Aramark (ARMK) Earnings Call Transcript & Summary

Good morning, everybody. I'm Ian Zaffino. I'm the equity research analyst at Oppenheimer. Thank you very much for coming today. I think it's going to be a great conference today. I'm really pleased to have with me Aramark as one of my first presenters. Tom Ondrof is with us, he's the company's CFO. Really pleasurable to have you here. Thank you very much. What I'm going to do and the way we'll structure this is it's going to be a fireside chat. I'll have some questions that I prepared already. And after that, we will take questions from the audience. [Operator Instructions] So with that, thank you very much. And Tom, thank you for joining us.

Good to be here.

What I'd like to do maybe to start off is, could you just provide us with a state of the union? What are you seeing out there, whether it's by business vertical, whether it's by geography? People are obviously starting to come back to national parks. They're starting to come back to entertainment venues. So any type of color you could give us there as it relates to the activity levels you're seeing? That would be helpful.

Sure. Again, good morning. Yes, we continue to see good progress as the weeks and months are moving forward here. By sort of geography, maybe start internationally, China, Lat Am continue to show great resilience. Europe has been a bit of a stop and start, but I think there's a little bit of momentum. I saw yesterday that Wimbledon is going to be anywhere between 50% and 100% full in a couple of weeks, which is a good sign. Canada, where we've got a decent presence, continues to try to get there and slowly but surely is making progress, so it certainly has been on the slower side. So overall, Europe has been slow, but I think moving forward a little bit -- I'm sorry, international. The Uniform business continues to have pockets of weakness, U.S. West, Canada again, and then particularly by mix within some of the hospitality businesses. But again, we anticipate a change, I think, in that over the next few weeks as to some of the restaurants and hospitality venues continue to reopen. And then within the U.S., B&I, we just talked earlier, and you got -- you're back in the office for the first time today. I think this summer, there's a lot of individual decisions being made, but people are inching back into the office. I think we've got a step change in B&I in September. I think a lot of companies are planning for post-Labor Day returns and then I think again in January being another one. So progress is slow, like we talked about months ago, probably expect that to be fairly linear over the next 2, 4, 6, 8 quarters, really hard to say yet, but again, moving in the right direction. Otherwise, sports leisure just coming back strong. Most Major League Baseball venues are going to be opened fully by the All-Star break at the latest, probably more likely early part of July, which is great news. NBA has got decent capacity through the playoffs, the Philadelphia 76ers, one of our teams is full capacity for the playoffs. Leisure, as you mentioned, the parks are jammed. So that's been positive for us. Still a little bit of an issue to -- in Denali and Alaska related to the cruise lines. But even there, there's some positive news, but I'm not sure it's going to have a big impact for the balance of the year. Health care facilities, corrections of all state, fairly constant through the last couple of quarters, so continue to see them moving in that direction. And then education, as you know, Higher Ed, K-12 are shutting down for the summer and going into hiatus, which is good news from a labor standpoint to sort of get through the summer and then come back in August. So overall, we see positive momentum across the estate, so to speak, and continue to serve our clients and reopen on their pace as best we can.

Okay. Good. And so as you look at that and I guess as you kind of project out, how should we be thinking about fiscal third quarter or really maybe even fiscal fourth quarter? How should we expect the cadence of growth third quarter to fourth quarter? And then also maybe margins as well?

Well, I think we've mentioned sequential improvement. So we certainly expect to see that second to third and then third to fourth. I think it could and should be a little sharper than the fourth quarter on the back of education. Again, we've got to see with the sports venues and then also the entertainment venues, concerts, that kind of thing, how they do specifically return into the back half of the summer. But again, we feel pretty good about that. But I think there should be an accelerating sequential improvement third to fourth quarter. And then again, from margins, we guided towards a 4% to 4.5% margin in the back half. Again, we'll -- I think that's a sequential improvement there to sort of hit that target, fourth quarter being a bit stronger than the third quarter.

Okay. And fourth quarter really be driven by what? Like a full kind of quarter of national parks, a full benefit of sports, is that what's driving it?

Yes, I think third to fourth quarter, a step-up in all those things, really, as well as the return of Higher Ed and K-12 back half of August and in September towards the very end of the fourth quarter. And we expect, and based on the conversations that we're having with our Higher Ed clients as we've begun to shift into more normal conversations for next fall, they are expecting full return, by and large, on campus in-class learning. So we're preparing for that as well as potential overflow for the dual freshman class, if you will. Everybody wanted to get back on campus and get the full college experience. So it should be an interesting and exciting fall in the Higher Ed arena and we're looking forward to it.

Okay. Good. And I think you kind of touched on this a little bit, but maybe we could dive a little bit deeper. Tell us where you are in the sales force, kind of your philosophy on the sales force? Any personnel changes there? And then also, how has that kind of translated into wins? And maybe you could touch upon some of the recent wins and maybe what has differentiated you guys or business opportunities that you may have won currently versus lost before you guys joined or right when you would have joined?

Yes. Well, it's been one of the key tenets to John's return and the overall cultural shift. I mean the 2 big things was to return to a customer service hospitality culture, which obviously impacts retention and reinvesting in the growth algorithm, which had been cut 35% to 40% in terms of sales resources since its peak in 2016. And so job #1 was really to reverse those 2 things. The retention -- the retention rate and get to do business going again as Aramark had proven in the past that they can do. So we're pleased with the progress made to date. It took some resolve through the pandemic to continue to make the investments that needed to be made in sales resources, feet on the street, but as well as support around that. And with the sales folks, we've changed a number of the line of business sales leads, brought in some really incredible talent and really excited about what they'll bring to the table. It has been a massive undertaking for us. And again, we've shown the resolve to get there. Beyond that, we've talked I think a lot about the Uniform sellers that we've added, over 300, probably 350 at this point over the last 15 to 18 months. We've rolled out new training programs, had some initial revamp of the comp client commission plan for sales folks. There was a cap historically by deal and removed that. We've simplified some of the bureaucracy that was attached to it. So all in all, I think -- sorry, added growth to management incentive plan, so all of us were vested in growth across the organization, whether you're in sales or not, which I think makes it a much more collaborative team effort. So we really had taken a lot to change it. It made a lot of changes to change the culture and really get ourselves focused on it. Again, early wins. We've announced a lot of them from Purdue into last year, Sacramento State, the FSU, Florida State, in the Higher Ed arena. Just announced Fort Worth, a really large school district that we just won this past couple of weeks. Corning in the B&I space, so really some great cross-sector. International continues to show great strength, University of Toronto in the Higher Ed space in Canada. Some good wins throughout Europe and China. So it's been broad-based -- geographically, has been broad-based by line of business. So we've been very pleased with that. I think we'll end up showing by the end of the year, record sales, historical record sales in a couple of lines of business and potentially for the company in total. I think retention rate, I would fully expect to be in the 96% to 97% range. And depending on your method of choice, if you start with 100% retention at the beginning of the year and then take that methodology, that it sort of works down. Under that, we're sitting around 98% right now. So we're very pleased on both fronts, both the cultural change on retention and then the investments and early progress to really change a heavy lift, so to speak, to change the growth model that was within Aramark 18 months ago.

And can we just dig a little bit deeper into that? Why are you winning? And then who are winning them from? Is it the typical 1/3, 1/3, 1/3, where it's 1/3 new outsourcers, 1/3 from smaller competitors and 1/3 from larger competitors? Is that kind of the same or what do you think?

Well, yes, I guess first, where, and then why. Where is a little higher on self-op right now for the last sort of 6 months, it's probably closer to [ 40% ]. Sacramento State was self-op, Corning was a self-op, Purdue of course was a self-op, so Northeast Georgia Medical was a self-op. So some pretty chunky self-op conversions. And as we talked about, I think the industry sees a little bit of a bump, a bit of an opening on self-op, a little bit more receptiveness to the conversions in -- on the back end of the crisis. We saw it at 9/11, SARS, the economic crisis, specifically within B&I, 11, 12 years ago. So it does get a little bit of a pop, which is good news for the industry overall. So a little bit more than that 1/3, 1/3, 1/3, it probably weighted towards self-op right now and probably a little bit more from the regionals and then a little bit less than that 1/3 from the other 2 big competitors. So a little bit of shift in that model at the moment, that historical model. In terms of why we win, it's never one thing. I mean I think that's part of what we've started to change within the business. If you don't do the work upfront, understand the client, take the time on the hello-to-contract phase, which, as John talked about many times, can be relatively short in sort of the Uniform, Refreshment, so a little bit of the B&I sales cycle can be very long in the Healthcare, Higher Ed, et cetera. But that hello to contract has got -- you can't cheat the process. You can't necessarily speed it up. You've got to do the work. If you don't, it really just becomes a price sort of investment gain. But if you do the work, you understand what the client -- what's important to the client, identify their pain points, why they potentially could or would switch and then create their solutions. Then it becomes about the sales team, the general manager, the candidate, your diversity plan, your sustainability plan, references, brand and those culinary innovations, technology. It's all those things combined that you bring to the table that you sort out and create that unique solution. And that's what I think we're doing a better job of is it's not a cookie-cutter approach. It's a more customized approach, again, and you can't cheat it and you can't speed that up. And we're winning because we're bringing that style and that approach to the table.

Okay. Yes. I mean it's definitely been effective. So as we look at just sort of coming out of COVID and getting past this, what are you seeing as far as -- because I know during COVID, you've moved a lot of contracts to cost-plus and off of P&L. It's very successful for you, so congratulations on doing that. How has it been transitioning clients from cost-plus back onto P&L? Like what's the receptivity been? Maybe how does that speak to your relationships with your customers?

Well, I think that's it. I mean that's the point. I mean if you've got a good relationship, you work together in partnership with the client. Moving back to the natural state, the original contract terms has been less difficult to where we've done it than it was moving back last April or May from P&Ls to cost-plus. So I think the resistance to move back to a normal state has gone, I guess, smoothly is the right word. But as anticipated, it hasn't had a whole lot of hiccups. And again, we said this back at the beginning of the pandemic, the conversations with clients are, again, if your relationships are right, are constant. And you start with a certain contract term and then it's constantly changing and evolving based on the environment that we're working in. So again, this is -- it's not a process that's particularly new to our DMs and RVPs and operators. They do a great job of it. And again, it's sort of forced the connection with the client that we needed to regroup on and make sure that we were, again, hospitality-oriented, client service-oriented. So in a way, it's -- the last year plus has been a good way to sort of reemphasize the importance of that approach.

Okay. Good. And as far as a return to pre-pandemic levels, where are you as far as what we should expect? And then also, any cost-outs that were permanent, so as we get back to pre-pandemic levels, maybe what does the margin profile look like as well?

Yes. I mean I'm still a little reluctant to predict with any kind of exactness when we'd get back to '19 levels from a revenue standpoint. B&I has still got some uncertainty to it, certainly, the pace of play. We don't see a -- at least under our mix of business, we don't see much, if any, permanent degradation to the revenue profile. We think there's some points and counterpoints to the work-from-home phenomena. And then our mix being a little more blue and gray collar, I think, ultimately helps. But -- so for us, I think it's a matter of when not if on B&I. But the wind is -- still got some clarity to play out here probably over the next 6 months or so. So predicting when we get back to the '19 levels of revenues is not quite there yet. But certainly progressing quite nicely towards that. Again, we think this back half of the year will take some major steps towards that. On our margin profile, again, like I said, we'd be very disappointed if we can't get back to '19 level margins, in the high 6s, before we get back to '19 level revenues. There's been good work done on the above-unit cost basis to -- or pockets of cost to take out some and look at hard at some peripheral costs that weren't needed, and those costs will stay out permanently. We've got to do some work to make sure that we don't get too far over ourselves over our tips as we do come back and we stay resolved to keeping those costs out of the business. So it's not a slam dunk. We've got work to do, but we've taken the costs out above unit, particularly around some of the corporate functions. And then we'll work very hard to keep those out permanently. But beyond that, I think there's opportunities to enhance the margin through a lot of work. That's been done on supply chain this past year, working to enhance some deals so that when the growth comes, it's going to be coming back with lower pricing and flow through to better margins. The compliance within the business has stepped up, I think, just because of need this past year. Buying the right products and the right suppliers is such a basic thing, you can go out and do great deals. But if we're not complying with them, we're not going to get the benefit. And this year has really stepped up that focus on compliance. So we got to keep that habit. That muscle has been developed. So we've got to keep that in place, too. So between a lot of supply chain work and some above-unit cost, particularly around corporate that we've worked on, those 2 things I think will be the key levers to get us back to that margin.

Okay, good. And maybe we could turn to the guidance change a little bit. On the free cash flow side, the range was adjusted. Can you maybe help us understand why it was adjusted? And what does it mean to be at the high end? What does it mean to be at the low end?

Sure. Yes. We broadened the upper end from neutral $200 million to neutral $250 million. That adjustment up was really based on feeling better about the fall and the Higher Ed environment. Prepaid for plans tend to drive, if you look at the seasonality of our cash flows, fourth quarter is very strong, and it's driven by the reopening of Higher Ed. And so I think we just felt as we were coming through the sort of half year and conversations that the Higher Ed space would be much more normal than maybe at the start of this fiscal year. So that drove the upper end. The lower end, we kept and really what that would mean was that we sort of amble through the summer. Part of it now is by the Boards, maybe a bit of that have some stop and starts, of course, the uncertainty of the reopening is what gets you. If we can continue to move at a pretty steady pace, that's good news. But if we're moving sort of stopping-starting, flare-ups, people are in, people are out. So we're staffing up, say, in your office, and then you got to shut back down for a few weeks or people aren't really coming in, but we were asked to staff up for it. Those kind of things create sort of the bottom end if the summer and into the fall was going to be a bit of a stop and start. And then just a -- maybe a big reopening in September, where we're having outlay, a lot of working capital upfront without the benefit of the profitability and the revenues. So that was sort of the play between the 2 back in -- a month ago when we were giving that guidance. But at this point, I think we would definitely have a bias towards the upper end a month later.

Okay. And maybe also, could we touch upon M&A and maybe capital allocation? You guys had a nice deal, the Next Level deal. Just tell us where we are in that? What you sort of -- what you learned so far? Like anything at Next Level surprised you? How does that speak to kind of your M&A strategy?

Yes. No, we're very happy to have Next Level be part of the team. Dave Carpenter comes back to us from a fairly long time with Aramark. And then a couple of the senior folks within the team are just steeped in the space and in the marketplace, helped develop Next Level from really the beginning. So we're excited to have the entire team and to be in the space. It's a $16 billion industry and there's a lot of room to move there. They have a great approach to it. It's a quality play in that space and it's really resonating with clients in terms of their growth rate so far. So we're excited. We're about 10 days in. So fortunately, no honeymoon period and no surprises yet and getting to know each other. We are going to -- they're going to run under their own brand. We'll start to assess the opportunities for us to help each other out in the coming months. So we're excited about it. We think they've got a great growth platform that, again, we're here to help them achieve that at a quicker pace than they might have on their own. But I think overall, for the M&A strategy, it does show you that John and I and the team want to be selective about it. We're not out there buying volume. That's not our approach. We want to buy something that either gets us into a new geography, a new line of business like Next Level or just brings a super high-quality management team and Next Level ticked a couple of those boxes. So it was a great one for us to pursue. We'll be selective about it, strategic about it. It's not core strategy to go out and start acquiring companies, but we'll continue to do that. We've also, underneath that, continue to do a few tuck-ins, particularly in Refreshments and Uniforms. Just building density in local markets, which is such a key component to that -- to those 2 sectors' profitability. So that's really -- that's been the approach, very, very targeted, very specific, very strategic.

Okay. And as far as additional deals, what are you looking for? What verticals? What geographies?

At this point, we're not really out seeking a lot. We'll continue, like I said, to do some of the tuck-ins in Uniforms and Refreshments. So looking constantly across the landscape for those, but again, typically, they're sort of single-market deals. Beyond that, probably just again a bit opportunistic what may come in front of us against those categories of new geography. There's potentially couple of places we might go that could fill a bit of white space, but don't feel compelled necessarily. So I don't know that you'll see anything big from us, certainly for the balance of the year, meaningful, but continue to seek out the tuck-ins.

Okay, good. [Operator Instructions] So let me give it one second to see any questions out here. Okay. Here's one. The question would be any views on your current portfolio? Any rationalization on the divestiture side?

Yes. Probably a Uniform question, I would imagine. So let me sort of tackle that specifically. As we've said repeatedly, we'd be fools to not think about and hear what folks have said about the Uniform business and does it fit? And is it the right thing to have it part of Aramark? We hear it and John and I certainly understand the viewpoint. And would certainly open to conversations about it and wouldn't turn away anything that -- any conversations that did happen. But that said, it's a great business. Back to the M&A strategy, if you've got a good management team, you've got a high-growth opportunity marketplace like Uniforms, you've got margin enhancement opportunities, it sort of ticks all the boxes of a business you want to be in. So we'll continue to move that business forward, create value, the implementation of the ABS route accountability system is an example of continuing to invest. As I mentioned before, 300, 350-plus new sales folks invested -- we've invested in the Uniform business. So I think we've taken the tack that putting a for-sale sign in front of a business isn't particularly motivational. So we don't want to do that at all. We want to continue to drive the business, drive the results, support the team. And if something comes up, certainly we'll take a look. But in the meantime, a lot of value to create.

Okay, good. And then another question just came in. Basically, why can't EBITDA margins after COVID be higher than 6.9%? Efficiencies from the pandemic that you might have had, I mean you would maybe think that this would be a structurally higher margin business now.

I think they can. I think that's a fair comment. It's a matter of getting back on top of the business and getting it back to a normal state. Like I said, the reopenings got some inherent inefficiencies to it, some stop and starts. So once we get beyond the reopening phase and we're back to talking about net growth and retention and true base business and managing that forward and a bit more of a steady state, I think there is absolutely opportunity to move beyond the historical margin rates, again, focused around longevity of the accounts, the longer we're in an account, we've talked about that, the more efficient you can get in that account. At the same time, we are providing better service. We've got supply chain efficiencies to drive. We've got to continue to leverage our above-unit overheads. So there's plenty of opportunity for margin expansion over time.

Okay. Good. And then I think we have about 1.5 minutes left. So just one other question. Just touch on buybacks and maybe dividends, et cetera, how do you think about excess cash?

Yes. Sure. Just in terms of priority, I mean, certainly, for capital allocation, use of free cash flow, capital, reinvest into the business and growth is going to be job 1. The tuck-ins on the M&A side will probably be behind that. If those opportunistically come up, we'll do that. Beyond that, we focused on delevering. That would certainly take precedent over buybacks at this point. And then we're very committed to the dividend, as you've seen over this past 4 quarters, keeping it in place at the same levels. So that would be where we sit, but we certainly are looking to delever before we would consider any buybacks.

Okay, good. So I think we're out of time. Tom, I know you have a busy schedule today. So thanks a lot for taking the time to do this. Really appreciate it. Thanks to Felise, thanks to Scott as well for turning this all up.

Great. Nice to see you. Thanks for having us.

You have a nice day. Okay.