Aramark (ARMK) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to day 2 of Goldman Sachs' Global Retailing Conference. I'm Stephen Grambling, and I cover the gaming, lodging and leisure space, but many of you may recall me as the supermarkets and broadlines analyst for about 10 years before transitioning to this space. To kick things off today, it's my pleasure to be hosting Aramark with CEO, John Zillmer; and CFO, Tom Ondrof. John, Tom, welcome.

Good morning. Thanks for having us.

Good morning.

Well, so for those new to the story, perhaps set the stage for us with what brought you each to Aramark and how you thought about the opportunity from a financial or fundamental standpoint, and then even help us just think about what changes you've made to date and what's still to go.

Sure. I'll start and then Tom can jump in. First of all, I had stayed connected to the industry pretty significantly over my time away from Aramark through both Board affiliations in Ecolab and Performance Food Group and through relationships with both clients and the management team at Aramark. Many of the people that are here today are people that I had recruited and hired and trained over the years, so I stayed very closely connected to the organization. And as the company struggled in terms of its performance and as people struggled with kind of the culture that existed, I had kind of an inside view of what was taking place. And so for me, it was a very easy decision to come back. I knew what the issues were that the company was facing. I knew what needed to be changed in terms of culture and what needed to be changed in terms of refocusing the organization. And so I had a very strong view about what the playbook should look like, how to rebuild the culture, how to rebuild the organization and how to transition it back to a culture of hospitality and a culture of growth. And so I saw the opportunity. I knew that the bones and the DNA of the organization were extraordinarily intact and were very good and just needed to be really reenergized and unleashed. And Tom, why don't you add your thoughts as well?

Yes. Just a lot of common themes there, Stephen. For John and I, I mean, we had reconnected through PFG when John was on the Board and I was CFO and had conversations about this industry and what was going on and the opportunities that were specifically at Aramark, shared a lot of the common views on the industry, the growth trajectory and opportunity. In particular, the market is just so overwhelmingly big and the opportunity to take advantage of that and grow, and Aramark had drifted from that balanced approach. And so we both saw an opportunity.

And so maybe following up, just where are we in that journey then in terms of what you've been able to implement and what's still to go as you look at the primary business segments?

We really began first by reintroducing leadership into the businesses that were highly experienced executives with domain expertise in their lines of business. And so we really started by rebuilding the management team and then reorganizing the company to take this focus on central decision-making back to the way the company had operated, which was to basically put it back into a line of business structure, to give those lines of business the resources they need to focus on their customers, and then to give them the freedom of action to go ahead and serve their customers the way they want it to be served. So essentially taking the shackles off, if you will, and eliminating this kind of overly centralized approach. And thankfully, we were well on our way to getting all of those changes implemented and adopted prior to COVID impacting the company. And we've been able to continue that process throughout. So the strong leadership organization, the changes we made there were really fundamental to getting the company restarted. And from a growth culture perspective, the investment in sales resources both in the Food business as well as the uniform business, we've continued to make throughout the last 2 years, and that has paid very significant dividends. And then culturally, it was really almost like flipping a light switch, to be honest. So all we really need to do is tell people, go do what you know how to do, go back to serving your customers, go back to selling. And people got very excited about it. Some of the technical changes we made or some of the tactical changes we made, things like changing commission structures, changing incentive compensation programs not only for the senior leadership but down through the organization, fundamentally all that's been complete. So we'll continue to rebuild, and we'll continue to innovate. We'll continue to refocus. But we are largely complete with the transition, if you will. And just really, the company is operating very effectively and efficiently. So we're excited about our positioning, and we're really ready for -- to really unleash the organization.

So you obviously have a lot of the building blocks in place effectively. So the pandemic is still obviously having an impact as well on different aspects of the business. If we think about what success looks like longer term, maybe you can help us frame how you would define success given there's a little bit of, I would say, opaque view of the industry right now. There's at least some restrictions in place. So there's a governor that's outside of your control. But when we get to normalize, whatever normalized looks like, what does success look like for these building blocks?

Yes. First of all, it's getting back to a mid-single-digit growth rate on a consistent basis. It's having our client retention rate above 96%, which is where it is right now. We've had great success in improving retention. So it's fundamentally getting back to that growth trajectory and growth paradigm and then maintaining it going forward. And that -- and with that comes margin expansion. We believe that as we continue to grow, that's the fuel for margin expansion. And we've got a relatively fixed cost structure from an SG&A perspective. So as we grow the business, it creates significant leverage. It creates supply chain profitability opportunities, so we continue to grow spend. So it really is the growth fuel, if you will, that moves the needle forward for the entire company from an earnings perspective. And so that mid-single-digit growth rate, very high retention rate leads to long-term earnings improvement and performance. And Tom, I think you may have some commentary as well.

Yes. No, just to put a wrap around that, the mid-single-digit growth, I think, gets us with some of the work we've been doing and reinvestments back to and beyond the 2019 margin. I really don't see any issue with that over the medium and long term. And then that profitability then leads to some deleveraging. We'll continue to be very specifically targeted in our M&A and capital allocation use, stay committed to the dividend and certainly get the leverage down into the 3s, back to historical norms as we drive that margin up and through 2019 levels fueled by that mid-single-digit growth.

That's all great. And I did mention that the pandemic has obviously been having an impact on your business. Maybe you can elaborate on how it's affecting your business in each one of the segments. And then what are maybe some of the long-term potential implications from the pandemic on your business?

Certainly. First of all, we're seeing extraordinary demand across a range of the businesses that we operate. And really, there's only a couple of businesses that are -- that have longer-term fundamental impacts. I think business dining is one that we've talked about that has, we believe, a longer tail to recovery as companies reengage their workforces and adopt either hybrid working strategies and that -- so fundamentally, the Facilities business, Higher Education, K-12, Sports & Entertainment have largely returned to pre-COVID levels in many respects. And so it's really the B&I business and, say, Refreshment Services, think office coffee and vending or mini marts, as kind of the 2 businesses that are most impacted for the balance of this year and moving forward probably into 2022. But we do believe that those businesses recover long term as well, that many companies are engaging and reevaluating their strategies with employee foodservice, many organizations transitioning to highly subsidized food programs as a way to induce workers back to the office. And companies are kind of reawakening to the idea that foodservice as a benefit is a very low-cost alternative compared to the other benefits that they provide, whether it be medical care or dental or whatever. I mean the cost on a per-hour basis for foodservice are de minimis. And so companies are recognizing that this is a way to really attract people back to the office, to give them a benefit that's exciting and very high value from the employee's perspective, something that everybody has an opportunity to use. And so they're adopting new changes in strategy. And we think, ultimately, that leads to increased participation through better product and better culinary offerings and expanded offerings. And frankly, safety and security is an issue as well. So when companies do have their employees return to work, I think there's going to be a much greater focus on making sure that on-site foodservice is what's utilized as opposed to having massive numbers of deliveries coming in from outside or having employees leave the building and then come back, particularly over the course of the next several months as people return to the office. So we think participation also has an opportunity to improve. So the international segment is highly variable. We've got businesses that are really ramping up rather rapidly like China and Chile and other countries. And then we've got a few that are still lagging a little bit. In Europe, obviously, the U.K. and Ireland, very back with a vengeance; Germany, a little bit slower to respond. So there's a little bit of variability based on the company -- the country's response to COVID and their reopening strategies in individual countries. But long term, we see the business really ramping nicely. New account sales, both domestically and internationally, impacting that growth trajectory. And so we're very excited about the prospects. We'll manage through the COVID impacts here over the short term, and we've been very adept over the last 18 months. And we can pivot to whatever we need to do from an operational perspective. In an organizational perspective, we can pivot and adjust to the circumstances at the time.

And maybe a follow-up there, just to clarify. How much -- when you say very strong demand, is that the core consumer spending in these segments more? Or is it also increased maybe sales opportunities, outsourcing trends? And if it is the consumer standpoint, maybe it's both. But is there any impact from stimulus payments or other exogenous factors that we should be thinking about that could have subsided or changed over time?

Yes. Well, I think there is higher consumer demand. We are seeing increased spending particularly in sports and entertainment venues, where touchless payment technologies have really kind of freed up the consumer to consume more. So check averages or per capita spending in Sports & Entertainment are definitely running higher than they were pre COVID. And think about it this way. You're no longer limited to the $20 you have in your pocket when you walk up to the concession stand. You've got your Apple Pay or your phone or whatever, and you're paying without having to have cash. And that is -- that cashless phenomenon that affects all businesses is definitely impacting us in Sports & Entertainment. But we also have that technology available in Higher Education, in B&I and other businesses as well. So we see that having a significant impact from a consumer perspective. But your point about increased outsourcing is absolutely right. We are seeing increased outsourcing both from a first -- on a first-time basis as well as a very high level of pipeline activity for new account sales. And so that is definitely occurring in the business, and we're -- we've been very successful here over the last year in terms of selling new accounts. About 50% of the business that we have sold this year has been first-time self-op conversion, which is running at a higher rate than normal. It normally would be about 1/3 of the business that we sell. And our pipeline is made up of some very significant self-op conversion prospects going forward. So we do see some tailwind. As companies reevaluate their strategies and really focus on their core business, they're making the determination. And I say companies, I really mean organizations because they can be in the K-12 sector, the Facilities sector, Higher Education. Significant components of self-op conversion still left available to us. So there is an accelerating trend there.

That's great. I may follow up on that. But you did mention this cashless technology, so maybe that's a good segue into some of the changes that were going on from a structural standpoint to the industry. Prepandemic, food delivery apps were often discussed with us by investors as potential disruptors. I guess what do you envision as the future of foodservice looking like as we evaluate digitally enabled delivery, ordering, meal planning and maybe even just broader changes in consumer preferences?

Yes, that is absolutely a trend. The -- existing in our technology suite today is that ability to go ahead and do delivery in every single location that we operate. So the consumer today at Goldman can go to their app on their phone and order from Aramark to be delivered to either their workstation or a central delivery point. And that technology is enabled in all of our operations and in all of our businesses. So it really does enhance the -- our ability to serve the consumer wherever they are. And we've got -- we have an advantage over the delivery services in that we're there and we can be there very, very quickly. And there's a -- it's a relatively low-cost alternative to the comparable fees that are charged by those other delivery companies, plus it offers that enhanced safety and security benefit. So instead of having to have deliveries come in from outside, they can have that delivery, that same service provided by their on-site provider. And so we don't see them as a disruptor to what we're able to offer. We see the technology as a means to go ahead and serve the consumer more effectively and give them a broader range of choice. Now -- and there's no question that some consumers will go outside because today they want to have pizza from this place, and they'll continue to do that. But that has not represented a threat to our total value proposition or to our total business. The technology really is an enhancement to our capability and our opportunity for revenue growth.

And maybe a follow-up on that. I mean when you think about the digital-enabled consumer in your business and providing that technology, what has been the response from the consumer so far? And what have you learned from rolling that out to your various customers?

Yes, it's -- well, the consumer response is strong. In particular, you have -- it's somewhat generational. Older customer is less likely to use it than the younger customer, who's adept and used to using the technology for a whole variety of things that they do. I know my own granddaughter, who just graduated from college, never has her iPhone out of her hand. She's constantly using it to do whatever she's doing. And so that youthful component is something that we continue to try to take advantage of, to really create for those consumers an experience that kind of ties them to us as an organization from a consumption perspective. So having an Aramark app at every college and university that not only transitions them while they're there, but then when they move on to their first job, having that Aramark app that they can then use at their employer establishment is really kind of a unique proposition. And so there's been very good adoption. But as I said, it's somewhat generational. And you don't see it as much in a Ford automotive plant as you would at, say, Salesforce.com. And definitely, consumers -- the consumer and -- both the age of the consumer and the type of consumer tend to have an impact on the adoption, if you will.

That's super interesting. And so going back to the sales initiatives, and you referenced this pipeline that's building, how does Aramark typically differentiate itself from peers, why you typically see existing contracts get lost or new contracts potentially not get won? And how do you feel like you're addressing those customer concerns or potential customer concerns?

Yes. As -- this has always been a relationship sales business. And where we had fallen down over the course of the last few years had been in our ability to really foster, develop and maintain those strong relationships with our prospects because we had reorganized the sales force, we had centralized it, we took responsibility from the field operations, put them in the center. And so we lost that connectivity, if you will, to the client and the customer on a continuing relationship basis. So the reorganization that we've gone through has put us back into a position of really focusing on that relationship management process and the focus on customization that's required for each individual client. So we are not being prescriptive anymore about the way we sell business. We are letting the sales team and the operating team design proposals that are best suited to serve that particular client and customer, giving them the flexibility and the freedom to build the relationship and then to craft a proposal that's really high value for that particular client. And that's how we win. We don't win on the basis of price. We don't win or lose on the basis of price. We win or lose on the basis of relationship and customization. So how well do we understand the pain points that, that particular client is facing in their operation and then what have we done to solve for those pain points. And when we lose an account, it's generally because we're not performing. And that is fundamental. It's us. It's Compass. It's Sodexo. When we lose business, it's not about the economics, it's about performance. And so that speaks to the issue of quality of leadership, quality of management and focus on the client and the customer. And when we have those things in place, we win. There's no question about it. So that's what's driven our improvement in sales results, that change in focus, that change in energy. And so we're excited about that. I think there's continuing work to do. We have great process in place. We've made a number of technical changes to our incentive comp programs. We provided additional sales development through training to the entire team, including the operating team as well. So we've done all the blocking and tackling. Now it's really all that just getting out there and executing against it. Tom, this is an area you obviously have a lot of interest in as well, so I'll let you finish here.

Yes. I think the only couple of things I'd add is stability and empowerment are probably 2 key words in this area. Stability in the workforce is crucial to develop those relationships. And I think from a peak in -- around 2016, the sales force had slowly been eroded and reduced, and you just can't have that. So reestablishing those territories, getting stability back into them has been crucial. And that doesn't happen overnight, as John just said. So we didn't want to waver over the last 1.5 years from that investment and creating that stability so that we can benefit from that going forward. And then the empowerment really is the key word for retention. We want to be a yes program for our clients, not a no program. And I think that, that had fallen away in the past few years. Our clients will get very tired quickly if you're continually saying no when they ask for something. And so we have to find a way to empower our folks without sacrificing margin, if we, will you, Mr. Client, so that we can work that partnership. And I think the last silver lining in the last 1.5 years has really been to strengthen a lot of those relationships, and I think it's come through in the retention rate for the industry overall. But I think we'll benefit from that going forward because clients are remembering, we see it now, what we've done and what we've worked together on over the past 1.5 years.

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And as a follow-up -- go ahead. And as you say -- as a follow-up there, so you mentioned peak sales force in 2016. I guess how far did it fall? And are you back to where you were? Do you feel like there's room to run?

Yes, it's down about -- at the bottom, about -- call it about a year ago, it was down about 35% from its peak, almost 40% in terms of heads. And we're not quite back there yet. I mean we're being very diligent on the rehires, made a lot of progress on it. But we've changed out 6 of the 8 sales leaders in the U.S. lines of business. Really a strong group now to complement the strong operational leadership that John has put in place in the lines of business. And they're working very hard to get themselves fully staffed, but we're not quite there yet.

And maybe that's a good area to jump off to just labor in general. I mean you did reference that execution is key for these contracts. And there's obviously been a lot of discussion about labor shortages in the broader hospitality retail market. It seems like historically, Aramark has been able to weather inflationary pressures and labor pressure as well. Can you just remind us how you've been able to, one, mitigate labor inflation across the entire enterprise? And then two, how are you managing through these labor shortages that we keep hearing more about?

Yes, that's a great question. And yes, we're subjected to that same environment as you're hearing about from other hospitality companies and retail companies. And literally, everybody is working through staffing shortages. But for us, it's very -- it's almost micro geographic. And if you take a look at our account base in an individual city and talk about the various locations, you'll see some that have 100% staffing, you'll see some that are significantly challenged. And in many respects, it has to do with local workforce dynamics. Is it an urban or a suburban environment? Is it a rural environment? So there's lots of impacts or lots of different items that affect that availability. We do see we have a terrific talent acquisition team, and that's been in place for a number of years. We've got a great functional organization that's focused on this both from a frontline staffing level as well as management staffing. So we've got a very strong process in place that's led by our human resource organization. And we've implemented a number of changes to continue being an -- to continue to accelerate our employer-of-choice kind of dynamic, if you will, things like the employee stock purchase plan, which are really impacting our ability to attract and retain and recruit employees, seeing that as an opportunity to build wealth creation for frontline staff is just fantastic, and there's been great uptake of that program; the implementation of our new Careers website that really makes it much easier to both apply for a job as well as to navigate your way through the organization after you've joined the company. So we've adopted a number of approaches to really make it easier to join the organization and to be an employee and to work for a great company. And so -- but we are impacted. Our people are working aggressively to staff, particularly as you think about the acceleration and opening of all these new accounts and the reopening of all the Higher Education business that occurs in August/September, and our are people working to go ahead and get that done. But we have always been able to work through it. We have the contractual capability to pass along inflationary cost pressures if necessary. But it's always our lever of last choice. It's a lever of last resort. And we want to make sure that we're optimized from an operational perspective and that we're doing the things from a staffing perspective to really optimize our labor positioning and not just passing along cost increases to the consumer where higher prices ultimately lead to inflation for them. So we're working very carefully to optimize first and then pass along costs second. And we do that both from a food perspective as well as labor perspective.

And so on a similar -- in a similar vein, Tom, I think at the beginning of the conversation, you talked about being confident in margins getting back to and/or exceeding 2019 levels. I guess what are the big puts and takes influencing where margins will go in each segment? And what are some of the biggest areas of cost-outs that were potentially identified during the pandemic?

Well, the biggest take is top line. As John mentioned, leveraging the above unit cost is a very powerful tool on the margin, and we saw that, obviously, on the way down a year ago. And so top line is a key driver as that drives itself back both through the return of the base, which we're very confident in, short of the timing of B&I, as well as the layering on of the new business that is starting to show the green shoots here this year. And again, with the reinvested in base, we feel good about going into fiscal '22, '23 and beyond. So that's the key driver. The next port of call really is stability. We need certainty and stability to be able to staff properly, and that really gets down into the unit level. Right now, we're feeling a bit of pressure because of that uncertainty. It's sort of a start, stop, start environment we find ourselves in with units. B&I in particular, as we all know, really has been struggling to understand the reopening of the business. And so they're staffing up and then finding out we're pushing out 4 weeks. And so at that point, do you do then sort of re-furlough those folks or do you just keep them on because it's just going to be another 4 weeks? So that's put some near-term pressure on us. But that stability, that will even out. And that's another key component. Beyond that, we've just done, as we talked about a year ago, in essence, a zero-based budgeting look. We've taken some costs out of the business that we thought were peripheral or a bit of a luxury. Those won't come back. Certainly, we've added on the other side in terms of bringing back the sales staff in particular and reinvesting there. We have had to reinvest in cybersecurity, particularly here this year with a lot of what's been going on. And that was under-resourced, as most companies were a couple of years ago, through nobody's fault. And so those are a few of the puts and takes that we've had. Certainly, supply chain is something that is poised to improve considerably with John Orobono's return, refocusing on some of the supplier relationships. It's a crazy sort of time right now for supply chain with some of the fill rates and the pressures that the distributors have at the moment. But that, too, will level out. And some of the work that's been done on new deals with the growing and returning revenue volumes and purchasing volumes will help us as well. So yes, we feel, again, very good about getting back to the '19 levels. And certainly, that's not a goal. We feel confident over the next few years that we can exceed that as well.

So you mentioned the supply chain, so maybe a follow-up on that. I guess what's been the biggest lever that you've been able to pull or that you plan on pulling to mitigate some of these pressures? Is it just trying to increase lead times, shifting production, moving to air freight? I guess how are you thinking about that? Maybe it varies by segment.

Yes, it really does vary by segment. Our focus early in the last -- well, over the course of the last 1.5 years, our focus has really been on redeveloping and renegotiating those relationships we have with our key distributors. As you know, we renegotiated our deal with Cisco, both domestically and internationally, which creates enhanced economics for us. And at the same time, we had our spend start to drop due to COVID. So we have put in place these new relationships. And then as the growth comes back and as spending begins to accelerate, they'll be more productive from a profitability perspective for us. And so we're excited about those prospects. From a disruption perspective, the distribution companies are suffering from a shortage of drivers. They've got stock-outs. They're doing product substitutions. We're having to give our employees and our managers much greater flexibility in terms of where they source product in the short term while they work through these supply chain disruptions. But the great thing is we have total menu design flexibility. So we can manage around commodity issues, shortage issues, product issues by literally adjusting our menu on a day-to-day basis. So if I -- as an extreme example, if I can't get beef today, I can serve fish tomorrow. So it's -- there is total menu flexibility. We're not locked in like a chain restaurant that has a fixed menu and has to have this particular product today in order to open the doors. And so our supply chain people have worked very aggressively, along with our field operations people, to minimize the disruption. And even in extreme circumstances where you have strikes like we did last week in Chicago with Cisco, where their drivers weren't delivering to our locations, we are able to manage through that crisis with the cooperation of Cisco and the other companies that serve us. So it's temporary, it's transitory, and our people are very good at managing through these kinds of short-term disruptions.

Now most of the conversation has been, I think, focused to a degree on the catering side, the food services and support side of the business. As we look at the uniform business broadly, how do you think about the potential growth, both sales and EBITDA, there versus catering?

Yes. Well, as a matter of fact, the uniform has had a very good new account sales year and a very good retention year. Their retention is running 300 basis points better than prior year. Their customer satisfaction scores are running 10% higher than historical pre-COVID levels. So there's -- the new sales organization and the additional resources that we've invested in, in that business have really been very productive. And so we're very excited about the long-term prospects for the growth trajectory and to close the growth gap with our competitors in that segment. And as you know, we're in the throes of the implementation of ABS, a route accounting system, which has impacts on both cost management and our ability to serve our customers but also has significant impacts on our growth prospects as well. We're -- we expect to be largely complete by the end of this calendar year, with some leaking into, say, January, February, March of next year. But to have that process largely behind us on a very accelerated time frame, I think, is a real testimony to what that leadership team has been able to get done. And we do have a very significant focus on the business. We think there's opportunity both to improve margins in the business and to improve the growth of the enterprise. And that's -- those are the core strategies, optimize and grow. And that will translate into significantly improved economics for us and our shareholders.

And are there opportunities for synergies between food services and catering? Or do you feel like there's already been benefits from having everything under the Aramark umbrella? Or is that something that's an untapped opportunity?

Yes. No, there have been synergies over the years. The cross-selling opportunity exists. Many -- most of our business services clients, our uniform services clients, the -- we do have an opportunity to continue the cross-selling, particularly as we add additional ancillary services on the uniform side like restroom sanitation, like first aid and other elements that we can bring to bear against that client base. So there are synergies. I think we've been actually working against that for a very long time as the company has been together for -- it feels like, forever. And so I think that a lot of that synergy potential has already been developed and tapped. But we do see continued value enhancement opportunities by being together. And we'll continue to pursue and adopt those strategies moving forward.

And with the last couple of minutes here, you are targeting, I think, $150 million to $250 million in free cash flow this year. How should investors think about free cash flow conversion and a normalized benefit? And with some of the supply chain changes that you've talked about or otherwise, are there benefits to working capital, CapEx or even contract investments to think about long term as we try to contemplate a free cash flow margin?

Yes, I think there are. I think, again, as we dig into the supply chain, sort of reorganize it, rebuild the relationships, a lot of the payment terms deal with relationships as opposed to just straight negotiation. So I think there are some opportunities for working capital improvement. The business has always done pretty well. It's generally, give or take, a fairly neutral working capital model. So we continue to work to tweak those not just in the supply chain area but other uses as well. CapEx, I've gotten a question a bit about as you accelerate the growth model, does CapEx requirement start to increase. We don't really see it. As John said, we're not winning -- if we really build the right model and have the right relationships so we're not RFP responders, we're not winning on price and CapEx, we're winning on all the other things that matter to clients, and so that shouldn't and we don't expect it to drive up the CapEx usage to any great extent. It depends a little bit on where the new business comes. As you know, the Higher Ed and sports worlds are a little more capital intensive than the others. So from a free cash flow standpoint, we feel very good about that -- delivering the number this year. And we continue to feel as though as the margin and profitability increases, the working capital dynamic won't change, the CapEx won't change, and the free cash flow should drift up with the profitability.

That's great. And we are right at the time here. We covered a lot of ground. There's a few more things we probably could have asked, but I want to be cognizant of everybody's time. So thank you, everybody, for joining us today. Thank you, John and Tom, for all the insights, as always.

Thank you very much, Stephen.

Thank you, Stephen.

Thanks, everyone.

Take care.

Be well.