ABM Industries - 10-Q quarterly report FY2010 Q3

 

 

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See accompanying notes to the condensed consolidated financial statements.

(Continued)

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

See accompanying notes to the condensed consolidated financial statements.

(Continued)

See accompanying notes to the condensed consolidated financial statements.

The accompanying condensed consolidated financial statements of ABM Industries Incorporated (“ABM”, and together with its subsidiaries, the “Company”) contained in this report are unaudited and should be read in conjunction with the consolidated financial statements and accompanying notes filed with the U.S. Securities and Exchange Commission (“SEC”) in ABM’s Annual Report on Form 10-K for the fiscal year ended October 31, 2009. All references to years are to the Company’s fiscal year, which ends on October 31.

The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in ABM’s condensed consolidated financial statements and the accompanying notes. These estimates are based on information available as of the date of these financial statements. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods. In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments, which are normal and recurring, necessary to fairly state the information for each period contained therein. The results of operations for the three and nine months ended July 31, 2010 are not necessarily indicative of the operating results that might be expected for the full fiscal year or any future periods.

The Company’s Parking segment reports both revenues and expenses, in equal amounts, for costs directly reimbursed from its managed parking lot clients. Parking revenues related solely to the reimbursement of expenses totaled $55.8 million and $57.2 million for the three months ended July 31, 2010 and 2009, respectively, and $169.0 million and $175.0 million for the nine months ended July 31, 2010 and 2009, respectively.

Effective November 1, 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) updated authoritative standard for accounting for business combinations, which is included in Accounting Standards Codification ^TM (“ASC”) Topic 805 “Business Combinations” (“ASC 805”). Upon adoption, on November 1, 2009, the Company expensed approximately $1.0 million of deferred acquisition costs for acquisitions then being pursued. In addition, during the nine months ended July 31, 2010, the Company incurred an additional $0.6 million of acquisition costs related to the acquisition of Diversco, Inc. (“Diversco”) and other acquisitions currently being pursued. This authoritative standard will impact the way in which the Company accounts for business combinations.

Effective November 1, 2009, the Company adopted the FASB updated authoritative standard for determining the useful life of intangible assets, which is included in ASC Topic 350-30 “General Intangibles Other than Goodwill” (“ASC 350-30”). This authoritative standard amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset and requires additional disclosures. This authoritative standard must be applied prospectively to all intangible assets recognized as of the effective date. This authoritative standard had no impact on the Company’s condensed consolidated interim financial statements, but could impact the way in which the useful lives of intangible assets acquired in business combinations will be determined, if renewal or extension terms are apparent.

Effective November 1, 2009, the Company adopted the FASB updated authoritative standard on employers’ disclosures about post-retirement benefit plan assets, which is included in ASC Topic 715 “Compensation—Retirement Benefits” (“ASC 715”). The authoritative standard expands the annual disclosures by adding required disclosures about how investment allocation decisions are made by management, major categories of plan assets and significant concentrations of risk. Additionally, an employer is now required to disclose information about the valuation of plan assets similar to the disclosure required under ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC 820”). This authoritative standard will not have an impact on the Company’s condensed consolidated interim financial statements as it only amends required annual disclosures.

Effective November 1, 2009, the Company adopted the FASB authoritative standard on fair value measurements for non-financial assets and non-financial liabilities measured on a non-recurring basis, which is included in ASC 820. The Company’s non-financial assets and non-financial liabilities principally consist of intangible assets acquired through business combinations and long-lived assets. During the nine months ended July 31, 2010, the Company did not re-measure any non-financial assets or non-financial liabilities at fair value, therefore, this authoritative standard did not have any impact on the Company’s condensed consolidated interim financial statements. This authoritative standard will impact the way in which fair value is measured and disclosed for non-financial assets and non-financial liabilities that are measured at fair value on a non-recurring basis in periods subsequent to initial recognition.

Effective February 1, 2010, the Company adopted FASB accounting standard update No. 2010-6, “Improving Disclosures about Fair Value Measurements”, issued in January 2010 related to fair value measurements and disclosures, except for the additional gross presentation disclosure requirements for Level 3 changes which will be adopted in the first quarter of 2012. The update requires entities to make new disclosures about recurring or non-recurring fair value measurements of assets and liabilities, including: (1) the amounts of significant transfers between Level 1 and Level 2 fair value measurements and the reasons for the transfers; (2) the reasons for any transfers in or out of Level 3; and (3) information on purchases, sales, issuances and settlements on a gross basis in the reconciliation of recurring Level 3 fair value measurements. The FASB also clarified existing fair value measurement disclosure guidance about the level of disaggregation of assets and liabilities, and information about the valuation techniques and inputs used in estimating Level 2 and Level 3 fair value measurements. The Company did not have transfers of assets and liabilities between Level 1, Level 2 and/or Level 3 during the nine months ended July 31, 2010 and the required additional disclosures had no impact on the Company’s financial position or results of operations. See Note 3, “Fair Value Measurements” and Note 4, “Auction Rate Securities”.

As required by ASC 820, fair value is determined based on inputs or assumptions that market participants would use in pricing an asset or a liability. These assumptions consist of: (1) observable inputs — market data obtained from independent sources; or (2) unobservable inputs - market data determined using the company’s own assumptions about valuation. ASC 820 establishes a hierarchy to prioritize the inputs to valuation techniques, with the highest priority being given to Level 1 inputs and the lowest priority to Level 3 inputs, as described below:

Level 1 – Quoted prices for identical instruments in active markets;

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs or significant value-drivers are observable in active markets; and

Level 3 – Unobservable inputs.

The following tables presents the Company’s hierarchy for financial assets and liabilities measured at fair value on a recurring basis as of July 31, 2010 and October 31, 2009:

The fair value of the assets held in the funded deferred compensation plan is based on quoted market prices.

The fair value of the investments in auction rate securities is based on discounted cash flow valuation models, primarily utilizing unobservable inputs. During the nine months ended July 31, 2010, the Company had no transfers of assets or liabilities between any of the above hierarchy levels. See Note 4, “Auction Rate Securities”, for the roll-forwards of assets measured at fair value using significant unobservable Level 3 inputs.

The fair value of the interest rate swap is estimated based on the present value of the difference between expected cash flows calculated at the contracted interest rates and the expected cash flows at current market interest rates using observable benchmarks for London Interbank Offered Rate forward rates at the end of the period. See Note 7, “Line of Credit Facility”.

Due to the short-term maturities of the Company’s cash, cash equivalents, receivables, payables, and current assets and liabilities of discontinued operations, the carrying value of these financial instruments approximates their fair market values. Due to the variable interest rates, the fair value of outstanding borrowings under the Company’s $450.0 million line of credit approximates its carrying value of $150.0 million. The carrying value of the receivables included in non-current assets of discontinued operations of $2.1 million and the acquired insurance deposits related to acquired self-insurance claims of $42.2 million approximates fair market value.

As of July 31, 2010, the Company held investments in auction rate securities from five different issuers having an original principal amount of $5.0 million each (aggregating $25.0 million). At July 31, 2010 and October 31, 2009, the estimated fair value of these securities, in total, was approximately $19.6 million and $19.5 million, respectively. These auction rate securities are debt instruments with stated maturities ranging from 2025 to 2050, for which the interest rate is designed to be reset through Dutch auctions approximately every 30 days. Auctions for these securities have not occurred since August 2007.

The Company estimates the fair values of auction rate securities it holds utilizing a discounted cash flow model, which considers, among other factors, assumptions about: (1) the underlying collateral; (2) credit risks associated with the issuer; (3) contractual maturity; (4) credit enhancements associated with financial insurance guarantees, if any; and (5) assumptions about when, if ever, the security might be re-financed by the issuer or have a successful auction. Since there can be no assurance that auctions for these securities will be successful in the near future, the Company has classified its auction rate securities as long-term investments.

The following table presents the significant assumptions used to determine the fair value of the Company’s auction rate securities at July 31, 2010 and October 31, 2009:

L — London Interbank Offered Rate

The Company’s determination of whether impairments of its auction rate securities are other-than-temporary is based on an evaluation of several factors, circumstances and known or reasonably supportable trends including, but not limited to: (1) the Company’s intent to not sell the securities; (2) the Company’s assessment that it is not more likely than not that the Company will be required to sell the securities before recovering its cost basis; (3) expected defaults; (4) available ratings for the securities or the underlying collateral; (5) the rating of the associated guarantor (where applicable); (6) the nature and value of the underlying collateral expected to service the investment; (7) actual historical performance of the security in servicing its obligations; and (8) actuarial experience of the underlying re-insurance arrangement (where applicable) which in certain circumstances may have preferential rights to the underlying collateral.

Based primarily on an unfavorable development in the Company’s assumption about the expected life for one security, at April 30, 2010 the Company recognized an additional other-than-temporary impairment credit loss of $0.1 million. The Company had previously recognized an other-than-temporary impairment credit loss of $1.6 million for this security in 2009. The credit losses were based upon the difference between the present value of the expected cash flows to be collected and the amortized cost basis of the security. Significant assumptions used in estimating the credit loss include: (1) default rates for the security and the mono-line insurer, if any (which were based on published historical default rates of similar securities and consideration of current market trends); and (2) the expected life of the security (which represents the Company’s view of when market efficiencies for securities may be restored). Adverse changes in any of these factors could result in additional declines in fair value and further other-than-temporary impairments in the future. No further other-than-temporary impairments were identified.

The following tables presents the changes in the cost basis and fair value of the Company’s auction rate securities for the nine months ended July 31, 2010:

The other-than-temporary impairment (“OTTI”) related to credit losses recognized in earnings for the nine months ended July 31, 2010 is as follows:

At July 31, 2010 and October 31, 2009, unrealized losses of $3.7 million ($2.2 million net of taxes) and $3.9 million ($2.3 million net of taxes) were recorded in accumulated other comprehensive loss, respectively.

Basic net income per common share is net income divided by the weighted average number of shares outstanding during the period. Diluted net income per common share is based on the weighted average number of shares outstanding during the period, adjusted to include the assumed exercise and conversion of certain stock options, restricted stock units and performance shares. The calculation of basic and diluted net income per common share is as follows:

The diluted net income per common share excludes certain stock options and restricted stock units since the effect of including these stock options and restricted stock units would have been anti-dilutive as follows:

The Company’s self-insurance reserves during interim periods are based on actuarial rates established from the most recent third-party actuarial report, considering known or expected subsequent trends. An actuarial report is expected to be completed during the fourth quarter of 2010 and may result in an adjustment to earnings in that period.

At July 31, 2010, the Company had $103.8 million in standby letters of credit (primarily related to its workers’ compensation, general liability, automobile, and property damage programs), $42.2 million in restricted insurance deposits and $112.1 million in surety bonds supporting insurance claim liabilities. At October 31, 2009, the Company had $118.6 million in standby letters of credit, $42.5 million in restricted insurance deposits and $103.2 million in surety bonds supporting insurance claim liabilities.

The Company holds a $450.0 million five-year syndicated line of credit that is scheduled to expire on November 14, 2012 (the “Facility”). The Facility is available for working capital, the issuance of standby letters of credit, the financing of capital expenditures, and other general corporate purposes.

The Facility includes covenants limiting liens, dispositions, fundamental changes, investments, indebtedness and certain transactions and payments. In addition, the Facility also requires that the Company maintain the following three financial covenants which are described in Note 9, “Line of Credit Facility”, to the Consolidated Financial Statements set forth in the Company’s Annual Report on Form 10-K for 2009: (1) a fixed charge coverage ratio; (2) a leverage ratio; and (3) a combined net worth test. The Company was in compliance with all covenants as of July 31, 2010 and expects to be in compliance in the foreseeable future.

As of July 31, 2010, the total outstanding amount under the Facility in the form of cash borrowings was $150.0 million. Available credit under the line of credit was up to $196.2 million at July 31, 2010. The Company’s ability to draw down available amounts under its line of credit is subject to compliance with the covenants described above.

As of July 31, 2010, the fair value of the interest rate swap was a $0.7 million liability, which is included in retirement plans and other on the accompanying condensed consolidated balance sheet. No ineffectiveness existed at July 31, 2010. The amount included in accumulated other comprehensive loss is $0.7 million ($0.4 million, net of taxes).

The components of net periodic benefit cost of the Company’s defined benefit plans and the post-retirement benefit plans, including participants associated with continuing operations, for the three and nine months ended July 31, 2010 and 2009, were as follows:

The Company has been named a defendant in certain proceedings arising in the ordinary course of business. Litigation outcomes are often difficult to predict and often are resolved over long periods of time. Estimating probable losses requires the analysis of multiple possible outcomes that often depend on judgments about potential actions by third parties. Loss contingencies are recorded as liabilities in the accompanying condensed consolidated financial statements when it is both: (1) probable or known that a liability has been incurred; and (2) the amount of the loss is reasonably estimable. If the reasonable estimate of the loss is a range and no amount within the range is a better estimate, the minimum amount of the range is recorded as a liability. Legal costs associated with loss contingencies are expensed as incurred.

The Company is a defendant in various purported class action and class action lawsuits related to alleged violations of federal or California wage-and-hour laws. The named plaintiffs in these lawsuits are current or former employees of ABM subsidiaries who allege, among other things, that they were required to work “off the clock,” were not paid for all overtime, were not provided work breaks or other benefits, and/or that they received pay stubs not conforming to California law. In all cases, the plaintiffs generally seek unspecified monetary damages, injunctive relief or both.

The Company is a defendant in the lawsuit filed July 19, 2007 in the United States District Court, Eastern District of California, entitled U.S. Equal Employment Opportunity Commission, Plaintiff Erika Morales and Anonymous Plaintiffs One through Eight v. ABM Industries Incorporated et. al. (the “Morales case”). The plaintiffs in the Morales case allege sexual harassment and retaliation. In 2009, fourteen claimants joined the lawsuit alleging various claims against the Company. The case involved both Title VII federal law claims and California state law claims. In June 2010, the Company agreed to a settlement of $5.8 million for the Morales case, subject to court approval, which amount was accrued for at July 31, 2010. At April 30, 2010, $5.0 million had been accrued for this matter. The Company expects the court to approve the settlement in the fourth quarter of 2010.

The Company accrues amounts it believes are adequate to cover any liabilities related to litigation and arbitration proceedings, and other contingencies that the Company believes will result in a probable loss. However, the ultimate resolution of such matters is always uncertain. It is possible that any such proceedings brought against the Company could have a material adverse impact on its financial condition and results of operations. The total amount accrued for probable losses was $10.8 million at July 31, 2010.

On January 11, 2010, the Company’s Compensation Committee approved the grant of 256,637 performance share awards under the terms of the Company’s 2006 Equity Incentive Plan, as amended and restated. The fair value of the performance share awards granted and valued as of January 28, 2010 was approximately $5.0 million and these awards vest over a period of three years.

On March 31, 2010, the Company’s Compensation Committee approved the following grants: 262,344 stock options and 80,185 restricted stock units, each under the terms of the Company’s 2006 Equity Incentive Plan, as amended and restated. The fair value of the awards granted on March 31, 2010 was approximately $3.4 million and these awards vest 100% on the fifth anniversary of the grant date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option valuation model. The fair value of stock options granted was $6.41 per share. The assumptions used in the option valuation model for the stock options granted on March 31, 2010 were: (1) expected life from date of grant of 5.6 years; (2) expected stock price volatility of 38.52%; (3) expected dividend yield of 2.66%; and (4) a risk-free interest rate of 2.62%. The fair value of the restricted stock units granted was determined using the closing stock price on the date of grant.

No share-based grants were made under the Company’s 2006 Equity Incentive Plan during the three months ended July 31, 2010.

During the three months ended July 31, 2010, the Company determined that the financial performance targets, which were established in connection with certain performance share grants, were no longer probable of achievement. As a result, the Company reversed approximately $3.4 million of previously recorded share-based compensation expense in the three and nine months ended July 31, 2010. This adjustment was recorded in selling, general and administrative expenses.

The following table presents the components of comprehensive income for the three months ended July 31, 2010 and 2009:

The following table presents the components of comprehensive income for the nine months ended July 31, 2010 and 2009:

During the three months ended July 31, 2010, the Company acquired all of the outstanding shares of Diversco from DHI Holdings, Inc. for $30.6 million in cash and incurred direct acquisition costs of $0.2 million, which were expensed as incurred. The purchase price was subsequently adjusted to $30.3 million in connection with a working capital adjustment. Diversco is a national provider of outsourced facility services. The acquisition expands the geographic reach of the Company’s janitorial and security businesses, particularly in the Southeast, Midwest and Mid-Atlantic regions of the United States. The results of operations for Diversco are included in the Company’s Janitorial and Security segments as of June 30, 2010. The amounts of Diversco’s revenues and earnings included in the Company’s condensed consolidated statements of income for the three and nine months ended July 31, 2010 were $6.9 million and $0.3 million, respectively. Pro forma financial information for this acquisition is not required to be provided as this acquisition is not material to the Company’s financial statements.

The preliminary allocation of the purchase price to the underlying net assets acquired and liabilities assumed was based on their estimated fair values as of the acquisition date, June 30, 2010, with any excess of the purchase price allocated to goodwill. Certain estimated values are not yet finalized, such as self-insurance reserves and residual goodwill, and are subject to change as the Company obtains the actuarial analysis of assumed insurance liabilities needed to complete the purchase price allocation. Accordingly, any further changes to the fair values of the self-insurance reserves and residual goodwill will be finalized during the remainder of 2010.

The preliminary purchase price and related allocations are summarized as follows:

The acquired customer contracts and relationships will be amortized using the sum-of-the-years-digits method over their useful lives of 11 years, which is consistent with the estimated useful life considerations used in the determination of their fair values. Intangible assets of $10.8 million were assigned to the Janitorial and Security segments in the amounts of $9.2 million and $1.6 million, respectively. Goodwill of $12.7 million was assigned to the Janitorial and Security segments in the amounts of $10.8 million and $1.9 million, respectively, and is expected to be deductible for tax purposes. The amounts of intangible assets and goodwill have been assigned to the Janitorial and Security segments based on the respective profit margins of the acquired customer contracts. The transaction was taxable for income tax purposes and all assets and liabilities have been recorded at fair value for both book and income tax purposes. Therefore, no deferred taxes have been recorded.

Total additional consideration paid during the nine months ended July 31, 2010 related to the prior years acquisitions totaled $3.3 million. The additional consideration represents contingent amounts based on financial performance, which has been recorded as goodwill.

At July 31, 2010, the Company had unrecognized tax benefits of $102.4 million, all of which, if recognized in the future, would affect its effective tax rate. The Company includes interest and penalties related to unrecognized tax benefits in income tax expense. As of July 31, 2010, the Company had accrued interest related to uncertain tax positions of $0.8 million. The Company has recorded $2.0 million of the unrecognized tax benefits as a current liability.

The effective tax rate on income from continuing operations for the three months ended July 31, 2010 and 2009 were 38.6% and 29.0%, respectively. The effective tax rate on income from continuing operations for the nine months ended July 31, 2010 and 2009 were 38.9% and 36.3%, respectively. The effective tax rate for the three and nine months ended July 31, 2009 includes non-recurring tax benefits of $1.7 million and $1.5 million, respectively.

The Company’s major tax jurisdiction is the United States. ABM and OneSource Services, Inc. U.S. federal income tax returns remain open for examination for the periods ending October 31, 2006 through October 31, 2009 and March 31, 2000 through November 14, 2007, respectively. ABM is currently being examined by the Internal Revenue Service for the tax years 2006-2008. The Company does business in all 50 states, significantly in California, Texas and New York, as well as Puerto Rico and Canada. In major state jurisdictions, the tax years 2006-2009 remain open and subject to examination by the appropriate tax authorities. The Company is currently being examined by Illinois, Maryland, Arizona, Utah, New Jersey, Massachusetts, and Puerto Rico.

The Company is organized into four reportable operating segments, Janitorial, Parking, Security and Engineering, which are summarized as follows:

Most Corporate expenses are not allocated. Such expenses include the adjustments to the Company’s self-insurance reserves relating to prior years, certain legal costs and settlements, certain information technology costs, share-based compensation costs, severance costs associated with acquisitions and certain chief executive officer and other finance and human resource departmental costs. Corporate expenses for the nine months ended July 31, 2009 included the net benefit of a $9.6 million legal settlement related to a claim that was settled and resolved in the three months ended January 31, 2009.

On October 31, 2008, the Company completed the sale of substantially all of the assets of its former Lighting segment, excluding accounts receivable and certain other assets and liabilities, to Sylvania Lighting Services Corp (“Sylvania”). The remaining assets and liabilities associated with the Lighting segment have been classified as assets and liabilities of discontinued operations for all periods presented. The results of operations of the Lighting segment for all periods presented are classified as “Loss from discontinued operations, net of taxes.”

The carrying amounts of the major classes of assets and liabilities of the Lighting segment included in discontinued operations are as follows:

The following discussion should be read in conjunction with the unaudited accompanying condensed consolidated financial statements of ABM Industries Incorporated (“ABM”, and together with its subsidiaries, the “Company”) included in this Quarterly Report on Form 10-Q and with the consolidated financial statements and accompanying notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 31, 2009. All information in the discussion and references to years are based on the Company’s fiscal year, which ends on October 31.

The Company provides janitorial, parking, security and engineering services for thousands of commercial, industrial, institutional and retail client facilities in hundreds of cities, primarily throughout the United States. The Company’s business is impacted by, among other things, commercial office building occupancy and rental rates, industrial activity, air travel levels, tourism and transportation needs at colleges, universities and health care service facilities. Revenues at the Company’s Janitorial, Security and Engineering segments are primarily based on the performance of labor-intensive services at contractually specified prices. Revenues at the Parking segment relate to parking and transportation services, which are less labor-intensive. In addition to services defined within the scope of client contracts, the Janitorial segment also generates revenues from extra services (or tags) such as, but not limited to, flood cleanup services and snow removal, which generally provide higher margins.

During 2009, the Company experienced losses of client contracts that exceeded new business, reductions in the level and scope of client services, contract price compression and declines in the level of tag work, primarily in the Janitorial segment. These losses and reductions continued to influence results in the nine months ended July 31, 2010. Total revenues in the nine months ended July 31, 2010, as compared to the nine months ended July 31, 2009, decreased $19.4 million, or 0.7%, primarily related to the losses and reductions experienced during 2009 and some additional reductions in the level and scope of client services and contract price compression in the nine months ended July 31, 2010 in the Janitorial segment. These revenue decreases in the Janitorial segment were partially offset by additional revenues from new clients and the expansion of services to existing clients in the Engineering segment. Despite the reductions in revenues, the Company’s operating profit, excluding Corporate, increased $2.1 million, or 1.5%, in the nine months ended July 31, 2010 compared to the nine months ended July 31, 2009, primarily related to increases in the operating profit in the Engineering and Parking segments as a result of increases in revenues from new clients and the expansion of services to existing clients and cost control measures in all segments.

In addition to revenues and operating profit, the Company’s management views operating cash flows as a good indicator of financial performance, as strong operating cash flows provide opportunities for growth both organically and through acquisitions. Operating cash flows primarily depend on revenue levels, the timing of collections and payments to suppliers and other vendors, the quality of receivables, the timing and amount of income tax payments and the timing and amount of payments on self-insured claims. The Company’s cash flows provided by continuing operating activities was $73.0 million for the nine months ended July 31, 2010.

The Company believes that achieving desired levels of revenues and profitability in the future will depend upon, among other things, its ability to attract and retain clients at desirable profit margins, to pass on cost increases to clients, and to keep overall costs low. In the short-term, the Company plans to remain competitive by, among other things, continued cost control strategies. The Company is continuing to monitor, and in some cases exit, client arrangements where the Company believes the client is at high risk of bankruptcy or which produce low profit margins and focus on client arrangements that may generate less revenues but produce higher profit margins. Additionally, the Company is exploring acquisitions, both domestically and internationally. In the long-term, the Company expects to continue to grow organically and through acquisitions (including international expansion) in response to the perceived growing demand for a global integrated facility services solution provider.

During the three months ended July 31, 2010, the Company acquired all of the outstanding shares of Diversco, Inc. (“Diversco”) from DHI Holdings, Inc. for $30.6 million in cash and incurred direct acquisition costs of $0.2 million, which were expensed as incurred. The purchase price was subsequently adjusted to $30.3 million in connection with a working capital adjustment. Diversco is a national provider of outsourced facility services. The acquisition expands the geographic reach of the Company’s janitorial and security businesses, particularly in the Southeast, Midwest and Mid-Atlantic regions of the United States. The results of operations for Diversco are included in the Company’s Janitorial and Security segments as of June 30, 2010. The amounts of Diversco’s revenues and earnings included in the Company’s condensed consolidated statements of income for the three and nine months ended July 31, 2010 were $6.9 million and $0.3 million, respectively.

The Company’s self-insurance reserves during interim periods are based on actuarial rates established from the most recent third-party actuarial report, considering known or expected subsequent trends. An actuarial report is expected to be completed during the fourth quarter of 2010 and may result in an adjustment to earnings in that period.

The Company believes that the cash generated from operations and amounts available under its $450.0 million line of credit will be sufficient to fund the Company’s operations and cash requirements, except to the extent cash is required for significant acquisitions, if any. As of July 31, 2010, the total outstanding amounts under the Company’s line of credit in the form of cash borrowings and standby letters of credit were $150.0 million and $103.8 million, respectively. Available credit under the line of credit was up to $196.2 million as of July 31, 2010. The Company’s ability to draw down available amounts under its $450.0 million line of credit is subject to compliance with certain financial covenants, including covenants relating to consolidated net worth, a fixed charge coverage ratio and a leverage ratio. In addition, other covenants under the line of credit include limitations on liens, dispositions, fundamental changes, investments and certain transactions and payments. As of July 31, 2010, the Company was in compliance with all covenants and expects to be in the foreseeable future.

Working Capital. Working capital increased by $3.2 million to $281.5 million at July 31, 2010 from $278.3 million at October 31, 2009. Excluding the effects of discontinued operations, working capital increased by $8.2 million to $276.8 million at July 31, 2010 from $268.6 million at October 31, 2009.

The increase was primarily related to:

partially offset by:

Cash Flows from Operating Activities. Net cash provided by operating activities was $80.3 million for the nine months ended July 31, 2010, compared to $76.5 million for the nine months ended July 31, 2009.

The increase in cash flows from operating activities was primarily related to:

partially offset by:

Net cash provided by discontinued operating activities was $7.3 million for the nine months ended July 31, 2010, compared to $23.8 million for the nine months ended July 31, 2009. The cash provided by discontinued operating activities for the nine months ended July 31, 2010 primarily related to cash collections from the transferred client contracts that contained deferred charges related to services performed by the Company prior to the sale.

Cash Flows from Investing Activities. Net cash used in investing activities for the nine months ended July 31, 2010 was $47.9 million, compared to $32.3 million for the nine months ended July 31, 2009.

The increase in cash used in investing activities was primarily related to:

Cash Flows from Financing Activities. Net cash used in financing activities was $33.6 million for the nine months ended July 31, 2010, compared to $47.3 million for the nine months ended July 31, 2009. The decrease in cash used in financing activities was primarily related to the financing of the Diversco acquisition which was partially offset by the repayments made on the Company’s line of credit.

Net Income. Net income in the three months ended July 31, 2010 increased by $8.7 million, or 70.8%, to $21.0 million ($0.40 per diluted share) from $12.3 million ($0.24 per diluted share) in the three months ended July 31, 2009.

Income from Continuing Operations. Income from continuing operations in the three months ended July 31, 2010 increased by $8.6 million, or 69.1%, to $21.0 million ($0.40 per diluted share) from $12.4 million ($0.24 per diluted share) in the three months ended July 31, 2009.

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

partially offset by:

Revenues. Total revenues in the three months ended July 31, 2010 remained relatively flat, as compared to the three months ended July 31, 2009. Revenue decreases in the Janitorial segment were partially offset by revenue increases in the Engineering segment.

Operating Expenses. As a percentage of revenues, gross margin was 10.7% and 10.1% in the three months ended July 31, 2010 and 2009, respectively.

The gross margin percentages are affected by the following:

Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $10.0 million, or 15.5%, in the three months ended July 31, 2010 compared to the three months ended July 31, 2009.

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

partially offset by:

Interest Expense. Interest expense in the three months ended July 31, 2010 decreased $0.3 million, or 21.9%, to $1.1 million from $1.5 million in the three months ended July 31, 2009. The decrease was primarily related to a lower average outstanding balance and a lower average interest rate under the line of credit in the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The average outstanding balance under the Company’s line of credit was $148.2 million and $205.0 million during the three months ended July 31, 2010 and 2009, respectively.

Provision for Income Taxes. The effective tax rates on income from continuing operations for the three months ended July 31, 2010 and 2009 were 38.6% and 29.0%, respectively. The effective tax rate for the three months ended July 31, 2009 includes a non-recurring tax benefit of $1.7 million, which primarily consists of California Enterprise Zone hiring credits.

Segment Information. The revenues and operating profits for the Company’s reportable segments (Janitorial, Parking, Security, and Engineering) were as follows:

Janitorial. Janitorial revenues decreased $12.1 million, or 2.0%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The decrease was primarily related to reductions in the level and scope of client services provided to existing clients and contract price compression as a result of decreases in client discretionary spending.

Operating profit increased $3.6 million, or 10.2%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The increase was primarily related to lower labor expenses resulting from one less working day in the three months ended July 31, 2010 and cost control measures, partially offset by the reduction in revenues.

Parking. Parking revenues decreased $0.5 million, or 0.4%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The decrease was primarily related to a $1.4 million reduction of expenses incurred on the behalf of managed parking facilities, which are reimbursed to the Company. These reimbursed expenses are recognized as parking revenues and expenses, which have no impact on operating profit. The decrease in management reimbursement revenues was offset by a $0.9 million increase in lease and allowance revenues from new clients and the expansion of service to existing clients.

Operating profit increased $0.8 million, or 17.2%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The increase was primarily related to the increase in lease and allowance revenues and cost control measures.

Security. Security revenues increased $0.4 million, or 0.5%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The increase was primarily related to additional revenues from new clients, partially offset by a reduction in the level and scope of client services provided to existing clients as a result of a decrease in client discretionary spending.

Operating profit decreased $0.7 million, or 26.4%, in the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The decrease was primarily related to margin compression, which was the result of reductions in the level and scope of client services provided under arrangements that produced higher gross profit margins.

Engineering. Engineering revenues increased $10.8 million, or 14.2%, during the three months ended July 31, 2010 compared to the three months ended July 31, 2009. The increase was primarily related to additional revenues from new clients and the expansion of services to existing clients, partially offset by the effects of one less working day in the three months ended July 31, 2010.

Operating profit increased by $1.0 million, or 21.1%, in the three months ended July 31, 2010 compared to the three months ended July 31, 2009, primarily related to the increase in revenues.

Corporate. Corporate expense decreased $10.1 million, or 37.2%, in the three months ended July 31, 2010 compared to the three months ended July 31, 2009.

The decrease in Corporate expense was primarily related to:

partially offset by: