Aramark (ARMK) Earnings Call Transcript & Summary

Good morning, everybody. This is Shlomo Rosenbaum. I'm the business services analyst here at Stifel. I want to welcome everyone to what is the Fourth Annual Cross Sector Insight Conference for Stifel. We are hoping that this is the last virtual cross-sector conference for Stifel and look forward to welcoming everybody in person next year. Hopefully, in Boston, we'll get a chance to meet a person. Thank you very much, John. John Zillmer is the CEO of Aramark. I want to thank you for joining us this morning for the fireside chat. We were looking forward to talking with you. I know you're very energized about the business and the opportunities that are in front of you. And I want to have a -- hopefully, a lively discussion about it. I just want to let everybody know from the investors there, if you want to ask any questions, we encourage you to submit questions. There -- you should submit them through the website. And they will come up to me, and I'll pose them to John as they come. In the meantime, I have my own questions to ask him, and I'm happy to do that. But again, I want to encourage people to make this an interactive session.

And with that, I'm just going to start off, John, asking a little bit about something that I think is a little near and dear to your heart. Can you talk about the pace of reopenings in Sports and Education? And is it progressing along the lines that you were expecting? And maybe you could talk about that both in the U.S. and internationally.

Sure. Certainly. Yes, we're very excited about the pace of reopening in Sports & Entertainment. Our second quarter results reflected some sequential quarterly improvement in all segments of the business, with client reopenings throughout the portfolio. And in recent weeks, we've experienced ongoing momentum across the business sectors. Sports & Entertainment is quickly increasing fan attendance at client locations. I've been on the road spending time with team owners. And as the reopenings are accelerating, nearly all of our major league baseball clients planned to be at 100% capacity by July 1, and many are already at 100% capacity. Those organizations that are going to step up, for instance, the Colorado Rockies are going from 70% to 100% on June 28. The Astros are at 100%. The Red Sox are at 100%. The Mets are at 75%. They expect 100% by July 1. So we're seeing robust increases in the opportunity for attendees. And we're seeing full attendance, for example, at the 76ers as they play in the playoffs. The arenas are full. And so we are seeing an acceleration of that activity that's taken place through the month of May and on into June, and there was continued acceleration over that time period. Really, the only team in baseball that's still somewhat affected is Toronto Blue Jays. They're playing games in Buffalo as they continue to kind of work through the issues in Canada. But that's the last team that has any significant impact moving forward. All the NFL teams are expected to be at 100% capacity as they reopen the seasons and start in the fall. And so that's very encouraging as well. With the rest of the business, international, I think, is still going to continue to have organic revenue improvement over the course of the balance of the year. They're still managing through various stages of restrictions. As you know, the international countries continue to lag behind the U.S. with respect to vaccination rates. And so it's a slower reopening internationally in some markets. But China and Latin America have demonstrated significant resilience. So we're encouraged by the momentum, and we're seeing it organically evolve very rapidly. Literally, from week to week, we're seeing improvements in the business. Business employers are beginning to adopt their return-to-work strategies. And so we expect a significant step-up over the course of the summer and, frankly, I think, what's likely to be kind of a very significant change starting around Labor Day in the business services area. On Higher Education, we expect full campuses in the fall, and that's also extraordinarily encouraging for the business.

And maybe on Education, you could talk a little bit about the expectations. Because there -- is there potential for kind of a bumper crop this year because you had people who had deferred last year from going to college because it wasn't in-person? And now you're going to -- I assume, in the United States, it's going to be fully opened, plus you're going to have other people who didn't get a chance to go last year. What are your clients telling you about that potential?

Yes, that's absolutely right. I think most universities are expecting to have -- to be at full capacity. And in some cases, we're talking to clients who are -- have expectations of housing shortages on campus but -- because they do have students who have deferred in -- weren't on campus last year and want to be back on campus this year. So we expect a very robust fall. We'll have probably the best enrollment data around the 1st of July. Typically, in the Higher Education sector, you have very firm enrollment data around the 1st of July, but all the indications are for a very strong fall opening. Almost all the universities are expecting to be on-campus, in-class learning and very, very little online learning going forward, with maybe rare exceptions due to capacity constraints. But those students, they expect to be on-campus and using our services as well. So we're very excited about the fall reopening for campus.

That's great. Because I know, particularly internationally, there were some concerns from the investors about the potential for the pandemic to push more of the student learning onto online platforms. And what it sounds like -- I thought maybe you could comment on that. Because what it sounds like, for what you're seeing from actually talking to the schools and a significant amount of them, is that, that's not really what it looks like is happening.

Yes. No, that is not -- it's clearly not happening. Students are showing a very strong preference for on-site, in-person learning, and that the online is really more just a fill-in, in particular, for capacity constraints. Yes, students have voted. They want to be on campus. They want to be in class. And they recognize the differential gap, and the quality of the educational experience is significant. And that was one of the key concerns of students voiced over the course of this year as they were forced into making that choice. They didn't prefer it, and they made their voices very clear and -- to the educational community. And so our expectation is online learning will not be a significant component going forward of the educational experience, except where it fits a capacity constraint demand.

Got it. That's great. And maybe you could talk a little bit, this is a question I've been getting more lately, given the kind of the environment -- the rising wage environment, and how is Aramark managing through the inflationary environment right now? Can you talk about the company's ability to pass through wage inflation at this point in the recovery? Because, obviously, people are just starting to open up in certain areas. And do you see this as potentially a material challenge in terms of generating the operating leverage as more markets open up but, at the same time, maybe your costs are going up?

Yes. Generally, we've always had inflationary pressures in this industry because we operate on relatively thin margins. When there's food cost inflation or labor inflation, the industry has had to respond and deal with these kinds of issues historically. And this one is no different. I mean we'll have -- we've got some commodity pressures on the food side. We've got some wage pressures on the labor side. But we have contractual rights to go ahead and pass those costs along to the consumer and/or the client, depending on the type of contract that we're operating under. And so it's not our first choice to raise prices. It's a mechanism that we use and a lever that we use. We're very adept at doing it. We're very targeted. Our people have great pricing strategy, tools that they can use to go ahead and optimize price, to go ahead and offset inflation. So it's a phenomenon that's definitely existent this year, but it's something that we're prepared to deal with and have always been able to adjust for those kinds of dislocations. The -- on the supply chain side, we expect the commodity prices to normalize. The dislocations have kind of worked their way through the system. We've got modifications we can make to menu design, to program design. We've got so many different levers that we can use in the business to manage the cost structure, that we're very confident in our ability to continue to deliver the kind of operating margins we have historically and to continue to improve them even in light of this -- what we think is a temporarily inflationary environment.

Great. No, so it sounds like you feel like you -- the business has a handle on that, and you should be able -- that should not be an impediment to the margins.

That's absolutely right.

Okay. That's great. There's another question that comes up to me often from investors is in terms of how the contract mix is trending in terms of like P&L versus cost plus. Because one of the mechanisms the company used to, frankly, protect itself on the way down in the pandemic was shifting a lot of the contracting over onto kind of these master service agreements and cost-plus type contracts. But in terms of profitability and where the company really wants to be, you want to be more on the P&L side, which tend to be more profitable. And what's -- how do you envision the trajectory of moving those contracts back to the way that you had them before? And do you have any issue, potentially, where the clients say, "No, hey, I think I want to keep it in this situation that we had during the pandemic," which would be a little bit more challenging for the company to move their margins back up?

Yes. Interestingly, the margins on the feed contracts are really driven by -- the contract type doesn't really dictate the overall margin, right? So the management contracts, the difference between the margin on management fee and P&Ls is really driven by the volume associated with them, not necessarily the contract type. So the average margin, even on the management fee contracts is, call it, 6% to 6.5%; the average margin on a P&L contract, 6.5% to 7%. So there's not a difference there. What impacted margins during the course of the pandemic is that the volumes attached to those contracts were dramatically reduced. So If the volumes return, even under the -- even under our management fee structure, if population returns, the earnings will rise to an anticipated level that's very consistent with the P&L contracts. The -- but you should understand that the vast majority of our contracts have transitioned back to their original terms with the extent -- B&I marketplace, where we're still having that evolutionary return-to-work strategy developed by various companies and employers. And so all the other businesses are back operating on P&L, where they were P&L before; or management fee, where they were management fee before. So it's really business timing that's really the laggard with respect to that contractual phenomenon. Right now, there's not a lot of impetus on the part of our clients to go ahead and reconvert them to P&L. And frankly, we're prepared to operate in this environment for as long as our customers want us to. It gives us downside risk protection. And frankly, a lot of customers are now trying to make decisions that are maybe different than the way they operated the business before. We're seeing a lot of customers talk about, "I really want to treat food as a benefit to my employees now so I can stimulate the return-to-work strategy, so I can attract my employees to come back to the pooling. So we're seeing many companies adopt lower pricing for their employees. We're seeing many companies adopt free food as an option, free lunches as an option. So we think there's opportunities to offset with increased participation as employees -- as employers really look at foodservice now as a very low-cost benefit to attract employees back into the workplace.

That's really interesting. That's a very interesting thought. I haven't heard that. It just basically is. As they're looking to try and incent employees to come back in, this is one way to get them in there by using the food program?

Yes, absolutely. And it's extraordinarily low cost. When you really think about the average cost per person on a either per person basis or an hourly basis, in terms of the cost to the employer, it's virtually nothing compared to the other benefits that are typically afforded employees. And so we've used this process to help reeducate customers to what that benefit really is and what it can mean. So we're seeing -- as I said, we're seeing many companies, including our own. We offered our own employees free food to come back into the Aramark headquarters. And it's one of the things that our employees are talking about every day that, "Hey, this food is great." This is really an opportunity to reconnect. And foodservice does afford that reconnection opportunity. When people come back into the building, into their workstations, they can now get back into a mode where they're connecting culturally, and it's a strong motivator.

That's very interesting. Maybe you could talk a little bit about last summer, one of the things that was a very interesting trend that you talked about was the interest from self-operators to potentially start outsourcing more their foodservice. And I would think that, given kind of the sales cycle, particularly in the Education clients, that we'd see that kind of run through June, and you'd start to see more contracts being announced and some of that hitting, really, this summer. Maybe you could talk about some of the trends over there? And are the discussions turning into RFPs that are -- that look like they really are going to increase the amount of contracts that are going to come into the industry from self-operators?

Yes, they definitely are. And there is an increased level of first-time outsourcing at -- most significant in Higher Education, in K-12 and in Healthcare. And so there are active processes underway for self-op conversion. This year, we've -- the examples we've talked about before, where we produced retail operations with this self-op conversion. The Sacramento State University have first-time outsourcing and just recently, Corning, which was one of the large -- one of the last large B&I self-op conversions available in the U.S. that just took place over the last couple of months. So there is significant activity. It also impacts the facilities business for us. There's significant self-operation conversion dialogue going on with large manufacturing organizations, large food manufacturing organizations, thinking about outsourcing significant parts of their facilities management activities as well. So there are a number of -- as you know, we don't announce contracts until we have signed the contracts. And there's a number of pent-up decisions that I think that will become -- that we'll be able to announce here over the next several months that will also be strong indicators of that trend.

So when we're talking on the next quarterly call, and hopefully, you're taking my question then, if we could go ahead and I'd say, "Are you going to be -- have like a number of hits -- contracts in Jay? Hey, I talked to you about this last summer. Here are some of the ones that are coming out right now." Do you expect to be able to talk about that then?

Yes, absolutely. Absolutely. Some are very traditional, some are nontraditional, some are rather large and some are very significant. So yes, there's a lot of pent up. The pipeline is very robust. It's probably the best way for me to describe it. And we are -- I'm extraordinarily excited by the level of activity. But what's even more exciting to me is our level of closure rate. The closure rates that we're experiencing, the level of retention that we're experiencing as a business, I really -- we're seeing this growth paradigm really change for Aramark. And that's very exciting. And this self-op conversion is a piece of it. We also expect to have very good results against our competitors, both the small and the large, and we're excited about the growth trajectory.

Maybe just kind of piggybacking off of that. There -- you -- throughout the pandemic, you've been investing in the business. And that's one of the things that I know, from talking to you, you didn't want the pandemic to cut into the plans that you had for taking this business to the potential that you think it has. Can you talk a little bit about kind of the resources you put in? And because of the level of revenue is not a normal level of revenue, it's not so apparent to investors that you're having the success in that area. But can you talk a little bit, from your vantage point, on what you're seeing in terms of like, "Hey, we've made investments. There are certain sales resources, and we're seeing a return on that, or we're seeing the success that we expect the volumes to accelerate?" Maybe you could talk about that.

Yes, you bet. Yes, certainly. And the investments we've made have been both on the foodservice side as well as the uniform side. And on the foodservice side, we invested in both leadership inside the businesses as well as sales functional leadership as well as sales managers, feet on the street, if you will. So that was a very significant gap for us between us and our competitors. The company had focused on margins in the past, and sales was one of the areas where they really made significant cuts. So we have made the commitment to go ahead and rebuild those sales organizations because this business is a relationship-selling business. It's about having people in the business that really understand their customers. And when the opportunities to present proposals come up, having such a deep understanding that they're able to customize a solution that's unique and serves their needs in a way, that they pick Aramark. And so you can't do that with people that are just RFP responders, that don't know the customers, that don't have time and grade, that haven't really had that experience. So we've taken -- the Board made the commitment to go ahead and spend the resources. We've added significant numbers. Our sales force is about 30% higher today than it was 18 months ago across a range of businesses. And we've added salespeople to Higher Education, to B&I, to Healthcare, to Facilities. We've added sales resources across the enterprise. And so I think as the year closes, and we talk about the actual results year-over-year in terms of our selling performance and our retention performance, you'll see dramatic erratic changes, regardless of whether the numbers flow through the revenues yet. Because of the timing of the award of the contracts and the opening of the contracts, you'll see those numbers begin to really accelerate going into next year. On the uniform side, we have growing that sales force as well. We made the commitment to go ahead and invest the money, to go ahead and close the gap between us and our 2 large competitors. And so that sales force is nearly 30% higher today than it was 18 months ago, and that's resulting in improved closure rates there and retention there. So the results are occurring. It's evident in the data. It's evident in the numbers and the closure rates and retention, and will become evident in the actual revenues of the company as we continue to accelerate out of the pandemic. The other investment for growth that we made, obviously, was in the route accounting system, the ABS implementation and new services, which continues to move very rapidly and to get done. So all along the way throughout the pandemic, we made very tough decisions from an organizational perspective, but we continue to invest in management talent, we continue to invest in the sales resource talent, and not -- didn't make a single cut there or a single furlough there. That was the part of the organization we left untouched because it's my firm belief that it's that growth paradigm that really needed to change and that will drive the future success and the earnings power of the business. Our -- we can manage the cost structure extraordinarily well, as we've demonstrated, and we can manage the costs. The way that you really create the engine for earnings growth is by adding new accounts and retaining your existing accounts. And so that was the key driver for us, and that's why we continue to invest.

Yes. So I have a question -- a couple of questions from investors on the line. One is, should we expect structural change to organic -- the organic growth profile of the business, given the share gains, contract terms or scope enhancements, et cetera? So should we see that, hey, the growth of the business is actually structurally different than what we saw before, given all the positive things you've talked about?

Yes, absolutely. That is the objective. And I think one of the key indicators of the company's commitment to it is the change in the compensation approach that the company has put in place. As you know, we shifted a significant portion of compensation from just pure EPS to net new growth. And that is 40% of the compensation for me and for everybody throughout the organization is now focused on net new and net growth. And so that fundamentally has really changed the way people think about the business. And so yes, the answer is we will see an acceleration of the growth rate coming out of this, getting to that mid-single digits number that we think is most important in terms of our earnings growth and our future growth.

Okay. Great. Maybe just talk a little bit about the agreement to acquire Next Level Hospitality. Is there a big self-op conversion opportunity in the nursing home sector? Is there -- how does Next Level differentiate itself out there in the marketplace? And are there other key assets out there that you think that you're going to be interested in purchasing as well?

Yes. I would say -- I'll answer the last part first. I would say, we're not really interested in acquiring additional assets. I think Next Level is a great company, positioned well against that segment. There is -- it's essentially $16 billion in size. It's largely self-operated. There's significant conversion potential there. Next Level differentiates itself on the basis of its culinary offering and an enhanced culinary capability. It's really focused on skilled nursing facilities and rehab facilities. And they're also focused on relationships with large organizations. So they don't go and sell them one-off. They sell systems, and then develop long-term relationships and contracts with those systems. And we love the management team. There are people that we know, the leadership that we know. They've been in that segment forever, it's what they -- they've grown up in. And we're excited about the level of growth opportunity that's associated with that sector. So I don't know that we would be acquiring other assets to build onto it, but I do know that they've got the capability to grow that sector very rapidly.

And so was that something -- maybe you could just give a little history. Like, did that deal -- was that something that was interesting to you for a little while? Or how did that deal just show up?

Yes. Well, that sector, that segment has always interested us, particularly as that sector has become much more professional in terms of its approach to operations. So as the companies that operate those facilities began to really professionalize themselves, become much more -- maybe the best way to put this is, this isn't the nursing home of the '60s or the '70s. These are very different kinds of facilities, where, if you have a hip replacement, you go and do rehab. Or if you have a long-term care issue, you go and stay there for a period of time to get skilled care. So these are very professionally run system kinds of operations. And that's a business that we were never in, but it's a segment that's so large and growing so rapidly. We felt we were compelled to go ahead and find a way to really step into it in a meaningful way, with a company that's got a great reputation, a very strong growth trajectory and good earnings and a good credit profile. So it was an opportunity. It was a white space for us in terms of our offering from a health care perspective, and it does round that offering out. So that's why we were most interested.

Great. So there's another question from one of the investors. Should we expect structural changes to margins coming out of the pandemic from some of the cost efforts that the company has put through in terms of improving efficiency in the business?

Yes. We believe so, yes, that there have been a number of actions that we've taken over the course of the pandemic and some that were taken in advance of the pandemic that have continued to show impact going forward. Supply chain is a great example. We had already started down the process of renegotiating our master distribution agreements and key supply agreements with major manufacturers. And those agreements were all basically done and put in place just as COVID hit. And so the benefits of those agreements have yet to really manifest themselves in the earnings of the company because the volumes dropped precipitously and these programs are targeted towards volumes. So as the volumes return, you'll see supply chain will produce a higher level of profitability, and that is absolutely margin accretive. We've got significant improvement coming out of the supply chain organization. We also have made structural improvements in terms of the SG&A structure. We are positioned extraordinarily well. And frankly, we've got the strongest leadership team in the industry and the strongest leadership team we've had in many, many years. And so all 3 of those elements will contribute to what we think are structurally improved margins coming out of this. We know how to do more with less, and we've demonstrated that. We can do more with less capital. And we've got significant improvements on the supply chain side, which will drive, ultimately, some improvement as well.

Okay. We're coming towards the end. I thought maybe I'll squeeze in just one more and ask you about just when you characterize the business pipeline right now and just looking at the 3 segments of the business, you've got the North American food services, the international food services and then uniforms, could you just go through 1, 2, 3, how you would characterize the pipeline in each one of them?

I would say it's robust in all 3. We're seeing very significant selling opportunity, very active pipelines. Part of that is us rebuilding that sales organization and rebuilding the capabilities in it. But I would say the pace of opportunity is very strong. And maybe uniform is slightly less than domestic foodservice just because the pace of recovery is a little bit slower in some parts of the country, but still very robust activity and improving closure rates. And so all in all, I'm very encouraged. Nothing -- there's no indication in any of the data that leads me to believe that we have a concern from a growth perspective, particularly as it relates to the opportunities in front of us. Some of these opportunities are very significant, both domestically and internationally, and we're working very hard against them.

Great. Thank you very much, John. I want to really thank you for joining us today at the last day of the Stifel Cross Sector Insight Conference. We really appreciate your participation and your time. I know you're very, very busy on the road, going out and trying to capitalize on all those opportunities that are in front of you. And thank you very much for making time for Stifel and for investors.

You bet. Thank you very much.