Aramark (NYSE:ARMK) Q4 2023 Earnings Call Transcript

Aramark (NYSE:ARMK) Q4 2023 Earnings Call Transcript November 14, 2023

Aramark reports earnings inline with expectations. Reported EPS is $0.64 EPS, expectations were $0.64.

Operator: Good morning, and welcome to Aramark’s Fourth Quarter and Full Year Fiscal 2023 Earnings Results Conference Call. My name is Kevin, and I’ll be your operator for today’s call. [Operator Instructions] At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are in a listen only mode. We will open the conference call for questions after the conclusion of the company’s remarks. I will now turn the call over to Felise Kissell, Senior Vice President, Investor Relations and Corporate Development. Ms. Kissell, please proceed.

Felise Kissell: Thank you, and welcome to Aramark’s Earnings Conference Call and Webcast. This morning, we will be hearing from our CEO, John Zillmer; as well as our CFO, Tom Ondrof. There are accompanying slides for this call that may be viewed through the webcast and are also available on the IR website for easy access. Our notice regarding forward looking statements is included in our press release. During this call, we will be making comments that are forward looking. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties and important factors, including those discussed in the Risk Factors, MD&A and other sections of our annual report on Form 10-K and SEC filings. We also will be discussing certain non-GAAP financial measures. A reconciliation of these items to U S GAAP can be found in our press release and IR website. With that, I will now turn the call over to John.

John Zillmer: Thank you, Felise, and thanks, everyone, for joining us. This morning, Tom and I will provide a detailed review of our fourth quarter and full year fiscal ’23 results and key performance drivers, including net new business. Our growth teams continued to deliver including significant new business wins closed in just the past few weeks, which I will review shortly. I’m proud of the work we’ve done to strengthen performance and culture and I’m eager to capitalize on the numerous opportunities our client focused approach continues to generate. We’ll also preview our performance expectations for the year ahead, which show positive momentum entering this new era for Aramark following the completion of the Uniform Services spin-off.

We will take a moment to highlight the results for Uniforms at a high level and Kim and Rick will provide more detail in their upcoming earnings call for Vestis, now an independent publicly traded company. Aramark’s performance this past fiscal year demonstrated the progress we’ve made towards the strategy and financial goals outlined at Analyst Day nearly two years ago, resulting in a stronger balance sheet, improved profit margin performance and meaningful sustainable growth. Over the past year, organic revenue grew nearly 16% and adjusted operating income increased 34% on a constant currency basis. Free cash flow was $334 million that included a payment of deferred payroll taxes related to the CARES Act as well as transaction and restructuring costs associated with the spin-off.

Free cash flow before these items was $471 million which along with higher EBITDA and over $800 million of net debt reduction throughout the year resulted in a 1.4x leverage ratio improvement from the prior year to 3.9x at year end. Adjusted EPS increased 50% on a constant currency basis compared to prior year. As part of these results, global FSS consisting of the food service for the US, food service International and corporate reportable segments drove organic revenue growth of nearly 18% and AOI growth of more than 46% on a constant currency basis. And in the Uniform Services segment, organic revenue grew 5.5% and AOI increased 10% year-over-year on a constant currency basis. The Uniform team’s strategic initiatives contributed once again to its improved profitability in the fourth quarter.

AOI grew 15% on a constant currency basis and AOI margin reached 11.8%, nearly 70 basis points better than the third quarter and 106 basis points better than the fourth quarter of last year. We believe the pathway for value creation that Kim and Rick outlined at the Vestis Analyst Day in September is taking shape and we’re excited for their promising future as a standalone company. Turning now to global FSS net new business. With a growth mindset now well established, our net new business momentum continued achieving a 4.3% of prior year revenue. High retention rates and strong new business wins drove growth in this priority area. The hospitality culture that we continue to cultivate and enhance has resulted in strong relationships with our clients.

We’ve also been opportunistic in repositioning the portfolio within our next level business as we create a new senior living offering, which we believe has enormous potential ahead. Retention rates were 95.5% with strength across the portfolio maintaining the positive step change versus our historical levels even as the environment normalized this year. Annualized gross new business wins totaled nearly $1.2 billion representing 8.8% of prior year revenue. Now entering another year of expected strong new business performance, we believe that we are starting to reach a cruising speed and delivering consistent growth. We added clients both large and small across multiple lines of business and geographies. Among others, a notable win added in the fourth quarter was the Indianapolis Motor Speedway one of the world’s biggest sports complexes and homes to the iconic Indy 500.

Favorable outsourcing trends continued throughout the year with 40% of our wins globally and close to 50% in the US coming from self op conversions compared to around one-third historically. While we provide more detailed disclosures on our net new business performance at the end of each fiscal year, our focus on driving growth is constant. In just the first few weeks of fiscal ‘24, we’re off to a great start, which includes having just been selected to provide food and nutritional services to one of the most admired and respected children’s and pediatrics institutions, Boston Children’s Hospital. We remain confident in our robust pipeline for fiscal 2024 and expect to achieve net new business equivalent to 4% to 5% of prior year revenue for the third consecutive year.

Now turning to our fourth quarter results again exclusively focused on global FSS. Overall performance reflected a strong top and bottom line across the portfolio. Revenue of $4.2 billion included organic revenue growth of more than 12% year-over-year driven by strong net new business, pricing and base business growth. Operating income was $220 million. Adjusted operating income was $256 million, representing an increase of 33% year-over-year on a constant currency basis. Operating leverage from higher revenue and the maturing of new business from prior years as well as improved supply chain economics and disciplined above unit cost management resulted in higher year-over-year profitability in the quarter. The FSS U.S. Segment increased organic revenue more than 10% compared to the same period last year and AOI grew more than 24% on a constant currency basis.

Performance was driven by strong per capita spending and greater event attendance in sports and entertainment as well as continued favorable trends across the B&I sector. As we previewed last quarter, we’ve made notable progress on the price inflation lag within the education sector and Corrections business. This pricing partially benefited the fourth quarter and will more fully contribute to results in the first quarter of fiscal 2024 and beyond. The FSS International segment grew organic revenue approximately 19% year-over-year and increased AOI more than 50% on a constant currency basis, even without the AIM operations following its divestiture in April. Performance in the quarter reflected strong results across geographies including a busy events calendar and greater B&I participation rates in Europe, strong mining activity in South America and the start of the school year for higher education clients in Canada.

Corporate expenses were relatively flat year-over-year as we remain focused on above unit cost containment while appropriately supporting the international and U.S. Segments. Collectively, our performance in the quarter was a strong end of the fiscal year and sets a solid foundation going forward. Given our strengthening financial profile, the Board of Directors just approved a 15% increase to our pro rata portion of the pre-spin dividend. The $0.095 dividend per share will be payable on December 8. We remain focused on driving our ESG and DEI strategies which resulted in the following recent accomplishments. Aramark was selected as one of America’s Greenest Companies by Newsweek for our commitment to our sustainability footprint. We were recognized as the Best Company for Diversity, Equity and Inclusion by Black Enterprise and named the 2023 Champion of Board Diversity in the form of executive women.

And just a few weeks ago, we announced our partnership with JPMorgan Chase on their 1diverse supplier grant initiative that is focused on assisting diverse owned businesses. Before turning the call to Tom, I want to congratulate two exceptional Aramark leaders on their well-deserved retirements. First, Bruce Fears with 40 years of stellar service to the company most recently as President and CEO of Aramark Destinations. Bruce’s commitment to our business and stewardship to some of the country’s most iconic places is legendary and we’re grateful for all the years he served Aramark and this industry. Sasha Day will step in to lead Aramark Destinations returning to her roots where she initially joined the company 20 years ago. Most recently Sasha served as Chief Growth Officer for the Collegiate Hospitality business.

And Andy Siklos, President and CEO of Aramark Canada since 2016. With his passion and focus on results, Andy established strong client relationships and elevated Aramark’s position as a Canadian company. Steve Frisco has been named President and CEO of Aramark Canada. Steve has extensive experience within the Canadian business, which he joined in 2004 having served in roles including Assistant General Counsel, Chief Financial Officer, Regional VP for Canada’s largest operations, and most recently Chief Growth Officer. I wish the best to Andy and to Bruce in their retirement and I know that Sasha and Steve will be remarkable in their new roles. Tom?

Tom Ondrof: Thanks, John, and good morning, everyone. Fiscal ’23 represented another significant step towards delivering our strategic and financial goals. As John just reviewed, our reestablished hospitality driven customer focused culture has resulted in the third consecutive year of strong net new business performance, which helped drive a 16% increase in full year organic revenue compared to prior year. Adjusted operating income grew at more than twice the rate of organic revenue resulting in significant AOI margin improvement over last year and we continue to meaningfully delever through focused cash management and strategic asset optimization, which when combined with AOI growth led to a 50% year-over-year increase in adjusted EPS on a constant currency basis.

We also completed a major milestone with the Uniform Services spin-off that we believe will drive enhanced performance and value creation as each independent business executes on its own distinct strategic vision. As we move past this exciting inflection point for Aramark, my commentary today will be focused on the Global Food and Facilities business in fiscal ’24 and beyond. The fundamentals of the business remain unchanged. We expect to deliver profitable growth and margin through Scale. Revenue performance will continue to be led by net new business, appropriate pricing actions, and expanding our base business. AOI growth, which is favorably positioned for outsized increases in the near term, we believe, will be driven primarily by five factors.

First, the profitability ramp of new business as a result of operational maturity and efficiencies, following three consecutive years of adding new clients. Next, the recovery of the price inflation lag and expected benefits from recent trends related to the slowing of inflation. As John mentioned, we made particular progress here in our Education Sector and Corrections Business that benefited the fourth quarter. And assuming continued moderation of inflation, we believe will continue to contribute to AOI growth during the first quarter of fiscal ‘24 and beyond. Third, the run rate from improved supply chain economics, both externally as product availability has returned to normalized levels as well as internally through enhanced purchasing compliance, efficiencies from SKU rationalization and benefits from new deals driven by greater purchasing scale.

Fourth, the continued recovery of unit profitability as middle of the P&L cost related to food, labor and other direct stabilize, coupled with the flexibility of our variable cost operating model. Labor dynamics continue to improve compared to a year ago, particularly in Collegiate Hospitality where we are no longer relying on excessive agency labor. Our frontline teams continue to innovate in impressive ways to drive unit costs down without compromising the customer experience. As just one example, we are using AI to streamline labor scheduling and more efficiently and effectively planned menus. And lastly, the disciplined control and containment of above unit cost as we continue to create a fit for purpose overhead structure post spin that appropriately supports the remaining business.

The combination of all these factors being in play at once is expected to drive AOI growth at a faster rate than revenue, even more so than our typical business model, resulting in an expected strong margin progression over the next few years. As a reminder, we still expect the historic U-shaped AOI margin cadence with higher profitability in the first and fourth fiscal quarters, primarily related to seasonal peak activity in the education sector as well as the Sports and Entertainment and Destinations businesses. Let me now move on to the fiscal ‘24 outlook and then recap the half time review update of our fiscal ‘25 goals from Aramark’s Analyst Day back in December 2021, which were set for the total company including Uniforms. Recently, we broke out the original assumptions for just the global FSS business and our published materials this morning include certain disclosures in more detail to help ensure we are – we are all working from the same starting point.

In fiscal ‘24, for our global FSS business, we currently anticipate organic revenue growth of 7% to 9% comprised of 3% to 4% pricing and 4% to 5% net growth, AOI growth of 15% to 20% on a constant currency basis. Adjusted EPS growth of 25% to 35% on a constant currency basis and a leverage ratio of approximately 3.5x at fiscal yearend as we continue to prioritize deleveraging through profit growth, focused cash management, and disciplined investment. We are proud of what we accomplished in fiscal ‘23 and we’ve built solid momentum going into fiscal ’24. Assuming a continued easing of inflation over the next couple of years, we believe that we remain on track to deliver the Analyst Day goals for global FSS adjusted for the spin of the Uniform Business and divestiture of AIM Services as follows: Revenue of greater than $17 billion.

We expect to hit this goal a year earlier than initially planned as captured in the fiscal ‘24 outlook as a result of stronger net new business and higher than anticipated pricing over the past couple of years. AOI margin of 5.9% to 6.4%. When we originally set our target following COVID impacted fiscal ‘21, the global FSS AOI margin was 1.2%. Just two years later, AOI margin has increased nearly 350 basis points to 4.7%. Fiscal ‘24’s AOI is expected to grow more than twice the rate of revenue, driven by the outsized AOI growth factors just reviewed which we anticipate will deliver another significant jump in AOI margin this coming year. However, due to 40 year high inflation experienced over the past two years and the price inflation lag in a few of the business lines, we now expect to reach the AOI margin goal by fiscal ‘26.

Adjusted operating income remains on track to be in the $1 million to $1.09 billion range in fiscal ‘25. Adjusted EPS and leverage were not specifically broken down by segment when we originally set these targets. So I’d like to take the opportunity to share our latest thinking here for the global FSS business. Adjusted EPS is expected to be in a range of $2.30 to $2.50 by fiscal ‘26, simply as a result of the roughly 250 basis point rise in interest rates since Analyst Day. The debt leverage ratio for the total company was originally targeted to be in a range of 3x to 3.5x by fiscal ‘25. Since that time, we divested our interest in certain non controlling assets including AIM Services and paid down debt. With that, we currently expect to be at the top end or just inside our initial target range in fiscal ‘24, achieving our Analyst Day goal a year early as we just reviewed and in a range of 2.75 to 3.25 by fiscal ‘25, as we remain committed to deleveraging.

We have a lot of confidence in not only achieving these financial goals, but getting to and through each one as we continue to build a sustainable business model set on providing valued services in a highly attractive recession resilient growth market that can create long term value for our shareholders. With the Uniform spin complete and a new era dawning for Aramark as a focused global food and facilities provider, we couldn’t be more excited for the future of the company. Thanks for your time this morning. John?

John Zillmer: Thank you. Thank you, Tom. I’m extremely proud of the milestones we accomplished this past year as a global team and I’m excited about the positive momentum we’ve generated for the year ahead. Our strong performance is driven by our commitment to our strategic priorities, which we believe have established the groundwork for more opportunities and success to come, both in the near term and long into the future. With the spin off now complete, fiscal ‘24 represents a new chapter in the company’s history. We’re confident in our ability to build upon what we’ve worked hard to establish leveraging the hospitality culture and growth mindset now firmly rooted within the organization. Operator, we’ll now open the call for questions.

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Q&A Session

Operator: Thank you. We’ll now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Harry Martin with Bernstein. Your line is open.

Harry Martin: Hi, I am [Indiscernible]. Good morning. I thought I’d ask one on the guidance, please. The Q4 EBIT number, I calculate as being 3% ahead of 2019, it looks like the 15% to 20% AOI growth into next year can be hit assuming a pretty similar 3% ahead of 2019 number for the – the rest of the quarters to come in 2024. So I just wondered how conservatively you feel like that guidance has been set and what the moving parts are there? And then just a more strategic question you mentioned on the supply chain and the benefits that can have on the margin from compliance scale and new deals. I wonder if I could get a little bit more detail to help quantify that. What is the purchasing volume of the GPO today? What percentage of that is in food items versus the other hospitality items of procurement? And then what proportion of the sites today are in compliance? And how much do you expect that to drive an improvement going forward? Thanks very much.

Tom Ondrof: John, you want to start with supply chain?

John Zillmer: Sure, I’ll start with supply chain. First of all, compliance is just statistically measure across the Contract Food Service Business. So those statistics are reviewed with each operating business every month. They have a goal in terms of their overall compliance and are working very hard to achieve those numbers. There is always opportunity in the last year that – that was significant because of the disruption that occurred in supply chain over the course of the last couple of years. So our compliance numbers are very, very close to optimal. We continue to push and to get units to purchase the right products from the right suppliers. So there is always opportunity to improve upon that, but in general I’d say we’re very close on the compliance numbers. The GPO spend today, I don’t think that we disclosed with the total GPO spenders.

Tom Ondrof: Yeah. It’s – it’s about $16 billion.

John Zillmer: Yes about $16 billion which includes, both our – our Contract Food Service revenues as well as the spend that we manage for our clients through Avendra and the other GPOs we operate. So, we have – we have significant scale and we work very aggressively to utilize that total spend to benefit both our clients as well as Aramark as we continue to manage new deals with suppliers and manufacturers and that supply chain team is very expert at optimizing for all of those contingencies. So we’re very comfortable with the potential growth for the GPOs. We have significant opportunities to grow both domestically and internationally in the GPO market and we see continued supply chain economics improvement as a result of that focused growth of that in that area.

Tom Ondrof: Yes, and Harry, I think on the margin question, as a conservative and if you play it off against either ‘22 or – or ‘19, and I’m not sure how relevant ‘19 is anymore, given the spin and – and different economic dynamics versus five years – five years ago now. But we’re very thoughtful about what we’re trying to accomplish here in building this sustainable model. We all know what chasing margin does, and it doesn’t end well. So we’re continuing to move the business forward in a thoughtful way, trying to balance retention, new business growth, our client needs. We’re very happy with the progression of the margin off the low of 1.2% in ’21, like I said improved it by 350 basis points so far. We’ll continue to progress and we still feel, as I said, very comfortable and confident in the goals that we set out with some adjustments for timing.

We’ll continue to push through that. If there’s an opportunity to move it faster, which will probably be driven off a stronger easing of inflation over the next few quarters and – and couple years, we’ll do that or – or we’ll have that opportunity. If it goes the other way, it’ll be a bit of a headwind. So overall we feel good about the number. I don’t know if it’s conservative or not, but we’ll continue to do what’s right for the business.

John Zillmer: And I would just add final commentary to that is that we’re off to a good start in the quarter. We see continued improvement in the slow moderation of inflation that’s our expectation built into the model and built into the plan. And if inflation continues to ease more rapidly then certainly we’ll be able to – we’re well positioned to take advantage of that. As we discussed in our commentary, we’ve made significant progress on the price recovery in those – in those businesses that were lagging. We saw that in the fourth quarter and we continue to see that play out in the first quarter in early days. So – so we’re confident in the targets and as Tom said, we have a commitment to the goals that we established at Investor Day. We see ourselves reaching those goals and getting through them and doing even better in the long term.

Harry Martin: Thank you.

Operator: Our next question comes from Neil Tyler with Redburn Atlantic. Your line is open.

Neil Tyler: Thank you. Good morning, John, Tom. Actually, I think I’ll start by following up on Harry’s question about the margin and your comments there. So the guidance suggests, if I’m calculating correctly, that the basis point improvement will be a little bit better than your typical operating leverage, but not significantly. And so I wanted to ask with the comments you just made in mind, to what extent you’re sort of reinvesting in the business in order to maintain growth, just really in operating costs? That’s the first question. And second part of that I suppose is, I don’t know whether you look at the business this way, but can you compare gross margin or in unit margin on business won versus business lost over the last say 24 months. I’m trying to get a sort of taste for any structural change in the profitability of the – of the business that’s coming in? Thank you.

Tom Ondrof: Yes, I mean the margin is business won is always lower than business loss. So that churn is where we’re getting up to the cruising speed that John referred to is the headwind we’ve talked about for the last couple of years. But as we – as we consistently build that – that COG, it levels out over time and that’s where we’ll get to here over fiscal ‘24 and fiscal ‘25. The normal model in my mind, this is a 6, 9, 12 model, and I said that to some folks before, in a normal space of 6% top line, 9% bottom, 12% EPS, probably be a bit outsized for us on EPS because of the – as we delever. That yields probably a 20 basis point margin improvement in the normal course of things. We expect to double maybe triple that over the quarter if you take the guidance this year.

So it is quite outsourced – are outsized and I think that that has the opportunity that for fiscal ’24 and ‘25 and – and even into ‘26. And obviously they hit the goals as everybody’s doing the math, that’s what we have to do, but we feel confident in that. So I think it is the next couple of years is quite outsized AOI growth, margin growth compared to the normal model, which would probably be around 20 bps.