ABM Industries - Earnings Call - Q3 2016

Transcript

Speaker 0

Good day, ladies and gentlemen, welcome to the ADM Industries Third Quarter Fiscal Year twenty sixteen Conference Call. At this time, all participants are in a listen only mode. Later, there will be a question and answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Susie Choi, Head of Investor Relations.

Ma'am, you may begin.

Speaker 1

Thank you all for joining us this morning. With us today are Scott Salmiers, our President and Chief Executive Officer and Anthony Scaglione, Executive Vice President and Chief Financial Officer. We issued our press release yesterday afternoon announcing our third quarter fiscal twenty sixteen financial results. A copy of this release and an accompanying slide presentation can be found on our corporate website. Before we begin, would like to remind you that our conference call today contains 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 a slide that accompanies our presentation. 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.

Speaker 2

Thanks, Susie. Good morning and I want to thank everyone for joining today's call. Hopefully, had a chance to review our third quarter results for fiscal year twenty sixteen. Before I get started, I want to take a moment to express my tremendous pride in our organization as we have completed another quarter of successfully managing the delicate balance between transforming and executing on our day

Speaker 3

to day

Speaker 2

business. I'm so pleased with our quarterly performance, which would not have been possible without the focus and diligence of our entire company. So thank you, team. As you know, our 2020 Vision transformation is predicated on a phased approach. The major focus of Phase one was organizational design and the development of our industry groups and a shared services support model.

We are now into Phase two. Last quarter, I shared with you that Phase two was focused on building a practice around our newly formed center of excellence and transitioning accounts into their specific industry groups. I want to provide you a few updates on Phase two. In the third quarter, we initiated several work streams in our center of excellence, which will underscore our long term approach to facility services. As part of that process, we are now identifying and codifying best practices or what we call bright spots across our organization, which will allow us to develop standard operating procedures for four key areas.

They are labor management, account management, employee development and safety and risk. This will greatly help our industry groups as they will have standardized tools to manage their business and the advantage of being more efficient through a consistent approach. There is nothing more foundational to our 2020 vision than consistency across the platform. We believe that approaching the market in a standardized way across the country with the best of ABM's thinking will be a key driver of our acceleration over the coming years. From an account transition standpoint, we are on track with the process of moving accounts from on-site into our industry groups.

As of today, we are well into the development of our specific account transition plans and we remain on target to complete this process by the 2017. While this process is progressing smoothly, transitioning accounts can be challenging and we are monitoring closely to ensure that our clients remain satisfied and we minimize any bumps in the road. So far, I'm really encouraged by what I see and the client feedback has been good. I've said over and over again on these calls that our employees will drive the success of our transformation. We've been tracking the change management process internally and we are seeing that the organizational changes are taking hold as well as a greater understanding throughout the company as to why our 2020 vision will benefit our clients, employees and our shareholders.

For us, it's all about clear communication to our stakeholders. That has been the main focus and the main factor for our success to date. Now before I get into our operational results for the quarter, I want to take a minute to discuss our full year guidance outlook, which we increased to 1.7 to 1.75 Similar to last quarter, we continue to benefit from the timing of investments in open positions created through our 2020 Vision organizational design process. We also benefited from timing of investments in IT systems as well as slightly higher than anticipated 2020 Vision savings, which was primarily due to tighter expense management and the impact of certain discrete tax items. With respect to timing, we anticipate this benefit will dissipate over the next several quarters, but it's difficult to determine exactly when these expenses will be incurred.

This is a dynamic process. Organizational transformation takes time and doesn't necessarily run-in a straight line, underscored by what we are saying about the timing of investments. While we had a solid quarter, we are not measuring the success of our 2020 vision on a quarterly basis. We encourage you to think of the transformation in the same way as I know many of you already do. Our goal is to remain focused on delivering sustainable, profitable growth in accordance with our 2020 Vision Plan and we will continue to look at ways to maximize value.

Okay, on to our third quarter segment performance. Execution remains consistent and we generally saw revenues at higher operating margins this quarter due to a better contract mix and additional tag work. In our janitorial segment, we saw the expansion of business with some great customers within the Business and Industry Group. Through a formal RFP process, we expanded our relationship with JPMorgan Chase and are now providing janitorial services to the entire commercial, retail and data center portfolio throughout the Northeast. We also announced the contract expansion with Commonwealth Partners for multiple services, including janitorial and engineering.

And we continue to serve the best sports venues in the world, including extending our contract with USC at the LA Coliseum, home to both the USC Trojans and the newly relocated LA Rams. We also won a contract with the Prudential Center in New Jersey. And for the UK Business and Industry Group, we recently announced expanded work with Realm Limited, a destination London designer outlet in Wembley. The additional services included energy, HVAC and mechanical and electrical. Our overall performance for the Building and Energy Solutions segment was mixed.

This segment is comprised of our Abe's business, government and healthcare. Let me share with you where we performed well and where we are having some challenges. As with previous quarters this year, our Abe's technical service business exhibited robust growth driven by a strong backlog and bookings. We expect this performance to continue throughout the remainder of the year, although the year over year comparison for the fourth quarter will feel a bit muted because of their extraordinary performance last year. Westway, which is our recent acquisition and technical services area in The UK contributed positively to both revenue and profit this quarter continuing their trend.

Although our government service business is small from a scale perspective, given the size of our organization, we should note that it has continued to track below our expectations due to a handful of unsuccessful bid opportunities throughout the year. This negatively impacted the Building and Energy Solutions segment this quarter from both the revenue and profitability standpoint. And finally, our air serve business in our other segment demonstrated another stellar quarter of revenue growth driven largely by an increased scope of work within current contracts. I would point out that the enthusiasm around our aviation industry group is palpable. There is no other firm that could influence the traveler experience like ABM and that is resonating with our clients.

Overall, this was a good quarter. We're pleased with our results and the progress we have made on our 2020 Vision journey. Looking towards the end of the fiscal year, we're encouraged that 2020 Vision continues to permeate our entire organization and culture and that will keep us intently focused. As we stand up our industry groups and their new structure, we are gaining greater visibility into profitability by industry and account. This will help us better define our business plans and drive decision making heading into 2017.

And while it's too early to share specifics, we are confident that as we enter the New Year, we will have successfully established the foundation upon which we built our 2020 vision. So with that, I will now hand the call over to Anthony to go into further details on our financial performance.

Speaker 3

Thank you, Scott, and good morning, everyone. I would like to reiterate Scott's sentiment and recognize all of the teams have focused and delivered results throughout the year, while working through our 2020 vision. We are executing according to plan and slightly exceeding some of the targets we originally set out to achieve. I'll now review our results for the third quarter that are described in today's earnings presentation, which I will refer to periodically and provide a discussion of our revised guidance. I'll be referring to results from continuing operations, which exclude the sale of our security business.

Revenues for the quarter were up 3.8% versus last year, driven by organic growth of 2.2% and approximately $19,000,000 of revenues from acquisitions, which are reflected in our Building and Energy Solutions segment. On a GAAP basis, our income from continuing operations was $32,900,000 or $0.58 per diluted share. Please note, GAAP income for the quarter reflected the favorable impact of tax credits related to uncertain tax positions in years in which the statute of limitations have expired. This tax benefit more than offset prior year insurance related increases and other GAAP items which impacted the quarter. On an adjusted basis, income from continuing operations for the quarter was 30,600,000.0 or $0.54 per diluted share.

Several factors favorably impacted the quarter. Revenue contribution, including higher TAG revenue and the higher margin Abe's business model helped drive the quarter. Additionally, the quarter also benefited from twenty twenty Vision savings, timing, certain discrete tax items and one less working day. I'd like to take a moment to address insurance. During the third quarter, we completed our full year actuarial evaluation.

As I mentioned on previous calls, we continue to make significant changes to our risk management and safety programs, which included the consolidation of the risk and safety function and the hiring of a new group leader. As a result, I am pleased to report that in a short time, we are seeing some modest improvement in the cost of current year insurance programs. Having said that, we do not anticipate changing our current rates until we see some more evidence of long term meaningful improvement. However, we continue to deal with adverse developments related to claims reported in the prior periods, albeit decreasingly. And we feel that with the changes we have made, the degree of volatility related to prior year development is expected to decrease.

Moving on to EBITDA. We ended the quarter with adjusted EBITDA of $61,100,000 and an adjusted EBITDA margin of 4.7% compared to 3.9% last year. Adjusted EBITDA and margin benefited from better contract mix in janitorial and higher technical services revenues, benefits from twenty twenty savings and one less working day, which helped offset the impact of legal and bad debt reserves in the quarter. Before I discuss our segment results for the quarter, I'd like to discuss several items that impacted the quarter. As I alluded to earlier, the results for the quarter were positively impacted by one less working day, primarily in janitorial.

Additionally, similar to last quarter, we continue to experience greater in year savings related to open investments, which have not yet occurred. The breadth and depth of these investments varies and given the transitional nature of this year, it is difficult to pinpoint when these investments will occur exactly. Now turning to our segment results for the quarter, which were impacted by many of the items I just described. Please turn to page four of today's earnings presentation. As mentioned earlier, one less working day in janitorial and twenty twenty savings positively contributed to segment operating results.

For janitorial, revenues increased 2% versus last year and operating margins were 6.3%. Margins benefited from additional tag revenue and a good mix of revenue from new and expanded business, which offset an increase in legal expenses during the quarter. Facility Services revenues decreased 0.8% or $1,100,000 due to certain contract losses, which were partially offset by new and expanded business. Operating margins were 5.4% versus 4.1% last year, benefiting from TAG revenue and lower legal expenses. Parking generated 3.5% increase in revenues versus last year.

Operating margins declined slightly to 4.6% versus 4.8% last year, attributable to higher costs associated with new locations, which we are working to normalize through labor management and slightly higher legal expenses. Building and Energy Solutions revenues increased $18,700,000 or 12.5% versus last year, driven by $19,300,000 of revenue related to our Westway acquisition and higher Abe's or technical services revenue. Similar to last quarter, strength in Abe's was offset by our government business, which continued to experience challenges. Having said that, and as we've been saying all year, Abe's was a back half story in 2015, and therefore, comparisons are tougher in the second half of this year, and we expect Q4 to be relatively flat year over year. Operating margins for the overall segment, however, increased due to higher contribution of technical services revenue, but also benefit from a larger degree of open position in Abe, which we expect to normalize next year.

Finally, revenues for our other segment or AeroServe increased by $10,500,000 or 9.3%, driven by continued strength in our cabin cleaning service in The U. S. Operating margins increased 70 basis points to 4.7% versus last year, primarily due to lower amortization expense. And as Scott referenced, we continue to see nice growth opportunities in Aviation. Turning to liquidity.

We ended the quarter with total debt including standby letters of credit of $357,000,000 and our total debt to pro form a adjusted EBITDA was roughly 1.8 times. During the quarter, we repurchased approximately 300,000 shares of common stock for roughly $10,000,000 As of July 3136, there was approximately $157,000,000 of remaining under our $200,000,000 share repurchase program. And finally, the Board has approved ABM's two hundred and second consecutive dividend of $0.01 $65 per share payable on 11/07/2016 to stockholders of record on 10/06/2016. Now I will turn to our adjusted guidance outlook. As Scott discussed earlier on the call, we continue to benefit from higher savings related to people, processes and systems that have not yet occurred, tax related benefits and higher than expected 2020 savings.

Accordingly, we are raising our full year fiscal twenty twenty six adjusted guidance outlook to a range of $1.7 to $1.75 per share compared to our previous guidance range of $1.55 to $1.65 per share. Operator, we are now ready for questions.

Speaker 0

Thank you. Our first question is from Andy Wittmann with Robert W. Baird. You may begin.

Speaker 4

Great. I wanted to start with questions to clarify some things on the quarter probably directed at Anthony. Anthony, just given there's a bunch of tax items in the quarter, it looks like most of which were excluded from adjusted EPS but some were not. Can you just verify that my calculation is at $06 there was a $06 benefit from the tax item that was not excluded that was included in adjusted EPS but the majority of these tax items were excluded. Can you just talk about that in a little bit more detail, so we're all on the same page?

Speaker 3

Sure, Andy. So you're absolutely right. Roughly $06 is included in our adjusted EPS and that relates predominantly to an early adoption of an accounting standard related to stock based compensation. The majority of the other discrete, the largest being the passage of position that we had from that we had mentioned earlier at the end of last year is an IIC and that was roughly $0.32

Speaker 4

Got it. And the $06 one that was included, it sounds like I mean this is a new accounting standard that you've adopted. So is it fair to think that this is now part of the earnings stream going forward? In other words, this is not really necessarily a one time item that this could occur next year as well?

Speaker 3

Yeah, absolutely. So it's not a onetime item, but it's hard to quantify whether it will be positive or negative. It's really dependent on the existing grants and the share price. So it's a variable, but it is part of our normal operations that we'll be providing guidance at year end related to what we expect that impact to be for next fiscal year.

Speaker 4

Okay. Just continuing down this thread a little bit. The self insurance adjustment was excluded of $19,500,000 That's a bigger number than we've been seeing recently. Obviously you guys like you mentioned in your script have taken some actions to account for your self insurance things more conservatively I guess. Dollars 19,500,000.0 pretty big number.

Was that all prior period? And is that why it was excluded? Was there any in period adjustment to the quarter?

Speaker 3

No. Again, we break it up into two buckets consistent with prior years and prior periods. So that was all prior year, the adjustment that you're referring to. In the current year, as I mentioned in my prepared remarks, we're seeing some good indications that some of the initiatives that we started late last year are starting to provide some benefits and we're as you know, we're accruing at a much higher rate year over year. So we're charging the business what we feel like is the right long term appropriate rate.

But that being said, we are seeing some benefits, but it's too early for us to move away from the higher accrual rate. So ultimately, we feel like the current charge of the business is the appropriate charge and we're still dealing with the prior period adverse development.

Speaker 4

And what I would

Speaker 2

say Andy too just to chime in on that. I think what we're enthusiastic about is the stuff that we can control this year because we have a good amount of control on what happens in the year And the culture is changing and really being fortified internally around the safety programs. We're seeing a decrease in frequencies across the board. So, so much of this for the long term is about a cultural shift and it's really taking hold here. So again, enthusiastic about where we are and where we're headed.

Speaker 4

Great. I wanted to do one more question kind of going down that angle here and before going back into the queue. This is just around the margins. Obviously, it was very good led by the growth in the core janitorial segment. Scott, I get the timing of the reinvestment happened.

But given that you hit this 4.7% level, it's a quarterly number. And I know there's seasonality, but we're starting to bump up against some of the long term goals that you talked about at your Analyst Day when you talked about adding 100 basis points. Can you talk about your comfort level about going beyond the 100 basis points that you committed to given the early successes that you've had? And maybe the addendum to that question would be, as you make some of these reinvestments that from the open positions that you have filled yet, is there potential to move into 2017 that margin don't see any further expansion or even go the other way? I'm just trying to gauge the magnitude of the reinvestments that still need to be made.

Speaker 2

Yes. No, listen, I think it's still early on in our 2020 Vision program, right? I mean we did get 30 basis points of benefit this quarter from having one less day. But these reinvestments are so important, Andy, because they're going to be the foundation for the future. We set up our organizational design and it's pretty, I would say, it's a quicker route to take cost out than it is to build cost in because you're building a new structure.

One thing I'd point out is we're developing a new talent organization that's going to be focused on how we onboard the right people, how we do development training for people in the field, how we do performance management. And that's a group right now. We just hired the head of that group literally over the last couple of weeks. So there's two people in a group that could be as many as 10 people. So I don't want to trade away short term by not filling those positions.

So those are going to be, again, fundamental to long term success of ABM. And we're going to make those investments. It's just it's hard to predict the timing, but so it's early on in this.

Speaker 3

And I think Andy, this is from what we projected as the 100 basis points, we broke it out into components. We said the org design was going to be roughly 40 to 50 basis points. We said procurement is going to be roughly 10 to 15 basis points and then the rest is going to come from account planning and the vertical acceleration. I think what we're seeing is on the org design, we're trending at the upper end of our original 40 to 50 and maybe slightly exceeding that. So I think it points to we're headed in the right direction, but it's too early to tell whether the 100 basis points becomes 110 or more or whether the 100 basis points is on track.

But we are trending a little bit higher on the org design.

Speaker 4

Okay. Thanks guys.

Speaker 0

Thank you. Our next question is from Sean Egan with KeyBanc Capital Markets. You may begin.

Speaker 5

Hey, good morning everyone. Can you hear

Speaker 2

me? Sure.

Speaker 5

Great. Thank you. Hey, I was just hoping you could help put some clarity around the swing in operating cash flow or cash from operations. Was there a large swing in working capital? If you could bridge that gap, that'd be real helpful.

Speaker 3

Yes. We look this is Andrew. We look at our cash flow on an annual basis and there's always going to be timing elements. So if you look at it from a year to date perspective with the increase in severance payments, the increase in cost related to 2020 Vision, we're right on track with where we were last year. So it's I wouldn't take this quarter as an indication of anything fundamentally change in our cash flow outlook.

It's just not a matter of timing. So I would look at it on an annual trailing 12.

Speaker 5

Got it. Thanks for that. And then secondly, within the janitorial operating margin, I know you guys quantified 30 basis points due to one less workday. Is there any way that you can at least either quantify or help us understand the order of magnitude of the other impacts that you noted such as the more beneficial mix and higher TAG work?

Speaker 3

It's hard to go down to that level of granularity, but what I can tell you is that TAG continues to be a focus in the organization. I think back to Scott's point, culturally, the organization is starting to embrace the margin story and TAG is one of the easiest drivers for that margin story, specifically in janitorial and to a lesser extent in our facility services business. So it continues to be a great story from a TAG perspective and it continues to be a focus area for the firm.

Speaker 2

Yes. Think when you think about TAG revenue, you could think that it has

Speaker 5

a

Speaker 2

margin profile that's 2x our base contracts. Again, as the margin story resonates in the firm, you'll see that there'll be a focus towards TAG just because it's the high value capture for the team. It all comes down to kind of contract mix and blend and market segmentation. And again, we have the right trajectory into the higher margin.

Speaker 5

Great. Thanks. And then staying on that same point, the contract mix benefit, is that are those contracts that you are actively exiting or are you waiting for contracts to come up for renewal and roll off and you're just choosing not to renew your lower margin items?

Speaker 2

So that's going to be part of our account management process that we're initiating in our center of excellence. So as we start standing up these industry groups and look at business by vertical, we'll start creating detailed account plans for the future. And there are some that will end up tailing off. There are some that will actually put a plan together to say it's not the kind of thing where something's not performing at the right level, so you just send a cancellation notice. You actually put a plan together to accelerate margin.

And if you can't do that, that's when you make those tougher decisions. But for us, if we have lower performing accounts that we can't put together a robust acceleration plan around, you'll see us exiting those accounts.

Speaker 3

And it'll typically we're going to look at it from a renewal cycle. So this is a very dynamic piece of our business. And as those accounts come up for renewal, to Scott's point, either we're going to be able to put a plan in place to bring the margin up through TAG or through other operational levers or we're going to bid the account at an appropriate margin and if we lose it then we're okay with that.

Speaker 5

Got it. Understood. Thanks so much.

Speaker 3

Thank you.

Speaker 0

Thank you. Our next question is from Jeff Kessler with Imperial Capital. You may begin.

Speaker 6

Thank you and thanks for taking the question. Just following up a little bit on that, in some of these I know that you're trying to go to these contracts, particularly in the government area with one voice. In those contracts, particularly in the facility services area where you've bid and you haven't won, is there a way to start constructing the contract and the way you're going to serve that contract so that you can either make you can start making final decisions with regard to are we going to stop even bidding on these contracts or are we going to, you know, reinvent the way that we come to this so we can still provide the value proposition that the customer is demanding and still be cheap enough in a sense to win that contract?

Speaker 2

Yes, think it's a combination actually of everything you said. What we'll be doing is I could give you a good example of something that happened this quarter. So we were pursuing a very large contract with JPMorgan Chase and JLL who's their managing agent and it was for the commercial cleaning portfolio in the Northeast. And, you know, while price was very, very important to, JPMorgan and JLL, workplace was as important to them, kind of quality of sustainability, quality of our training, of safety. And we had as much conversation with them on that as we did on price.

And we ended up winning the entire portfolio. As I mentioned in my script, won the entire portfolio business. At the same time, we had a similar size opportunity with another institution, which wouldn't be appropriate for me to name, but it was a similar opportunity, almost exact in scale and size. And their key driver was price alone. And all the conversations were around price.

And they wanted to work with us because they liked our organization and had a good history, but it was only a price conversation. And we just couldn't get there. And we didn't see a trajectory to raise margins over time. And we just said to ourselves, we're going to end up not making our client happy and we weren't going to achieve our goals. And we actually passed on that opportunity.

It was something very new culturally for ABM to walk away from a large scale revenue opportunity because it didn't have the right margin profile and it ultimately wasn't going to satisfy the client. So it was I could tell you both of those assignments culminated at the same time at the firm. And there was as much excitement internally for us not pursuing that low margin price opportunity as there was for us winning this large scale, high profile account.

Speaker 6

I'm sure there are probably some salespeople who are not all that happy about passing up that type of opportunity. But if you are paying them to you know, if their compensation is based on their capability of mixing businesses, then that changes the culture and it obviously alleviates that somewhat. So I guess my question to you is my question to you, to what extent can you bring the full bearing of the various services you offer to these contract discussions now and when? Are there increasing amounts of these types of contract discussions that are out there where they do care about the workplace and sustainability and not just about price? I mean, has this really changed or is this you forcing the issue to talk about these other things?

Speaker 2

I think it's mostly, in that case, it's us forcing the issue, you know, in the example that I gave you. But for us, it's going be about our approach to market. And like I said, in our center of excellence, we have this account management work stream. So what that's going to mean is that when we look at an assignment, especially a larger assignment, what we're going to be saying is, okay, on this base assignment, what's the margin profile today and where could it go? But more importantly, what are the services that we can tie in from an IFS standpoint, right, integrated facility standpoint?

What are the services that we can leverage? Like if you think about our education vertical, right, We've been and this is a really important point. Prior to twenty twenty Vision, we had four different regions of the firm each with about $60,000,000 in education in a billion dollar portfolio that they were managing. So it didn't really grab the attention that it should have, right? Now we have a $250,000,000 education vertical that we're looking at holistically in terms of IFS and how we could bring the resources of ABM to bear, match that with our Abe's technical services group that does a significant amount of business and education and never really married up with ABM internally.

So now you have a head of ABM education for facility services partnering with an education person in our Abe's technical services group that does a 35% gross margin and they're figuring out how to pull through the Abe's technical services into education. So in the future, when ABM looks at an account and potentially an education account, we're going to say, well, we can capture the janitorial award here at a 7% EBITDA margin, but we're looking at their facilities and we're seeing that the equipment, the mechanical equipment is aged. There's a great opportunity here to pull through our Abe's technical services business. So if we can execute, we're going to be able to pull that in and move the whole account up to maybe a 13% blend. That's the kinds of conversations that are starting to happen at ABM that never happened before.

And that's where the excitement is.

Speaker 6

Okay, great. One more question, that's on parking. Everybody people are beginning to talk about, you know, driverless Ubers. But I'm actually thinking about the technical capabilities that you may be required to produce for the end user going forward in terms of bringing more technology for managing ID, managing safety and things like that to parking. Is something that is going to impinge on parking margins for a while as you invest?

Or is this something where the folks that are out there already realize that they're going to have to pay more to get more technology into parking facilities?

Speaker 2

What I would say is I think that for us presents an opportunity. We have a person and a team in our center of excellence just working on parking innovation and where the market's going, what are the latest trends. And if you think about firms in the parking space, there's very few that have our scale, right, that have our balance sheet to terms of investment in technology and innovation. So I think for us, we look at change in the parking industry as a key way for us to accelerate. Because when we're dealing with a small local company in a particular market that doesn't have the ability to invest in innovation and technology, we think that's going to be a great opportunity for us in the future.

Speaker 3

When you think of parking, from an experience standpoint, what we're trying to do for the individual parking, if you look at our parking business and you map it, majority of the parking business is going to be mapped to our aviation industry group or vertical, a good portion is going be mapped to our healthcare group or vertical, and then there's going to be a component that's going to be in B and I. So when you look at those three segments and what we call the patient or passenger experience, we're working on the integration of parking as an end to end solution so that when someone parks their car at an airport, we then can shuttle them to the front gate, we can do the wheelchair, we can do the baggage handling, we're cleaning the terminal. So it's an integrated story versus historically being run as a service line, which really was purely a price driven model.

Speaker 2

Yeah, and I think if you think about the future of ABM, you know, going forward, there's going to be less conversation about janitorial or parking because if you were to ask me in 2017 when you asked me a question about parking, I'm probably going to say, well, which industry group are you talking about? Aviation, healthcare, business and industry? It's going to be less of a holistic business, more focused practice area as part of an experience in that industry group.

Speaker 6

Okay, great. Thank you very much.

Speaker 3

Thank you. Thanks.

Speaker 0

Thank you. Our next question is from George Tong with Piper Jaffray. You may begin.

Speaker 7

Hi, thanks. Good morning. Scott, can you discuss whether you expect any of the recent pressures in janitorial organic revenue growth to repeat over the next year? And what potential drivers you see for janitorial revenue growth reacceleration?

Speaker 2

Sure. It's funny, I hadn't thought about janitorial growth and pressures Because we're kind of pleased with our organic growth, having 2.2% organic growth. And our growth is seasonal, it happens around this time anyway. So to be 2% organic growth for us wasn't a pressure story.

It was actually a pretty positive story because you have to remember the backdrop of everything we're doing is around organizational transformation. So you have this huge dynamic in the firm where people are changing jobs, they're shifting clients around and focusing on keeping the transformation together. So to do that and then to grow the business organically is a home run. And last time this year when we were looking forward to where we would be now, we put some pretty aggressive targets in place. And the fact that we're meeting them and growing, we're pretty excited.

And we think that trajectory is going to continue. We don't see any reason to think that it's going to slow down. And again, especially as we start moving into this industry group format and people in these industry groups are focusing on end to end. Again, the story when we talk about janitorial, we're going to be talking about it by segment. So we're encouraged.

Speaker 7

Got it, that's helpful. Could you elaborate on the pacing of Phase two cost savings that you expect in fiscal twenty seventeen and what specific steps you have to take to achieve those savings?

Speaker 3

Sure. So majority of the savings at the end of Q4 should be at a run rate as we kind of outlined initially. So the organizational and procurement savings should be at a full run rate by the end of fiscal twenty seventeen, which should be a dollar for dollar and point for point contribution throughout the year. As it relates to the account planning and vertical acceleration, that's as we initially indicated, that's a second half FY 2017 story. But overall, we're going to end the year roughly 4.1%, 4.2 EBITDA margin and we should end next fiscal year at 4.7% roughly EBITDA margin.

So we're well on our way with what we outlined as part of 2020, slightly ahead on the org. Too early to tell on the other components. But based on the work we're doing in Phase II, the account planning, labor management and some of the COE, what's coming out of the COE, we feel pretty confident that we're on the right trajectory.

Speaker 2

Yeah. And I want to reiterate what we said earlier. It's not necessarily a quarter by quarter story. It's kind of a trailing twelve month story, right? Because again, these transformations could be bumpy in terms of timing of investments and when you deploy.

In terms of where we're heading and I guess I'll always come back to kind of the culture in the organization. We're we're really encouraged.

Speaker 7

Got it. That's helpful. And then lastly, Anthony, can you discuss how much of your guidance increase for the full year is due to deferral of investments and how much is due to higher 2020 Vision savings?

Speaker 3

Sure. Let me break out kind of all the components to our guidance beat. So we had roughly from 2020, if you think about we had roughly $6,000,000 in the first half, first two quarters. We recognized approximately $7,000,000 in Q3 and we expect roughly $9,000,000 more in Q4, which gets us to that $22,000,000 upper end of the range. And as I mentioned earlier, we've outlined 40 to 50 basis points roughly for org and we're heading towards the higher end of that range.

On timing, we expected roughly 5 or we recognized roughly $05 in the first half. It's really hard to pinpoint timing just given the dynamic nature of when we're going to make investments and how, but roughly $04 to $06 in the second half. So overall $09 to $0.11 on a full year basis is related to timing and the rest is the tax which is $06

Speaker 0

Thank you. Our next question is from Michael Gallo with CLK. You may begin.

Speaker 8

Hi, good morning.

Speaker 3

Hey Mike, how are doing?

Speaker 8

Good. Just two questions. I want to drill a little bit on the savings. As you've gone through the process, I was wondering if you're just realizing the savings faster than expected or if you're going through the process, you're just finding more low hanging fruit and more opportunities and things that you really hadn't thought about before when you put the savings together or are you pretty much finding what you thought you'd find?

Speaker 3

I think overall from the org, you know, when you outline the process, you know, you have an estimate of what you expect to say for the org. There are some things that we didn't necessarily factor one for one, one being the share based compensation expense associated with individuals that may have been impacted through the redesign. So that's, I would say, new findings, but we're also benefiting from just overall lower T and E with those individuals that are no longer with the organization. Those are things that are going to ebb and flow over time, but overall from an organization standpoint, we're a little bit higher than what we expected and outlined and it was a very robust process, a long term process. It was not just a percentage across the board.

We are designing to the organization of the future and that's why some of the investments we haven't made are critical. And then on the procurement side, early phases, we've hired a head of procurement. He's put in place policies and practices. His next phase is really going be on the compliance of those policies and practices, so it's a sustainable savings going forward. And we're well on our way on the run rate that we've outlined on that front.

And then the other outlines for 2020 currently in process and we expect that to begin to accelerate in 2017.

Speaker 8

Okay, great. And then second question I have is for Scott and I think you touched on it earlier and that's the education vertical. I was wondering if you can speak Scott to what you think the opportunity for the education vertical is for ABM as you look out a few years. I know you had a couple wins in the last quarter or so. But it seems relative to your other industries that you're tremendously under indexed in that vertical relative to where you should be.

So have you started to frame around how big you should be in education? How long it might take you to get there? And with some focus, whether you already see early traction at least with it getting more attention within the organization? Thanks.

Speaker 2

Yeah, so I think it's too early on for us to kind of sketch out where we can be three or four years from now. But I can tell just the fact, if you think about it, that we're focusing it as one unit and kind of one enterprise going after the market with kind of some basic standard operating procedures that we never have is just going to be huge for us and then pulling through our Abe's technical services. So we hired a gentleman named Dave Carpenter who was formerly of Aramark where he ran their education business and their healthcare business. Really, really tremendously experienced gentleman and understands kind of what's possible. He's encouraged, you know, he came on board with us because he sees what the future could be in education, what the trajectory could be.

But, you know, it's less of probably a 2017 story than a 2018 story as we start pulling the groups together. And, you know, I could just give you one example with Department of Education in New York City here. It was a $20,000,000 account that was already kind of on our radar because it wasn't performing well and we were trying to put together an action plan as to how you can raise margins. We didn't think it was going to pan out. And fortunately for us, a timing standpoint, they made the decision to go in house.

So it was a fortuitous event. So even before we could take action to start cleaning up and getting our focus right on education, we had this forced event which was again fortuitous. Now, again, when we look at kind of year over year comparisons, it will look like the education vertical is shrinking, but the quality of the education vertical is going to be stronger. So I'm really enthusiastic about what this could be. We're a two fifty million dollars vertical in a sea of some larger competitors that all have $1,000,000,000 in front of their number, 1,000,000,000, 2,000,000,000 in that market.

So I think we have great, great trajectory and the right team to go after it.

Speaker 8

Thanks very much.

Speaker 0

Thank you. Our next question is from Mark Riddick with Sidoti and Company. You may begin.

Speaker 9

Hi, good morning.

Speaker 2

Good morning. Good morning, Mark.

Speaker 9

I wanted to go back over a little bit with the TAG revenue and wondered if you could spend a little time talking about that because the idea that there's a greater focus in that opportunity and twice the margins, that's great. But I was wondering if you could shed a little light on maybe some of the areas, specific areas where you're having success in that transformation and what you maybe are most excited about or might have greatest legs going forward with TAG? And then I have a couple of follow ups.

Speaker 2

Sure. And I think I want to frame out what TAG revenue is and how you should think about it. TAG revenue is not passive, right? It's something that you go after. It's something that you're soliciting.

So picture an office building, right, where we have a project manager there who's interacting with the client or who would happen to be the building manager. And this is where you're going around and you're creatively looking for ways to hopefully add value to the building but also help us create revenue and margin story. So you may be so there's different there's levers to pull, but you have to actively go after it. And that's kind of the buzz that's happening in the organization now. We have our portfolio managers talking to our project managers in the field and having them have these really deep conversations with the clients about how we can add to that TAG revenue.

So it's not something that just happens because the economy is good or what have you. You have to solicit it. And so we're seeing that happen. And I think that's the key driver because our managers know that there's a much higher margin capture in that area. So that's been the key driver of this.

It's been us actively pursuing TAG revenue.

Speaker 9

Okay, great. And I wanted to touch also as far as some leadership spots. I sort of wanted to get a sense of where you were as far as key hires of are there any open spots of leadership areas that still need to be filled? Or do you have those seats already filled going forward?

Speaker 2

When you look at the industry groups itself, I think for the most part, we have our senior management in place. We are looking to build our sales infrastructure. We have a good one now, but that's going to be an area that you're going to see some build. And then on the support services side, I mentioned some HR hires. We're also putting together a shared service center in Houston that's going to be the center of all of our financial transactions.

So we have some work to do in terms of hiring on the support side as well. But I think in terms of our client facing portfolio management and project managers, I think we're probably 90% of the way there.

Speaker 9

Okay, excellent. Thank you very much.

Speaker 2

Thanks. Thank you.

Speaker 0

Thank you. We have time for one more question. Our last question is from Andy Wittmann with Robert W. Baird. You may begin.

Speaker 4

Great. So Scott now that Phase I is done and the org chart's in place, you just talked about that, now that the dust is settling is there more fine tuning that can happen there and opportunity as you move through Phase two to refine that, find more?

Speaker 2

Yes, well, I think so. And I think it's going to come in that center of excellence that I'm talking about earlier in my script. In terms of labor, just let's take labor management, right? We are a labor company, right? At the end of the day, we have 100,000 workers in there that are performing their tasks out in the field.

And right now, our approach has been pretty siloed, right? There are things that we do in Chicago that we're not doing in New York, things we do in New York we're not doing in LA and vice versa. And we haven't codified best practices. And I believe that when we go through this consistent excellence, center of excellence process that we have going on right now in labor management, in account management, in our approach to how we're going to manage a client account, I think there's just great promise over the long term. We've brought some people into the organization that worked at other companies that put together standard operating procedures and actually went through a program of what we're doing now, again, codifying best practices.

And they've talked to us about the trajectory they've seen internally. And as you know, we've been working with the Boston Consulting Group that does this across hundreds and hundreds of organizations in the service business. So I think we're enthusiastic about what this can lead to in the long term. But it's just hard, Andy, right now to kind of say what this can do next quarter or even the next six months. It's more about what is this going to be able to do for us in the coming years.

And it's just a great, great story.

Speaker 4

Got it. What about the level of disruption? Can you give us maybe a more detailed sense about where you are in terms of reassigning those the account managers from service oriented to vertical and market oriented? And I mean, sounds like things are so far on track, but it also seems like there's another few months of this to go. I guess I'm just trying to get a sense of the potential risk or lack thereof risk as those accounts get transitioned.

Speaker 2

Yeah. So I think we got through the biggest hurdle in terms of people knowing they have a seat at the organization, right? Because we've done the exits already. So kind of all the tension that was built up in the organization prior to us making those announcements two or three months ago has been alleviated because people know they have a role, they know they have a seat. And so that anxiety has passed.

So now it's all about transitioning accounts. And we are probably 75% through the process at least in terms of transitioning accounts. In terms of actually putting together actual plans for each account, we're even farther ahead. So I can tell you, and this is probably more anecdotal, but I can only think of probably even less than a handful of accounts where our team has come back and said, you know, no, we're not exactly ready yet because it may be more than the client is ready to handle because we just put this one person on the account to take them off right now is not great timing. But I'm telling you, I mean, less than a handful.

So for the most part, our clients have been really receptive. They know us well. And I said this before, this is not the first time we've kind of transitioned managers from one account to another. We kind of always did that on a regular basis too to refresh accounts. So it's not like someone's been on an account as a project manager for seven years and now all of a sudden we're taking them off and there's this, you know, kind of dramatic shift.

So I'll always say that there's caution. I'll always say that there's risk. But I think so much of it, Andy, has been mitigated by the fact that people know that they have a seat and they're working productively. And frankly, in an organization that's accelerating, right? If you think about what's happening here with our results, with what's happening with our stock price, it's a great atmosphere at the firm here.

And to know that you're part of this, it's been palpable.

Speaker 4

All right. Thanks a lot.

Speaker 2

Thanks, Andy.

Speaker 0

Thank you. I would now like to turn the call back over to company for closing remarks.

Speaker 2

So I just want to thank everybody for joining in. I hope everyone had a good summer. We're off to the fall and good things ahead and we'll keep you posted on Phase II and everything we get accomplished over the next few months until our next call. So thanks for the time and for sticking with us. We're excited about where we're going.

Thank you.

Speaker 0

Ladies and gentlemen, this concludes today's conference. Thanks for your participation and have a wonderful day.