Aramark (ARMK) Earnings Call Transcript & Summary

Hey. Good afternoon. This is Heather Balsky, BofA's business and information services analyst. This is our last fireside chat of the day. So I want to welcome the team from Aramark, CEO, John Zillmer and CFO, Tom Ondrof, to help close this off. It's great to have you both here today.

Thank you. Happy to be here.

I know you guys had some slides to kind of run through before we kick off the fireside chat. So I want -- I'll leave it to you for few minutes.

Sure. I'll start off, I think. First of all, I really want to just focus on a couple of areas. We've been going through a cultural transformation in the organization to drive profitable growth over the last couple of years and we very strongly about the performance in terms of new growth opportunities. The net new business performance over the last 2 years has been truly extraordinary. And we feel very good about the progress we've made there. We continue to have very strong ongoing momentum on both the top and bottom line. And the revenue growth has been driven by net new business and base business recovery. And we also have significant year-over-year profitability improvements, with continued progression expected. We're working to improve the leverage ratio at an accelerated rate. That's one of the concerns that gets raised by investors over time, the fact that Aramark has historically been more highly levered than some of our competitors. While we're very comfortable with the leverage that we have in the business and our ability to generate free cash flow, we recognize that's an area that is something that will drive our financial metrics. And so we are continuing to take strategic actions to go ahead and reduce that leverage level, including the transaction that we announced just a few weeks ago with the divestiture of our AIM Services joint venture in Japan with proceeds of approximately $500 million. So we continue to make -- we also continue to make progress on the separation of our Aramark uniform services business. Our intention is to do a tax-free spin sometime later this year. We're making very good progress on that, and we feel very good about the trajectory of both the business and the process to get it done. And we're also very confident in our ability to drive historic margins and over time that -- as we have our contracts mature, as the new business matures, those contracts continue to improve profitability. Supply chain provides scale and stability. And so we're very confident in our ability to deliver those margins over historic levels over a period of time.

I think I'll just pick up here in the next couple of slides. So John, along the margin lines is just reminding folks that as the business has sort of reinflated to especially on the top line to pre-COVID levels towards the end of last year, the seasonality of those natural in the business has reemerged. And so we do have peaks in Q4 and Q1 -- sorry, Q1 and Q4 in the year. It's sort of a U-shaped cadence to our margin. And you can see it's starting to really mirror the fiscal '19 numbers, and we expect that to continue with quarters 2 and 3 being the margin troughs. And that's primarily driven because of the seasonal shutdown of our education business that really creates that and a bit of contribution in the seasonality from the parks and destinations business. This also on the next slide shows up in the free cash flow. So we do have typically a big outflow in Q1. As you could see in sort of fiscal '18 and '19 on this slide, mirroring in '22 and '23 as the businesses volumes have returned to normal with a big inflow in Q4, as you saw in last year and then those 2 years prior to COVID. So just a moment to remind people, as we move back into and above pre-COVID revenue levels that, that seasonality does return.

Okay. Great. So we'll go to fireside chat, and I appreciate it. So you're now about 3 years into Aramark's turnaround -- the turnaround strategy. What do you think are your biggest accomplishments to date?

I think we'll both take a shot at that. First of all, I think recreating the hospitality and growth culture that need to be achieved is maybe our biggest win. And you see that show up in the results of the net new business going from essentially 0 growth over the previous 5 years to essentially growing $500 million in 2022 -- I'm sorry, in 2021, $800 million in 2022 and continuing that trajectory this year. We're very pleased with that. From our perspective, the real missing link in terms of the performance of the company in the past -- over the past has been that growth culture and the hospitality culture that had waned under previous leadership. So we're excited to have that return. It really is fundamental to the growth of the profits of the company, and we continue to be very excited about the growth prospects for the organization.

Yes. And the only thing I'd add is that by necessity, I think, through the pandemic and now with inflation, we battled a couple of multi-decade first-timers since we returned. And that's probably brought a little bit more focus to the business. It's proven out the variable nature of the cost base and our ability to flex to meet client needs, whether it was just pre or post pandemic or through inflation to be able to manage through that. We've progressed the margin. Our teams have been very, very focused by necessity in helping to drive the profitable side of that growth equation. And so I think we're set up to really be in a good place over the next few years, as fingers crossed, things normalize on the inflation side and a lot of the hard work that's being done on the top line starts to flow through the rest of the P&L.

You guys both talk about the setup to the next few years kind of when you -- what do you think your most significant opportunities are from here?

Personally, I think -- organizationally, we've done all the culture work. We've done all the systems work. We have a very strong team in place. I think we'll continue to focus on the growth of the organization to get the spin process complete. And when we get that done, I think we'll be a highly focused food service specialist that is really engaged in a winning business model. We have a lot of opportunity in terms of leverage on both the overhead side and as the growth continues to improve, supply chain profitability continues to improve. There's just a really good pathway to sustained earnings growth and shareholder value creation.

And I'd add, Heather, on that, that I think our biggest challenge, if I could turn the question just a bit is to stay resolved to that. I mean we've put a lot of work in over the last 3 years that with everything that's been going on, the benefit is we're poised, you see it a bit on the net growth coming through. But I think down the line, as John just said, we've just got to stay resolved to the model.

Helpful. The shift to outsourcing and self-op conversions has really been a nice tailwind for your business recently. And how much of that do you think was the tight labor market and inflation? Do you think that momentum has legs? Or will it wane as the environment normalizes?

I think it has lagged. I mean we definitely have had -- the industry has had a tailwind on first-time outsourcing over the last couple of years and long may have lived, as we've said many times. But even if it doesn't, we talked about back in December '21 with our Analyst Day, a 4% to 5% net growth target. And we think that's still very achievable in the medium term. Even at the first time outsourcing does tail off a bit. The market is so large. We've talked about that many times. We've got a structural difference in our sales force. We're building stability. And we're building productivity. We're not to the productivity the close rates that we want to be at. And so even if the first time outsourcing wanes a bit, and it returns more to that 1/3, 1/3, 1/3 is our source of new business, 1/3 from the big players, 1/3 from regional operators and 1/3 from first-time outsourcing versus an inflated number at the moment from first-time outsourcing. Productivity gains should offset that. We still feel very comfortable with that 4% to 5% run rate for the foreseeable future.

I want to ask a follow-up on something you mentioned the close rate and sort of you're not where you think you can get. What gets you there?

Discipline in the process. It's one of those we've said before, we'd rather win 3 out of 5 bids and 2 out of 10 because we understand what the client wants and we can move on for those 5 accounts where we really just don't have a chance, which is for a variety of reasons and really focus on the ones where we do and win more of those. So I think it's just the discipline and the confidence to be able to say that was not for us, and we'll move on to the next.

And I would add that, frankly, having the sales organization in place and focused in their respective businesses, in their respective geographies makes all the difference in the world because this really is a relationship sale. And so the constant dislocation of salespeople in the past kind of led us to the poor performance. The fact that we can maintain this discipline and have people in territory and in grade and focused on developing those customer relationships so that when they do respond to a process or do engage in a process, they're doing it from a basis of understanding and really creating a customized approach and solution for that client. That's what really leads ultimately to our success. And so it's not an out-of-the-box solution. It's not a price-driven solution. It's really designed to meet their individual needs and pain points. And that's what really drives hit rate. That's what makes us more successful.

That's helpful. You also expect -- talking about new customer growth, some part of your story is also there's opportunity for share gains from customers that are already being served. So you're going to be -- that means taking the competitors. How is Aramark more competitive today than it was before where you have joined?

I think, again, we'll both take a shot at that. I think -- first of all, I think we have reengaged a leadership team that's really focused on this industry that really understand the business. It really understand the customer set. And -- so they have a deep understanding and they're fully engaged and focused on their respective line of business. And that is, I think, a competitive advantage over companies that maybe take a different approach from an organizational perspective. We also have just the scale and technology and systems infrastructure in place to deliver very high-quality solutions across a range of the businesses and the portfolio that we operate. I think we've got -- frankly, I would characterize it as the best team in the business. And of course, I'm a bit biased, but I think it's -- that's -- that team, the people are our competitive advantage. And that may sound silly and trite, but it's really what we're focused on, building the best organization we can and being just a great at execution, great at discipline and highly focused.

That's helpful. I want to shift to international. Can you talk about the changes you've implemented there since you've joined? What's going on in international?

Sure. We have I think a terrific international team. It's led by Carl Mittleman, who's our Chief Operating Officer for international. He has a lifetime of experience in the industry. He grew up inside of Aramark, joined us out of Cornell, really understands the various business segments. And we compete in different segments internationally than we do somewhat domestically. Each of the countries has a somewhat different business portfolio. But Carl's broad experience, he's able to bring to bear against that entire set. And -- so I think the fundamental change that we've made over the course of the last couple of years is making sure we have disciplined leadership in each of the individual countries. We focus on operating them with local teams. We don't run Germany from the U.S. Germany runs itself, and it's really focused on the German market. And yet we provide the tools and support that they need to go ahead and continuously improve their operations and make a real difference in the world. So I think we've got a lot of runway internationally. We're in all the geographies that we really want to be in. We don't need to plant flags in other countries in order to grow, and we've got a lot of runway and room for that team to be successful.

Okay. The segment has been posting very strong growth. What have been the biggest drivers of late?

For international?

For international, yes.

Stability, I think, is the key there. For whatever reason, the U.S. sales team was really pulled apart for 4 or 5 years prior to John arriving, I think, to drive out costs and it created instability on the sales force that really had to be reestablished. And again, we're seeing the early benefits of that in the last 2 years. For international, was not really. They were left to their own, and they had a stability -- everything John talked about what we're driving for in the U.S., that was sort of left intact. So if you look at the results and the net growth difference between the U.S. and international, I mean you can see them very much diverge around 2016, '17. International stayed very steady. U.S. fell off and the international business has been able to reap the benefits of that as we've sort of got further and further away from COVID, they've had that have machines sort of going, and that's helped them as they've gone through their recovery.

That's a positive sign for the U.S. as you continue to gain traction. So you said new geographies. But I guess, what are your goals in terms of expanding that market? And what are you most excited about?

Our growth -- our goals are to continue to accelerate growth in those geographies where we operate. We do have -- we have made some tuck-in acquisitions, particularly in the U.K. to build capability and geographic concentration. That business has a very strong leader and a very big presence. Of course, that was where we won our largest contract with Merlin, and that's been a terrific implementation, very strong leadership team in Helen Milligan-Smith and the rest of the team in the U.K. And -- so we're going to continue to focus that team on growing the business to extending the boundaries, to looking at other markets. And when I say markets, I mean other lines of business in their respective geographies, looking at health care in Germany, which is a part of the business we haven't typically played and where we've been more B&I focused in sports and entertainment focused. So there's plenty of runway and plenty of opportunity. So we're just focused on continuing to keep the international team focused on growth, and continuing to build the capability of that organization.

COVID disruption, you talked about earlier, took a big toll on Aramark's business, but you exited 2021 or your fiscal 2021 with about 95% of that business recovered. That was what you said for the fourth quarter, so not full year. I know you stopped providing an update on recovered sales. But can you speak to how the recovery has progressed so far this year? Is it consistent with your expectations? Have there any been any setbacks or surprises?

Yes. We exited fiscal '22 at 95%, but...

Yes, sorry.

We've all lost a sense of time. But -- yes, we expected the remnants of the recovery to continue throughout this year and certainly level off. And that's what we're seeing. I mean a big recovery in first quarter, not so much in the -- by Q4 of this year. I think there's still opportunity for a bit more. We got a combination of confluence of events really between recession possibility and return to work, and they are cutting across each other a little bit. So as return to work sort of continues to build throughout this year, it could be offset a little bit by some of the particularly white collar layoffs that we've sort of heard of. But there's been a funny phenomenon also within the work from home and return to office is that you hear a lot of companies talking about going back, but they haven't really. So we're not sure that the full recovery story is over. So we do have people who have headlines say, let's go back and maybe it's gone up to 2 days. But that could continue, and you could see more mandates as opposed to strong suggestions or mandates that are being ignored by some companies. And you see it very much different in different sectors, financial, hospitality, you name it. So we are seeing a leveling versus the full-on '21, '22 recovery. But just because we seem to be plateauing out at 95%, I think there's still potentially some more room as we finish out this year and maybe even a bit into '24.

I think some people are trying to back into how your recovery looked in the fiscal first quarter. Is it fair to say though that it kind of was within your expectations and that the recovery is still kind of holding up?

It is, yes.

Okay. That's helpful. And you talked about this in B&I. It seems like in terms of the sort of uncertainty in the environment and that sort of thing, is that something you're kind of looking out for in terms of if there's an impact from the downturn? Or have you started to see -- especially your first quarter, do you see any of that pressure yet?

You know we haven't. It's been more headline than I think reality at this point. And just to remind everybody, we -- a little less than 20% of our global revenues are from B&I. And of that, 20% is truly white collar, which seems to be where a lot of the noise is around recession, tech, financial. So putting the math together, that's sort of less than 4% of our overall revenues. So even with some level of impact, we're not particularly concerned about it. And the rest of our portfolio, we're well-diversified. And between health care, education, parks, sports stand up very well in recession. We've seen that in the past, even though that's discretionary spend. So really, in other cycles, recessionary cycles, B&I has been the only business affected.

Yes. I was -- later on, I was going to ask you about sort of where the most there's the most cyclicality in your business, and we're the most durability. Maybe it'd be nice, can we -- as you go through your segments, kind of where are the most resilient? I think some of it might be surprising?

Yes, it is. It's been John add in here, but I've been through 2 recessions in my career of contract foodservice, and it's just been incredibly resilient. Health care and education, people tend to go back to school when jobs are lost. They tend to get sick when jobs are lost. So those 2 businesses held up really well. Like I said, parks and destinations, sports, very resilient in the past. So yes, across the board, really, other than B&I, we've seen in the past, very little impact from recession.

Yes. And I would just add that when you think about discretionary spending, sports and entertainment, in particular, baseball games, football games, national parks represent an opportunity for people to continue to enjoy their circumstances in their lives. And the national parks are a great business. We love it. And even in times of recession or economic concern, the national park attendance rates are always very high, and may be a driving vacation as opposed to a flying vacation. And so we tend to be the beneficiary of that. And then we have a couple of businesses, obviously, that are very consistent, the corrections business, the facilities business, you have to keep buildings clean. You have to continue to operate them. So those businesses are also very recession-resilient. And so overall, I think if you go back to 2008, 2009 to the last great recession, if you will, I think our sales were only off 3% during that time period. So it is -- as a portfolio, the business is highly resilient to recession.

That's helpful. Talk about another macro topic, which is food inflation. It's persisted this year. We just got another CPI number. I think food-away-from-home was up 8.4% or so year-over-year. What are you seeing? And what are some of the tools that are still available to manage through this higher customer...

We are seeing that persistence on the food inflation side. And luckily, because we are such a large purchaser of food products and such a big customer of most of our manufacturer partners, we do have preferred pricing and we are managing those relationships aggressively. And we continue to grow the organization, and we get rewarded for that growth through enhanced purchasing deals and enhanced volume discounts, if you will. So that is a lever we continue to work very aggressively just the supply chain management process. And we are seeing some progress with respect to commodities like coffee and other soybean oil, things that we had to stay away from over the course of the last 12 months. So we're seeing some glimmer of hope, if you will, on the inflationary side. But in the meantime, our managers have a series of tools that they use to manage the inflation in a particular unit. And that's both the menu design, it's service hour changes, concept implementations. There is a number of different tools that they bring to bear to manage the costs in the middle of the P&L, whether it's both food or labor. And they've got the tools that they need to go ahead and get the job done.

I think, Heather, as we look forward, it's one of the things that excites us about the opportunities over the next few years because we have -- the supply chain has been disrupted massively. Our team has really been fighting the good fight to manage those costs and work with suppliers, as John said, aggressively, to help mitigate our cost and continue to help the business move forward and recover through COVID. But combined with buying Avendra about 18 months before the pandemic and the new growth volumes that we're starting to see, as we merge out over the next few years, that platform of vendor, which really we didn't have time to take advantage of, plus the new growth opportunity is going to put us in a really good position going forward with suppliers to leverage that and really drive down costs. So with some easing of inflation, the continued normalization of the supply chain combined with our growth and a new platform, it's exciting about what we can do with it.

Interesting. And how the customer has been in terms of your client side? How are customers responding to price increases? Are you seeing any pushback on that end?

Well, these -- we look at these customer relationships as annuities. We keep these customers for 15, 18, 20 years. And so we have very strong relationships, and we're always working very aggressively to make sure that we're delivering value to that customer and that client, so that when we're in a position of having to negotiate price or service changes or other, we're doing it from a position of relationship and strength. And so we're working always very diligently to both optimize the profitability equation for us, but also the service equation for them. And so I wouldn't say we're getting a lot of pushback from clients or customers. But we're being very careful not to push so far that for whatever reason it might jeopardize that relationship because the relationship is worth much more to me over the long term than this particular quarter. So we're always very cognizant of that. But we're working to deliver value not just the profitability in this particular quarter.

That's helpful. Yes. And I wanted to ask lastly on end consumers, so folks like me who are eating in cafeterias. Are you seeing any changes in behavior such as diners trading down or cutting back?

I'll jump in for a second. One of the things we're seeing in B&I that's been very interesting is bit of human nature is kicking in. When people were in the office, pre-pandemic 5 days, we were capturing roughly half the time they were eating in the cafeteria. So 50% participation. That is -- we theorize that, that would move up post pandemic just at the start because there was -- things weren't as available out on the high street, main street. But then also once you came into the building, you were sort of happy to stay in the building. So participation kicked up, also some free lunch or subsidized lunches being offered. But as things have sort of opened up a little bit more and there are options. If you're coming in 3 days a week, you're there to work with your colleagues, see your colleagues, have lunch with your colleagues, so you're staying in the building. So we're sort of capturing you 3 out of 3 days now rather than 2.5 out of 5. So even though people aren't there 5 days a week, we're getting the same participation or even maybe a bit more in some cases.

Interesting. I'm going the cafeteria more personally. So that makes sense. But I don't want to read into that. You guys are -- with 10 minutes left, I kind of want to jump to something which is the uniform. And why do you think that business should be What drove that decision?

Obviously, the company has wrestled and the Board has wrestled with that decision over a very long period of time. There really are no synergies between the 2 businesses. We have a commercial relationship between the food business and the uniform rental business, but it is a truly arm's length commercial relationship. So it's not like we're getting discounts from AUS for our foodservice operations. They're paying a market-based price. And we have an obligation to do that because we exist in our clients' facilities. So we need to be paying a fair price [Audio Gap] synergistic benefits to having the 2 businesses combined. And frankly, it's been operated independently from a management perspective forever. It's never really been operated on an integrated basis. And so we felt that on a stand-alone basis that the shareholders would benefit from a focused valuation that really looks at the business in its competitive environment. It has significant opportunity for both growth and for margin accretion going forward. And that a focused leadership team, a separate entity would be more capable of delivering that than manage as part of the conglomerate. So I mean you can do all the theoretical math around what kind of conglomerate discount exists by combining the 2 organizations. And you can make all the multiple assumptions about, well, if it's trading as an independent and it's in the uniform services industry, what multiple will be attached. We did all those strategic evaluations and came to the conclusion that, ultimately, that was the best decision for our shareholders. We looked at the range of strategic alternatives, and an outright sale certainly doesn't make sense because of the tax basis of the company and the way it was put together over time. And so a tax-free spin made the most sense in terms of delivering economic value to the shareholders and ultimately, to create focus and real discipline in the business. And so we've hired a team of great people that have both the operating discipline and the financial discipline to run that business going forward as an independent concern. We have assembled a terrific Board that we'll be making an announcement about relatively soon. We're well on our way in terms of the process of managing the spin. Expect to get that complete through by the end of the year. And so we're very pleased with the progress we've made, and we think it's just ultimately the right strategy.

And I know as you get closer to the uniform spin, we'll have opportunity to hear from that team. But I'm curious if there's anything in particular outside of the spin that the uniforms team is most excited about. And just kind of where they are in terms of using -- like using and sell-side research where they are in terms of innings on that on the turnaround opportunity of that business?

Yes. Well, I think they're very excited about the value delivery that can be achieved. One of the things that Kim has brought to the organization is a deeper understanding of the route-based businesses and the true operational metrics required to run it effectively. And I think -- she's very excited about the forward-looking business case and the strategy, particularly when you apply certain marketing elements to it that -- it's not something we've historically done, but something that she brought to the equation based on her past experience. And so I think the team is very excited about the future prospects and about that value delivery that they believe they can achieve.

Yes. I think they have a number of opportunities to continue to enhance their margin going forward. ABS was rolled out and completed last fall and the opportunity for it to be fully used and productive is exciting. They've done that a little bit through pricing initiatives recently that they were going to be able to do is going to be very manual for them over the past couple of quarters without the ABS tool. So we're excited about that. And continuing the progression on sales. I think Kim would be the first to admit that the growth -- top line growth in the uniform business to date isn't what she wants. And that even though we've added a number of folks, 300-plus folks over the last couple of years, the productivity gains still need to be there. And proportionately to the competition, there's still some incremental investment to be made. So a lot to go after. And top line is so important in that business given its fixed cost base. So yes, excited, as John said, really high-quality team that's been assembled.

And when you did your slides, you guys talked about leverage. You're targeting 3.5x exiting fiscal 2025. Why is that the right leverage level for your company?

Yes, again, there's no right level. I think we are in this environment, in particular, we just feel as though a little bit less is better. Aramark's carried higher leverage over its history, and it's a great cash flow producer. So I don't think there was any great stress about that. But I just think it gives us a more solid platform to go forward. I've said to a few people that if over the course of time, we really want to get to the point where we're a mid-single-digit top line grower, margin progression, leverage down below 3.5, probably below 3, so we're returning money to shareholders and just sort of get boringly consistent that way. And I think that, that drives a lot of value. And I think that this business model is really built for that, and this industry is really built for that.

So in light of the spin, how are you thinking about optimizing the balance sheet for both core Aramark business and then uniforms as well.

Yes. I think we'll come out in terms of the leverage profile for each. I think will come out pretty consistent. I mean with the sale of AIM Services, our leverage target by the end of the year is at 4x, and we're on that path to 3.5. So we're getting there quick. And I think with a couple of other things that will happen here in the second half of the year, we'll probably end the year below 4. And with that, we'll probably spin off in a pro rata basis, so that either side is really burdened at all and they're able to do what they need to do to grow and remainco the same. So yes, we're moving down that leverage curve pretty quick.

That's really helpful. And I'm going to squeeze one in over the last few minutes. There's a lot of uncertainty in the environment. I asked you about B&I, but are you seeing anything in your business that reflects the sort of economic uncertainty that we're seeing? Have you I guess just in terms of your customers, in terms of their behavior, sales cycles, anything like that?

Certainly not in terms of sales cycles. The pipeline is as active as we've ever seen it. We continuously review every month with each of the business operations, their -- both their financial results as well as their growth projections and their current pipeline of opportunities and the current prospects that we're working on. So that level of activity is as high as we've ever seen it. And so we're very encouraged by that. We think there's a lot of momentum in the business and a lot of runway, if you will, across the portfolio. We haven't seen any behavioral changes on the part of prospects or clients related to macro environmental trends. There are pressures in all the businesses. They're all somewhat different. You have -- in [ collegiate ] hospitality, you have, in theory, an enrollment cliff coming in a few years. In health care, you have always the pressure cost recovery and reimbursements and the like. So there is always some kind of pressure from a macro perspective in the various business units. But historically, we've always been able to manage very aggressively through those. And frankly, we become a solution to those clients under those circumstances that we can help them get through those kinds of pressures and meet the demands that they're facing as a result of those macroeconomic challenges.

I appreciate that. Well, with that, I want to thank you for being here, closing off our conference. Thank you to everyone who's been listening to all of our various fireside chats today and those who came for the conference in person, we really appreciate it. And thank you very much.

Thank you.

Thanks.