UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 31, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                     to                    

Commission file number 1-8929

ABM INDUSTRIES INCORPORATED

Registrant’s telephone number, including area code: 415/733-4000

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes x No o

Number of shares of common stock outstanding as of August 31, 2004: 48,520,153

ABM INDUSTRIES INCORPORATED
FORM 10-Q
For the three months and nine months ended July 31, 2004

Table of Contents

1

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

ABM INDUSTRIES INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Continued)      

2

ABM INDUSTRIES INCORPORATED AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of the consolidated financial statements.

3

ABM INDUSTRIES INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

The accompanying notes are an integral part of the consolidated financial statements.

4

ABM INDUSTRIES INCORPORATED AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JULY 31, 2004 AND 2003

     The accompanying notes are an integral part of the consolidated financial statements.

5

ABM INDUSTRIES INCORPORATED AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. General

     In the opinion of management, the accompanying unaudited consolidated financial statements contain all material adjustments which are necessary to present fairly ABM Industries Incorporated and Subsidiaries’ (the Company) financial position as of July 31, 2004 and the results of operations for the three and nine months then ended, and cash flows for the nine months then ended. These adjustments are of a normal, recurring nature, except as otherwise noted.

     The information included in this Form 10-Q should be read in conjunction with the management’s discussion and analysis, the consolidated financial statements and the notes thereto included in the Company’s Form 10-K Annual Report for the fiscal year ended October 31, 2003, as filed with the Securities and Exchange Commission.

     The operations of the Company’s Elevator segment have been classified as a discontinued operation for all periods presented. Accordingly, the operating results and cash flows are shown as discontinued operation in the accompanying consolidated financial statements. See Note 7.

     The Company has investments in two low income housing tax credit partnerships. Purchased in 1995 and 1998, these limited partnerships, organized by independent third parties and sold as investments, are variable interest entities as defined by FASB Financial Interpretation (FIN) No. 46R, a revision to FIN 46, “Consolidation of Variable Interest Entities.” In accordance with FIN 46R, these partnerships are not consolidated in the Company’s consolidated financial statements because the Company is not the primary beneficiary of the partnerships. At July 31, 2004, the at-risk book value of these investments totaled $4.2 million.

2. Net Income per Common Share

     The Company has reported its earnings in accordance with Statement of Financial Accounting Standards (SFAS) No. 128, “Earnings per Share.” Basic net income per common share is based on 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, including common stock equivalents. The calculation of net income per common share is as follows:

6

     For purposes of computing diluted net income per common share, weighted average common share equivalents do not include stock options with an exercise price that exceeds the average fair market value of the Company’s common stock for the period (i.e., “out-of-the-money” options). On July 31, 2004 and 2003, options to purchase common shares of 23,250 and 3.4 million at a weighted average exercise price of $19.04 and $16.14, respectively, were excluded from the computation.

3. Stock-Based Compensation

     In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amended SFAS No. 123, “Accounting for Stock-Based Compensation” to provide for alternative methods of transition to SFAS No. 123 and amended disclosure provisions. SFAS No. 148 was effective for financial statements for fiscal years ending after December 15, 2002. The Company continues to account for stock-based employee compensation plans using the intrinsic value method under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and adopted the disclosure provisions of SFAS No. 148 effective November 1, 2002. The Company’s application of APB Opinion No. 25 does not result in compensation cost because the exercise price of the options is equal to the fair value of the stock at the grant date. Under the intrinsic value method, if the fair value of the stock is greater than the exercise price at grant date, the excess is amortized to compensation expense over the estimated service life of the recipient.

     As all options granted since October 31, 1995 had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost is reflected in net income for the three and nine months ended July 31, 2004 and 2003. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to all outstanding employee options granted after October 31, 1995 using the retroactive restatement method:

7

     For purposes of calculating the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models. The use of these models requires subjective assumptions, including future stock price volatility and expected time to exercise, which can have a significant effect on the calculated values. The Company’s calculations were made using the Black-Scholes option pricing model with the following weighted average assumptions:

* No options were granted in the three months ended July 31, 2003.

     The Company’s pro forma calculations are based on a single option valuation approach. The computed pro forma fair value of the options awards are amortized over the required vesting periods. For purposes of the pro forma calculations, should options vest earlier, the remaining unrecognized value is recognized immediately and stock option forfeitures are recognized as they occur.

4. Revenue Presentation

     The Company has reported its revenues in accordance with Emerging Issues Task Force (EITF) Issue No. 01-14, “Income Statement Characterization of Reimbursements Received for Out-of-Pocket Expenses Incurred.” For the Company’s Parking segment, this pronouncement requires both revenues and expenses be recognized, in equal amounts, for costs directly reimbursed from its managed parking lot clients. EITF No. 01-14 did not change the income statement presentation of revenues and expenses of any other segments and had no impact on the Company’s operating profits or net income. Parking sales related solely to the reimbursement of expenses totaled $54.3 million and $55.1 million for the three months ended July 31, 2004 and 2003, respectively, and $160.3 million and $160.4 million for the nine months ended July 31, 2004 and 2003, respectively.

8

5. Goodwill and Other Intangibles

     Goodwill. The changes in the carrying amount of goodwill for the nine months ended July 31, 2004 were as follows:

(In thousands)

* see Note 6, “Acquisitions”

     Correction of an error in the second quarter of fiscal 2004. In October 2002, the EITF released Issue No. 02-17, “Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination.” EITF Issue No. 02-17 provided guidance regarding the use of certain assumptions, such as expectations of future contract renewals, in estimating the fair value of customer relationship intangible assets acquired in a business combination. EITF Issue No. 02-17 was effective for business combinations consummated after October 25, 2002 but the Company failed to reflect the effect it would have had on the three business combinations completed in fiscal 2003 until the second quarter of 2004.

     Prior to adopting EITF Issue No. 02-17, the Company assigned little or no value to acquired customer contracts and related customer relationships because the contracts generally had one year terms with 30-day cancellation provisions. With the effectiveness of EITF Issue No. 02-17, assumptions regarding expectations of future contract renewals must now be incorporated in estimating the fair value of customer relationship intangible assets.

     In the second quarter of 2004, the Company engaged a third party valuation firm to independently appraise the value of the customer relationship intangible assets related to the two largest business combinations completed in 2003 namely, the acquisition of the commercial self-performed janitorial cleaning operations of Horizon National Commercial Services, LLC (Horizon) acquired on January 31, 2003 and HGO Janitorial Services (HGO) acquired on August 29, 2003. The valuation of the customer relationship intangible asset related to the smallest business combination completed in 2003, Valet Parking Services (Valet) acquired on April 30, 2003, was performed internally using the discounted cash flow technique, the same technique used by the third party valuation firm.

     As a result of these valuations, in the second quarter of 2004, the purchase accounting was adjusted to reflect a reduction in goodwill for the customer relationship intangible assets acquired in Horizon, HGO and Valet of $4.2 million, $7.1 million and $1.7 million, respectively. In addition, $0.3 million of the total HGO acquisition cost was re-allocated to trademarks and trade names. Of the $4.2 million Horizon intangible assets only $0.2 million was recorded as intangibles at the time of the acquisition. The total amount reclassified from goodwill to other intangibles was $13.1 million. The impact of these re-allocations on amortization expense is discussed below.

     Other Intangibles. Effective April 30, 2004, Other Intangibles and the related amortization expense have been presented as separate line items on the balance sheet and statement of income, respectively. Prior periods presented have been reclassified. The gross carrying amount and accumulated amortization of other intangibles apart from goodwill as of July 31, 2004 were as follows:

9

* See Note 6, “Acquisitions”

** Reclassification of catch-up amortization recorded in the quarter ended April 30, 2004

     Correction of an error in the second quarter of fiscal 2004. As described above, a total of $13.1 million of customer relationship intangible assets and trademarks and trade names was reclassified from goodwill to other intangibles in the second quarter of 2004. These intangible assets have finite lives and must therefore be amortized. The related catch-up amortization expense recorded in the second quarter of 2004 for fiscal 2003 and the first quarter of 2004 totaled $1.5 million, as shown below.

     The weighted average remaining life and the amortization expense for the three and nine months ended July 31, 2004 (including the $1.5 million catch-up amortization) and July 31, 2003, as well as the estimated amortization expense for each of the five succeeding fiscal years are as follows:

     The customer relationship intangible assets are being amortized using the sum-of-the-years-digits method over the useful lives consistent with the estimated useful life considerations used in the determination of their fair values. The accelerated method of amortization reflects the pattern in which the economic benefits of the customer relationship intangible asset are expected to be realized. Trademarks and trade names are being amortized over their useful lives using the straight-line method. Other intangible assets, consisting principally of contract rights, are being amortized over the contract periods using the straight-line method.

6. Acquisitions

     Acquisitions have been accounted for using the purchase method of accounting. Operations of the companies and businesses acquired have been included in the accompanying consolidated financial

10

statements from their respective dates of acquisition. The excess of the purchase price (including contingent amounts) over fair value of the net tangible and intangible assets acquired is included in goodwill. Most purchase agreements provide for initial payments and contingent payments based on the annual pretax income or other financial parameters for subsequent periods ranging generally from two to five years. Cash paid for acquisitions, including initial payments and contingent amounts based on subsequent earnings, was $48.2 million and $21.1 million in the nine months ended July 31, 2004 and 2003, respectively.

     The Company made the following acquisitions during the nine-month period ended July 31, 2004:

     On March 15, 2004, the Company acquired substantially all of the operating assets of Security Services of America, LLC (SSA), a North Carolina limited liability company and wholly-owned subsidiary of SSA Holdings II, LLC. SSA, also known as “Silverhawk Security Specialists” and “Elite Protection Services,” provides full service private security and investigative services to a diverse client base that includes small, medium and large businesses throughout the Southeast and Midwest regions of the United States. The total acquisition cost included an initial cash payment of $40.7 million, net of liabilities assumed totaling $0.3 million, plus contingent payments equal to 20% to 25% of adjusted earnings before interest and taxes, depending upon the level of actual earnings, for each of the years in the five-year period following the date of acquisition. Of the total purchase price, $7.1 million was allocated to customer relationship intangible asset and $2.7 million to trademarks and trade names. The values of these intangible assets were independently appraised by a third party valuation firm. The appraisal was completed in the third quarter of 2004. Additionally, $2.3 million of the total purchase price was allocated to fixed and other tangible assets and $28.9 million to goodwill.

     On April 2, 2004, the Company acquired substantially all of the commercial janitorial assets of the Northeast United States Division of Initial Contract Services, Inc., a provider of janitorial services based in New York. The acquisition included key accounts throughout the Northeast region totaling approximately 50 buildings. The total acquisition cost included an initial cash payment of $3.5 million, of which $0.9 million was allocated to customer relationship intangible asset, $1.8 million to accounts receivable and $0.8 million to other assets, plus annual contingent payments for each of the years in the five-year period following the acquisition date, calculated as follows: 3% of the acquired operation’s revenues for the first and second year, 2% for the third and fourth year, and 1% for the fifth year. The valuation of the customer relationship intangible asset related to this acquisition was performed internally using the discounted cash flow technique.

     Acquisitions made during the year ended October 31, 2003 were as follows:

     On January 31, 2003, the Company acquired the commercial self-performed janitorial cleaning operations of Horizon, a provider of janitorial services based in Red Bank, New Jersey. Assets acquired by the Company include key customer accounts in the eastern, mid-western and south central United States. The total adjusted acquisition cost was $14.7 million, which included the assumption of payroll-related liabilities totaling $0.2 million. Of the total adjusted acquisition cost, $12.9 million was allocated to goodwill and $1.8 million to fixed and other assets at the time of acquisition. In the second quarter of 2004, $4.2 million of the $12.9 million goodwill was re-allocated to other intangibles (see Note 5, “Goodwill and Other Intangibles”).

11

     On April 30, 2003, the Company acquired selected assets of Valet Parking Service, a provider of parking services based in Culver City, California. The total acquisition cost included an initial cash payment of $1.7 million, most of which was allocated to goodwill, plus annual contingent payments of $0.3 million for the three years subsequent to the acquisition date, if specified levels of variable gross profits from the acquired operations are maintained. In the second quarter of 2004, the $1.7 million previously allocated to goodwill was re-allocated to other intangibles (see Note 5, “Goodwill and Other Intangibles”).

     On August 29, 2003, the Company acquired substantially all of the assets and operations of H.G.O., Inc., d/b/a HGO Services, a provider of janitorial services based in King of Prussia, Pennsylvania. Assets acquired by the Company include key customer accounts in the greater Philadelphia metropolitan area, including locations in New Jersey and Delaware. The total acquisition cost was $12.8 million, plus annual contingent amounts of approximately $1.1 million for the three years subsequent to the acquisition date if specified levels of customer accounts are retained, and additional annual contingent amounts for the three years subsequent to the acquisition date if financial performance exceeds agreed-upon levels. Of the total initial acquisition cost, $12.4 million was allocated to goodwill and $0.4 million to fixed and other assets at the time of acquisition. Contingent amounts, if paid, will be allocated to goodwill. In the second quarter of 2004, $7.4 million of the $12.4 million goodwill was re-allocated to other intangibles (see Note 5, “Goodwill and Other Intangibles”).

     The operating results generated from these acquisitions are included in the consolidated financial results of the Company from their dates of acquisition. Due to the size of these acquisitions, pro forma information is not included in the consolidated financial statements.

     During the nine months ended July 31, 2004 and 2003, contingent amounts totaling $4.0 million and $5.0 million, respectively, were paid on earlier acquisitions as provided by the respective purchase agreements. All amounts paid were added to goodwill.

     The original asset purchase agreement for the operations of Lakeside Building Maintenance, Inc. and an affiliated company (collectively, Lakeside) stated that the final contingent payment of $5.3 million would be paid in September 2005 provided that the gross sales of Lakeside during the third year following the acquisition are equal to or greater than $131.2 million and the seller (part of current Lakeside management) fulfills the other terms and conditions of the asset purchase agreement. As second year sales already exceeded $131.2 million at $172.5 million, the asset purchase agreement was amended to eliminate only the sales requirement to better align Lakeside management with ABM Janitorial in the renewal of customer contracts.

7. Discontinued Operation

     On August 15, 2003, ABM Industries Incorporated sold substantially all of the operating assets of Amtech Elevator Services, Inc., a wholly-owned subsidiary of ABM that represented the Company’s Elevator segment, to Otis Elevator Company, a wholly-owned subsidiary of United Technologies Corporation (Otis Elevator). The operating assets sold included customer contracts, accounts receivable, facility leases and other assets, as well as a perpetual license to the name “Amtech Elevator Services.” The consideration in connection with the sale included $112.4 million in cash and Otis Elevator’s assumption of trade payables and accrued liabilities. The Company realized a gain on the sale of $51.5 million, which is net of $31.9 million of income taxes, of which $30.5 million was paid with the extension of the federal and state income tax returns on January 15, 2004.

     The operating results and cash flows of the Elevator segment have been reported as discontinued operation in the accompanying consolidated financial statements. Income taxes have been allocated using the estimated combined federal and state tax rates applicable to Elevator for each of the periods presented.

     The operating results of the discontinued operation for the three and nine months ended July 31, 2003 are shown below.

12

8. Line of Credit Facility

     In April 2003, the Company increased the amount of its syndicated line of credit to $250.0 million. This line of credit will expire July 1, 2005. No compensating balances are required under the facility and the interest rate is determined at the time of borrowing based on the London Interbank Offered Rate (LIBOR) plus a spread of 0.875% to 1.50% or, for overnight borrowings, at the prime rate plus a spread of 0.00% to 0.25% or, for overnight to one week, at the Interbank Offered Rate (IBOR) plus a spread of 0.875% to 1.50%. The spreads for LIBOR, prime and IBOR borrowings are based on the Company’s leverage ratio. The facility calls for a commitment fee payable quarterly, in arrears, of 0.175%, based on the average, daily, unused portion. For purposes of this calculation, irrevocable standby letters of credit issued primarily in conjunction with the Company’s self-insurance program and cash borrowings are considered to be outstanding amounts. As of July 31, 2004 and October 31, 2003, the total outstanding amounts under this facility were $92.0 million and $69.0 million, respectively, in the form of standby letters of credit. The provisions of the credit facility require the Company to maintain certain financial ratios and limit outside borrowings. The Company was in compliance with all covenants as of July 31, 2004.

9. Comprehensive Income (Loss)

     Comprehensive income consists of net income and other related gains and losses affecting stockholders’ equity that, under generally accepted accounting principles, are excluded from net income. For the Company, such other comprehensive income items consist of unrealized foreign currency translation gains and losses. Comprehensive income for the three and nine months ended July 31, 2004 and 2003 approximated net income.

10. Treasury Stock

     On September 16, 2001, the Company’s Board of Directors authorized the purchase of up to 2.0 million shares of the Company’s outstanding common stock at any time through December 31, 2001, which authorization was later extended through January 31, 2003. As of October 31, 2002, the Company had purchased 1.4 million shares at a cost of $23.6 million (an average price per share of $16.88). In the three months ended January 31, 2003, the Company purchased the remaining 0.6 million shares at a cost of $9.3 million (an average price per share of $15.50).

     On March 11, 2003, the Company’s Board of Directors authorized the purchase of up to 2.0 million additional shares of the Company’s outstanding common stock at any time through December 31, 2003. As of October 31, 2003, the Company purchased 1.4 million shares under this authorization at a cost of $21.1 million (an average price per share of $15.04). In the two months ended December 31, 2003, the Company purchased 0.1 million shares at a cost of $1.7 million (an average price per share of $16.90).

     On December 9, 2003, the Company’s Board of Directors authorized the purchase of up to 2.0 million additional shares of the Company’s outstanding common stock at any time through December 31, 2004. In the three months ended July 31, 2004, the Company purchased 0.5 million shares under this authorization at a cost of $9.4 million (an average price per share of $18.77). As of July 31, 2004, 1.5 million shares remained available for purchase under this authorization.

13

11. Employee Stock Purchase Plan

     On March 9, 2004, the stockholders of ABM approved the 2004 Employee Stock Purchase Plan under which an aggregate of 2.0 million shares may be issued. The participant’s purchase price is 85% of the lower of the fair market value of ABM’s stock on the first day of each six-month period in the fiscal year (i.e., May and November, or in the case of the first offering period, the price on August 1, 2004) or the last trading day of each month. The first offering period is a three-month period which commenced on August 1, 2004. Employees may designate up to 10% of their compensation for the purchase of stock, subject to a $25,000 annual limit. Employees will be required to hold their shares for a minimum of six months from the date of purchase.

12. Retirement and Postretirement Plans

     The net cost of the defined benefit retirement plans and the postretirement benefit plan for the three and nine months ended July 31, 2004 and July 31, 2003 were as follows:

     The defined benefit plans include the Company’s retirement agreements for approximately 55 current and former directors and senior executives and an unfunded severance pay plan covering certain qualified employees. The severance pay plan was amended effective January 1, 2002 to no longer award any further benefits. The postretirement benefit plan is the Company’s unfunded postretirement death benefit plan.

     The Company made matching 401(k) contributions required by the 401(k) plan for the three and nine months ended July 31, 2004 in the amounts of $1.3 million and $3.8 million, respectively. The Company anticipates contributing an additional $1.2 million in the fourth quarter for a total of $5.0 million in fiscal 2004.

14

13. Segment Information

     Under the criteria of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” Janitorial, Parking, Engineering, Security, and Lighting are reportable segments. Mechanical and Facility Services are included in the Other segment. Corporate expenses are not allocated.

14. Contingencies

     In September 1999, a former employee filed a gender discrimination lawsuit against ABM in the state of Washington. On May 19, 2003, a Washington state court jury for the Spokane County Superior Court, in the case named Forbes v. ABM, awarded $4.0 million in damages. The court later awarded costs of $0.7 million to the plaintiff and an additional $0.8 million to mitigate the federal tax impact of the plaintiff’s award. The trial court recently reduced the tax mitigation amount to $0.4 million, a ruling that Forbes has challenged. The U.S. Supreme Court is currently deciding whether courts are permitted to award any amounts for mitigation for federal tax consequences in wrongful termination cases. ABM is appealing the jury’s verdict and the award of costs to the State Court of Appeals on the grounds that it was denied a fair trial and that Forbes failed to prove that ABM engaged in discrimination or retaliation. ABM has stayed enforcement of the judgment by procuring a $7.0 million letter of credit. At the time the letter of credit was procured, statutory interest on the judgment was 12% per year. However, Washington lowered the interest paid on judgments to 2% above the U.S. Treasury Bill rate. ABM believes that the award against ABM was excessive and that the verdict was inconsistent with the law and the evidence. Because ABM believes that the judgment will be reversed upon appeal and that it will prevail in a new trial, ABM has not recorded any liability in its financial statements associated with the judgment. However, there can be no assurance that ABM will prevail in this matter. As of July 31, 2004, ABM had incurred and recorded legal fees of $0.3 million associated with the appeal. These fees, which include the cost of a new trial, are expected to total approximately $0.5 million. In addition, ABM will incur annual fees of approximately 1% of the amount of the letter of credit.

15

     The Company and some of its subsidiaries have been named defendants in certain other litigation arising in the ordinary course of business. In the opinion of management, based on advice of legal counsel, such matters should have no material effect on the Company’s financial position, results of operations or cash flows.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

     The Company provides janitorial, parking, engineering, security, lighting and mechanical services for thousands of commercial, industrial, institutional and retail facilities in hundreds of cities in the United States and British Columbia, Canada. The Company also provided elevator services until August 15, 2003, when it sold substantially all of the operating assets of its Elevator segment (see “Discontinued Operation”). The largest segment of the Company’s business is Janitorial which generated over 60% of the Company’s sales and other income from continuing operations (hereinafter called “sales”) and over 63% of its operating profit before corporate expenses for the first nine months of 2004.

     The Company’s sales are substantially based on the performance of labor-intensive services at contractually specified prices. Janitorial and other maintenance service contracts are either fixed-price or “cost-plus” (i.e., the customer agrees to reimburse the agreed upon amount of wages, payroll taxes, insurance charges and other expenses plus a profit percentage). The quarterly profitability of fixed-price contracts is impacted by the variability of the number of work days in the quarter. The majority of the Company’s contracts are for one-year periods, but are subject to termination by either party after 30 to 90 days’ written notice. In addition to services defined within the scope of the contract, the Company also generates sales from extra services, such as when the customer requires additional cleaning or emergency repair services, with extra services frequently providing higher margins.

     Sales have historically been the major source of cash for the Company, while payroll expenses, which are directly related to sales, have been the largest use of cash. Hence operating cash flows significantly depend on the sales level and timing of collections, as well as the quality of the customer accounts receivable. The timing and level of the payments to suppliers and other vendors, as well as the magnitude of self-insured claims, also affect operating cash flows. The Company’s management views operating cash flows as a good indicator of financial strength. Strong operating cash flows provide opportunities for growth both internally and through acquisitions.

     The Company’s most recent acquisitions significantly contributed to the growth in sales and operating profit in the first nine months of 2004 from the same period last year. Internal growth in sales also contributed to the growth in sales and operating profit but was partially offset by the reduction in retrofit jobs at Lighting and terminations of some unprofitable contracts, as well as the loss of profitable contracts to competition. Internal growth in sales represents not only sales from new customers but also expanded services or increases in the scope of work for existing customers. Sales in the Company’s Lighting and Mechanical businesses are primarily related to the level of capital investments by customers. To mitigate the adverse effect on operating profit of low levels of capital investment by customers, in the first nine months of fiscal 2004 the Company successfully lowered its overhead expenses in Lighting and Mechanical. In the long run, achieving the desired levels of sales and profitability will depend on the Company’s ability to gain and retain, at acceptable profit margins, more customers than it loses, pass on cost increases to customers, and keep overall costs down to remain competitive, particularly against privately-owned companies that typically have the lower cost advantage.

     In the short-term, management is focused on actively managing its business, converting bids into sales and integrating its most recent acquisitions. In the long-term, management is focused on

16

implementing its strategic plan to grow the business through a combination of internal growth and selective acquisitions in the Company’s core disciplines.

Liquidity and Capital Resources

     Funds provided from operations and bank borrowings have historically been the sources for meeting working capital requirements, financing capital expenditures and acquisitions, and paying cash dividends. As of July 31, 2004 and October 31, 2003, the Company’s cash and cash equivalents totaled $49.5 million and $110.9 million, respectively. The relatively high cash balance at October 31, 2003 was primarily due to the $112.4 million of cash proceeds from the Elevator divestiture received during 2003. The decline in the first nine months of 2004 reflects the payment of estimated income taxes associated with this divestiture (see “Discontinued Operation”), the initial cash payments made for the purchases of the operations of Security Services of America (“SSA”) acquired on March 15, 2004, and Initial Contract Services, Inc. (“Initial”) acquired on April 2, 2004 and the cash payments for the purchases of 0.6 million of the Company’s common stock, offset in part by cash from operations.

     Working Capital. Working capital decreased by $30.2 million to $213.8 million at July 31, 2004 from $244.0 million at October 31, 2003 primarily due to the initial cash payments made for the purchase of SSA and Initial, offset in part by cash from operations. The largest component of working capital consists of trade accounts receivable, which totaled $307.9 million at July 31, 2004, compared to $287.9 million at October 31, 2003. These amounts were net of allowances for doubtful accounts of $7.6 million and $6.3 million at July 31, 2004 and October 31, 2003, respectively. As of July 31, 2004, accounts receivable that were over 90 days past due had decreased $4.2 million to $24.0 million (7.8% of the total net outstanding) from $28.2 million (9.8% of the total net outstanding) at October 31, 2003.

     Cash Flows from Operating Activities. Net cash generated by operating activities from continuing operations during the nine months ended July 31, 2004 increased only slightly to $42.9 million from $42.8 million for the same period in 2003 despite the increase in income from continuing operations due to slower payments by some large customers.

     Cash Flows from Investing Activities. Net cash used in investing activities for the nine months ended July 31, 2004 was $29.0 million higher than the same period last year. Net cash used for the purchase of businesses in the first nine months of 2004 was $48.2 million, of which $44.2 million was used for the purchase of the operations of SSA and Initial. In the first nine months of 2003, $21.1 million was used for the purchase of businesses of which $16.4 million was used for the purchase of the operations of Horizon National Commercial Services, LLC (“Horizon”) and Valet Parking Services (“Valet”).

     Cash Flows from Financing Activities. Net cash used in financing activities was $18.2 million in the nine months ended July 31, 2004, compared to $14.9 million in the nine months ended July 31, 2003. The Company generated less cash from the issuance of the Company’s common stock in the nine

17

months ended July 31, 2004 compared to the same period last year as the employee stock purchase plan terminated upon issue of all the available shares in November 2003. A new employee stock purchase plan was approved by the stockholders in March 2004 and the first offering period began on August 1, 2004. (See Note 11, “Employee Stock Purchase Plan.”)

     Line of Credit. In April 2003, the Company increased the amount of its syndicated line of credit to $250.0 million. This line of credit will expire July 1, 2005. No compensating balances are required under the facility and the interest rate is determined at the time of borrowing based on the London Interbank Offered Rate (LIBOR) plus a spread of 0.875% to 1.50% or, for overnight borrowings, at the prime rate plus a spread of 0.00% to 0.25% or, for overnight to one week, at the Interbank Offered Rate (IBOR) plus a spread of 0.875% to 1.50%. The spreads for LIBOR, prime and IBOR borrowings are based on the Company’s leverage ratio. The facility calls for a commitment fee payable quarterly, in arrears, of 0.175%, based on the average, daily, unused portion. For purposes of this calculation, irrevocable standby letters of credit issued primarily in conjunction with the Company’s self-insurance program plus cash borrowings are considered to be outstanding amounts. As of July 31, 2004 and October 31, 2003, the total outstanding amounts under this facility were $92.0 million and $69.0 million, respectively, in the form of standby letters of credit. The provisions of the credit facility require the Company to maintain certain financial ratios and limit outside borrowings. The Company was in compliance with all covenants as of July 31, 2004.

Cash Requirements

     The Company is contractually obligated to make future payments under non-cancelable operating lease agreements for various facilities, vehicles, and other equipment. As of July 31, 2004, future contractual payments were as follows:

     Additionally, the Company has the following commercial commitments and other long-term liabilities:

     Not included in the retirement plans in the table above are union-sponsored collectively bargained multi-employer defined benefit plans under which certain union employees of the Company are covered. These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts. Contributions for these plans were $24.2 million in the nine months ended July 31, 2004. Contributions for these plans averaged approximately $7.0 million per quarter in fiscal 2003.

18

     The Company self-insures certain insurable risks such as general liability, automobile property damage, and workers’ compensation. Commercial policies are obtained to provide for $150.0 million of coverage for certain risk exposures above the self-insured retention limits (i.e., deductibles). For claims incurred after November 1, 2002, substantially all of the self-insured retentions increased from $0.5 million (inclusive of legal fees) to $1.0 million (exclusive of legal fees). Effective April 14, 2003, the deductible for California workers’ compensation insurance increased to $2.0 million per occurrence due to general insurance market conditions. While the higher self-insured retention increases the Company’s risk associated with workers’ compensation liabilities, during the history of the Company’s self-insurance program, few claims have exceeded $1.0 million. The Company annually retains an outside actuary to review the adequacy of its self-insurance claim reserves.

     The self-insurance claims paid for the nine months ended July 31, 2004 and 2003 were $45.8 million and $45.2 million, respectively. The total claim payments made in the fiscal years ended October 31, 2003 and 2002 were $58.9 million and $52.7 million, respectively. Claim payments vary based on the frequency and/or severity of claims incurred and timing of the settlements and therefore may have an uneven impact on the Company’s cash balances.

     In connection with the gender discrimination lawsuit against ABM in the state of Washington (see Note 14, “Contingencies”), ABM has stayed enforcement of the $4.0 million judgment, $0.7 million award of costs and an additional $0.8 million to mitigate the federal tax impact of the plaintiff’s award by procuring a $7.0 million letter of credit on February 4, 2004. In the third quarter of 2004, the trial court reduced the tax mitigation amount to $0.4 million, a ruling that Forbes has challenged. ABM will incur annual fees of approximately 1% of the amount of the related letter of credit. ABM believes that the award against ABM will be reversed upon appeal and that it will prevail in a new trial. However, the damages in this case cannot be determined at this time, and these damages may range between $0, should ABM prevail in a new trial, and an amount awarded by the jury in a new trial, should the plaintiff prevail in a new trial. If ABM does not prevail in a new trial, then the plaintiff may also receive the award of costs associated with the new trial.

     The Company has no significant commitments for capital expenditures and believes that the current cash and cash equivalents, cash generated from operations and the expected renewal of its line of credit prior to July 2005 will be sufficient to meet the Company’s cash requirements for the longer term.

Insurance Claims Related to the Destruction of the World Trade Center in New York City on September 11, 2001

     The Company had commercial insurance policies covering business interruption, property damage and other losses related to the WTC complex in New York, which was the Company’s largest single job-site with annual sales of approximately $75.0 million (3% of the Company’s consolidated sales for 2001). As of October 31, 2002, Zurich Insurance (“Zurich”) had paid two partial settlements totaling $13.3 million, of which $10.0 million was for business interruption and $3.3 million for property damage, which substantially settled the property portion of the claim. The Company realized a pretax gain of $10.0 million in 2002 on the proceeds received.

     In December 2001, Zurich filed a Declaratory Judgment Action in the Southern District of New York claiming the loss of the business profit falls under the policy’s contingent business interruption sub-limit of $10.0 million. On June 2, 2003, the court ruled on certain summary judgment motions in favor of Zurich. Subsequent to the June 2003 ruling, additional rulings by the court have limited the Company’s recourse under the policy to the amounts paid plus additional amounts related to physical property of the Company located on the WTC premises and certain accounts receivable from customers that could not be collected. Based on a review of the policy and consultation with legal counsel and other specialists, the Company continues to believe that its business interruption claim does not fall under the $10.0 million sub-limit on contingent business interruption and that the Company’s losses under its WTC contracts are eligible for

19

additional business interruption coverage up to the policy maximum of $124.0 million. Therefore, the Company is appealing the court’s rulings.

     Under the guidance published by the Emerging Issues Task Force (“EITF”) of the Financial Accounting Standards Board (“FASB”) “Accounting for the Impact of the Terrorist Attacks of September 11, 2001,” the Company has not recognized future amounts it expects to recover from its business interruption insurance as income. Any gain from insurance proceeds is considered a contingent gain and, under Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies,” can only be recognized as income in the period when any and all contingencies for that portion of the insurance claim have been resolved.

Off-Balance Sheet Arrangements

     As of July 31, 2004, the Company did not have any off-balance sheet arrangements as defined by Item 303(a)(4) of the Securities and Exchange Commission Regulation S-K.

Acquisitions

     The operating results of businesses acquired have been included in the accompanying consolidated financial statements from their respective dates of acquisition. Acquisitions made during the nine-month periods ended July 31, 2004 and 2003 are discussed in Note 6 to the consolidated financial statements.

Results of Operations

     The following discussion should be read in conjunction with the consolidated financial statements of the Company. All information in the discussion and references to the years and quarters are based on the Company’s fiscal year and third quarter which ended on October 31 and July 31, respectively.

Three Months Ended July 31, 2004 vs. Three Months Ended July 31, 2003

     Income From Continuing Operations. Income from continuing operations for the third quarter of 2004 increased 26.9% to $13.4 million ($0.27 per diluted share) from $10.6 million ($0.21 per diluted share) for the third quarter of 2003. The impact of acquisitions and improved margins contributed to the increase in the third quarter of 2004. All operating segments showed significant improvement in income from continuing operations except for Lighting.

20

     Sales and Other Income. Sales and other income for the third quarter of 2004 of $623.8 million increased by $54.7 million or 9.6% from $569.1 million for the third quarter of 2003. Acquisitions completed in fiscal year 2003 and nine months ended July 31, 2004 contributed $40.3 million to the sales increase. Additionally, new business in Janitorial and Engineering and expanded service to existing Janitorial and Engineering customers contributed to the higher sales in the third quarter of 2004. However, these increases were partially offset by decreased project sales in Lighting.

     Operating Expenses and Cost of Goods Sold. As a percentage of sales, gross profit (sales minus operating expenses and cost of goods sold) was 11.0% for the third quarter of 2004 compared to 10.1% for the third quarter of 2003. The higher margins were primarily due to one fewer work day in the third quarter of 2004 compared to the same period of 2003 which favorably impacted fixed-price contracts in Janitorial due to lower labor and related expenses and the termination of unprofitable airport contracts in Parking.

     Selling, General and Administrative Expenses. Selling, general and administrative expenses for the third quarter of 2004 were $46.0 million, compared to $41.4 million for the third quarter of 2003. The increase was primarily due to an increase of $2.9 million in selling, general and administrative expenses attributable to the fiscal year 2003 and year-to-date 2004 acquisitions, and higher professional fees primarily related to Sarbanes-Oxley Act compliance, as well as higher cost associated with two Chief Operating Officers with the transitioning in of the new Chief Operating Officer.

     Intangible Amortization. Intangible amortization was $1.3 million for the third quarter of 2004 compared to $0.3 million for the same period of 2003. The higher amortization was due to intangibles acquired in business combinations completed in fiscal year 2003 and nine months ended July 31, 2004. (See Note 5, “Goodwill and Other Intangibles.”)

     Interest Expense. Interest expense, which includes loan amortization and commitment fees for the revolving credit facility, was slightly higher in the third quarter of 2004 compared to the third quarter of 2003.

     Income Taxes. The effective tax rate for income from continuing operations was 35.7% for the third quarter of 2004, compared to 31.8% for the third quarter of 2003. The 35.7% effective tax rate was based on a higher estimated tax rate for income from continuing operations for fiscal 2004 of 37.3% compared to the estimated tax rate of 35.3% for fiscal 2003. The estimated tax rate for continuing operations for fiscal 2004 reflects a higher estimated state income tax rate due to the combined income tax return filing requirements in certain states where separate income tax returns were previously filed. The income tax provision for continuing operations for the third quarter of 2004 included a tax benefit of $0.6 million principally from adjusting the income tax liability accounts after filing the 2003 income tax returns and from filing amended tax returns primarily to claim higher tax credits, while the income tax provision for continuing operations for the third quarter of 2003 included a tax benefit of $0.7 million principally from adjusting the income tax liability accounts after filing the 2002 income tax returns.

21

     Segment Information. Under SFAS No. 131 criteria, Janitorial, Parking, Engineering, Security, and Lighting are reportable segments. The operating results of the former Elevator segment are reported separately under discontinued operation and are excluded from the table below, see “Discontinued Operation.” All other services are included in the “Other” segment. Corporate expenses are not allocated.

     The results of operations from the Company’s segments for the three months ended July 31, 2004, compared to the same period in 2003, are more fully described below.

     Janitorial. Sales for Janitorial increased $24.2 million or 7.1% from the third quarter of 2003 to the third quarter of 2004. The increase in sales was primarily due to the $18.1 million increase in sales from the Horizon, HGO and Initial acquisitions. Additionally, sales increased due to new business in the Northern California and Southwest regions, price increases in the Southwest and Midwest regions and expanded scope of services to existing customers in the Northwest region. These sales increases were partially offset by decreased sales in the Northeast, South Central and Southeast regions primarily due to reduced scope of work and lower prices on services provided to existing customers.

     Operating profit increased $4.0 million or 28.9% in the third quarter of 2004 compared to the third quarter of 2003. Of the increase, $1.7 million was due to one fewer work day in the third quarter of 2004 than in the same period in 2003. Significant margin improvement in New York and the Northwest region and new business in Northern California, as well as lower bad debt expense contributed to the increased operating profits. The Horizon, HGO and Initial acquisitions contributed $0.8 million to the operating profit increase.

     Parking. Parking sales were essentially flat while operating profits increased by $1.1 million or 48.6% during the third quarter of 2004 compared to the third quarter of 2003. Although sales generally improved at remaining airport locations with improved airline travel, this was offset by the termination of unprofitable airport contracts after July 2003. The increase in operating profits resulted from the termination of unprofitable contracts, airline travel improvement and higher margins on renegotiated contracts, partially offset by higher state unemployment insurance expenses, especially in California.

22

     Engineering. Sales for Engineering increased $7.1 million or 15.9% from the third quarter of 2003 to the third quarter of 2004 primarily due to new business in California. Additionally, as the economy recovered, customers began increasing the number of onsite engineers at their locations. Operating profit increased $0.5 million or 20.0% from the third quarter of 2003 to the third quarter of 2004 primarily due to increased sales in California.

     Security. Security sales increased $23.6 million or 56.8% due to the SSA acquisition, which contributed $23.0 million to the sales increase, and the award of several major contracts which started in the third quarter 2004. Operating profits increased $0.7 million or 36.7% due to the $0.6 million operating profit contribution from SSA, and slightly better margins resulting from a rate increase program. The SSA operating profit was net of $0.4 million of amortization of intangibles.

     Lighting. Lighting sales decreased $3.1 million or 10.3% for the third quarter of 2004 compared to the same period of 2003 and operating profits decreased $0.9 million or 67.8% due primarily to decrease in sales, partially offset by savings from staff reductions. The decrease in sales was due to significantly fewer retrofit projects in 2004 compared to 2003.

     Other. Sales for the Other Segment increased by $2.4 million or 21.4% for the third quarter of 2004 compared to the same period of 2003, while operating profit increased by $0.2 million or 59.5%. Higher sales in Facilities Services resulting from a new major contract and slightly higher Mechanical project sales contributed to the sales increase. The increase in operating profit was primarily due to higher sales in Facilities Services partially offset by lower operating profit at Mechanical despite staff reductions.

     Corporate. Corporate expenses for the third quarter of 2004 increased by $0.2 million or 3.4% compared to the same period of 2003 mainly due to higher professional fees primarily related to Sarbanes-Oxley Act compliance and higher cost associated with two Chief Operating Officers with the transitioning in of the new Chief Operating Officer.

Nine Months Ended July 31, 2004 vs. Nine Months Ended July 31, 2003