Aramark (ARMK) Earnings Call Transcript & Summary

This call is not for media representatives or BofA Securities investment bankers or commercial bankers, including corporate and commercial FX. All such individuals are instructed to disconnect now. A replay will be available for BofA Securities investment bankers and commercial bankers, including corporate and commercial FX. The replay is not available to the media. Good day and welcome to the Aramark call. Today's conference is being recorded. At this time, I would like to turn the conference over to Gary Bisbee. Please go ahead, sir.

Yes. Thank you, and welcome, everybody. I'm Gary Bisbee. I'm the business information services analyst here at BofA Securities. And I'm pleased to have the management team -- I should say, relatively new management team of Aramark here to talk through the business and the opportunities ahead. We have John Zillmer, Chief Executive Officer; Tom Ondrof, Chief Financial Officer; and Felise Kissell, VP of Investor Relations, with us today.

Given current events and what's going on in the world, maybe I'll kick our Q&A here off by just asking the company to provide a quick thought process on how we're seeing the impact of the coronavirus today on your business.

Certainly. Thanks, Gary. First of all, I would say that we are in constant communications with our customers, our clients and our employees around the world. We have very strong and rigid food safety and sanitation protocols in place. We literally have daily meetings with all of our frontline staff to talk about reinforcing the processes for both food safety and sanitation so that we can minimize the impact on our customers -- the potential for impact on our customers and ensure their safety and great service. As an organization, we have seen little impact to date with respect to actual business operations. We are in a constant state of discussion and planning for potential eventualities. As you know, we have some business in China. We have roughly 2% of our revenue is there in China. And it's largely focused on the health care market and with some exposure in the Wuhan region. And our people have been providing services on a 24/7 basis to the Chinese government and to the health care institution dealing with the crisis on the ground there. And we've actually won new hospital contracts as a result of the response to the crisis there in China. So we're very pleased with the efforts of our Chinese team and the hard work and dedication to the company. As it relates to the businesses we operate around the rest of the world, we are seeing some small impacts in the K-12 sector and in the higher education sector as people make proactive decisions to go ahead and potentially close down operations for brief periods, particularly around the spring break season in higher education. While those disruptions have been to date not very significant, we really can't predict what further reductions might take place or what further closures might take place over the next few weeks. We're in very significant touch with all of our customers to make sure that we have the right contingency plans in place going forward. As some of you know, our cost structure is highly variable. It is -- we can adapt and flex our operations very rapidly to those changing needs, and we'll be able to do that in all the businesses that we operate.

Okay. I'd love to just emphasize that last point because I'm not sure if it's well understood as it should be. So if revenue is impacted, particularly in your foodservice and facilities businesses, my understanding is you have the ability to ramp down your costs quickly. You've got 2 big cost buckets, people and food, and in both cases, you got real flexibility. Can you just quickly highlight how that works?

Yes. I mean I'll use a live example. And I don't want to make light the current situation because it is obviously very serious and something John and I have both seen throughout our careers, be it SARS or MERS or Ebola or the other issues that have sort of come the industry's way. But the business model is really built on a variable cost and flexible basis. Just in the ordinary course, we see that, for example, in sports and entertainment, a team will go on the road for 2 weeks and the arena will, in essence, go dark, run off a skeleton staff and then come back to life when the team is back. Also, it does that in the off-season. K-12 and higher ed, we deal with week-long -- multi-week-long closures every winter with blizzards and do the same thing. So all these contracts are built to be profitable, whether you've got 19,000 fans in the seats or 4,000, depending on how well the team is doing. And so we're able to flex it, be profitable under both scenarios. There's no fixed rents. There's no fixed labor. There's no fixed product cost in any of them. And so we deal with -- and certainly not in these kind of situations frequently, fortunately, but in just the ordinary course, we deal with those ups and downs of the business every day, every month.

Yes. I would just add, as you've noted, the 2 big components of costs for the company are the food suppliers and inventory, if you will, and the employees. And in operations that are closed, we're not producing food, so there's no waste. The food inventory that we carry on hand is probably less than 2 weeks total inventory. Most of that is dry storage and/or frozen. Very little fresh product that exists in the operations for more than a couple of days. So you've got very little inventory risk. On a human resource -- from a human resource perspective, our employees, if the operations are closed, typically are not paid. So really, the only costs we deal with in terms of fixed costs are fixed management overhead, which can also be scaled in the event that we have significant long-term kinds of impact. So highly variable cost structure, a very flexible capital structure, no short-term debt repayment requirements, very strong and predictable cash flows and $1 billion revolver that's undrawn. So a lot of flexibility in the cost structure we're used to managing in these kinds of environments and feel like we can manage through this one as well.

Great. Great. Maybe we'll shift to some more growth-related strategic questions. So John, since taking over, you've highlighted a number of key focused strategies here to reinvigorate growth, top line growth of the business. You've talked about the hospitality culture, increasing the focus. Certain places within the business, you're realigning resources to support growth in the field, and obviously investing in sales headcount being a key one. Maybe just a question on each of those. So on sales headcount, where are you at in sales headcount? And what really is the opportunity by doing that?

Yes. Terrific. We are adding headcount in all the businesses that we operate. To date, we've added 100 new sales managers to the Uniform services organization and just recently made the decision to add another 100 people through the balance of this year as part of that $35 million that we talked about investing in the business. We're also adding resources to higher education, business dining, health care refreshment services. So really, pretty much across the board we're adding resources to the sales force. We believe that on the foodservice side, that we were probably 25 to 30 managers short in terms of the optimal sales force structure. And so we've begun the recruitment process and the hiring process for those 25 to 30 managers. That's underway. We've had -- some people are already joining the organization, and we'll be continuing to scale that up through the balance of the year.

Okay. And then on the concept of the hospitality culture, I know there's a number of things that fall under that. But my sense is you believe that focusing on customer satisfaction, improving that will ultimately drive retention. What's the key to that strategy?

Yes. Absolutely. Really, there are a couple of different elements to it. Our company had been founded -- really has been managed for many years on the basis of having a very entrepreneurial frontline management team that was really focused on customer service and delivering to the unique needs of the customers in their respective businesses. And for the last several years, that decision-making freedom had been taken away and a much more central-led approach had been adopted with respect to decisions around menus, product offerings, style of service, labor cost components, really kind of dictating from the top down how they were going to serve their customers and the elimination of the flexibility to really do what they thought was right for the business. So to me, reinvigorating the hospitality culture is about unleashing their potential to provide that customized solution for those clients, really letting the frontline managers know -- do what they know how to do best, giving them the tools and letting them design venues and service offerings and product offerings that really do fit the profile of the customers they serve, which are all very unique. Here in New York City, the needs in the dining rooms in the financial industry are much different than the needs in a Ford Motor plant in Ohio. So having the opportunity for those frontline managers to customize solutions that are very specific to the needs of their consumers is what really reinvigorates that culture. And we've seen a very dynamic change. People are really excited about that opportunity. The supply chain organization is positioned to go ahead and serve their needs, and it's really an exciting time inside the company.

Okay. Great. And then the concept of realigning resources back to the field and into areas that will focus on growth, so what's the key to that strategy? And where are those opportunities?

Yes. I think it's a matter of getting those resources to where they're most effectively used. It's not so much that, for example, marketing was over or under-invested in. It just wasn't localized enough or effective enough, in some cases. So for example, when you're creating a marketing program within K-12, you're trying to get 8-year-olds enticed and excited about eating the food pyramid and all that, so that's great. That takes a certain level of knowledge and intimacy with that client and that client base. Flip that over in, say, in business dining, you're trying -- you're in a staff cafeteria and you're trying to market to keto diets and paleo diets and how that hooks up with your Peloton workout, and it's a very different dynamic within the marketing scheme in that group. So when you try to centralize those things into a center of excellence, somebody wins with the resource, somebody loses. Usually, as John would say, it's the person who screams a lot is the one who wins. Here, by getting those business lines reequipped with their own culinary, marketing, sales, operating teams, obviously, they get what they need. They're more effective, more efficient, more in line with their clients, and they can sort of speed to market, so to speak, with these programs and help drive, not in new businesses, but in order to charge revenue growth, it's also the same-store sales, in essence, and you can get a bit of that through that alignment. So that's what we're talking about when we are realigning it. We're not talking about just reestablishing chaos, but this is a thoughtful realignment and fit for purpose with these, really, in a large sense, current dollars that are around the business. It's not additive.

Yes. Right. We repositioned resources from the center of the organization back into the field where they can have the maximum impact on the customer and the client. And in many cases, these are people who were pulled up out of the businesses and put in the center of excellence and then asked to serve multiple businesses. So their ability to be effective, their ability to prioritize, their ability to really serve all of the...

And they went through it, they want it, where they like to be as opposed to where the business needed them.

So now they've got dedicated teams of people that know the business, know the industry and know their customer set and can be more impactful.

Okay. That's great. One of the questions I get a lot from investors is I think people understand these strategies and they seem very logical, but -- and I guess they have also seen this without a major coronavirus impact, we'll see how that goes. Is there a reasonable case that these changes and investments to date can position the company for accelerating growth that we actually see in fiscal '20? Or should we see -- to think that this year is more about building momentum, it's '21 when we start to see the fruits of all these investments materialize?

Yes. I think from a numbers perspective, in '21 is when we can expect it to show up in the numbers. We are seeing the green shoots, if you will. We are seeing some wins and impacts. Keep in mind that anything that we sell in higher education today is going to open up in the fall. So they won't have any impact until the fiscal '21. So it is -- we are seeing an impact on the pipeline activity. We're seeing an impact on the company's closure rate in terms of opportunities. We're seeing an impact on retention. And all of these -- keep in mind, we look at growth as being multiple elements. As Tom said, it's selling new accounts, but it's also improving the base business operations, selling more product to existing customers as well as keeping the business that we already have. And we're moving that retention rate back up into what I would characterize as my goal in the 96%, 97% range. So off the bottom, that was probably 93.5% last year, up to 95% to 96% this year and trending, hopefully, to 97% going forward.

Okay. And another question I get a lot is just you've talked about this year using the incremental synergies from the 2 2018 acquisitions to fund a lot of this. How confident are you that we should think of it as sort of onetime step-up in costs and then from beyond this year, sort of incremental growth in investments as you grow the business? Or is there -- are there some areas where it might take a longer duration of accelerating investment to deliver on your plan?

We're very confident that once we expect the $35 million of that, and that's built into the run rate going forward in future years, that that is the right normalized level of expenditure, that we'll be at a kind of an optimal point. When we were solving for the number of salespeople we've been wanting to hire, we were solving for what's the optimal sales organization structure look like for the company. And so -- and we think we'll be in very good shape with respect to that. So no significant ongoing incremental investment but potentially some add-on expenditures, particularly as we try to accelerate growth on the Uniform side related to additional sales managers, particularly in the first aid space and other areas where we see significant return on capital by adding more resources.

Okay. And then I guess along that, as we think out over the next several years, obviously, not fiscal '20, how do you -- confident you feel about the ability to deliver both stronger revenue than the company's delivered in the recent years and also improving margins? And one perspective I have, I mean, I covered Aramark when it was public before the LBO was, from 2013 to 2017, revenue grew about double. Actually, I think it's a bit more than double what it's grown in the last 5 years. But margins were flat to trending down, not a lot but during that whole 4- to 5-year period. So is that a trade-off you have to make? Or are you confident that over time, there are opportunities to deliver both top line and margin?

Well, I think there is absolutely the ability to deliver both top line growth and margin improvement. There's a lot of leverage in our overhead structure. We don't see the need to add significant overhead to support the new business beyond the $35 million that we're going to invest. So we can absorb the new account infrastructure without having to add additional field overhead, additional district managers, additional RVPs. There's a lot of leverage in that field organization infrastructure. So we see the opportunity for that. Unit-level margins have been trending up across the industry. We don't see any reason to think that they would degrade. And we think there's opportunity on the supply chain side that will help to improve margins overall for us as we continue to bring leverage from the GPO purchase, from the vendor acquisition and the other GPOs that we've acquired. And the new supply chain agreements that we've been working on negotiating, we see continued improvement on that side that would be accretive to margins as well.

Okay. All right. Maybe I can shift to Uniform business, one that over a lot of years being involved at Aramark, I feel like, hasn't got a lot of discussion with investors, although that felt like it changed a bit last quarter where it was actually on the conference call quite a topic of discussion. You've outlined the case to deliver improving profitability and growth in that business, which has mirrored the foodservice business in not having a lot of growth historically. What are the key opportunities there? And again, how confident are you in your ability to deliver better top and bottom line at Uniform?

Well, there's a couple of key opportunities. First and foremost, by adding the sales resources that we've committed to this year, over 200 additional sales managers, just having the feet on the street, if you will, to really accelerate the growth of the business will be, I think, extraordinarily helpful as a company, and we've not invested in growth in that industry for quite some time. And so we've been at a competitive disadvantage to our largest competitor, in particular, with respect to the number of feet on the street actually selling the services. Additionally, we're now focused on new parts of the marketplace like first aid and restroom services that we can sell off the same truck using the existing infrastructure, utilizing the existing delivery personnel at very accretive margins. And you've got hundreds of thousands of customers that we serve every day, and each and every one of them is a prospect for the -- for both the first aid and the restaurant services. And that comes at very high incremental margins. So then we also have an opportunity as a result of the acquisition of AmeriPride. The company's route accounting system has been in existence for decades. It is no longer providing the kind of functionality that we really need to optimize both from a sales perspective as well as an efficiency perspective. And the AmeriPride who was using the system, which was actually chosen by Aramark as they began to evaluate the need to upgrade their systems, they've actually chosen that system as the one that would serve their needs the best. Coincidentally, by way of acquisition, we have access to the system and we've now been piloting that system in a number of existing Aramark operations, and those results have been significant in pilot, and we're excited about the possibilities. We just went live with -- in Fresno, one of our largest facilities. And again, the early results have been very encouraging, both from a management perspective in terms of reducing inefficiency as well as the ability to dynamically route and create better route accountability, more efficient routes and also the significant reduction in administrative time that's currently devoted by our district managers and our truck drivers and our drivers to just really reconciling the daily billing process. So lots of benefits associated with it and significant margin enhancement potential coming as a result, which we'll be able to quantify more effectively once the pilots are fully done.

And is it right to assume that that is incremental to how the company has historically discussed the synergy potential from that acquisition, from AmeriPride?

Yes.

Yes, it is. We didn't factor in those -- in that synergy, potentially, we didn't factor in the route accounting system at all. That's really a secondary benefit and one that, frankly, we think, has maybe more potential than the synergy potential we had originally outlined.

And so I guess the next question or topic, my sense is there was some good that came out of the centralization efforts of the prior team over the last 5 or 6 years and some areas were not so good and likely delimited the ability of the business to grow. Can you just at a high level talk through what has been good and where has there been progress that does position Aramark well and where -- and I think we've already gone over areas you're investing and maybe -- and what wasn't so good. But is the business better positioned to compete today broadly and to be an efficient, attractive business after some of that?

I think the approach to the business really is to have your verticals by business line. The customer-facing functions, the sort of very specific, as John mentioned before, to those business lines. So again, within health care, education, corrections, parks, sports, on down the line, to have a dedicated president, CFO, culinary talent, marketing, sales, those kinds of things. Then horizontally supporting those businesses, you can and should drive efficiencies in the back house, the noncustomer-facing opportunities. Those are the things you can centralize, and they were. And so the global business service center that was stood up in 2014, '15, for example, which does a lot of the back-office accounting transactional work that was pulled out of the field, rightfully centralized for efficiency and accuracy, and it allows the units to be more customer-facing than in their office doing payroll. It was a great thing, and so that's in place. And that, I think, certainly positions the leverage point that John just made about growth perfectly. That was a good example of good. Again, going back to the bad was cutting the sales force. At least that -- if I had to pick out all the things that we're having to recover from, that's the one.

Yes.

And then there's -- I know you probably don't want to talk directly about competitors, but there's been a lot of discussions with investors over the years that, too, are the real structural advantages that have allowed Compass, which obviously, John, you're very familiar with, to have outgrown its industry peers, not just Aramark over time. And one of the cases that I've made over time was historically the lack of GPO scale in the U.S. has likely been a factor. In addition to that, the legacy margin discount that the business had, along with a management strategic focus on driving margin, likely inhibited to a certain extent the ability to win business. With that margin gap having narrowed in the GPO scale, certainly not at Compass' level but far more meaningful, is it reasonable to think that the business has -- is better positioned today to compete for new business than it might have been 3, 5 years ago? And is that an important factor? I realized investing at the right level and doing the things you're doing is obviously a key part of it. But do you feel like the business is better positioned where it is today than in the past? Or is it really all about investment?

I'll start. I think the business is certainly positioned well to grow. Having the GPO, having that volume to work with is certainly helpful. And then reinvesting in the sales force will sort of give us the ability to leverage that point and go from there. The operations are sound. John has done a ton of work to get, again, that hospitality culture reinvigorated and ownership back at the unit level. I'll challenge your point a bit about -- and I think there's no structural difference that that creates any advantage for Compass whatsoever. As a matter of fact, in the early days, we at Compass wanted to really emulate the Aramark model, which was the sector-based, localized, customer-centric model. If -- when I joined the company in the mid-'90s, Compass was about half the size of Aramark, and at that time, Marriott Managed Services, which became Sodexo from -- that was about '95. By 2010, we were neck and neck with Aramark. We had both passed Sodexo. So over that 15-year period, we didn't have Foodbuy, and yet we caught up and equaled Aramark in terms of top line growth and profitability at that point. Foodbuy just came to us through the Morrison acquisition in 2002. We'd spent about 5 years just figuring out what we were going to do with it, how we were going to grow it and what it sort of meant. And so it wasn't until 2008 and '09 that it really started to get its feel like. And so if it was a structural driver of growth, we wouldn't have been able to do what we did in that time frame. Now since then in the last decade, I think it's been very helpful as Avendra will be for us, but it's everything else. This is a relationship business. To come back to, we, Compass, had a constant and very stable workforce, which always grew through SARS, through 9/11, through economic downturns. We've never cut the sales force. We had a very stable process with stable leadership, and we had a commitment and a hunger to grow. And those are the differences. And all that, I think, John and I are committed to here.

Yes. I would add, there's -- Tom's absolutely right. There is no structural reason that they should be growing more rapidly than we are. There's no technological reason. There's no product reason. There's no branding reason. There's really nothing that stands in the way of us achieving growth rates at least as good and margins at least as good as Compass with the exception of supply chain leverage, which we're working very hard to close. And with our new agreements, we think we're extraordinarily competitive, and we'll have that opportunity to close that gap. But it really is about discipline, focus and investment in relationship building in the core businesses that is the key driver. You think of the leadership team that Compass has in place, they've been in place for 20 years. Every person managing those businesses has been there forever. They know the customers. They know the clients. They know the industry as well as anybody. And that's what Aramark had as well up until the time that -- call it, 2012, 2013, when we kind of made decisions to take an alternative approach.

Okay. That's incredibly helpful color. John, are there any major changes in the industry you'd call out, you're observing since you last -- it's been, I guess, 20 years at the company but more than a decade ago? Or is it -- do you feel like it's more similar today than different?

Yes. It's more similar than different. Certainly, you have different consumer tastes, different changing preferences, a desire for a higher degree of digital interface in the higher ed community, and people want to have access to apps that help them to make their choices and selections and payments and things like that. So there is more of a technological and digital depth. But by and large, there's still people eating food in campuses, businesses, health care institutions, it's still the same core business. And if -- there's much more similarity than difference in the business. And what has not changed, one degree, is as I've met with customers in all the different industries and all the different business lines, every one of them talks about the quality of management, the quality of the company, the quality of the relationship is really about the connection between the client organization and Aramark that drives our success. And that's why I'm more convinced than ever that that's a critical success factor, that they're having the management team that's right, the best team on the ground focused on those customers day in and day out, kind of a laser-like focus on hospitality and customer -- and being customer-centric is what makes us win.

And that's unchanged.

That is unchanged.

Yes. Okay. And then, Tom, you highlighted a number of areas of focus on the Q1 call. Two I wanted to ask you about was just improving free cash flow and prioritizing reducing debt in the near term as a likely focus. Are there meaningful opportunities in your mind to improve free cash flow generation? Or should we think it's just a new set of eyes and incrementally maybe some minor opportunities?

Yes. I think more of the latter. I mean what I don't want -- I think the point of calling that out was to give people the confidence and the comfort that while we emphasize growth, it's really a balance. That's what John and I are tasked with. That's what we believe in, and that can be accomplished. And we believe we can grow the top line into a mid-single-digit. The industry sort of C-level, if you will, believe we can progress the margins, and we believe we can deliver free cash flow. And those don't need to be mutually exclusive. The improvements on free cash flow, probably, first and foremost, would be on the payable cycle as we continue to build leverage on the supply chain and our negotiating power with manufacturers and suppliers so we can continue to get terms and better cost. As we negotiate this again and again, it's a never-ending cycle, as John or Martin like to say. And then we also think that we can spend some more time focused on the client AR side of it in the sales process to help get better terms there because once you get into a client facility and you insert that in the terms, it's really hard to change at that point and renegotiate them. So trying to get that upfront. So between those 2, we think there's some continued incremental improvement.

Okay. And on the debt focus in the near term, I certainly agree with that premise. Do either of you have a view of what the right long-term leverage is? Or should we give you a little more time in your seats to talk about that kind of stuff?

I think 3x, 3.5x is on -- 3x is comfortable. You never know what will happen as the last few weeks have dictated, and so you certainly don't want to be caught out. So I think getting in there is sort of the right space. Once we get below 3x, I think we'd be thinking hard about what are -- are there other M&A opportunity on the horizon. If not, is there a dividend or special dividend or some other returns to shareholders that would be in the cards. John and I both believe if we can't find the right place to put it, we won't waste it. So we'll give it back to shareholders. But I think there's ample opportunity here to get good value-enhancing investments, growth investments into the business. But if we can't, we'll look at other alternatives.

And maybe I'll close just the last question. On that point, the industry, both in the foodservice and also Uniform side, have histories of consolidation. But Aramark in the last decade with the frequently high leverage it's had has not been an active player in the M&A markets. If we think over the next 5 years, do you believe there are opportunities for the company? And what kind of things will you look for, whether it's geography or whether it's certain business? Or is there anything you think would really help your capability?

I think there certainly are opportunities. I hate to prejudice or I hate to arm my competitors with my thoughts, to be honest. But I think there are opportunities, certainly, on the Uniform side for tuck-in -- and refreshment services for tuck-in kinds of acquisitions, which we do as a matter of normal course. They're highly accretive, build scale, those kinds of things. But I think there are other opportunities when you think about -- particularly in the GPO space. It's highly likely there will be continued consolidation in the GPO space that might lead to greater purchasing benefit for us and greater scale for us. On the foodservice side, there are still regional players out there that might be attractive in certain segments that we would consider looking at under the right circumstance. But for right now, we're going to work on continuing to pay down the debt, although as I -- [ John Neubauer ] used to be very fond of saying that debt never killed anybody, but unpredictable cash flows do. And that's one of the advantages we have in this business. Cash flows are very predictable, it's a business that's extraordinarily well run. It's very defensive in nature. And so our current debt level doesn't bother us. I would say, we'll be looking to our investors to really help us understand what they think the optimal capital structure ought to look like and that once we're there, then there's all kinds of alternatives.

Great. Well, I'd like to thank you both, actually, all 3 of you for your time today. That was a great rundown. And I'd close just by saying that we continue to recommend Aramark. I look at my coverage in the last 2 weeks of zaniness in the markets, and it feels to me like one of the, if not the most, sort of impacted, in an outsized way, and so it feels just like a real opportunity here. Wish you good luck in executing and look forward to watching your progress.

Sure. Thank you very much.

Thank you.

Thank you. We'll end the call there. Thanks.