Aramark (ARMK) Earnings Call Transcript & Summary

[Audio Gap] and welcome to the first day and the first session of the Baird Growth Consumer Technology & Services Conference. We're really to have -- happy to have you all back virtually this year. To kick things off, I wanted to welcome the team from Aramark. We've got the company's CEO, John Zillmer, here. We've got the company's CFO, Tom Ondrof, here as well. I, of course, am Andy Wittmann. I'm the senior analyst that covers facility services here at Baird. We covered Aramark for a long time since the IPO, this time and on the prior public entity before that. So we're very happy to have them join us here at the conference again this year.

And I'm just going to kick it off right away with, I think, what people are thinking about, first and foremost, which is COVID and the impacts that's happening on the business. The company gave us an update a couple of weeks ago on their earnings conference call and gave us some of the trends. I think it's worth checking in approximately a month later or so and see how things are going. So John, maybe I can start with you, and what can you tell us about the business trends in terms of revenue trends in your business? I think in the last earnings conference call, you guys were suggesting that the business was trending in April down roughly 50%. What have you seen, maybe talk by segments and some of the trends that you're experiencing.

Sure, Andy. Thanks, and thanks for having us. First of all, we have continued to see improvement since that call that as businesses are reactivating, we're seeing improvement across a range of the businesses. And of course, health care, corrections and facilities were operating at pretty normal levels or very close to normal levels beforehand. But we're beginning to see, in the month of May, some improvement across a range of the businesses, including Uniform services. So that -- we definitely believe that we troughed in April, and then May has been a month of kind of step-wise or steady improvement over the course of the May time period, as more and more businesses kind of stage a reopening. On the various sectors, probably the one that's still the most affected is B&I and sports and entertainment are 2 that will ramp up more slowly, but we're seeing improving trends in Healthcare as elective surgeries are beginning to take place again. We're seeing improving trends in the Uniform business as more and more businesses reopen. International has seen improvement across the world, as the various economies begin to reopen, most notably in China where we're pretty much at normal levels prior to COVID-19 and actually operating more business now than we did before the crisis began. So in Higher Education, obviously, that business is essentially shut down, but we're seeing more and more positive momentum with respect to reopening taking place in the fall. As you know, major universities have come out and said that they intend to reopen in the fall, and that momentum is going on in all the discussions that we're having. People are really focused on. They've set the goal for September and are really working towards achieving that. And of course, we're partnering with them in a number of different ways, making sure that they can be confident that we've got the practices and the protocols and the methodologies in place that they can effectively reopen safely, that the students can feel that they're in a safe environment. And then lastly, in the K-12 sector of education, we've continued to operate pretty significantly, serving almost 1 million meals a day throughout the country to students that aren't attending school, but need meal support and food support. And so the USDA has granted a waiver. We're allowed to continue to provide meals. And so that's providing some significant revenue generation in the K-12 sector.

Interesting. That's a good start there. I wanted to dig into the B&I segment, in particular. You said that was one of the segments that was most affected. And I was just wondering, as people are starting to trickle back into work, I mean, you didn't suggest that it's happening fast. I don't think anybody has that expectation. But are you able to keep your cafeterias closed basically until there's a big enough critical mass of people coming into the facilities and workplaces? And then how do you know -- if that's the case, how do you know what the right time is to kind of reopen those cafeterias?

Yes. Many of those facilities are open in very small scale operations, and we've renegotiated terms with customers to go ahead and supply services, whether it be for minimum sized crews inside of buildings, providing some support services for people who have to maintain those infrastructure. So even though the business has been down significantly, we have many more operations open and operating in some kind of minimal capacity. So what we've done is we've arranged with the customers to provide that support. The -- because we've got such a flexible operating model, it is relatively easy for us to adjust to the demand that's -- as it ramps up. So you can limit the number of service stations, limit the number of menu items. You can do a lot of things around the scale up to make sure that we're able to do it in a way that serves the needs of the customers, but also minimizes any financial impact, either to Aramark or to the client, if they're subsidizing the operation. So we think in B&I, it will be relatively slow. Although manufacturing operations, we think, will ramp relatively quickly, it will be the white collar knowledge worker that maybe trickles back into the operations as they take the opportunity to transition from working from home back to the centralized office.

Yes. In the past, you guys -- I'm sorry.

No, I was just going to say I do believe that people will return to the offices over time, but it will be a slower process.

Yes. And I think you guys have talked about a little bit about in the mix of B&I given that, that's such an important segment for you, the types of jobs in there between -- the split between white collar and blue collar. Can you just refresh us, so that we can understand maybe in the cadence of how that is just based on your mix there?

Sure. It's 20% pure white collar, 20% pure blue collar. And then it's an amalgam of about 60% of the rest of the business is kind of a combination. And think of in the Midwest, a manufacturing facility that also has an office or a regional office for a manufacturer attached to it. So you may have a cafeteria operation serving the plant and the blue collar workers, and you may have a dining facilities also serving white collar workers in that environment. So you may have a mix of business there. And so geographically, we're pretty well dispersed across the country with just a slight bias towards the Midwest, and then in the Midwest, kind of a bias towards manufacturing. The Northeast, obviously, much more white collar insurance, financial services and banking, that kind of thing. So it will be an interesting kind of scale up in B&I. I would also say, while B&I is an important business for us, and it's relatively large from a revenue perspective, it's one of the smaller businesses from a profit perspective. So the detrimental impact in terms of the long-term profitability of the company, if B&I takes longer to recover, is relatively low.

Interesting. That's helpful. I also just want to dig into the sports and entertainment business. We're starting to see some signs certainly in the leisure business, I guess. Some of the national parks are reopening, and those are some of your larger contracts, if I'm not mistaken. And there's also -- I'm seeing headlines that the NBA is getting close to finalizing some stuff there. And then, importantly, I think baseball, given the number of games, and I think you've got more stadiums in baseball than anything else, there's talk there. What can you tell us about the Sports & Leisure business, in particular, in terms of your outlook for the end of the summer, the middle of the summer, and how the terms of those contracts need to change that you can still be profitable, even if attendance is really low? Because I think attendance is a really key factor in how you guys can perform your services to the quality that they expect as well as be profitable while doing so. And so I was just hoping you could walk us through some of those dynamics a little bit.

Sure. You bet. And feel free to jump in here, too, when you would like to or cut me off at any point. First of all, let's start with the positive news, and that's in the leisure sector, the National Parks business, and that is the National Parks have reopened. Many of them already reopened, for instance, Lake Powell, which is one of our largest national park operations. We're renting house boats. We're renting speedboats. The marinas are open, the gas docks on the lake. The hotel is open. So we are beginning to see fairly significant activity in those national parks, particularly Lake Powell, Quinault. And it's -- in the bookings, the level of activity is relatively high, in fact, higher than we expected. And part of that is a phenomenon of driving vacations. People are able to drive to the national parks from their localities and can participate and engage in a socially distanced vacation in an exciting environment. So I think the national parks really offer that opportunity, and we believe we'll continue to see those scale up. Yosemite is not quite yet open. We think that, that will open shortly. They're still working through some of the logistical issues. And Denali is trying to open sometime mid-June to early July. So again, that will be a very different experience because Denali is primarily served by cruise ships. And so it will be much more of a local vacation environment. But -- so positive news in the National Parks and the leisure business. With the major league sports, we still have a lot of uncertainty. The league is trying to work through a complex set of negotiations between the players, the owners, the medical issues. So still, I think they're all grappling with what the likely outcomes are going to be. And so we haven't -- we have flexed the cost structure down as low as we possibly can, and we're working to be ready when the leagues come back to their stadiums. And some of the leagues are really talking about playing with no fans in the stadium. So obviously, that's -- that doesn't help us in our business in the short term. I do know that ownership, the players and the leagues, they all want fans in the stadiums. That's what drives revenues for them. The economic business model -- well, the economic model doesn't really work completely without fans. And so I think they're trying to consider every possible alternative, looking for ways that, that can be done. In baseball, if you think about limiting capacity and taking temperatures of participants, taking temperatures of workers in the stadium, those are all protocols that can be put into place and allow for fans to come back into the stadium. You've got facilities that have capacity in the tens of thousands or the 50 -- call it, 40,000, right, 35,000. So you could create an environment where you can limit capacity to 25% or 30% and still have enough fans in the stadium for an exciting experience that you can serve in a very safe way. And so we're hopeful that they'll get to a point like that, but we're not certain when it will happen and, frankly, if it will happen. So in the meantime, we're just working hard to minimize cost and impact to the company.

In the meantime, you've been doing a lot of things. I mean you think about the way that your services are going to need to be delivered after we are reopened. Can you talk about some of the innovation and some of the things that you're putting in place now in preparation for a broader reopening? Because I just went to our office building for the first time in 2 months this past weekend in preparation for this conference, and I could even tell, even if nobody in the building on a weekend that it's going to be a new normal after we all are back at this. And I was just wondering what that's going to mean for your employee base, for your service levels. And what are some of the things that you're going to do to make sure that you can deliver on your customer promise, safety, quality and the like?

Right. It's a great question. First of all, we've developed reopening plans by location, by line of business. So we've got very specific sets of protocols and processes created for each of our locations. And obviously, the things that you would expect, PP&E and all of our workers, temperature taking of all of our support employees, physical barriers and social distancing, modifications to menu, so that you won't see a self-serve salad bar in the early stages. You'll have much more prepared food, single-serve kinds of products and/or products that are prepared for you by a service worker, but not something that you will physically touch. So think of the Saladworks at your local mall. You'll still be able to craft a salad, but somebody will be preparing it for you as opposed to you doing it yourself. So lots of service modifications. We partnered -- announced a partnership just a couple of weeks ago with Jefferson University Hospital called EverSafe, which is a trademarked customized safety, sanitation, hygiene and food preparation protocol that can assure our customers that they're coming to a safe and healthy environment. And in partnership with Jefferson, we've created these what we think are really strong operating models to go ahead and provide that scope of services in a way that customers feel safe and healthy across the range of businesses. So we feel very confident that we can deliver in a way that our customers will be comfortable with.

Okay. And then through all this, Tom, just to get you involved a little bit here. You guys -- I thought it was great when you went in the intra quarter. You said our decremental margins are trending around 20% to the operating income line. You report the quarter, you're right there, and I think that's -- that builds some confidence around your ability to manage through this. And I guess just kind of to build on that trend, you also mentioned, I think, previously that if you needed to, you could go to decremental margins of 15%. Tom, I was just wondering if you could just -- based on what you're seeing right now, if you think that the measures that you've got in place are kind of where you're going to be. I know the business is evolving every day, and you're finding opportunities. But can you just update on how you're thinking about the decrementals as we get through this? And then my next question that I also want to talk about is talk a little bit about free cash flow through this and how it might pan out for the balance of the fiscal year.

Sure, Andrew. I think on the decremental margins, I mean, it's a number that we're trying to manage to -- generally just for the goal setting to have some level of guardrail for the business to aspire to because, obviously, prior year and plans are out the window when you're in an environment like this. So it does give everybody some sense of guardrail and measurement. But it's not really the focus. John and I are very committed to the longer-term growth of the business, as we've talked about, and as John has talked about since the moment he walked in. So the ability to drive that lower is there for us. We have those levers, but we're not managing to that. We're continuing to invest in the long-term growth through sales resources. So those things, while -- if we took them out, could improve the decremental margin, the flow-through, if you will, we're not doing that. So we're trying to strike a balance. We feel in this near term, these first few quarters, as we figure out what the new normal is, that around 20% is a balanced goal, if you will, so that we could both drive the -- preserve free cash flow, manage for the near term as well as prepare ourselves for the inevitable bounce back that we know this industry always has coming out of a crisis, particularly around the sales side. So we're comfortable with it. We have plenty of levers if we need to go lower if this -- if the duration of this is longer that we can pull. But for the moment, very comfortable around -- in and around 20%.

Got it. That's helpful. And then just -- I'm curious, in all of this, there's a lot of moving pieces. Obviously, this fiscal third quarter is going to be pretty heavily impacted as well here. But I guess I wanted to get your sense on your ability to generate free cash flow this year. What can you tell investors on that front in terms of what to expect on that? Obviously, the set-up for this question that you guys have proactively addressed your credit facility. That's given you a really nice credit relief basically -- or covenant relief, basically replacing this third quarter to the next fourth quarter and, if I'm not mistaken, maybe even the first quarter of this year with last year's numbers. So that gives you a nice EBITDA for your bank covenant just -- but I'm just kind of curious on the debt incurring side or maybe debt paydown side, how you're thinking about the balance sheet and the cash flows as it relates to the rest of this fiscal year.

Well. Yes, again, the bond issue was really a matter of prudence back in April. We wanted to be prepared for what may come. It's hard to even think back a month ago as -- where everybody's minds were and the uncertainty. And every day seems to be a little bit clearer that we still, I think, have a long way to go. So it was a matter of prudence for us to get that cash on hand. Since then, and if you look at April and May, we continue to manage the cash flow very tightly. If I can break it down, I guess, as we look to the second half of the year, maybe that's helpful perspective. The operating cash flow, probably slightly negative. We feel like working capital, we can manage to neutral out of the gate, as this initially impacted us. It was a bit tough. The world kind of froze, and collections were tough to come by and whatnot. So we took a little bit of a hit on working capital. That since rebalanced as people have gotten into the virtual workplace. So we feel like working capital can be neutral for the second half. CapEx, sort of moving on the free cash flow line. CapEx in the third quarter, tough to stop CapEx when there's a shovel in the ground of the client. So there really wasn't a lot of opportunity in the first -- this quarter to defer or negotiate with clients on CapEx. But we do feel -- and the teams have been working hard to move things in the fourth quarter out to renegotiate as part of, as John referred to, some new operating models. And so we feel like we'll be able to bring the CapEx levels down in the second half, particularly in the fourth quarter. So if you put those pieces together, a slightly negative operating cash flow in the second half, working towards a neutral working capital and then minimizing the CapEx, we feel like we'll be pretty minimal free cash flow use in the second half, if any use at all, so in a pretty good shape. So at that point, to follow on to your question, you'd say, "Okay. Where -- what are our capital allocation strategies?" Well, certainly continuing to use the cash flow that we have for growth opportunities, continued new business. Pipeline remains robust. So we'll continue to focus on CapEx. There are -- and we had a very robust pipeline on M&A tuck-in deals, nothing significant, but primarily as we talked about around the Uniform and refreshment sides of the business. We'll continue to look at those. Valuation gaps between buyer and seller are sort of large now, so I feel that we'll be able to get done, but continuing to look at that as a second priority. And then lastly, the debt reduction. So as we come to the end of the year, as things look a little more certain, we'll consider the debt reduction. But certainly, the priority is to try to play a little offense, if we can.

Yes. Great. That's super helpful. And I'm glad you brought up the growth angle because, John, when you were brought in and when you decided to jump on board here, this was -- it seemed like priority #1 was to kind of pivot away from that margin focus to that growth focus. And I got to think, with the disruption out there, it's harder maybe. But I wanted you -- to hear it from you. If customers are still willing to listen to switching providers or outsourcing for the first time and how you feel like your sales wins can be with your new investments in sales force, how that might play out as you look at potential net new business heading into fiscal '21. Do you feel like the sales initiatives made in '20 can lead to an uptick in, what I'd call, effective net new, right? Because maybe nobody is running at 100%, but like you have an idea of what that business should be. So can effective net new business pay at or above prior year levels as you move into '21, do you think?

Right. Yes. Absolutely. I think we've made very significant progress. And as Tom alluded to, we have not reduced the cost on the growth side of the company at all. We've continued to invest in new sales infrastructure and continue to make investments in sales management. And we've continued to focus on those sales opportunities, which, surprisingly, have been pretty robust during even COVID-19, that we continue to engage in some very significant processes, some of which we can't quite announce yet. We're excited about and still putting pen to paper with respect to the contracting process. So we feel very good about the actions that we're taking because it is the #1 priority of both the Board and the management team to grow this organization, to reestablish that hospitality culture and the growth paradigm. And so all the actions we took early on, we're focused on that, and we continue to be engaged in those activities. Surprisingly, we think that there will be significant opportunity going forward. Self-op conversion rates, we believe, will accelerate as more and more organizations and institutions have come to the realization that they weren't prepared in this environment as well as they could had they had Aramark or a professional service provider handling these services. And we're seeing a lot of dialogue with major institutions that have historically been self-operated that are really giving this some serious discussion. And so yes, we think that the going in new business rate for next year will be positive, and we'll have net new positive growth, even in light of the fact that some of those operations may be smaller than historic numbers. So yes, we're very excited about it.

Great. I wanted to spend the last amount of time that we have talking about your Uniform business, which, historically, while only being about 10% of the company's revenues, with the margin profile as high as around 20% of the company's profits, I wanted to just understand a little bit about what you're thinking about this business, in particular as it relates to the growth environment today because it is labor-focused and, obviously, unemployment is high and then strategically how it fits inside of Aramark, if the environment today accelerates or changes your perspectives on your strategic options with that business for the longer term.

Right. Really, the Uniform business is very key to the whole cleaner, safer, healthier kind of environment that companies, I think, are going to be looking for going forward. And it is an essential service. We continue to operate at very high levels. The dip in the business rate was significant as you expect during April, but the recovery has been much more rapid there with respect to the ramp back up, as more and more businesses open, and more and more businesses are interested in that cleaner, safer, healthier paradigm. And as you know, we shifted production in our manufacturing operations in Mexico to PP&E, barrier gowns, sterile gowns, masks, respirator masks. And those activities are generating significant revenues in the month of May, and we expect they'll continue to do that going forward. We do like the business. Obviously, we see synergies between the foodservice business and the Uniform business. Every foodservice customer is a Uniform customer or a potential customer. And so the -- we see significant potential in terms of profit improvement in the enterprise in Uniform services. We're very excited about the synergy capture that they've been able to achieve with the AmeriPride acquisition. They've delivered on the synergy promises. And one that is yet to come, which is the implementation of the route accounting system that came over from AmeriPride, that has significant potential for margin improvement throughout Uniform services. And so the optionality in terms of the business hasn't changed, but we believe that there is significant improvement potential that we can mine as an organization. We've got a great team running the business, and they've responded very positively during this crisis. So the Aramark Uniform services people will be providing all the PP&E needs for all of the Aramark foodservice customers domestically and globally, so having that linkage and supply chain capability is really significant for us. And frankly, the value of the production that they're able to sell into the PP&R -- PP&E marketplace going forward, I think, will be significant for the future.

Okay. Well, that's helpful. Thank you for your time, guys. We're going to cut it there. We're at the top of the hour. Going to let you get your one-on-ones and do the same. So thank you, John and Tom, for your time today, and best of luck.

Thank you very much.

Bye-bye.