Aramark (NYSE:ARMK) Q1 2024 Earnings Call Transcript

Aramark (NYSE:ARMK) Q1 2024 Earnings Call Transcript February 6, 2024

Aramark isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Aramark’s First Quarter 2024 Earnings Results Conference Call. My name is Kevin, and I’ll be your operator for today’s call. At this time, I’d like to inform you this conference is being recorded for rebroadcast and that all participants are in a listen-only mode. We will conduct a — we’ll open the conference call for questions at 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 first quarter fiscal 2024 earnings conference call and webcast. This morning, we will be hearing from our Chief Executive Officer, John Zillmer; as well as our Chief Financial Officer, Jim Tarangelo; who started in this role in January. We at Aramark are excited for Jim’s appointment. As a reminder, our notice regarding forward-looking statements is included in our press release this morning, which can be found on our website. 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 our other SEC filings.

Additionally, we will be discussing certain non-GAAP financial measures. A reconciliation of these items to U.S. GAAP can be found in this morning’s press release, as well as on our website. With that, I’ll now turn the call over to John.

John Zillmer: Good morning, and thanks for joining us. Before we get started, I first want to acknowledge our team in Chile as they are dealing with devastating wildfires near Santiago. Although, our operations are not affected, scores of our employees have been impacted. We’re working with our leadership team on the ground to ensure everyone’s safety, and we’ll be coordinating a thorough response with the appropriate relief organizations. Now to the quarter, I am really pleased with a great start to the new fiscal year, generating broad-based revenue and AOI growth with solid margin improvement across the business. The strong performance resulted in record revenue for both the FSS U.S. and International segments, along with record first quarter profit in International.

Our growth-focused strategies are working and we’re seeing favorable margin trends driven by prior year’s new contract maturities, scale efficiencies in our purchasing and tight SG&A cost management, and which has been helped by moderating inflation. We’re extremely encouraged by what we are seeing in the business and Jim will be reviewing in greater detail shortly. We’re excited to have Jim as Aramark’s newly appointed CFO. As you know, Jim is a 20-year veteran of the company with a proven track record and he’s worked closely with Tom over the past four years. His depth of knowledge about the company across the Board and across borders, having served as CFO for International segment is a tremendous asset in his new role. Tom is also joining us today as he continues to serve as a Trusted Partner and Strategic Advisor to help ensure a seamless transition over the next few months.

Tom leaves a strong legacy that is both broad and deep, focused on accelerating net new business, optimizing supply chain economics, containing above unit cost and instilling a value creating mindset throughout the organization. Our top-line momentum continued in the first quarter with year-over-year organic revenue growth of 13%, which was driven by especially strong base business growth net new business and pricing. A combination of higher sales volume and pricing contributed to the favorable trends that are positively driving the top-line. The U.S. segment increased organic revenue 10% compared to the prior year, starting with Collegiate Hospitality which experienced strong performance in residential dining, retail and catering, as well as improved pricing with the start of the academic year.

We’re having early success with our recently launched Eat to Excel health and wellness program, which is focused on providing student athletes with a balanced nutrition regimen to support peak competitive performance, personalized to each athletes training schedule, goals and biometrics. The dietary recommendation is fully integrated with our Collegiate Hospitality dining program and is easily accessible through a digital app. Sports & Entertainment demonstrated strong per capita spending and high attendance levels from the NFL and NCAA regular seasons along with more concert events. Our culinary team had great success partnering with well-known NFL mom Donna Kelce during the holidays at Lincoln Financial Field and Arrowhead Stadium, adding the famous cookies she makes for her sons in support of the Eagles Autism Foundation and Kansas city-based Operation Breakthrough, a win for everyone involved.

I also want to congratulate the Kansas City Chiefs for reaching this weekend’s Super Bowl. And workplace experience benefited from the startup of significant new client wins and strong base business growth as our services provide a compelling solution for employers, with revenue in this business now fully recovered from pre-COVID levels. International organic revenues increased 21% year-over-year. Performance was driven by consistently strong net new business combined with an active events calendar in Europe, particularly in the UK and Germany, continued strength in education in Canada and greater mining activity in Chile. New business wins at this early stage in the fiscal year have been broad-based across the company. This includes adding Tulane University and Collegiate Hospitality, expanding our services for the European Central Bank in Germany, and more locally being awarded the Philadelphia Zoo among others.

We believe our new business pipeline is robust and we continue to see high retention levels across the client portfolio. Now let me turn to global supply chain. Our overall focus continues to be growing and leveraging spend to generate value for the enterprise, while also providing quality product and services to clients and our customers. We’ve seen inflation moderating over the past quarter, and while some areas of the globe are slower to show this trend, overall inflation is running better than originally expected and the first quarter benefited from this tailwind in improved product costs. We believe the current supply chain landscape presents enormous opportunities and we are actively seeking to take further advantage of this potential, working closely with our manufacturing and distribution partners.

Last week we released our Be Well. Do Well. progress report highlighting our commitments on responsible business practices, specifically on people, which includes enabling equity and wellbeing for millions on the planet, including promoting planetary health on our path to net zero and on governance by assuring robust ethics and compliance in everything we do. We’re proud of our efforts in these areas and encourage you to review this in depth update. Before turning the call over to Jim, I’d also like to welcome Brian DelGhiaccio as our newest member of Aramark’s Board of Directors following our annual meeting last week. Brian is currently Executive Vice President and Chief Financial Officer of Republic Services, a company I know well from my time at Allied Waste.

Brian’s extensive executive experiences will provide valued perspectives, particularly in strategic planning and M&A. I want to also thank Art Winkleblack for his immense contributions to our Board. Art announced his retirement and did not stand for re-election. On behalf of all of us at Aramark, we’re extremely grateful for Art’s service to the company. Jim?

Jim Tarangelo: Thanks John, and good morning, everyone. I wanted to start by thanking Tom for his tremendous leadership and partnership over the past four years. Combined, we have over 50 years of industry experience. It’s been a real pleasure and privilege to be on this transformational journey with you. We look forward to continuing to have you as a Strategic Advisor and wish you well as you transition toward a full retirement in May. We are off to a terrific start in fiscal 2024. The company generated strong financial performance with broad-based revenue and profit growth. In the first quarter, Aramark reported consolidated revenue of $4.4 billion, representing organic growth of 13% versus the prior year period, driven by strong base business growth through a combination of volume and pricing as well as a contribution from net new business.

Both the U.S. and International segments reported double-digit top-line growth in the quarter. Operating income in the first quarter was $167 million, up 10% versus the prior year. Adjusted operating income was $231 million, up 28% on a constant currency basis compared to the same quarter last year. AOI margin was 5.2%, increased 64 basis points year-over-year on a constant currency basis. The higher profitability was from leveraging higher sales volume, disciplined cost management at both unit level P&L and SG&A as well as supply chain efficiencies. We also did experience favorable inflation trends overall, which benefited the quarter. Our results were aided by our innovative yet practical approach to technology. We continued to leverage technology, including most recently utilizing AI throughout our supply chain, to aggregate spend more effectively and get better pricing from our suppliers and manufacturers.

Turning to the business segments, the U.S. reported AOI growth of 19% with an AOI margin improvement of almost 50 basis points compared to the same period last year. Education, B&I, and sports, leisure and corrections all had particularly strong quarters, driven by effectively leveraging higher revenue, especially in our Collegiate Hospitality and correction businesses, from our ability to recover the price inflation lag we’ve previously discussed. On a constant currency basis, the International segment had year-over-year AOI growth of 37% and an AOI margin improvement of 54 basis points, led by the team’s efforts in the UK, Germany and Canada. Turning to the remainder of the income statement, interest expense in the quarter benefited from the $1.5 billion debt repayment associated with the proceeds from the Uniform Services spin transaction.

The $1.5 billion debt repayment will result in interest expense savings of about $100 million in fiscal 2024 compared to the prior year. Our adjusted tax rate was approximately 26%. The quarterly performance resulted in GAAP EPS of $0.11, which included expenses related to the completion of the spin and adjusted EPS of $0.41, an increase of 33% versus the prior year on a constant currency basis. Regarding cash flow, as expected and consistent with our normal first quarter cadence, we experienced a cash outflow due to the natural seasonality of the business, specifically in Collegiate Hospitality and Sports & Entertainment. This increased moderately compared to the first quarter last year due to a higher use of working capital as a result of the strong growth of the business and increased capital expenditures, which is consistent with historic levels as a percentage of revenue.

In addition, we also had the one-time impact of cash taxes paid on our gain on sale from AIM. We’ve taken several strategic and proactive steps to strengthen our balance sheet, resulting in a reduction of our net debt position by more than $2.2 billion compared to the end of the prior year period. This includes debt repayments of $1.5 billion from the spend proceeds and another $630 million from divesting our non-controlling interest in AIM and the San Antonio Spurs. We continue to expect our leverage to be at approximately 3.5x for fiscal 2024 and our debt repayments combined with improved business performance has us on the right path to achieve this goal. This would represent the lowest leverage Aramark has experienced since 2017. At quarter end, the company had over $1 billion in cash availability.

We will continue to opportunistically enhance our capital structure given our financial flexibility. This includes evaluating additional shareholder returns as our leverage ratio comes down. I’ll wrap up with our performance expectations for this fiscal year. We are highly encouraged by what we saw in the first quarter and the continued strength in the business around organic revenue growth, supply chain initiatives and cost discipline combined with inflation moderating. As a result, we are updating our fiscal 2024 outlook for both AOI and adjusted EPS growth to reflect these favorable profitability trends and reaffirming our expectations for organic revenue growth and our leverage targets. With that, we expect organic revenue growth between 7% and 9%, AOI growth between 17% and 20%, adjusted EPS growth between 30% and 35%, and a leverage ratio of approximately 3.5x by the end of the fiscal year as I mentioned.

I’m very pleased with the financial results this quarter. We are confident in the momentum that continues to build across the business. I’ve had the honor to be at Aramark for 20 years of my career. I clearly see in the Aramark of today the unweavering commitment to serve our clients, the energy and focus of our growth teams to win profitable new business and our collective ability to achieve strong, sustainable performance. Our strategy is working and producing great results. Thank you for the time this morning. With that, I’ll turn it back to John.

John Zillmer: Thank you, Jim. The fiscal 2024 now underway, we look ahead with great confidence. The work we’ve done has centered on building a consistent and sustainable business, focused on providing valued hospitality services to our clients. The foundation is set for continued success and we expect our momentum to carry through this year and beyond. I couldn’t be more excited about what’s to come. And 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 Lizzie Dove with Goldman Sachs. Your line is open.

Lizzie Dove: Hi, good morning. Thank you for taking the question. Firstly, I just wanted to wish Jim a big congratulations on the appointment to CFO and this is certainly a great set of results to start with. One main question for me is that you really outperformed pretty much across the Board. I’d point out organic revenue coming in much higher than expected, particularly on the International side. And then, of course, your guidance range being adjusted to the higher end. I’m curious what drove the outperformance in these areas and if you can just provide some more details and color there.

Jim Tarangelo: Sure. Thanks, Lizzie, and appreciate it. Yes, I think if you think about the main drivers of the margin performance, right, it’s really the underlying levers we’ve talked about scale and SG&A, supply chain efficiencies. We’re seeing good results at the middle of P&L with food and labor cost. So I think really primarily the over performance, if you think about the 67 bps, just sort of 50 bps coming from the underlying performance, and then I think inflation moderating probably delivered a little bit of the upside.

Lizzie Dove: Perfect. Thanks so much.

John Zillmer: Thank you.

Operator: Our next question comes from Harry Martin with Bernstein. Your line is open.

Harry Martin: Hi, good morning, everyone. Thanks for taking my question. I guess, I’ll ask the obvious question on the guidance. You did 13% organic growth in the first quarter and kept the guide at 7% to 9%. I mean to hit the bottom end of that range would be quite a slowdown. So I wondered why you didn’t change that guidance and what your expectations are for the rest of the year on organic growth. And then I guess a question for Jim in the presentation in the revenues by segment, you’re now including FM services within the healthcare line, and that line was the spot of weakness down in Q1. I assume that’s related to the next level portfolio actions, but could you just add a little bit of detail on the underlying trend in the healthcare market and how long that next level headwind could last for. Thanks very much.

Jim Tarangelo: Sure, we’ll do. I’ll kick it off on the revenue outlook, so we’re very encouraged by what we saw in the first quarter and the trends we’re seeing with revenue, particularly strong base business growth. It’s still early in the year to make the call on revenue. As you know, the timing of new and loss could affect how we think about revenues going forward. As inflation moderates, obviously price can moderate, having an effect on the top-line as well. And then the base business trends that we’ve seen, they were very strong in the first quarter. I think it’s early to see if those are still sustainable. So with that and some seasonality, that’s why you do see a decline in revenue for the growth for the remainder of the year.

And we’re continuing to keep folks posted with how that progresses. And yes, with respect, we now have our reclassified how we show our healthcare revenue. And with that, you can see, as we’ve previously discussed, some pruning and optimization of our portfolio within next level is a key driver for why you see the revenues being moderately down in that segment.

John Zillmer: Yes, and I’ll just add that still — that’s a segment that we have a very strong level of confidence in going forward and growth opportunity in that segment remains robust. And so we see this as really kind of a temporary restructuring and re-portfolio — re-optimization of the portfolio and then turning back to significant growth going forward.

Harry Martin: Great. Thanks very much.

John Zillmer: Thanks, Harry.

Operator: Our next question comes from Andrew Steinerman with J.P. Morgan. Your line is open.

Andrew Steinerman: When looking at the fiscal year 2024 guide, I want to know what the implied AOI margin range is. I kind of try to calculate it and it’s either 40 to 50 or kind of 30 to 60 depending on how you do the math on revenues and AOI. And I also want to know if there’s been any change of assumption in the food inflation for the fiscal 2024 margin guide.

Jim Tarangelo: Yes, Andrew, this is Jim. So yes, I think the straight math sort of the load on the high right at 17 to 20 would be 43 to 47 bps again that sort of the straight math. If you’re at the sort of the lower end of the revenue range and higher end of the profit range, I think you’re sort of be closer to the 55 to 60 basis points.

Andrew Steinerman: And then I also asked about is there a change of assumption in food inflation in the 2024 margin guide?

Jim Tarangelo: The current guidance reflects how inflation is running today. So the guidance that we provided reflects our current outlook for inflation, and it’s pretty consistent with how it ran in the first quarter.

Andrew Steinerman: Okay. Thank you very much.

Operator: Our next question comes from Shlomo Rosenbaum with Stifel. Your line is open.

Shlomo Rosenbaum: Hi, thank you. Could you talk a little bit about the pricing trends? Just maybe give something quantitative to see where things are and just compare it to the last few quarters to see what the trends are there. And then also maybe you could give a free cash flow range that we should think about in terms of fiscal year 2024. I know that there’s that seasonality, but this is also the first year without the Uniforms business in it. And maybe you could give us some guidance on how to think about those items.

John Zillmer: Sure. This is John. I’ll tackle the pricing question and Jim can tackle free cash flow. First of all, we’re seeing — we’ve largely caught up in terms of pricing. We had the pricing lag in some of the businesses that were contractually bound over the course of the last year, and we’ve seen that pricing catch up. We feel like we’re in very good position from a pricing perspective now and that we’re able to go ahead and recover our cost increases as a result of that pricing. If, in fact, we enter an environment where inflation moderates more aggressively, it may put a little bit of pressure on pricing going forward, but we’re not seeing that currently. So right now it’s a pretty benign pricing environment. We’re able to recover our costs and we’ve caught up on the pricing lag which existed last year in, say, higher education and corrections.

Jim Tarangelo: And on free cash flow, yes, so we had a normal heavy seasonal use, as we always do in the first quarter. I think some of the drivers there additional working capital again due to the growth of the business, so that’s not a bad problem to have capital expenditures up as well, driven by the timing of new, but still in line with our historic averages. And then finally, cash taxes were up about $35 million in the quarter. And as I noted, we paid our cash taxes on the gain of sale of AIM. For the full-year again we’re not providing specific guidance on cash flow. We’re guiding more toward achieving the leverage of 3.5x. I noted the $35 million or so in cash taxes, the one-time part of that being with the AIM gain on sale. And then we have about $20 million to $30 million of addition — of incremental transaction cash costs from the spend that trailed into fiscal 2024.

Shlomo Rosenbaum: Thank you.

Operator: Our next question comes from Jasper Bibb with Truist Securities. Your line is open.

Jasper Bibb: Hey, good morning. Wanted to follow-up on the margin upside, I guess, curious if there’s been any change in what you’re seeing in labor cost inflation. I think your peers indicated that the growth in labor costs was remaining kind of sticky even if the food costs were coming down. So I’m curious if your experience has been similar there.

John Zillmer: Yes. I would say that generally we’re seeing labor costs moderate a touch as well as food costs. Clearly there is less pressure in the labor environment, particularly as it relates to contract workers and the like and the payment of overtime, that’s one of the benefits running through the P&L as our people are managing those middle of the P&L cost structures. There’s been significant improvement on the labor side there. But overall wage inflation, I think our expectations are probably no different than our competitors. Somewhere in the 5% range would probably be kind of an appropriate estimate on a going forward basis.