Aramark (ARMK) Earnings Call Transcript & Summary

Good morning. I'm Heather Balsky, BofA's Business and Information Services analyst. I'm excited to kick off our conference today. This marks my 3rd year of joining this conference, but it is only my second time doing in-person, and I'm really excited to see everyone face-to-face. We have a great lineup today. And I'm pleased to kick off the conference with Aramark Management Team, John Zillmer, Chief Executive Officer; and Jim Tarangelo, I hope I got that right, Chief Financial Officer. Jim, I heard this is your first time traveling with John to meet investors since you stepped into your CFO role. So it's exciting to have you both up here.

We appreciate it.

Thank you. Glad to be here.

So before we go into the fireside chat, if anyone in the audience wants to ask a question, I'll pause towards the end. But I have plenty of questions to keep us busy. So let's get started.

So first off, Aramark has been on a transformative journey over the past 3 years or so. When you look at Aramark in 2019 versus today, in what ways is the business different?

Yes. Well, first of all, it's been a joy to be back here since 2019 to rejoining the company just prior to COVID. Certainly, a number of things occurred in the last 3 years, which were unexpected. But truly, the transformation journey is -- has been terrific. We've been able to achieve a lot of very significant results. Really, what's most different is that organizational culture. We've reinvigorated that -- the growth culture and the hospitality culture, which was in the DNA of the organization, but had gone dormant for a few years based on former management's leadership approach and their approach to running the business. So really, we took a number of actions like decentralizing the organization, putting accountability and responsibility back into the field organization, reinvesting in the sales group and reinvesting in culture. And so we're really pleased with where we are now. We've gotten past COVID. We've gotten past the hyperinflation, which we all experienced. And we're really in a position now to really move forward and optimize the business in a very meaningful way.

Do you think there's still opportunity to further refine your execution? What are you focused on this year?

Absolutely. There's always opportunity to refine execution, and we continue to look at things like managing the middle of the P&L, giving people systems and processes that help to optimize food and labor cost, giving them the tools to help them do that, and continuing to focus on growing the business and growing the growth culture if you will. So we're never happy. We're always focused on improvement, and we'll continue to do so. I think this year is really about execution, optimization, doing all in -- taking all the things that we've achieved over the last 3 years, and really forcing them through the business and getting it done.

And for the past 2 years or so, you've talked about an outsized shift to outsourcing and self-op conversions. Is that still the case today? Or do you think -- have you seen things start to normalize? Do you think that eases as the labor market loosens and inflation moderates?

We -- first of all, we continue to see a very robust sales pipeline of outsourcing opportunities. It's not necessarily the primary segment of the market. We've always enjoyed a good -- a great outsourcing trend across a range of businesses, across a range of geographies. Over the last couple of years, it has been a little higher than normal and still remains elevated at this point. But the market size is so large, and the opportunity set is so big -- so significant that there really isn't, even if it goes back to kind of the normal 1/3, 1/3 and 1/3, there's plenty of tailwind for the organization to continue to grow rather dramatically.

That helps. And is -- a question we get sometimes is, is when you're competing against peers or larger regional players, what do you think is Aramark's competitive advantage or differentiating qualities?

Yes. I think that's a question we get asked a lot. And I always focus on the quality of the leadership, and the management team and the organization. And it's the management team's ability to create customized solutions for their clients, and to be listening and understanding client needs in a very significant way. And that goes back to the relationship that the people develop -- the management team develop with their clients and the sales group develop with their prospects, having a deep understanding, a better understanding than our competitors do on those particular clients' needs. And that's what drives our success in the long-term. It really is a relationship business. We all sell the same food product. We all have the same kind of technologies that we can employ. So it's really having that deep understanding and that deep relationship that drives the difference.

That's really helpful. So help us appreciate the broader demand environment and what you're excited about? In the first quarter, you raised your outlook for basically all financial measures and indicated it's very bullish or indicated that bullishness in your sales outlook with regards to volumes. Where are you seeing momentum?

Yes, I'll start. Listen, we were really encouraged by the trends we saw in the first quarter, 13% organic growth, 20% -- a little north of 20% growth in our international business and 10% growth in the U.S. business. And it was really broad-based growth across nearly all geographies and sectors. So we're really excited about that and the trends that we're seeing. I'll call on a few, I mean sports, fans -- level of fans, the attendance in the stadium is very high. Record levels of average checks. We switched to cashless. And with that, people tend to spend more with credit cards and B&I, folks are back to work. Not only are they back in the office, but they're in the office, the participation rates are up. So we're seeing really nice trends in our B&I sector. Europe, over 20% growth in the quarter. Germany sports, B&I and really, in the U.K., good trends in the dining sector as well. So the nice thing about the quarter and the outlook is it's really broad-based and across numerous geographies and sectors.

You mentioned over 20% growth internationally. And it's -- it's something that's kind of interesting. What's going on internationally? Like how does that compare to your domestic business? What's driving that really robust growth?

There's a couple of different factors. First of all, when the organization went through its cost-cutting phase back in the mid-teens, the -- a lot of the sales organization in the U.S. was cut. So they went from over 130 salespeople down to like 30 or 40. So literally, the sales resources were significantly reduced in the U.S. That wasn't done in the international business. The international business was left alone. So those sales managers were left in territory working against their prospects, and so getting their culture back to reaccelerate the growth was not as difficult. We had to rebuild the sales organization, leadership and functionality inside the domestic operation. So that was a significant part of it. Also, I think part of its law of big numbers. The international business is smaller. And so as we accelerate the growth, the percentages are a little larger. I'm very pleased actually with the growth in both parts of the organization. The U.S. has achieved very good results over the last several years as well. But we do -- we're very grateful that team -- the international team, Carl Mittleman and the leadership has really been able to refocus and reenergize the growth across the international sector, and their growth is broad based. It's in every geography, in every vertical. So we're excited about it.

And I can just jump in because I spent about 10 years in the international business accommodating in the CFO. And we've always had Visa Card sales, the growth engine of Aramark. So that growth mindset that we reinvigorated when John came back was really always, "Oh, here's there in international." So we've seen the model work. And now we have that mindset across the organization, which is a result of the proactive strategy we put in place.

That's helpful. And talking about that strategy, John, you've had a lot of great wins in your business recently. And while appreciating there can always be some headlines regarding a few customer exits. What's reflected in your guidance on the retention and new business fronts that you continue to feel comfortable about?

Yes. We -- first of all, we expect our retention rate this year to be at or above last year's rate. We don't see a significant change in retention, while there have been a couple of headline losses this year, they were anticipated for the most part, understood that those were -- those contracts are rehiring and that we were likely to go ahead and move on from those relationships. And our expectation is for our net new to be in the range that we've guided to. We're excited about the prospects that we have, the wins that we already have. You may have seen recently the San Francisco Giants selected us to be their new operator at Oracle Park in San Francisco. That's a very significant win, which more than offsets some of the other losses in Sports & Entertainment. So we're very comfortable with the trajectory both for retention and for growth that we've outlined for the year. That's in our guidance. And as I said, many of these potential losses were anticipated based on your contract expiration.

Okay. That's really helpful. Before I was going to ask you about your guidance for the year, but Sports & Entertainment, it's just been so strong. And it's just something -- what enables you to drive growth there? What are -- how -- what's the consumer doing that is driving business higher?

Yes. There's -- as Jim mentioned a little bit of it earlier, the transition to cashless payment systems has really driven significant per capita spending increases basically across the client portfolio. And then the introduction of technology, frictionless stores, for example, if you go to Coors Field in Denver and you want to get a certain beer, you don't have to wait in line and belly up to the old concession stand and wait for the person to pour it from the fountain. Basically, you walk into the store without ever touching anything, take it out of the cooler and walk out. And so it's -- the transaction speed is spectacular. And so people don't want to miss things at sporting events. So...

Yes.

They don't want to have to take the time at a concession stand, but if they can get to the store and grab it and go and be back in their seat to see the next inning that drives both participation and revenue growth. So it's been exciting to watch. There's a great leadership team in Sports & Entertainment, and they've done a terrific job of optimizing and using technology and using data to really drive enhanced consumer reaction to their offering.

It makes a lot of sense. I don't like waiting on line. I definitely have walked away from food just...

Yes.

Just because of that. So it makes a lot of sense. So moving to the kind of the year, your sales guidance seems to imply slower trends compared to 1Q for the remainder of the year. Can you walk us through what you're -- what we see happening in your business as we progress through the year? And is the sort of deceleration related to pricing? Or what's going on there?

Yes. Like I said, we're really excited and encouraged by the trends that we saw off to a really strong start with the first quarter. As we look towards the remainder of the year, the timing of net new and when new business rolls out is always a factor, the way pricing is impacted by inflation. We do a lot of our contractually based pricing in the June and July time period. So how inflation plays out will affect, or how the current outlook for the remainder of the year. And then there's always some natural seasonality as well. So that's why you see the cadence that you do. But having said that, like I said, we are very encouraged with the trends, the momentum of the business, and we'll be providing another update in terms -- as part of our May earnings update.

That's helpful. So it's funny, I wrote this question originally saying that we -- you talked about food inflation moderating from fiscal 4Q to fiscal 1Q. And I think until this past week, we hadn't seen that in the CPI data, and we finally saw a material step down. So it's interesting, there seems to be a lag there in the data we're tracking. And so I'm just curious if you can help us understand that dynamic, and kind of help us appreciate what you're experiencing right now from a cost perspective?

So I guess I'll start, John. Yes, the inflation was running 4% to 5% for us in the first quarter, close to 4% in the U.S., 5% globally. That was a little bit better than what we had expected. Embedded in our guidance for the remainder of the year is a similar level of inflation. So like you're seeing with the print that just came out, a similar level is what we are seeing, to the extent inflation should moderate there'd be a corresponding benefit to both AOI and margin. But at this point, what we're seeing is fairly consistent inflation is what we saw in the first quarter.

And I would just add that the data that we use for inflation is really our specific purchasing data, our specific cost data for the products we buy and, in the geographies, where we buy it. So we go through literally a very rigorous weekly analysis of our spend and our purchases and the cost. So we're very confident in our understanding of what's going on in the marketplace and in terms of the inflationary environment, and it is very consistent with the data that you're now beginning to see printed by BLS and others. So we're confident in our assumptions for the balance of the year. But as Jim said, if we see a continued step down, we're very excited about what that means for the business.

Makes sense. That's really helpful. And your guidance assumes and -- well, okay. Well, I guess, can you help us understand what it could mean for your business from a sales and margin perspective if we did see another step-down in inflation?

Yes, certainly. Jim, do you want to go ahead and...

Yes, I'll start. If you look at the first quarter, we generated 64 basis points of margin improvement. We talked about 50 basis points coming from the underlying levers of the business and about 14 coming from inflation. So I think it gives you a sense of inflation coming in a little better than expected, provided some additional tailwind to our first quarter results. So that gives you a proxy for what the opportunity could be should inflation moderate.

That's helpful. And beyond inflation and the sort of dynamics there, can you talk about the improvement you've seen in your supply chain as well? Are there -- are things nearing back to normal? Are they back to normal? And do we still have a ways to go? What's the update there?

Yes. First of all, we have a terrific supply chain organization managed by Autumn Bayles, and -- who I think is spending some time with investors over the next couple of weeks. And the supply chain team has done an extraordinary job of building an organization that can respond on a moment's notice to changes in the marketplace. And it is normalizing. Our supply chain is normalizing. Product availability is kind of pretty much back to normal. So manufacturers are back running at full speed. So we don't see the disruptions that existed last year in supply chain, and we see that both domestically and internationally, that things are generally available from a food production perspective. And labor availability has also significantly improved both domestically and internationally. So I'd say supply chain is in a very good place. We continue to have opportunity to continue to renegotiate deals, as we gain significant size and scale. So we now have a -- the GPO has over $19 billion of spend that it manages. And so they are bringing that to bear in terms of new negotiations with manufacturers and distributors, which will create benefit for our customers and our clients and for Aramark as we continue to leverage the supply chain for improved economics.

So you talked about your GPO, and it came up at the Investor Day a fair amount. I'm curious just update -- gave a total, but just update on that. How does that work within the organization, the benefits that you get from that? What opportunities to grow it further?

Yes. And first of all, we directly benefit from the purchasing power if you will, of the GPO. It has an impact on what Aramark purchases for its own consumption and use in our existing operations. And then our client customers and partners, like Marriott and Hyatt and others, benefit from that increased scale as they get reduced costs and improved economics as well. So we have an opportunity to continue to grow the GPO. We've made a number of tuck-in acquisitions, both domestically and internationally, to grow the GPO, and we have a significant opportunity to continue to grow at both domestically and internationally. And we have the opportunity to partner and to extend the relationship with people like Marriott and Hyatt outside of the United States. When we bought a vendor, international was not a part of that process. But we've been very diligent about building out those capabilities internationally and building the platform to go ahead and increase that potential. So we're excited about what that potential is, both domestically and internationally, and it will continue to be an increasing part of the profitability story of Aramark as we go forward.

That's helpful. And flipping back to the margin guide, the guidance that you gave for the year. We talked about inflation. Supply chain is better. What else are the key drivers of your margin expansion this year?

Yes. It all starts with what I call the fundamental underlying margin levers and really starts with a supply chain that we just covered in terms of scale. Not only scale, but internal compliance. We have a tool called MarketPro, which has generated significant improvements in the SKUs that we buy where we have better and more attractive deals. The middle of the P&L, as John mentioned earlier, certainly an opportunity as the operating environment continues to normalize. Containment of SG&A, it was -- the SG&A is relatively flat in the first quarter. By the way, that doesn't preclude us from growth, it's at the corporate level. We can continue to add a lot of growth and a lot of business with really limiting the amount of SG&A that we had at the corporate side of the organization. And then the progression of net new, right, with the record net new that we've had, strong net new over the past few years, and our business margins are lower when they roll out and they mature to a natural progression of our base business margin over 3 to 4 years. So that continued to provide some benefit and will continue to provide a benefit going forward. And I said like icing on the cake in the first quarter was inflation moderating. So those are really the levers in the core to our model about how we get margin enhancement for our business.

Helpful. And where are you in the -- in terms of -- in the last few years, you've been attracting net new business. And those businesses come in, they're a little -- they're margin dilutive. And so as you've sort of built up that muscle, you had some headwinds in the first few years. So you kind of -- where are you in that sort of normalization of scaling new business and getting that up to speed?

Yes. I think, as Jim said, those contracts mature over a period of time. And depending on the complexity, they take either shorter or longer to mature. So those accounts that we sold 3 years ago, if they were management fee accounts, they're fully mature. If they were P&Ls, might take a year to get them fully mature. So -- but once you've established this kind of consistent engine and you've got, call it, $0.5 billion worth of new sales every year, you begin to roll over those effects. So the accounts you sold last year are still maturing. The accounts you sold 2 years ago are maturing. The accounts you sold 3 years ago are beyond mature and starting to accelerate. So I would say we're get to that -- we're at that point now where we have consistent new sales development and consistent delivery of net new. And so you should lose the impact of seeing that in terms of margin degradation. It should normalize over time and become part of the tailwind for the organization as we grow to margin -- as we grow the margin over the next couple of years. So I think we're in a very good shape. And the only time you end up with and expect an anomaly is when you have an outsized sales here like we did when we sold...

Merlin.

Merlin and we had...

Yes.

$800 million worth of new business 2 years ago. And so that spiked, and so you end up having that kind of margin impact for year or 2 as you mature that business.

That makes a lot of sense. I figured I'd just check, in case anyone has a question, otherwise, we can keep going down my list. Okay. Great. So we may have checked all the boxes emerged, and they feel like we talked -- I just want to make sure we cover everything when you think about the next, not just this year, but the next 3 years.

No, I think when you think about our multiyear targets to, we're getting north of 5.9% by fiscal '26. It's really those core margin levers that I described, right? And what I like about the first quarter is, the core margin leverage generated 50 basis points of margin improvement. So we know that's sustainable, and it's been consistent and improves for us that the model is working. It gives us a lot of confidence in getting to the fiscal '26 financial objectives that we established.

Okay. And for those objectives, what is kind of factored in with regards to inflation? Is it renovations?

Over the long-term, midterm, inflation is sort of -- is neutral, right? We don't price for profit. Inflation and pricing will basically reach an equilibrium over time, right? It was transitionary headwind when inflation was rising, it's really a transitional tailwind as inflation is subsiding. But over time, it really should have a neutral impact on the business.

Okay.

Yes. You saw this industry and this business kind of operate with a neutral kind of platform for inflation for, call it, almost 15 or 20 years. As long as the inflationary environment is relatively benign, pricing remains pretty consistent. And that's pretty in the norm -- that's pretty much the normalized state that we expect to get back to. And -- but now that we've got the muscle rebuild for pricing, which had been lost during that kind of time that we can respond much more aggressively if we see a tick-up in inflation, we can be much more aggressive in terms of responding through price and levers to manage the business than we were able to last year, when it spiked so dramatically and unexpectedly.

Well -- and on the balance sheet, you're targeting 2.75x, 3.25x net leverage by 2025. Assuming you're in that range next year, what happens next? How do you think about taking leverage down further versus returning capital to shareholders versus having -- how to do acquisitions?

Sure. I'll start. I mean in terms of the outlook for this fiscal year, we're expecting to be about 3.5x levered. We'll be about 3x levered by the end of fiscal 2025. At 3.5x leverage is actually the lowest leverage we've had since we did the Avendra acquisition back in 2017. At 3x leverage, that will be the lowest we've since we did the [ LBO ] back in 2007. And so this is an organization that has a very strong track record of deleveraging. We have a very attractive cash attributes. So we're comfortable with the debt load that we had. Having said that, we recognize in a higher interest rate environment, we're very focused on deleveraging. The cash model that we have is very flexible so that as we delever, we are contemplating additional shareholder returns, whether that's in the form of an increased dividend or additional share repurchases. And we've already served some of those discussions at the Board level, and we're well positioned for them to be on the table.

Yes. That's absolutely right. There's -- we're very excited about the future prospects of the organization, we certainly have the cash and the ability to invest in the growth of the enterprise. We can do tuck-in acquisitions. We can do whatever we need to do from a capital perspective in the business and still achieve the deleveraging profile that we've talked about. And so it's exciting to think about, all right, what are the alternatives for return to shareholders and how do we best execute against the needs of shareholders going forward, and we'll be able to do both of those things. And the Board is diligently considering what those next steps might be and what the appropriate timing would be.

Yes. You talked about investing in the business in your answer. What are the investments that you're making right now that you're most excited about or you think about the next few years?

Yes. We continue to invest in the growth of the organization, continuing to add resources and capabilities so that we can continue to accelerate the growth. We're making significant investments in technology. We're not -- there's no headline that, hey, we're investing in an ERP system or something like that, but we continue to invest in technology in ways to improve the business, giving our frontline managers tools to improve the way they manage the operations using AI, for example, to go ahead and optimize supply chain. We buy thousands of SKUs of products, and every distributor calls the same product something else, right? So in one location, its cheddar cheese sliced and in other locations, it's cheddar cheese bricks. So our -- the computer systems have a very difficult time understanding what are the differences between those 2 items. Well, in essence, when you're trying to manage spend, you're aggregating that data in a way that you can then take it back to the manufacturer and say, "Okay, I bought 200,000 pounds of this product. Now let's negotiate the best price." With AI, we can get through that data and much more rapidly to aggregate that spend data and to really get meaningful negotiations started. And so we've begun to employ a number of different pilot tests for AI throughout the business for menu optimization, pricing optimization. So those investments aren't costing a lot, but it's really exciting to see the impact that they can have on the business.

Yes. It's interesting how -- I mean you talked about self-checkout earlier...

Yes.

And all that, the amount of technology that's involved in your business. Because as the...

Yes.

Customer, you're not necessarily seeing it, but...

No. No, that's right. And our frontline managers have handheld devices that essentially allow them to manage food cost, labor cost. They literally -- when I go back to the days when I managed as a frontline manager in our operation, walking around with a notepad and a pencil taking down inventory levels and the advances the technology have given our front line managers in terms of their ability to impact and to manage operations have been very significant. So it's actually fun to watch the evolution of the industry and how it's impacted our customers.

Yes. As it's fun to watch as an analyst, as well as I'm sure as an investor, too. I really appreciate this. Thank you so much for your time.

Thank you.

Thank you for having us.

Thanks.