Aramark (ARMK) Earnings Call Transcript & Summary

Okay. Good morning, and thank you, everybody, for joining us. I'm Gary Bisbee. I'm the business and information services analyst here at BofA Securities. I'm pleased this morning to have the senior team from Aramark here to discuss their business. From the company is CEO, John Zillmer; and CFO, Tom Ondrof. Guys, thanks for joining us.

You bet. Happy to be here.

Good morning.

As I was preparing for this, I thought back to where we were 1 year ago when this conference at the last minute was moved to a phone-based virtual, but the 3 of us actually sat together in a room and did the meetings and it's amazing how the world's gone in that last year. As I thought back on it, I think the 2 of you were the last 2 people I shook hands with physically at the end of that day, and we all said, should we do this. Yes, we're not squamish, we've got hand sanitizer. And look where we are a year later, right? It's amazing. I know a lot of the questions that we've asked you and you've heard from investors in the last year have focused on the pandemic and the impact on your business and how to think about recovery. And certainly, we'll have to hit on those. But I'm encouraged that 2021 can be a year where we move back to the post pandemic story and so that really starts to come in a focus later this year. And for Aramark, I think that's really the pre pandemic story of change led by you two and, among other things, pursuing a more growth-focused agenda for the business. So certainly, we'll save some time to ask those strategic questions, which I think are long term, the most important, but maybe I'll start with a couple of questions about the business today and the pandemic and how it's trending.

And so as a first one on that note, clearly, you've seen sequential revenue improvement in the business from the lows last spring. And given that it feels likely that the business inflects back to positive revenue growth in a couple of quarters, and we see the recovery begin. I guess how are you thinking about costs as that happens and margins and a return to profitability from the business? And is there a certain revenue level or utilization level that you need for the business to return to being consistently profitable?

Yes. Great question. I think it's a relatively complex one. We do have -- many of the businesses are operating at levels that are comparable in terms of profitability to pre-COVID levels and a couple obviously, still significantly impacted, like sports and entertainment, where the level of business activity is still very, very low. So -- but we're very hopeful of the springtime recovery for Major League Baseball, for example. So I don't think there's a predetermined revenue level that we're looking for. We are working very aggressively to manage the cost structure very tightly for each of these businesses, and we've been very focused on managing for the long-term growth of the organization. So we've continued to invest over the course of the last year in growth resources and salespeople and marketing infrastructure and organizations. We do believe that we are seeing green shoots of a recovery in many of the businesses. As the rate of infection drops and as companies begin to return to work, we think that we'll have a significant uptick here in the second half of the year. The most encouraging thing for us, obviously, is the return to sports. We believe that Major League Baseball and their intentions are to begin opening day with fans and stadiums, and that's a very significant contributor for us over the -- basically, the -- end of the third and the fourth quarter. So we do feel very optimistic about the next quarter and the return to work and the -- to higher levels of revenues and profitability. But we are managing aggressively. We could be profitable today. If you compare us to our larger competitors, they talked about a margin at the end of the last quarter that was on the positive side. We've made the choice to go ahead and manage aggressively for future growth. So we've continued to invest in those resources. To allow us to accelerate the growth paradigm coming out of this. Tom, do you have some additional thoughts you would like to share on that?

Yes. I think the only thing I'd add is beyond the growth investments, some productivity investments as well, like ABS within the uniform business as well as really hard luck this past year in our above unit costs, and we'll be very diligent about those on the way back as revenue comes back so that we can leverage those actions. We'll transition, Gary, as we've talked about from sort of managing a drop-through rate this past 4 quarters to second half of this year. We'll be driving margin progression, and we expect that to move pretty quickly and sharply in the second half of the year.

And I know there's a lot of moving parts of those investments. But is that 20% to 25% decremental margin you've seen on the downside, is that a reasonable number to use in the first year of upside? Or could the investments change that dynamic?

Not too much because the investments have been made on the downside. So sort of consistent on both. I don't think that will be the variable. The bigger variable will be what comes back when. So everything sort of fell at once, if it all came back at once, you would be able to do that math pretty consistently. But we expect B&I to be a little bit more linear, longer drawn out recovery, others could bounce back more sharply. As a rule of thumb, I don't think you'd be far off to use that, but it had been maybe a little bit choppy.

Yes. Okay. All right. Fair enough. So one thing you've talked about in B&I and some of the more challenged areas is transitioning at least temporarily a lot of the basic contracts to more management fee or cost-plus or something from the legacy P&L type contracts. How does that transition back? What's the catalyst for those discussions to move that back? And is it right to think in a normalized environment, I realize we're ways away from that, but that the P&L contracts allow Aramark to have higher profitability? And how do you think about that dynamic?

Yes. Interestingly enough, the management fee contracts in terms of the margin are very similar to the margins that we can earn on a P&L basis. So there's not a significant fall off from a margin perspective. It's really driven by the profitability, really driven by the revenue recovery. And the catalyst will really be around population levels as employers bring people back into their buildings, at what point does that population reach critical mass where you could transition back to an annual contract. And so that's really a very individualized kind of negotiation because all -- a lot of companies have planned to do it differently. They're stage -- considering staging, 25%, then going to 50%, then ramping over a period of time. Some are talking about a much more instantaneous return back to the office. So it will really be dependent on the individual specific mix locations. But generally, from a margin perspective, the B&I business, the management fees contracts can earn profits at a very similar level from a margin perspective. So the P&L...

Okay. All right. And one thing, even pre pandemic that was well understood was in the sports business, your ability to scale up your costs up and down with attendance levels and be able to earn profits even at lower than normal revenue. Are there learnings from that business that's helping you think through and manage recovery in some of the other businesses that are down? Or is this transition to more management fee contracts made that less relevant?

Well, in B&I, the management fee contracts really do give us a downside risk protection and allow us to really stage the recovery for the clients in a way that really meets their objectives as well while protecting us in terms of downside risk. But yes, there have been learnings throughout this process that we've extended to all the businesses, both domestically and internationally as the teams have done a very good job of scaling the services in order to meet the demands that each individual customer has for each business. And of course, you've got some that are operating at close to pre pandemic levels. The facilities business, health care, K-12 is just having a terrific performance as a result of the waiver from the USDA with respect to meal. So a number of the businesses are unaffected or slightly affected, and it's really just the core sports and entertainment, B&I and uniform services, which have been most severely impacted by the pandemic and the rest are kind of operating at very similar levels.

Okay. All right. In the last couple of quarters, you've talked about the flexibility you've had in meeting clients' needs. And you brought on a number of new service offerings, things like delivery or other things like that. Are any of those -- is that mostly just reacting to the environment? Or are there any medium and longer-term opportunities for the company in some of these newer models that you've been pursuing?

Yes. Absolutely. We do think there are some longer-term opportunities, particularly as you think about how it applies to certain verticals, certainly, on the health care side one of the most important elements of patient recovery is nutrition. What we've discovered is multiple institutions are really trying to find a way to continue the nutrition process for their patients after their discharge. So we are serving meals to patients who are now at home through delivery methodologies that we didn't -- that we didn't do before. So that's a longer-term contributor to that business that needs to expand and more institutions recognize the value of that continuing process. There's significant cost savings to a medical institution to provide that nutrition recovery service as opposed to having to readmit a patient because they don't get a lot of -- after they've been released. So a very significant cost opportunity for them, and a big revenue opportunity for us. So we pursued that initiative. A number of things in the B&I sector. We've got a program we call Munch Mail, which is delivering millions of dollars of revenue to us. We're delivering kits, curated kits to employees at home on the -- for the benefit of those employees from their employers. There's a range of offerings. It's really kind of the e-business and one that we'll continue post pandemic and continue to offer not only to B&I, but other businesses as well.

Okay. All right. Good. Well, in the last month or so, it felt like we're finally seeing the pace of vaccinations picking up and some signs for optimism, restrictions eased and whatnot. Where do you see the most opportunity in the business to benefit from a normalization? I guess you've called out, obviously, sports and B&I. Sports maybe could come back more quickly with attendance, B&I, you've said takes longer. But are there other pockets where you think you could get quick benefit or big benefit as we continue to see normalization in the next 6, 9 months?

Yes. Absolutely. The facilities business is one that will continue to benefit, I think, from the refocus on hygiene and safety. So we have more and more customers who are considering adding -- they've already added significant sanitation services and cleaning services and hygiene services, disinfection kinds of activities to their standardized building cleaning maintenance programs. And so that represents project work that comes at very high margins for the facilities organization. That we think will continue to be a long-term opportunity. More and more companies considering outsourcing their facilities management process because they recognized they weren't prepared with the right protocols and the safety procedures so we've got a number of customers in both existing and prospective customers that have reached out to us and say, we would consider taking on their employees. And of course, that's something that's core to our business. So we see continued outsourcing there. And we've seen an acceleration of the outsourcing trend in higher education and K-12. We're seeing more opportunities from those traditional businesses and then we're also seeing some nontraditional customers consider outsourcing as a way to reduce their cost and to ensure hygiene and safety going forward. So yes. We think there's some significant opportunities for us to accelerate the growth coming out of this. And then from a -- well, in sports and entertainment, for example, one of the phenomenons, contactless payment, which is very important for people right now, is something that we've instituted in the sports and entertainment world, and there's significant check average improvement, capita spending improvement that comes as a result of this contactless payment technology. So you don't have to walk up with a $20 bill to get a couple of beers anymore. You can use your contactless payment whether it's your Apple Card or whatever, and that has a dramatic impact on check averages and -- it will benefit us long term.

Yes. I -- do you need less labor? If you don't need someone making change? Or is that not a big part of that.

Well, it does have labor implications. It also have speed of service implications because no longer you have to wait for change. It's almost instantaneous. So we can serve more customers more rapidly and that's very beneficial for us. So you won't walk up to lines at concession stands, you walk up to a counter where you can get to a product very quickly.

Okay. Yes, that's interesting. Well, if I could shift a bit to a couple of questions on margins and medium-term profitability. One, given the focus on inflation recently and strong job numbers that then -- that I think is worth asking is just on labor costs, what are you seeing? Obviously, there's a movement for higher minimum wages in some markets, and I know the company has historically commented on that. But it also feels to us like there's risk of broader wage inflation, particularly when we see broader reopening in whether that's restaurants or theme parks or hotels or some of the areas that have been most impacted. If we see a quick reopening and a lot of that later this year, it would striking is likely to drive a potentially big increase in inflation at low and mid-level wages. How -- what are you seeing today? And how are you prepared for that if that happens?

Sure. Tom, do you want to go ahead and start with that and I'll add some color.

Sure. Yes. I mean, Gary, it's 25-plus years in the business, labor is the one constant that's always been there for us in the contract food service business. In 250,000 people at Aramark, it's a key component for us and hiring people, quality people, opening accounts in a good way, has always been part of what we do and part of the challenge. So the environment is not new to us. Wage inflation has been around for us for a long time. We've got the contractual right to pass that through. Now we don't want to necessarily because we've got to hold our end. And the client is not just going to want to straight pass-through, but we do have that right. So we've got to drive efficiencies. Some of the things John just talked about, but also be able to pass some of those costs through. So it's not a unique or new environment for us. As you mentioned, we don't really pay minimum wage. Minimum wage exists in the majority of states now anyway, and so we don't see it being any new headwind for us. We'll continue to manage through that. The ability to recruit people in is what we do. As I said, we -- with this many people in the industry we've got the infrastructure to hire seasonal folks. And I think the teams have done a really good job over this past year with the furloughs, staying in touch, being prepared for reopening. It's been one of the things you talked about all year. So it is definitely top of mind. It is definitely something that we've got to pay close attention to. It's always on the horizon for us, but we feel pretty good about being able to manage it. Yes. Okay.

Yes, that's exactly right. And just -- I'll add just a couple of elements. It is core to what we do, as Tom said. And we've got great infrastructure and a fantastic recruitment organization and human resource organization because it is a critical component of being able to serve our customers. One of the things that really adds to, I think, to all the value to us is we are recognized as an employer of choice. We are one of the most admired companies. A top employer for people with disabilities. A best place to work for disability inclusion. Best place to work for LGBTQ equality. We consider ourselves -- we work very hard to be a very inclusive environment so that we can have the best people come to work for us. And I think we end up with very good results and we've got the downside risk protection in our contracts. We typically don't pay minimum wage. So we don't see this as being a significant act item. It just continues to reinforce the need to be great at what we do.

Okay. All right. That's helpful. And then I think, John, you alluded to a couple of these a minute ago. But are there any changes you've implemented to the cost structure operationally because of the pandemic that you see having longer-term benefits after the pandemic? So that contactless payments was one example. But are there are there other things either big things within strategy or operations or at the unit level that you think are really going to be benefits on the other side of this?

Yes. I think maybe the biggest is the work we've done on supply chain. As you know, we brought down or back to the organization just shortly after I've rejoined and Pompe joined, and John has done an extraordinary job on the supply chain during the pandemic. We've renegotiated all our master distribution agreements that we've actually done that work prior to the pandemic impacting us. We've retreated all of our major supply agreements with manufacturers. And so as the growth comes back, as the revenues come back, the supply chain will be producing higher levels of profitability for us, which will drive significant benefit. So we're very excited about that work, that's already kind of built-in to the recovery model, and all we need is those customers to come back. And as we buy more product, those supply chain savings will accrue to the organization and get passed through to the contract. So that's a key driver. And then obviously, we've done a lot of work around the overhead infrastructure, a lot of the reductions that we've taken over the course of the last year are built into the system today, and we've learned how to do more with less. And the only place where we haven't really kind of made permanent changes to the cost structure is in the sales organization where we've taken resources and added to the company, so we can really accelerate that growth rate coming out of all this as well.

Okay. All right. And then just one last one on margins. You and also, frankly, your European industry competitors, have all commented that over the long term, you see profitability getting back to and maybe even above pre pandemic levels. What are the key puts and takes? Is it really just all about revenue coming back? Or are there other dynamics that are going to be important to delivering pre pandemic margins and above in the future?

Yes. Tom, do you want to start?

Yes. I mean the simple answer is yes, Gary, it's revenue. But behind that, there's a whole lot of work to be diligent on the things John said. It's bringing back the folks, the quality folks to serve the customers at the right time as those volumes come back it's about being really maniacal about managing our ability and overhead costs and really leveraging the actions that have taken place this past year. It's about continuing to execute on the service models that have been put in place that serve the customers' needs. Managing the transition back from cost-plus to P&L at the appropriate times based on volumes. So there's a multitude of things underneath that, but it's driven off the volume.

Yes. Our expectation is that we will come back with stronger margin. And that was one of the goals that established for the company as we rejoined, it's our belief that we can close that margin gap that we have to our larger competitor and the actions that we've taken have been designed to go ahead and achieve that. And we think that, that's a pretty real goal. And it's 1 that we've built into the compensation system of the company and the goals and objectives of the people who are managing these organizations. So our expectation is to come out with accelerating margin improvement over the part with the recovery.

Yes. Well, that's a great transition to some longer-term strategic questions. Then the -- prior of the pandemic, you've laid out a number of strategies that you were going to implement or begun to implement to drive better growth, continued efficiency and better overall operations for Aramark. Can you just, at a high level, give us a sense of what you've been able to accomplish in 2020 despite the pandemic towards these goals? And are there any areas where those efforts have been delayed by the pandemic?

Certainly. Yes, and we've been able to -- one of the -- a couple of the fundamental things that we believe were necessary, the investment in sales infrastructure and sales resources. So we have we talked about taking resources from what had been the center-led sales organization and putting them back into the field back into the specific business units, and then adding resources to go ahead and create a much more efficient and focused sales organization, all that work has been done. It was begun pre pandemic and has been accelerated during the pandemic. So we've got that infrastructure in place. We've got the number of salespeople increased in uniform services, for example, we added 150 sales managers last year, we're adding another 100 this year, really closing the resource gap between us and our other competitors in that industry. In the food service business, we've added significant sales resources and are continuing to add more going forward. And so we've been able to do that work, and we haven't taken a pause there. That's been one part of the organization where we've absolutely continued to invest and refocus. So we're very pleased about that. Sorry, go ahead.

Yes. So you targeted also about $30 million of spend towards, I think, a lot of that was what you just discussed. So it's right to think you put that money to work in the last year, it didn't slow those efforts because of the pandemic?

That's correct. And that was the investment that was approved by the Board for last year. We spent that money, and we're continuing to invest more this year. Those are -- 100 sales managers for uniform services are in addition to that 3. And then one of the other fundamental investments that we wanted to make was the implementation of the route accounting system in uniform service. It's called ABS. It replaces a route accounting system that is decades-old and no longer supportable. And we've accelerated the implementation of that because the impact of that system is so significant as we transition the old existing Aramark operations into that system it affords us a number of different opportunities to improve margins, both from a management perspective as well as a sales perspective. So it fundamentally gives us the opportunity to, for instance, implement 4-day work weeks for our route drivers and uniforms. It gives us a much greater degree of flexibility rerouting capacity is a dynamic approach and it's much more flexible. So we've accelerated that implementation, and we're absorbing those operating costs as we have teams running across the country, implementing ABS in a very fast way. We expect to have somewhere in the range of 80% of our revenues covered by the end of this fiscal year and by the end of the first quarter of next year to be virtually complete with that implementation. So we're investing in those resources as well in this year, and they're substantial.

Okay. All right. I think that's good to hear. One question on new business. In the last few quarters, you've cited a number of material new business wins, a couple of universities and a number of other clients. Can you explain the dynamic behind this? I've had a lot of investor questions around just given the significant headwind clients are facing, why would they be doing this now? So where a lot of those either RFP or other process started pre-pandemic and they've just been announced more recently? Or have you really seen this concept of self-operators saying, wow, I need health in this environment, and that's really accelerated the pace of wins?

Yes. I would say some of them were in process beforehand and then sorting out their RFP process during the pandemic, but most occurred during. So some came -- Florida state, for example, was a midyear transition from Sanexo to us. That was a relatively fast process, 1 that occurred this fiscal year. Sacramento state was one that had begun during the pandemic, that's a self-op conversion. And there have been a number of others. We have a significant improvement in our closure rates, which is something we're very excited about. So we're winning more of the -- a higher percentage of the opportunities that we're pursuing. There is the pipeline is very robust, but the process is being elongated a bit. There are companies that are taking longer to make decisions because of the pandemic environment. And so that's one of the reasons you see the retention rate in the industry has risen dramatically, not only for us, we're at historically high retention levels but for our competitors as well because there are companies that are elongating those decision processes. When you see -- and you see, for example, Chicago public schools, one of our largest operations in the country, was scheduled to be rebid this year, but that process has been extended into next year because of the pandemic. So there is an elongation of the sales cycle, but we're definitely seeing an acceleration of the number of companies both traditional as well as nontraditional organizations seeking to evaluate conversion from self-op to contract.

Okay. All right. That's encouraging. So I speculated that there could be an acceleration of the process because of the pandemic, but that could pull forward some demand on that self op conversion potential. It's probably difficult question to answer. But do you think that's a risk that you see a wave of outsourcing agreements in the next 12 or 18 months and then it slows thereafter? Or is this -- are these the reasons they're doing that, do you feel like they're likely to prove more durable?

Yes. I think the reasons will prove more durable. Tom, I don't know if you have any thoughts on that?

Yes, I do. Just generally, I think we've seen over a long period of time in the industry, just this standing march towards outsourcing, it's a very emotional decision for clients to outsource. And so they can evaluate this just sort of expressed a lot of times, they evaluate, pull back evaluate again and get comfortable with the process because ultimately, you're giving up control. And this pandemic has sort of gotten people to think just really what we should be doing, really where I should be spending my time and I capable of it. And still, I think it's a catalyst, but to evaluate -- to more seriously consider those who hadn't. But I don't think there's going to be any mad rush. I think it's a durable continued progression towards outsourcing.

Okay. And then on uniforms, you talked earlier about the systems investment there it sounds like it's a material opportunity on margins once you implement it everywhere and are using it, how does it help the top line? I think you've obviously talked about hiring salespeople as a driver of top line. But do the systems at all? Or is it really put people in place, drives customers, and this is an efficiency tool?

Yes. Well, it's actually a sales tool and an efficiency tool. It does afford us the opportunity to manage around more aggressively which does free up time for the district managers to be back in the field. This is kind of a silly example, but it's very real. Today, all of our district managers have to be back in the plant at the end of the day to check their route drivers in because of the archaic way the route accounting system works. There is all kinds of checks and adds and drops and adds the district managers have to be there at the end of the day to make sure that happens. So that takes the street away of your prospect customers, right, to do accounting work, which makes no sense whatsoever. So ABS completely eliminates that, the need for that process. And it gives our district managers and territory managers the times to be in the field. It also facilitates our 100% customer process. So we want to be seeing all of our customers consistently. And so this system gives us that flexibility in that capability as well. So we see margin enhancement as a result of more efficient operations. We see sales growth as a result of customer retention and improved customer sales prospect lines coming from it. And where we implemented this in our existing operations, we've seen those dramatic improvements rather rapidly begin to accrue. So that's why we've accelerated deployment because it really does have significant benefits going forward.

Okay. And obviously, Cintas has a different business than yours in a lot of ways, but I get the question a lot. Does the narrower set of offerings within Aramark's uniform business, is that really in a barrier to more effectively competing with Cintas. Do you think that's a fair question? Or do you feel like the investments in people and systems position the business to really start to close the gap on both the top line and profitability?

Yes. I think the investment in people and systems are definitely designed to help close that gap, no question about it. I think a range of offerings -- on the core rental business, our range of offerings is very similar. There's really nothing that they offer that we don't on the core rental. It's the ancillary services, the first aid, restaurant services and things that we're building that business today. They went out and acquired that business, and they've done a great job with it in accelerating that growth, but we have grown our ancillary services business rather dramatically and first aid and restaurant services as well. So we see that the product offering gap is narrowing. Now there are in some things that we're not. We're not in fire protection. And that's not something that I'm considering at this point in time. I guess at some point, maybe I'd evaluate it. But I'm not in that business today. So there are some gaps with the core rental business and the margin first aid business, we are absolutely able to compete with them, and we'll close the margin gap and we'll close the growth gap as well.

Okay. All right. Well, that's good to hear. Earlier, you mentioned facilities as something that is benefiting, you think, from the pandemic. Prior management team had actually carved that out as sort of a separate business with a separate management team and have talked over the medium term, and I'm going back a couple of years, obviously, but about investing more in this business and seeing real opportunities there. Is -- do you share those views that facilities has good growth potential? And it should be a separate set up somewhat as a separate business and that you should be aggressively trying to grow that business today? Or do you have different views?

No, I share those views. I was around when we first acquired ServiceMaster and a number of other organizations to begin building the facilities business. So I do think it's -- there's very high margins it's a very strong set of capabilities that we have. And so we've got it operating in a couple of different ways. The health care business goes to market as an integrated facilities management company. So health care sells it that way because that's the way the buyers buy it in the health care community. On the -- in the B&I sector and somewhat higher education, it is a separate company with the tone operating infrastructure and its own leadership. There's a lot of cooperation between the 2 parts of the organization in terms of resource sharing and capability sharing well, we see continued growth opportunity there. And it's -- every one of our customers in higher education, B&I is a potential facilities management customer, and many of them are. So we see the opportunity, not only for growth in our existing portfolio, but significant new customer acquisition opportunities as well. So we don't to invest resources there. And some of the sales resources that we've added in the last 12 months have been dedicated towards the facilities business.

Okay. All right. And then we don't have a lot of time here, but could you give us just a quick update on your GPO business today? So obviously, the vendor acquisition a couple of years ago added a lot of scale. There were some systems work that was going to be done post that. Where is the business? How is it operating today? And how are you thinking about both serving third party clients and obviously, running your internal operations through that business?

Yes. That and in the vendor business, all the supply chain organization does report to John Revana. So we have integrated the leadership of our supply chain with a Avendra as well. So Avendra continues to grow, to sell. They've added -- we've added multiple smaller GPOs into the Avendra system. Aramark had some existing GPO business that we have done in other parts of the world, like Canada. And so that's all being blended into the Avendra umbrella, if you will. We're excited about it. We've got lots of opportunity to continue to pursue growth where they're selling new accounts. That business obviously has been impacted by the drop in hospitality at a drop in the hotel and travel business, which was their genesis originally. And so as that business has been recovering, we're seeing improvements in that business, and we expect it to accelerate right here at is both business and personal travel begins to come back. So we're still excited about it. It does add significant leverage at scale to our supply chain and purchasing organization, and we're taking advantage of that. And we've been able to -- those new distribution agreements so we've been able to negotiate those new manufacture agreements or were the result of that consolidated spend, the both the Avendra spend as well as our contract catering spend. It does give us significant opportunity going forward.

Great. I think we're out of time, so we'll have to leave it there. But I wanted to thank you both very much for your time and participation.

Thank you so much, Gary. We appreciate it.

Thanks, Gary.

Take care.