Aramark

NYSE:ARMK

Earnings Call Transcript 2021-Q2

[Operator]

Good morning, and welcome to Aramark’s Second Quarter 2021 Earnings Results Conference Call. My name is Justin, and I will be your operator for today's call. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are on a listen-only mode. We will open the conference call for questions after conclusions of the company’s remarks.

I will now turn the call over to Felise Kissell, Vice President, Investor Relations and Corporate Affairs. Ms. Kissell. Please proceed.

[Felise Kissell]

Thank you, and welcome to Aramark’s Second Quarter Fiscal ‘21 Earnings Conference Call and Webcast. I hope those listening are doing well. This morning, we will be hearing from our Chief Executive Officer, John Zillmer as well as our Chief Financial Officer, Tom Ondrof. As a reminder, our notice regarding forward-looking statements is included in our release this morning, which can be found on our Web site. 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 and D&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 US GAAP can be found in this morning's press release as well as on our Web site.

So with that, I will now turn the call over to John.

[John Zillmer, Chief Executive Officer]

Thank you, Felise. Good morning, everyone, and thank you for joining us today. The strategic actions we recently executed, combined with our financial results released this morning, reflect our ongoing commitment to drive the business to new heights of success. In a matter of weeks, we've announced an upsized revolving credit facility and debt refinancing, a proactive $500 million debt repayment and an acquisition that creates an additional revenue channel in the rapidly growing senior living industry. This morning, I look forward to reviewing our second quarter performance and discussing the current state of the business as we advance strategies that align with our commitment to deliver value for stakeholders.

The transformation occurring has resulted in newly awarded clients, including Northeast Georgia Hospital and a self op conversion in the B&I sector, with the addition of Corning Inc., a Fortune 500 company and leading innovator in material science. We also expanded our role at the University of Hartford where we earned the facilities business, another self op conversion. With the higher ed selling season underway, we’re extremely pleased to be entering into new agreements with nine universities of the Pennsylvania State System of Higher Education, the largest provider of higher education in the Commonwealth. With these new agreements, we will be serving 11 state-owned colleges and universities within the state system. We're excited by these recent wins and remain highly optimistic about the extensive pipeline of opportunities.

Turning now to the second quarter. Revenue was in line with our expectations articulated in last quarter's earnings call and subsequent disclosures with organic revenue down 26% year-over-year, improving compared to the first quarter and lapping when we began to experience a significant impact from COVID in the prior year. The team's unwavering efforts to thoughtfully reopen client sites throughout the organization led to sequential quarterly revenue improvement across all segments. As sales volumes in the business began to reemerge more meaningfully, we maintained extraordinary cost discipline, effectively managing the AOI drop through rate to 15%, better than our outlook of 18% to 22% and returning to positive operating margins. While we continue to invest in growth oriented resources, AOI performance was driven by improved operating efficiencies. This disciplined approach contributed to strong free cash flow generation of nearly $260 million in the quarter, representing an improvement of over $150 million compared to the prior year. Cash availability totaled $2.6 billion at quarter end, providing the financial flexibility to execute the strategic actions I just articulated, such as enhancing our capital structure and pursuing opportunistic mergers and acquisitions.

I'd now like to review the performance by business segment in the quarter. US Food and Facilities reported solid sequential quarterly improvement with key drivers in each business sector. Education gained momentum as more students entered in person learning environments compared to the fall. In higher education, we're enhancing the on campus experience to offer university communities added stability, flexibility, connection, light mindedness and innovation. Our unique approach to creating a hospitality ecosystem was recently highlighted in Food Management Magazine. In the K-12 sector, approximately 70% of school districts across the US offer greater in person or hybrid learning with the USDA continuing its universal meal program just extended through June of 2022. Sports, Leisure and Corrections improved modestly with the anticipated spring season just underway. In the second quarter, the NBA and NHL introduced fans at partial capacity based on local regulation. Leisure maintained steady performance with solid early attendance at National Parks and Corrections reported year-over-year growth.

In recent weeks, we've seen an encouraging opening of Major League Baseball with our portfolio collectively operating at approximately one third of attendance capacity at this time, and we expect increasing fan counts over the course of the season. We've implemented innovative technology, including self ordering kiosks, mobile ordering, grab and go markets, just to name a few. In Leisure, we are experiencing record reservation demand for the upcoming recreational season. In Business & Industry, additional client locations opened throughout the quarter, while companies adopt evolving return to work strategies. We are experiencing early signs of success in solutions that extend the traditional office setting, including Munch Mail, our home delivery offering, launched last quarter that has already experienced increased online ordering traffic with conversion rates doubling.

Quick Eats, our award winning walk in, walkout digital concept utilizing Artificial Intelligence, is another business offering that is strongly resonating with our clients and has applicability to other areas of the business. Facilities and Other demonstrated success in selling more frequent and comprehensive services as clients remain heavily focused on safety and hygiene, particularly as locations began to increase in person activity. We continue to anticipate particularly heightened demand in this business. Healthcare continued to report gradual improvement as visitor restrictions eased and elective procedures increased. The team has worked tirelessly to create unique automated patient care experiences from the time of admission through discharge that include customized post-care emulation to best serve ongoing dietary needs.

International demonstrated modest improvement quarter-over-quarter, balancing strong performance from health care in China and extractive services in Chile, with government imposed restrictions in other geographies, particularly in Europe and Canada. The team continues to impressively pursue growth, now having won over $150 million in broad based new business since the start of the fiscal year, while simultaneously delivering record retention rates. I'm also extraordinarily pleased to announce the addition of Chris Garside, a seasoned foodservice industry executive, who many of you likely know. Chris joins us next week to lead our international growth strategies.

Uniform reported improvement quarter-over-quarter, while aggressively managing areas of the business that were affected by government imposed restrictions, particularly in Canada. We continue to focus on value enhancing initiatives, including adjacency services expansion, which once again delivered double digit growth in the quarter, strong productivity from investments and growth resources that have resulted in improved retention rates and improved closure rates, and ongoing progress in our ABS integration with this capability enhancing system on track to reach nearly 75% of revenues by year end, with the remaining market centers shortly to follow. These efforts collectively contributed to record high customer satisfaction scores.

In supply chain, we continue to optimize our spend pools and refine our relationships with the right suppliers to provide the best economics and access to innovative products. We are also focused on our commitments to diversed suppliers, local and regional suppliers and sustainability are leveraged. In addition, our simplification efforts with field procurement technology and process optimization are making considerable progress. We launched our employee stock purchase plan to all eligible US employees in early April, with the goal of expanding globally. The program delivered very strong participation in its first enrollment period with over 85% of those enrolled set to become first time Aramark shareholders. This initiative aligns our people, values and performance while reinforcing an ownership mindset within the organization.

Before turning the call over to Tom, I'd like to take a moment to review our recent agreement to acquire Next Level Hospitality announced two weeks ago. Next Level will strategically expand our presence in healthcare within the high growth senior living industry, specializing in skilled nursing and rehabilitation facilities. This provides an opportunity to immediately participate in a largely unpenetrated, highly self operated category with significant untapped potential to best serve this growing demographic. The business commands comparable margins to us, driven by culinary innovation, quality service offerings and client excellence. We know the team extremely well and are excited to work together in driving our combined capabilities and expertise.

Lastly, I would like to share that Jeff Gilliam, who leads our health care division, will retire at the end of this calendar year. I want to thank Jeff for his many contributions to the company. I'm also pleased to welcome Bart Carreker as our President and CEO for Healthcare. Bart is a healthcare veteran with over 20 years of industry experience. Throughout his career, Bart has played an instrumental role in driving significant growth, improving closure rates and building a culture focused on growth. We look forward to Bart's meaningful contributions.

And Tom will now provide a detailed financial review of the business.

[Tom Ondrof, Chief Financial Officer]

Thanks, and good morning, everyone. As John mentioned, during the quarter and specifically over the past few weeks, we continue to execute strategies that strengthen the business, whether it's bringing in new talent, acquiring new businesses, driving operating efficiencies or repaying debt. We are committed to positioning the company for profitable growth and to provide exceptional service to our clients and customers. While our performance remains affected by COVID-19, revenue in the quarter reached over 70% of fiscal '19 levels. Increased business activity throughout the portfolio and strong client retention rates contributed to improved revenue performance across all segments. US Food and Facilities reported an organic revenue decline of 31% in the quarter compared to 45% decline in the first quarter, with all sectors contributing to the improvement, a solid quarter-over-quarter result even as we begin to overlap the effect of COVID that, as a reminder, started towards the end of the second quarter last year.

Progress was led by the education sector, which benefited from greater in person learning and the heightened demand in Facilities and Other from higher frequency of services as well as increased project-oriented activity. International organic revenue was down 26% compared to the prior year, reflecting a modest improvement from the previous quarter. The team continues to tactically navigate government imposed restrictions, particularly in Europe and Canada, while simultaneously driving growth initiatives. We're extremely excited about the addition of Chris Garside, as John mentioned, with extensive background in the industry, who further complement the strong and experienced international team. Organic revenue in Uniforms decreased 9% versus the prior year, a slight improvement over the first quarter. Early signs of accelerated client reopenings from areas of the business that have been heavily impacted by COVID-19 as well as continued growth in revenues from adjacency services were offset by continued lockdowns in Canada and the US West Coast operations.

Adjusted operating income was $30 million in the quarter. Increased sales volume, combined with unit operating efficiencies and above unit cost discipline, led to a positive adjusted operating margin of 1.1% and an AOI drop through of 15% of the corresponding revenue decline. Bottom line performance was better than the previously articulated expectation of an 18% to 22% drop through for the quarter and included continued investment in growth resources and the ABS route system rollout in the Uniform segment. Corporate expenses increased year-over-year, primarily due to higher personnel and benefit costs, including the impact of equity based compensation awards made late last fiscal year, expense related to the rollout of the new employee stock purchase plan, 401(k) company match cost and bonus accrual compared to the same quarter last year. Adjusted EPS was a loss of $0.24. Due to our proactive $1.1 billion debt repayment of our US revolver and receivables facility, interest expense in the second quarter was $4 million less than in the first quarter. On a GAAP basis, Aramark reported revenue of $2.8 billion, operating income of $5 million and a diluted loss per share of $0.30.

Now let me turn to cash flow. Through positive operating income performance as well as effective management of working capital and capital expenditures, the company generated $259 million in free cash flow during the quarter, reflecting $151 million improvement compared to the prior year period. Note that the quarter included $94 million federal income tax refund due to NOL carrybacks in fiscal 2020 associated with the CARES Act. Smaller crew expenses within the SME business and lower deferred income payments within Higher Ed also contributed to the favorable year-over-year free cash flow result. In addition, we continue to participate in the appropriate country specific government assistance programs, including benefits from the CARES Act in the US. Through these global programs, we received approximately $42 million of labor credits in the second quarter to offset the costs we incurred globally related to the retention of employees and for absorbing 100% of the benefit costs associated with furloughed employees.

We will continue to pursue opportunities to optimize the available stimulus programs as appropriate. Strong free cash flow performance resulted in cash availability of $2.6 billion at quarter end. Consequently, we made strategic use of capital to advance our priorities and included debt repayment as well as refinancing to extend maturities and executing an upsized revolver. Collectively, the actions taken on capital structure will reduce net annual interest expense by over $14 million, of which approximately $4 million of that savings will benefit the remainder of the year. Going forward, we will continue to look at additional deleveraging opportunities, but balance that with the disciplined use of capital investment to facilitate new business wins and drive results in existing client accounts as well as pursue selective accretive M&A.

On the topic of mergers and acquisitions, I want to share additional insight regarding our recent announcement of an agreement to acquire Next Level Hospitality. Founded less than five years ago, this business has quickly grown to over $160 million in annual revenues, highlighting the growth potential in the $16 billion highly underpenetrated senior living industry. New contracts require minimal start up costs and have a strong profitability ramp. The business has generated high single digit operating margins and is focused on providing a premier culinary experience and high quality environmental services. Next Level will continue to be run separately under its own brand, but we will leverage the full scale of Aramark's resources where appropriate to help accelerate the business' growth. We expect Next Level to be accretive to Aramark's earnings by early fiscal '22, and the deal is expected to close later this quarter, subject to customary closing conditions and regulatory approval. We continued our commitment to return value to shareholders with the announcement this morning of our quarterly dividend of $0.11 per share payable on June 9th to shareholders of record on May 26th.

And finally, let me wrap up with an update of our view of the second half of the fiscal year, appreciating the pace and exact timing of recovery is evolving. We are encouraged by the current momentum of the business, and we'll continue to leverage our resilient variable cost operating model, while maintaining a growth oriented long term mindset. Based on our current expectations, we anticipate continued organic revenue improvement over the course of the fiscal year, adjusted operating income margin of 4% to 4.5% in the second half of the fiscal year with incremental quarterly progression and free cash flow of neutral to $250 million for fiscal 2021 depending on the timing of underlying revenue recovery raised by $50 million on the top end of the range. This will include efficiently managing working capital and CapEx investments associated with reemerging business activity and the pipeline of the new opportunities we have in front of us.

Thanks for your time this morning. Now I'll turn the call back over to John.

[John Zillmer, Chief Executive Officer]

Thank you, Tom. Before taking questions, I want to reiterate that the actions we are currently undertaking not only position Aramark as a key enabler in the broader recovery, but also provide a strong platform to drive long term sustainable growth and success. The immense opportunities that originally brought me back to the company are materializing, led by our vision to be the most admired employer and trusted hospitality partner, a company that's rooted in service to do great things for our people, partners, communities and plan. Thank you very much for your time this morning.

Operator, we'll now open the call for questions.

[Operator]

[Operator Instructions] And first online with a question is Kevin McVeigh from Credit Suisse.

[Kevin McVeigh, Credit Suisse]

I guess this would be for John or Tom. Obviously, really, really good results. As I've always thought about Aramark part of our really encouraging thesis was the potential to accelerate the organic growth, given some of the balance sheet actions, obviously, coupled with Next Level, things like that. How should we think about the potential to accelerate the organic growth and even coming out of COVID, it seems like clearly you're going to be a share gainer. So any thoughts on accelerating organic growth, I guess, even within the context of kind of the 2 to 4, how should we think about that longer term?

[Tom Ondrof, Chief Financial Officer]

Well, I mean, we're -- I think, Kevin, I understand the question. We are trying to get ourselves in a position where we've got flexibility. We want to pursue organic growth and have the capital available to do that where it's needed. We want to be able to reinvest in our sales force and training and the number of people that we have out there. So I think we're taking a balanced approach when we look at how our balance sheet is fixed, we'll supplement with what we’ve done with Next Level, some opportunistic and strategic M&A. And so again, provide that flexibility for us so that we don't miss opportunities that are in front of us.

[John Zillmer, Chief Executive Officer]

And I'll add that all the investments we've made over the last -- even during COVID over the last 12 to 18 months have been focused on organic growth. The additional sales resources in both the foodservice sector as well as the uniform sector, the additional leadership development activities, the leadership additions to the company, have all been focused on creating a growth environment and really focusing on that as a key aspect of company's value creation proposition. We see organic growth as a key to our future success. We're making those investments because we believe in it and we're enjoying significant results as a result of that investment, with key new wins that we've described over the course of the last year and significant opportunities with a very robust pipeline. We're very encouraged by our organic growth on both the foodservice and the uniform side as well.

[Kevin McVeigh, Credit Suisse]

And then maybe a comment just on the dynamics of the facilities and other business across the other end markets. I guess just are you seeing more linkage between education, sports leisure, business and industry and then ultimately, health care post COVID, again, more linkage across facilities from a cross sell perspective, and how should we think about that just relative to the Uniform business as well?

[John Zillmer, Chief Executive Officer]

We are absolutely seeing higher levels of activity in the facilities services area across multiple segments with increased outsourcing taking place in B&I, higher ed, healthcare and the like. So we are experiencing that very strong demand, as we mentioned in the script, for those services as companies come back and increasing in person activity in those locations. So it is touching all the various business units. And we're very encouraged by that activity of the business. That particular business has performed very well during the pandemic throughout and we expect it to continue to have very strong growth prospects going forward. Additionally, on the Uniform side, we're seeing additional requirements for cleaning and sanitation services as well in the ancillary or adjacency services offerings that we bring to bear. And so we believe that, that will continue to have an impact on the growth rate for AUS.

[Operator]

And our next question comes from Richard Clarke from Bernstein.

[Richard Clarke, Bernstein]

Congratulations on the good set of numbers today. Just as a starter here. Just wondering you're talking about incremental performance improvement through the rest of the year, whether you can give a sense of how the quarter looked, maybe how April has looked and how you're looking into the early bits of May in terms of your organic growth and where maybe you're seeing that incremental improvement to this stage?

[Tom Ondrof, Chief Financial Officer]

Well, the improvement is, as we said, fairly consistently across the board. We're pleased by that. Everybody is moving forward. April continues to trend. We're just looking at those numbers literally as we speak, and we don't see anything different at the moment that would cause us to not continue to move forward in the manner that it's been going for the last couple of quarters. So we're encouraged by that. Looking further than that, I don't know yet. Again, we're staying cautious and prepared for whichever way things move. We're certainly prepared to reopen at a pace if it accelerates. So we're encouraged by the trend at the moment than what we've seen in April, but still not quite, to say that things are going to reopen at a fast pace yet.

[Richard Clarke, Bernstein]

Maybe just a follow-up and probably related to that. You've raised the top end of your free cash flow guidance, but kept the bottom the same as it was before or flat, quite unusual, I guess, to widen a range with 1 more quarter of information. Are there scenarios? And maybe you can talk about what might drive you towards the lower end of that range or are you expecting to sort of be trending towards more the higher end?

[Tom Ondrof, Chief Financial Officer]

It's a good question, we did talk about that a bit. And I think in full transparency, there's a couple of scenarios that put us on each end. The low end is really is that scenario where things progress reasonably throughout the summer and then there's a bit of a sharp reopening rate at the end of the year. So there would be a working capital outlay to really reopen the NFL stadiums coming back full, higher ed coming back full and sort of that push right there at the end of the fiscal, that would create a work capital outflow to prep but not have the benefit of the revenues and profitability in the year. So really just a timing issue. That scenario, the upper end of the scenario, which is our bias at this point, is a more linear and continued reopening as we've seen over the last couple of quarters.

[John Zillmer, Chief Executive Officer]

I would just add a couple of comments on the original part of your question as well, and that is that the pace of recovery, we are prepared to advance the ball regardless of what happens. And I think we've been able to demonstrate over the course of the last year that the management team can quickly respond to a changing environment. And so if the pace of recovery accelerates, we'll be well positioned to take advantage of that. It really will be driven by our clients’ interactions and decision-making with respect to how fast they bring back employees or associates, and it will also be driven by rates of vaccination and rates of improvement in the Sports & Entertainment sector. So we're well positioned. We see, as many do, we see some light at the end of the tunnel. A little bit early yet to make the call in terms of how that will unfold over the course of the next few months, but we're excited by the opportunity in front of us.

[Operator]

And our next question comes from Ian Zaffino from Oppenheimer.

[Ian Zaffino, Oppenheimer]

Very good quarter, very good performance. Wanted to just maybe sense upon on higher ed. I know you had a big win there. Just walk us through how competitive was it, what was your competitive advantage in that win? And I believe you've been hiring a bunch in higher ed and education. So is that sort of one of the fruits of the move there, or how should we be thinking about that?

[John Zillmer, Chief Executive Officer]

We are certainly encouraged by our selling season in higher education. I think our operating team is doing a great job, and the sales team doing an extraordinary job of building on the pipeline and the opportunities that are coming to the market. That particular win, I think all of the business success that we typically enjoy across the range of businesses is because we have developed a proposal and a customized solution that fits the needs of that particular customer. And so in the case of the patchy win, I think our team demonstrated to the Pennsylvania system that we understood their needs, and very effectively that we've had a strong partnership in the past and some of the universities that we had already served. And so the result of that, both very good performance as well as, I think, an extraordinary proposal resulted in their selecting Aramark for that win. So we're always focused on the quality of the solution, the customization and the solution set that best fits that customer’s needs. And that's what typically drives our wins, not only in higher education, but across our various businesses. And so yes, we are out there in the market. We strongly believe that we're going to have a very strong selling season and a very strong fall as businesses continue to reopen and higher education reopens fully. And so we are out there hiring people very, very rapidly.

[Ian Zaffino, Oppenheimer]

And then maybe a question for Tom. How should we be thinking about inflation, labor, labor availability or shortages and maybe what you're seeing there?

[Tom Ondrof, Chief Financial Officer]

It certainly is top of mind right now for all of us. On the food side, as you know, the model is such that we're able to flex menus and move through certain -- inflation issues on certain products. So we'll leave that to the units and to our supply chain to get opportunity buys and really create menus that help mitigate that for us and for our clients. Contractually, in many cases, we're able to pass that on, particularly in this environment, more of a cost [loss] based environment. Same thing on labor, probably a little bit more pressure. But as I've said before, it's the one certainty, in my 20 plus years in the industry, is there's labor inflation, labor pressure. So it's not anything we haven't dealt with. But we do see opportunity or opportunities to mitigate those costs, but also we'll feel the labor pressures over the next couple of quarters as things settle down. But we'll manage through that both in the way we schedule the way we hire, the way we reopen and then again, ultimately, through contractual rights.

[Operator]

And our next question comes from Jaafar Mestari from Exane BNP.

[Jaafar Mestari, Exane BNP]

It looks like you're going to deliver H2 margins in line with what global peers expect to do, maybe even a bit ahead. So I just wanted to maybe go back to Q1 and Q2, where I think it's fair to say you were behind peers in terms of operating margins, let's call your margin broadly breakeven. And you said previously that you could have been higher, but you chose to invest in the business. So I'm curious if you're now able to quantify the investments you made into the business over the last six months in dollar terms and help us understand how you're thinking about the ROI on those investments, things like the route accounting system, the new sales team members in both divisions, et cetera? How much was it in total and how does it eventually all pay for itself?

[Tom Ondrof, Chief Financial Officer]

Yes, that's a level of granularity probably not willing to go into. But certainly, the cost effect is, as you've mentioned. And we've been very resolved through the past year to continue on with the investment, as John mentioned, primarily with sales, both in uniforms and food facilities, we're building that capability as we go further along in uniforms started a little earlier and then in certain productivity areas like the ABS investment. We'll reap the benefits of that over certainly the quarter we are and we'll continue to, of course, over next couple of years and beyond. So we feel very comfortable with the return on investment that we'll get from it. And again, we're very committed to it. Both John and I have seen the model work and are confident that we can deliver this year too.

[John Zillmer, Chief Executive Officer]

I would just add, we've been very consistent in terms of our discussion with respect to these investments that we've made over a period of time, beginning even last year with the additional salespeople added in Food and Support Services, and we continue to make strategic investments in terms of adding additional salespeople, additional sales resources and capabilities. And so we're taking a very disciplined approach. I think you're beginning to see -- as you saw in this quarter, you're beginning to see that the improvement in -- we're seeing record retention rates across the enterprise, not only in food but also in Uniform Services. Those are a direct result of the investments in those areas. And so I think the long term payback for those investments is quickly becoming evident and we're continuing to be disciplined from a cost management perspective, but we're focused on the long term growth of this enterprise as being the real driver of long term shareholder value creation. And so we're disciplined but focused and we'll continue to be.

[Jaafar Mestari, Exane BNP]

And I guess as a follow-up, you're seeing the results of those investments on the new business side, and you've mentioned a few of those wins. But just for the sake of transparency, could you talk about any contract losses that we need to be aware of? I see that Compass will be operating at Central Michigan University from June. So that's one sort of huge one, but that's one that's going away. So maybe just the other side of the net new business picture.

[John Zillmer, Chief Executive Officer]

Well, I would tell you that we're not going to talk about specific losses, although, you mentioned one that's obviously one that we're not happy about losing, but that does happen in our business as it does for our competitors. Some of our recent wins have come from them as well. But I will tell you that we are enjoying record high retention rates across the enterprise in Food and Support Services, as well as in Uniform Services. So I think the net new numbers will bear that out as we close the year. We're obviously in the midst of the selling season. So hard to say what the actual number will be at year end, but we're very encouraged by the results year to date and where we're positioned, and the wins we've been able to recognize so far. So we're very, very pleased with the net-net result.

[Operator]

And our next question comes from Stephen Grambling from Goldman Sachs.

[Stephen Grambling, Goldman Sachs]

On the senior living side, some of your peers have been in this segment for a while with some success. What are the competitive barriers to entry as you contemplated the acquisition versus perhaps building something yourself and what are the biggest benefits Aramark brings to the transaction?

[John Zillmer, Chief Executive Officer]

Well, first of all, this is a very underpenetrated segment. And obviously, there's $16 billion worth of revenue potential in this sector. It's an area where we haven't participated for many years. We were not focused on that segment. And frankly, our larger competitors haven't really been focused on this segment either. They have relatively small positions in it as well. Next Level was very attractive because of the quality of the management team, the organization that they have been able to build in a very short period of time and their focus on a high end culinary solution in a segment that traditionally didn't have that as a solution. So they've been able to grow the business very, very rapidly by offering a great combination of management talent as well as culinary capability. And that's why we've selected to operate that brand independently.

Next Level management team will continue that growth focus and we're excited about those prospects. Really, it's an area that we believe we can compete very aggressively in and grow very rapidly, and that it does have significant self op conversion potential. And the business is much more oriented towards systems kind of sales now than it has been historically. Instead of one off facility sales, there are system sales with large chunky opportunities. So that's what attracted us not only to the sector but to max level as a company, mostly the quality of the management team and the significant growth potential that's there in that segment.

[Tom Ondrof, Chief Financial Officer]

If I could add in terms of what Aramark brings to the table and why I think it was exciting for both Next Level and ourselves is besides the obvious a benefit as they continue to grow. You get to that point in time where you're going to have to add a lot of administrative support we’re having to do that, they can leverage our base. We bring procurement opportunities for them, of course. So those are the two basic sort of blocking and tackling benefits. But I think there's also a culinary innovation and level of resource that we bring that we can add to what they've already brought to the industry, and then facility technology. We've got a very advanced group and advanced set of technologies in our cleaning and environmental services, and we'll pair that up with theirs and hopefully make both better and advance those. So I think there's some good overlap even though they will be run under their own brand. We'll, again, very thoughtfully put together the businesses in the right ways and the right timing.

[Stephen Grambling, Goldman Sachs]

And then maybe a follow-up for you, Tom. You gave a number of items the quarter and year-to-date on free cash flow that were impacting the numbers that were reported. As you've raised the top end of the expected range for the year, how much of that is incremental confidence in the business versus upside in the quarter from some of the factors that you cited?

[Tom Ondrof, Chief Financial Officer]

It's a bit of both. So certainly, some of the factors I mentioned have helped to the upside. But I think the business is also operating very effectively and efficiently and just core working capital, receivables, payables, inventory, which has lifted some confidence in our range as we move through the first half of the year.

[Operator]

And our next question comes from Andrew Steinerman from JPMorgan.

[Andrew Steinerman, JPMorgan]

I just wanted to talk a little bit about the operating efficiencies that you have invested against, those are things like the supply chain enhancement, the systems upgrades and other operating efficiencies. I was wondering if you’d be willing to quantify what level of revenue Aramark has to reachieve to return to the pre-COVID operating margins Aramark had at the time?

[Tom Ondrof, Chief Financial Officer]

I'd say less, and I'll stand by that. How much less? Not quite ready to put a number on it, but certainly less. We’ll get to our pre-COVID margin before we get back to the $16 billion-ish revenue level.

[Andrew Steinerman, JPMorgan]

And maybe just one more comment. Obviously, the system upgrade, which is within the Uniform business. When you get back to prior peak revenues on Uniform, where do you feel like the margin trajectory is going for Uniform?

[John Zillmer, Chief Executive Officer]

Andrew, I think we've consistently talked about significant margin improvement as a result of the ABS implementation. And we expect that as we complete that implementation that the margin trajectory will be significantly improved. We've talked in the past about a couple of hundred basis points of margin improvement as a result of that implementation coming from a variety of areas. We don't see anything during this rollout that leads us to change that to lower that expectation. So we believe that we'll have very strong margin improvement as a result of both the ABS implementation as well as the secondary benefits that come from that by improving retention rates and improving closure rates on new account wins.

[Operator]

And our next question comes from James Ainley from Citi.

[James Ainley, Citi]

I just wanted to pick up on the comments that you made earlier about very high levels of retention, please. It feels a bit that the industry has seen some stalling of processes over the last year, and that's helped support retention. Are you now seeing evidence that those processes are being kick started and hence, why you're starting to see some more new wins coming through? And is that the kind of driver of those new wins from here?

[John Zillmer, Chief Executive Officer]

I would say the level of new account activity is back to pretty much normal pace. The companies that had deferred decisions have gone back into the mode of going ahead and going through bid processes, but we've enjoyed very strong proactive retention efforts throughout our business. And we're seeing a lot of proactive renewals of contracts in the organization. So I would say it's a combination of two things: improved retention has come as a result of that proactive effort as well as the recognition of many organizations of the quality of the job that Aramark had done during both pre and during the pandemic. So I think that's driving retention more than anything else. But we are seeing increased activity across the various business units in terms of bid processes. The pipeline is very active across all segments, both domestically as well as internationally.

[James Ainley, Citi]

And maybe as a follow-up, could I ask you maybe some similar color on the M&A pipeline. I think there's some thoughts that earlier on in the pandemic, there may be some opportunities to pick up distressed operators. Are you seeing that or is that kind of faded and how competitive are the bidding processes in M&A transactions?

[John Zillmer, Chief Executive Officer]

I would say that early on, there were a couple of opportunities to look at companies that were -- rather use a term distressed, I would say, look at companies that were looking for strategic partners. And we passed on several of those opportunities because it wasn't a good business fit. It wasn't a strategic extension of capabilities for us. And in some cases, those companies had, what I would characterize as, low margin profiles in certain sectors. So we did look at some opportunities. I would say that, that has been relatively quiet. The kinds of opportunities we're looking for are really strategic extensions into markets that represent both new opportunities from a self-op conversion perspective as well as kind of capability and service extension opportunities in our core business. So we do have a very active pipeline of opportunities that we're always considering, but we will be very disciplined. M&A is not our primary growth strategy, organic growth is our primary strategy. So we'll be opportunistic but we'll also be very selective in terms of those things that we pursue.

[Operator]

And our next question comes from Manav Patnaik from Barclays.

[Manav Patnaik, Barclays]

I was just hoping the 4% to 4.5% AOI margin you have, what kind of drop through have you baked into that number?

[Tom Ondrof, Chief Financial Officer]

Now that we're coming into the other side of COVID, we're obviously moving away from that as a benchmark or a metric on the upside. So I never really looked at it from that angle. We're looking at margin now back to sort of the traditional healthy upside way to look at the business.

[Manav Patnaik, Barclays]

And then just on the free cash flow, I apologize if I missed this, but how much was the CARES Act kind of tax benefit, either this quarter or what's baked into the year? And if you should think about that kind of rolling off the following year or how we should try and do that?

[Tom Ondrof, Chief Financial Officer]

So the CARES Act, we've got two major things going on, one is the reimbursement of carried costs for furloughed employees and government reimbursements internationally. Those are offsetting, so they're not a help or hurt this year, they're just there to offset cost carry cost. So it won't be a detriment next year. The NOL carryforward, the refund that we received for that through the CARES Act wasn’t cash flow benefit this quarter and this year, which we will not have next year, which is one of the reasons we don't want to call that out.

[Operator]

And our next question comes from Shlomo Rosenbaum from Stifel.

[Shlomo Rosenbaum, Stifel]

My first question has to do with kind of the new wins and the prospects in the coming quarters. John, you talked in the past about some of the no programmers becoming programmers. And can you talk a little bit about what we should expect over the summer? Because we're coming into a pretty big sales season particularly in higher edge. Should we see a lot more of that kind of coming through and really validating and illustrating that the pandemic net-net is going to be a benefit for the industry in Aramark, in particular?

[John Zillmer, Chief Executive Officer]

I would say we are seeing significant self-op conversions in multiple business segments, both in facilities, in B&I, in higher ed. There are -- we're seeing that. And we've got some -- we're working on some opportunities today that are very nontraditional in nature, which I really can't disclose because of the strategic value of those opportunities. So I would say, yes, we do see an increasing trend towards outsourcing. We do see that evidenced in both of our wins so far this year. Corning, for example, one of the last really big self op B&I opportunities was a great win for the B&I team and again, on the facility side. So yes. As the short answer, we are seeing more self op conversion and we expect it to continue.

[Shlomo Rosenbaum, Stifel]

And then can you talk a little bit about what you're hearing from the higher education clients of yours in terms of their plans for reopening in the fall? What are they looking at right now? What kind of visibility are they expecting? How much more in person are you really expecting to see any material hybrid? How should we think about that?

[John Zillmer, Chief Executive Officer]

I would say we are anticipating a very robust fall season with virtually all universities being in person on site, and the discussions have been very pointed with respect to their intentions. I would say that you never know, things could evolve over the course of the summer. But if we continue to see the trajectory of improvement in vaccination rates, in lowering of infection rates, et cetera, I think you'll see a very robust higher education season and, frankly, a back to school environment in the K-12 sector as well. So all of our conversations lead us to believe that, that will likely be the case. And in some institutions, they're actually projecting housing shortages based on very high student demand for in person opportunities. So I would say we expect a full higher ed season come fall.

[Operator]

And our next question comes from Toni Kaplan from Morgan Stanley.

[Toni Kaplan, Morgan Stanley]

I was hoping you could give a little bit more color on what's going on with Uniform. Your growth was pretty similar to the last two quarters and meanwhile, some of the public competitors have been improving. You mentioned the government imposed restrictions in Canada. But just help us understand if you think that you're losing share or if that's not the case, and whether you think it will improve through the year?

[John Zillmer, Chief Executive Officer]

No, I would say we're definitely not losing share. In fact, I would say, based on the level of new closures and the very high retention rates that we are maintaining or improving share in large part, I think there are two phenomenon that are occurring that caused that variation, one of which is the geographic presence in Canada. In our orientation in terms of the West Coast, as you know, the restrictions in California have been very strict. And so that business has been slower to respond. So I think our geographic orientation has been part of the issue in terms of the comp as well as our focus on hospitality and linen in the hospitality sector, both domestically and in Canada. So are those two issues really account for the vast majority of the difference.

And as we see the business, as we see restrictions ease, we can see the rate of sales and the rate of average weekly rental volumes tick up almost instantaneously. So as the state of California normalizes, we'll see significant improvement there. And Canada is the same way. It's been very restrictive in Canada. So our business operations there are working very, very hard just to maintain the level of service and the sales that they have. So I would say those are the two reasons. And we do a very deep dive operating review in the business literally every month. And as we walk through the data, as we look through the data, those are the two areas that are evident to us.

[Toni Kaplan, Morgan Stanley]

And earlier in the call, you mentioned that the Quick Eats program was resonating with clients and that there were some aspects applicable to other areas of the business. I was hoping you could just expand on what those might be? What opportunities you could get from that?

[John Zillmer, Chief Executive Officer]

Really Quick Eats is a hybrid artificially intelligent concept where you literally walk in the room and you select products off the shelf and you walk out and you're billed automatically to your credit card. So it's a contactless environment. Many employers look at that as being a very significant addition to their potential convenience store strategy, and that has applicability across all of our business units. It's one that is pretty exciting. It was award winning last year, and we were very excited about the implementation of that concept. And that really is a touchless solution that people really respond very positively to.

[Operator]

And our next question comes from Hamzah Mazari from Jefferies.

[Mario Cortellacci, Jefferies]

This is Mario Cortellacci filling in for Hamzah. I'm sorry if I missed this earlier on the call, but could you just talk about your mix of cost plus versus P&L contracts and what that looks like today? And then maybe even going forward, should we expect that mix to stay pretty consistent? And then I guess just for reference, just remind us of how that's changed versus pre-COVID?

[John Zillmer, Chief Executive Officer]

If you think back to our previous discussions, the mix of cost-plus contracts changed dramatically as a result of the implementation particularly in the B&I sector, so that type of contract. We haven't seen a significant shift back towards P&L. We do anticipate that as companies come back and reach and have their employees back in operations, that we will transition those contracts over time. But today, I would say there hasn't really been a significant shift. We're still operating at very high levels and fee agreements or cost plus agreements in the B&I sector. In the other businesses, higher education, we've transitioned back to our normal agreements under most circumstances. So it's really more of a B&I phenomenon than anything else, and that will take time to convert as employees come back into their work environments.

[Mario Cortellacci, Jefferies]

And then my follow-up is on -- just a turnaround. You talked about the investments that you made over the past few months and years, and I know you're not quantifying the exact amount that you're investing. But maybe you can just give us a sense for what inning you're in, in the US core FSS business? And then maybe how much you think COVID has matched the work that you've been doing underneath the hood? And then are there any milestones that we should expect at least over the next year or two in that turnaround?

[John Zillmer, Chief Executive Officer]

Yes, I would say, well, certainly, COVID has masked the impact of the work that's been done. We continue to invest in people and in resources in order to accelerate the organic growth rate across all the businesses. And so each of the business units has developed a three year plan with respect to growth expectations. They're working through those three year plans. There is phased investment in each of the years. And we're working very aggressively to go ahead and achieve those individualized plans that the business units have put together. So we won't quantify the dollar amount, but I would tell you, it is a significant investment on the part of the company. You'll see it in the earnings over the course of time as we continue to grow the business and accelerate the growth rate. And the returns, every time we add resources, we have a high expectation for those to return to profitability and to improve the ROIC in the businesses. So it's a disciplined approach. It's a measured approach. It's a multiyear approach, and we're very happy with what we've been able to achieve so far. And it will become more and more evident as COVID recedes and you see the new account wins and the retention rates continue to rise.

[Tom Ondrof, Chief Financial Officer]

Just to add in to your latter part of your question is, the lift was heavier in uniforms in terms of what needed to be invested in, both the growth and productivity initiatives. So we're probably fifth, sixth inning there. We did start earlier. On the food and facility side, primarily focused on the growth investments, probably third inning, fourth inning. I mean we're making good progress, but we've got a ways to go. And we're excited about that and the benefits to follow.

[Operator]

And our next question comes from Stuart Gordon from Berenberg.

[Stuart Gordon, Berenberg]

Just going back to the margin guidance, and I appreciate the comments that you're moving more towards thinking of the absolute margin. But I mean if we just look at where consensus sits in revenues for the second half of at $6.4 billion. It's going to imply a drop through to get that margin of between 6% and 9%, which is a pretty meaningful step change there. And so given that it's already pretty strong at 15%, is either that or you're beginning to see a reason to believe that the recovery comes much, much faster than it's currently anticipated by the market. So just wondering if you could give us some color on that? And whether there's any other moving parts in the second half that's going to make that drop through look so much better to give you the 4% to 4.5% margin?

[Tom Ondrof, Chief Financial Officer]

Stuart, like I said, I haven't spent a lot of time, and I'm happy to be getting off drop through rate as a metric, given that we're back in the positive territory. So I've been looking, as I said, more of the absolute margin. We feel comfortable with the 4% to 4.5%. Again, slightly revenue dependent. But as we talked about before, as long as we continue to progress at the rate we have seen over the last two or three quarters, again, April is in line with that expectation, we feel good about hitting that range. We don't expect to need an accelerated recovery in the second half of the year to achieve it. So I think that's probably the best color I can give you at the moment. It's not that that margin rate isn't dependent on anything different than we've seen over the past few quarters from the [mortgage].

[Operator]

And our last question comes from Gary Bisbee from Bank of America.

[Gary Bisbee, Bank of America]

A lot of comments and optimism around new business trends, and I realized the selling season is still ongoing. But if we just take a step back and look at the last year of wins, of which there have been many you've called out. How does this compare to at least selling season to date to a pre-pandemic year, are you ahead, is it in line, and is that a win given the environment or just how would you think about that? And then the second part of the question, given the success with the self op conversions, is there any risk that the whole industry, which is talking about that being a very positive trend today, is sort of pulling forward some of the future demand potential as a difficult environment led more than the normal level of people to make that decision? Any thoughts on either would be helpful.

[Tom Ondrof, Chief Financial Officer]

It's interesting the way you phrased the question because it's very accurate. It's probably in line that the new business is probably in line with past years, which is a win in the environment because, as John referred to, a lot of processes have been paused for the last year or so. So that sort of went in and of itself, and a testament to the teams we have in place and the growth culture that Jean reinstituted here over the last 18 months. So we think we then leverage off that as the RFP processes get back more to a normal cadence.

[John Zillmer, Chief Executive Officer]

It's hard to say how much of this business is pulled forward. And there's certainly a heightened level of activity from a self op conversion perspective and many companies who never considered it evaluating it as a possibility. But I would say the market is so big and there are so many opportunities, I don't really see it as a detriment to future years in terms of opportunity. It might change the percentage of where the business comes from in any given year, but I would tell you that there are plenty of pipeline opportunities that are not self op that are really customers who are already outsourced looking to improve the quality of their services from other providers. So I don't know that pulling it forward is something that I would be concerned about.

[Tom Ondrof, Chief Financial Officer]

And we talked about this before, Gary, that we don't see it in prior -- nothing comparable to what we've seen last year. But in other instances, whether it was '08, '09 or 9/11, SARs, all that before, there was always a little uptick in the move to outsourcing out of those. And we're seeing that start to play out here where there's not some massive rush, it's an uptick as people look at it more because it's to get a very emotional decision to go and to outsource, and that still tends to hold people back and them getting comfortable with the whole process. So the impression, there's this mass rush to outsourcing. It's as we think and hope and it anticipated, it's a nice bump up and that against the big runway that we have in this industry, it's a nice place to be but it's not sacrificing long term growth.

[Operator]

I would now like to turn the call back over to Mr. Zillmer for closing remarks.

[John Zillmer, Chief Executive Officer]

Again, thank you all for joining us this morning. Really appreciate the interest and the questions, and look forward to the opportunity to chat further as the days unfold. As I said, we are very encouraged by the results of the quarter. And I want to say thank you to all those Aramark associates around the world. Just last week, we had our Employee Appreciation Day, and the senior leadership team took the opportunity to express our gratitude towards the entire organization. And so again, I want to say thank you to all of the people of Aramark for your hard work and great effort and your love for this company. So thank you very much.

[Operator]

Thank you for participating. This concludes today's conference call. You may now disconnect.