for that. This next question, I apologize - I’ll try to keep it together, but I’m kind of pulling some data points from some other areas. The question might be, Scott, where you see the company, let’s say three years from now, so safely after the pandemic induced shifts and uncertainties have passed. You mentioned, and I have this figure in my head, 140,000 employees; you’ve mentioned a particular margin target, EBITDA margin target that’s above your historical level but below maybe where you’re trending shorter term, so this is a question whether you see the company evolving towards one where you’re going to pursue very aggressive top line growth or maybe alternatively one where you aggressively high grade and target your efforts and your labor and other resources and drive the operating margin line and maybe returns on capital.

So three years from now, will you have more than 140,000 employees and now 5.5% or 6% margin, or will you have fewer and a higher margin than what the current target was? Thank you

[Scott Salmirs, President, Chief Executive Officer]

Yes, it really is tough to speculate. I would suspect we’d be growing on all levels - you know, revenue, I think we’ll be growing on margin. We are going to be making investments in our IT infrastructure and digital. I think this is going to give us an opportunity to kind of leapfrog our competition on client-facing technology and analytics. Again, we learned through COVID how our scale matters, and I said it before on supply chain and on our advisory council, and now we’re recognizing if we could put technology in place, digital technology to connect with our customers to get stickier, we think that’s going to really drive some incredible value, especially as Internet of Things starts taking shape.

We are going to stick with our operational proficiency - that’s going to be super, super important for us. We’re going to stick with the rigor and discipline around standard operating practices like cash collections, but we are going to invest in this company in sales people and in our IT platform.

[Dean Chin, Chief Financial Officer (interim)]

David, this is Dean. Just wanted to add onto Scott. We’ll continue to be focused on our capital allocation strategy, which has historically been organic investment, looking or maintaining our longstanding dividend policy, and being opportunistic and thoughtful about M&A and share buybacks. As we look into the three-year period, looking at our capital allocation holistically, we’ll continue to do that.

[Scott Salmirs, President, Chief Executive Officer]

That’s great, great point.

[David Silver, CL King & Associates]

Okay, thank very much. I appreciate it.

[Scott Salmirs, President, Chief Executive Officer]

Thank you.

[Operator]

Thank you. That does end the question and answer session. I will now hand the call back over to management for any closing remarks.

[Scott Salmirs, President, Chief Executive Officer]

Just want to thank everyone for their time, and again hopefully you got the tenor of this call. We are super enthusiastic about where this firm is heading and our value proposition through this pandemic and our brand elevation. I just can’t say enough about it. The way this team has performed, it’s across all platforms whether it’s maintaining the resiliency of our revenue, our profit margins, our free cash flow, our new sales, EnhancedClean initiatives. We just feel like we’re firing on all cylinders and the management team has just really risen up. I’m just so impressed with what our team is doing and so excited, so more to come in Q4.

We’re heading in a lot of parts of the country into the colder weather, so you’re going to be more indoors. Don’t let your guard down. Stay safe and healthy, practice social distancing - it’s super, super important.

I appreciate the patience on this call and going though with us, and again have a great all, everybody. Thank you so much.

[Operator]

Thank you. That does conclude today’s conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.