Aramark

NYSE:ARMK

Earnings Call Transcript 2022-Q2

[Operator]

Good morning and welcome to Aramark Second Quarter 2022 Earnings Results Conference Call.

My name is Josh, and I'll be your operator for today's call. At this time, I'd like to inform you that this conference is being recorded for rebroadcast and that all participant lines are in a listen-only mode. We will open the conference call for questions at the conclusion 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, VP of IR and Corporate Affairs]

Thank you and welcome to Aramark's second quarter fiscal '22 earnings conference call and webcast. We also look forward to reviewing the plan to separate the uniform Services business into an independent publicly traded company announced this morning.

You'll be hearing from our CEO, John Zillmer; as well as our CFO, Tom Ondrof. As a reminder, our notice regarding forward-looking statements is included in our press releases 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, MD&A and other sections of our annual report on Form 10-K and 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.

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

[John Zillmer, CEO]

Thanks, Felise. It's good to be with all of you during this transformative time in Aramark's history. While we continue to build on the operational changes we've made over the past 2.5 years to drive a client-focused growth mindset throughout the business, we are also excited about our plan announced this morning, to separate Aramark Uniform Services, or AUS, into an independent publicly traded company. AUS is a terrific business that is well poised for continued success, and one that I believe will thrive as a separate company under Kim Scott's leadership.

Clearly, there is a lot to cover today and to ensure we wrap up in our usual timeframe, I will briefly highlight the key takeaways from our second quarter results and provide an update on the current state of the business. Tom will then share his financial perspective on the quarter as well as performance expectations for the remainder of the year. We'll use the final portion of the call to review the planned spin-off and open the line for your questions.

Our performance in the second quarter demonstrated the strong foundation we have built and the resilience of the business as organic revenue increased 35% year-over-year and surpassed 95% of the corresponding pre-COVID fiscal '19 levels.

The progress on the top line came from all three segments, and continued to be driven by the COVID index-based recovery, pricing pass-through to help offset the impact of inflation and contributions from last year's strong net new business as well as the start-up of this year's net new business, which is on pace for another record year.

Our teams remain focused on working closely with clients to effectively manage through this higher inflationary period and tighter labor market. While we're seeing an improvement in hiring availability and supply chain resources, the war in Ukraine is creating added supply chain complexities globally, which we're working to navigate even though we have no operations in the region. We continue to actively utilize our scale, our deep bench of suppliers and menu engineering flexibility to help moderate the inflationary impact in the business.

We have been opportunistic over the past year in selectively pursuing accretive tuck-in acquisitions and partnerships that we believe align with our mission and expand our capabilities. Most recently, we signed an agreement to acquire Union Supply Group, a commissary goods and services supplier with a strong infrastructure of distribution centers and warehouses that will serve as a resource for our U.S. food business primarily in corrections. Union Supply generated approximately $250 million in revenues last year. The acquisition is expected to close in the third quarter, subject to customary closing conditions and regulatory approvals.

As we enter the second half of this fiscal year, we will continue to execute on our strategic priorities. As an organization, we are rooted in service, and our vision is to be the most admired employer and trusted hospitality partner. Trust is earned by delivering on our commitments and exceeding the expectations of our stakeholders each and every single day.

Our deep commitment to these principles enabled Aramark to achieve a perfect score, yet again, in this year's Human Rights Campaign Foundation's Corporate Equality Index, in recognition of our work towards the LGBTQ workplace equality.

Last week, we were also named a top 50 company for diversity by Diversity Inc., and cited as the top company for employee resource groups. In addition, we were once again selected as a top 50 employer by Careers and the Disabled for providing a positive work environment for those with disabilities.

We appreciate the extensive accomplishments of our teams and their continued focus on enabling the equity and well-being of our own people, the customers we serve and communities in which we work.

I will now turn it over to Tom before reviewing the announcement regarding AUS.

[Thomas Ondrof, EVP and CFO]

Thanks, and good morning, everyone. Despite the current challenging macro environment, we remained resolved during the second quarter to execute on our strategy to build a customer-focused, growth-oriented company capable of achieving the financial targets we outlined at Analyst Day. The foundation we've built so far helped deliver strong revenue performance in Q2.

As John mentioned, organic revenue surpassed 95% of pre-COVID fiscal '19 levels compared to 71% at this time last year, with meaningful improvement across all segments. While these results reflected a continued steady recovery in pre-COVID based revenues, it was also driven by the impact of pricing pass-through and net new business, particularly from the contribution of accounts that are now up and running from our record net new business performance last year as well as a portion of new clients that started up operations during the first half of this year.

Consistent with what we discussed regarding our revenue recovery in COVID index last quarter, many operations have components of the business that have already approached or exceeded pre-COVID organic revenue levels. However, a few select areas within the portfolio continue to be slower to recover, specifically, white-collar business and industry, retail and catering and higher education and health care, conference and convention centers, concerts and select events within sports, leisure and corrections and some hospitality clients in our Uniform segment.

We estimate that pre-COVID base revenues were approximately 88% to 89% recovered in Q2, with the missing volume coming from the COVID index categories I just mentioned. This compares to an estimated 84% to 85% last quarter.

While encouraged by the steady progress we have seen in the recovery of the base volume, we still expect a residual impact from COVID as we exit the year of approximately $1.5 billion to $1.7 billion, slightly better than the $1.6 billion to $1.9 billion we communicated at Analyst Day. As these areas continue to recover through the balance of this year and into fiscal '23, we anticipate an incremental margin of 15% to 20% on the returning volumes.

In the second quarter, adjusted operating income improved $138 million year-over-year, driven by strong unit-based cost management and our ability to leverage above unit operational costs and SG&A support across higher sales volumes. This AOI performance resulted in a constant currency AOI margin of 4.5% compared to 5.9% in the second quarter of fiscal '19, meaning, we have now recovered 76% of the same quarter pre-COVID margins, up from 62% in the first quarter and 60% recovered in Q4 of last year.

While we are pleased with the progress made so far on the margin recovery, progress we expect will continue. It is important to note a couple of things on margin in this period of high inflation. First, in certain businesses, there can be a lag to pricing pass-through in a period of rising costs. An example is higher education, where most board plans are repriced twice a year before each semester. Conversely, in sports and entertainment, we can, in many cases, change prices event by event. Where there are timing delays, we are actively working with those clients to address the impact of rising inflation levels.

Secondly, with cost-plus contracts, higher costs are passed through to the client as incurred, which increases revenue, but our fee is most often fixed. This obviously pressures the margin percentage, but the AOI dollars remain unchanged. As you know, we currently have a greater proportion of cost-plus contracts than the historical norm coming out of the COVID environment, although clients are steadily transitioning back to P&L as volumes return.

The unexpected developments in the first half of the fiscal year, an increasing rate of inflation rather than abating, the exacerbation of the supply chain due to war in Europe rather than normalizing do not change our business' structural margin profile nor our views concerning achievement of our fiscal year '25 financial targets.

Our ability to recover and go beyond the fiscal '19 margin will be primarily driven by the incremental margin on the returning COVID index volumes, continued pricing to keep in pace with inflation and the normalization of off-program supply chain activity as well as our proven ability to leverage our variable cost base operating model and further drive operating efficiencies. And as a reminder, when compared to fiscal '19, AOI margin has been affected by our substantial strategic investments in growth-oriented resources and technology infrastructure, including cybersecurity.

Our performance in the quarter resulted in an adjusted EPS of $0.22 compared to an adjusted loss per share of $0.24 last year. On a GAAP basis, Aramark reported consolidated revenue of $3.9 billion, operating income of $142 million and diluted earnings per share of $0.14. These results included $95 million revenue contribution from next level hospitality that continues to be excluded from organic revenue until we lap the acquisition in June.

Upon its closed, the contribution of the Union Supply Group will also be excluded from our organic revenue and AOI metrics. We expect to close this transaction in the next few weeks following customary regulatory approvals. As John mentioned, unit supply reported revenue of approximately $250 million last year, and we expect it to be accretive to earnings not later than the end of fiscal '23.

Now turning to cash flow. In the quarter, net cash provided by operating activities was $375 million, and free cash flow was $278 million, driven by improved operating income performance as well as effective management of working capital. At quarter end, we had over $1.5 billion of cash availability and no significant debt maturities due until 2025.

In this period of rising interest rates, we will be strategic and opportunistic with regard to debt repayment and refinancing. While we will continue to support our businesses to invest in profitable new business opportunities when needed, we remain committed to leverage ratios below 3.5x by fiscal '25.

So let me wrap up by reviewing the latest outlook for fiscal '22. Following a strong first half of the year, we are pleased with the trajectory of the business, particularly with respect to our business -- our progress in net new business, while simultaneously navigating the current inflationary environment.

As a result, we anticipate the following for the fiscal year; organic revenue growth expectations to be at or near 27% compared to previous expectation of 23% to 27%; due to stronger contributions from net new business, increased pricing pass-through to recover incremental costs from inflation and slightly improved base recovery; annualized net new business in a range of $650 million to $750 million compared to previous expectations of $550 million to $650 million, which would reflect at the midpoint 5.8% of prior year revenues and 4.3% of fiscal '19 revenues and represent another record-breaking performance year for the company.

The raise in outlook is due to better-than-expected new account wins, while maintaining last year's improved retention rates. In addition, we have a robust sales pipeline and improving close rates.

AOI margin, to be at or very near 5% for the full fiscal year, compared to previous expectation of 5% to 5.5% as a result of start-up codes associated with better-than-expected new business wins, continued reliance on off program procurement as well as slower-than-expected conversion back from cost plus to P&L contract and the timing effect from pricing pass-through.

We expect Q3 AOI margin to be in the mid-4% range and Q4 to be mid-6%, and free cash flow between $300 million and $350 million compared to previous expectation of $300 million to $400 million due to working capital needs associated with higher-than-expected revenue, the timing of cost plus contract conversions back to P&L.

We continue to build the foundation to achieve our financial targets for '25, built on a sustainable and profitable growth framework. The transformational items we have taken over the last 2 years are making a meaningful impact in delivering results. As such, the planned spin of AUS reflects our confidence in that firm foundation and presents a timely opportunity to accelerate future growth and we believe will position both independent companies for great success.

I'll now pass it back over to John to review some of the details of the planned spin-off transaction. John?

[John Zillmer, CEO]

Thanks, Tom. I'll now share my comments on the planned spin-off of AUS, which we believe will create two strong independent publicly-traded companies, each greatly positioned for profitable growth.

The transaction is structured as a spin-off that is intended to be tax-free to Aramark and its stockholders for U.S. federal income tax purposes and expected to close by the end of fiscal '23, subject to certain customary conditions. One of my top priorities when I rejoined Aramark was to recapture a winning hospitality mindset and to reinvigorate the latent power of our people.

Due to the hard work and unwavering support of the entire team, Aramark is a company transformed, now stronger, focused and more energized than ever before. As a result, we're now able to execute on strategies that we expect will unlock significant value for our businesses. This includes the planned spin-off of AUS.

So why now? Together with the Board of Directors and management team, we regularly assess the business portfolio to enhance performance and drive value for all stakeholders. To that end, we believe the growth trajectory we have worked to achieve enables us now to create 2 successful independent publicly-traded companies with distinct growth and profitability strategies business characteristics and investment profiles.

Importantly, we anticipate this transaction will offer numerous value-creating compelling benefits for both companies. including enabling the executive leadership and Boards of each stand-alone company to focus solely on its respective business. Each businesses' narrowed focus and the ability to compensate employees with equity incentives, linked solely to its own performance, enhances the ability to attract and retain strong employees.

The availability of equity linked solely to its distinct business will facilitate each company's acquisition strategies. The flexibility for optimizing capital structures and capital deployment priorities and the ability for the investment community to value each business independently, which the company expects, will result in an optimized total stockholder returns.

Kim Scott, our President and CEO of AUS, who you all heard from at Analyst Day, is now firmly established in her role and has a strategic framework in place to successfully lead that business. We have assembled senior executives with extensive public company expertise, including Tim Donovan, as newly appointed General Counsel of AUS, who I worked closely with at Allied Waste and then Republic, as well as Jeff Friedel, as Senior Vice President, Human Resources of AUS, who has over 30 years of experience in labor relations, organizational impact and diversity and inclusion.

Rick Dolan also just joined as the CFO of AUS, adding over 20 years of financial leadership, including experience as a public company CFO and is quickly getting up to speed. Tom and I, along with the rest of the executive leadership team, will remain on the Aramark side.

Aramark will continue to operate as a proven global leader in Food & Facility services with world-class scale and capabilities. Food & Facilities reported pre-COVID full year fiscal '19 revenues of $13.6 billion, operating in an extremely attractive and growing addressable market, which is estimated to be approximately $500 billion in revenues, with favorable outsourcing trends.

Last fiscal year, Food & Facilities achieved record net new business performance, nearly 5x higher than the historical 5-year average, reflecting new business wins over $1 billion and retention rates of approximately 96%. This momentum has continued into fiscal '22, and we believe this is only the beginning.

As you know, AUS provides customers with full-service rental programs, resulting in a compelling contract-based recurring revenue model with pre-COVID full year fiscal '19 revenues of $2.6 billion. The estimated $40 billion revenue market presents a substantial opportunity for growth.

In the second quarter of '22, AUS's quarterly performance surpassed pre-COVID fiscal '19 year ago levels. and we see tremendous upside ahead. We remain committed to the financial targets provided at Analyst Day, which reflect opportunities for both companies to capitalize on accelerated organic growth and margin progression. While the separation will enable Aramark and AUS to implement capital allocation strategies that reflect their distinct growth opportunities and cash flow profiles, we expect both companies to have leverage ratios below 3.5x by fiscal '25.

Consistent with our messaging at Analyst Day, and it is our intention that the 2 companies will maintain an aggregate dividend, aligned with our historical practice, following the completion of the spin-off.

Today marks a milestone in Aramark's storied history and sets the stage for us to reach new heights of performance success. I have never been more excited about the company's prospects ahead within both Food & Facilities and AUS and with the teams we have in place to get us there.

Operator, we'd now like to open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Kevin McVeigh with Credit Suisse. You may proceed.

[Kevin McVeigh, Credit Suisse]

Great. Thanks so much and let me add my congratulations. It's obviously a very, very tough environment and you folks are really executing exceptionally well despite that backdrop.

I want to start with the Uniform business. It's been talked about for a while, John, and for years, I think as long as I've covered it. How are you able to get it done at this point? I guess, what was kind of the catalyst for that? Maybe we could start there.

[John Zillmer, CEO]

Sure. Absolutely. We have been obviously evaluating this for some period of time. And I've always believed that the company had work to do with respect to fixing the business, to getting the systems right, the infrastructure right and the management team right. And the investments we've made over the last couple of years, in both sales infrastructure, growth infrastructure, the route accounting systems, are largely behind us. And we are now well positioned to accelerate the growth and improve the margins in the business.

And then secondly, we've built a management team that I have a great deal of confidence in. I'm very pleased with the actions that the organization is already taking to improve the quality of the business and to improve the results. Kim is well positioned to lead this business into the future. And the team that we have assembled around her, I think, is extraordinarily talented and very strong.

So we felt we're well positioned. This was the right time. And I think, frankly, that the market will value both companies more appropriately going forward as two separate entities, focused on our respective businesses with the capital structures designed to optimize for those businesses. And as we stated in the dialogue, the benefits, I think, are very clear and the Board reached the conclusion that now was the right time to proceed.

[Kevin McVeigh, Credit Suisse]

That makes a lot of sense. And then just one quick follow-up on that. I know you discussed a potential dividend back to Aramark. I don't know if this is for maybe, Tom. But Tom, is there any way to frame what that could potentially be? And then will you hold any of the existing equity of the newco? Or will it be kind of completely stand-alone?

[Thomas Ondrof, EVP and CFO]

Well, Kevin, all that's really to be determined as we go forward in the process and a lot of things to do from here. But the debt structure certainly is one of those as well as the equity structure that we'll consider as we work through the details of this transaction.

I'll just reiterate what John said in our overall commitment to deleverage the company and really having both companies targeting to be below 3.5% consistent with what we said before. 3.5 times, sorry.

[Operator]

Thank you. Our next question comes from Stephen Grambling with Goldman Sachs. You may proceed.

[Stephen Grambling, Goldman Sachs]

Hi thanks. I'd like to stick with the Uniform separation. As we think about it, are there any dissynergies to think through as you separate the 2 businesses kind of qualitatively? And then I realized you do have work to do on the exact pro formas, but is there any reason to think about the segment reported AOI as being different than what we would see move over?

[John Zillmer, CEO]

Do you want to take the segment reporting?

[Thomas Ondrof, EVP and CFO]

Yes. I think it's directionally very accurate. I mean as we've talked about for a long time, these businesses have been run pretty distinctly. So I think that will give you a good feel for where to go.

There's certainly some costs that we're working through that Kim and the team are starting to assemble, some public company costs that will be added. And we still think there's some other opportunities in other areas to be a little more efficient. So we'll figure out what -- and eventually get to the point where Kim and the team and us will give a clear indication of where we think the next few years go. But by and large, they're very distinct.

[John Zillmer, CEO]

Yes. We've operated the businesses pretty independently over the last several years. So I don't believe there's any significant dissynergies in terms of building the public company infrastructure in place. The Board the IR activities, those kinds of things, will be added cost for Uniform services today, but we believe there'll be corresponding cost savings from other parts of the organization as well.

So all in all, we think this is a fairly easy split. I use that word very carefully because there's always a lot of hard work that goes with these. But because the companies have operated separately for quite some time and are structured -- have been structured that way, and we think this will go relatively quickly.

[Stephen Grambling, Goldman Sachs]

Makes sense. And then on the benefits, you mentioned more focused capital deployment, including, I believe, for inorganic growth. What does that landscape look like in each segment? So what's remaining and what's being separated as it relates to M&A in the current environment? And do you generally think of those opportunities as being more tuck-in or tangential growth opportunities?

[Thomas Ondrof, EVP and CFO]

Yes. I mean eventually Kim and the team talk about the AUS opportunities. But by and large, I think they'll at least continue on with the opportunities to fill in density in many parts of the country with tuck-in deals. It's highly synergistic and accretive for them to do those, and they've had good past experience with it. So I'm sure that will be a continued strategy on the M&A side for AUS.

On the food side, same. I mean, you've seen our activity here over the last 12, 18 months. We've been very happy with some of the deals, Wilsonville being the recent the announcement with Union Supply. So we'll continue to look at very targeted opportunities to build our service offer and strengthen our management teams across all our sectors. I don't see anything -- John, you can add to this. But I don't see anything transformational on the food side, but more of what we've been doing.

[John Zillmer, CEO]

Yes, I think that's exactly right. Our first priority is continue to be growth organically through new account sales and support debt pay down and the occasional tuck-in acquisition when it makes sense in terms of expanding capabilities for our customers and looking at new niches for the organization that might make sense from a base business perspective.

So we are committed to the targets that we established for Analyst Day. We see everything that's occurring in the business is very supportive of that strategy, and we like the trajectory. And we'll continue to be focused on the metrics that we've outlined for our stakeholders.

[Operator]

Thank you. Our next question comes from Ian Zaffino with Oppenheimer. You may proceed with your question.

[Ian Zaffino, Oppenheimer]

Hi great. Just wanted to kind of touch on the core business. On the net new business side, very, very strong. Are there areas that are like, let's just say, massively outperforming expectations that's really pushing this up or anything that's particularly strong you'd like to call out? And then I have a follow-up.

[John Zillmer, CEO]

Sure. It's actually a very broad-based performance, both domestically and internationally across all the business units. We're very pleased. The growth culture that's been reestablished has really energized the entire organization. So very strong performance across all the sectors. And so we're pleased by that.

We continue to see pipelines building, closure rates improving. The net new business profile much stronger than our previous history, and we're very encouraged by that. So I wouldn't say there is weakness in any of the businesses that we operate today. And I think they're all looking very solid, and we're encouraged.

We have had significant self-op conversions. Obviously, we've talked about Merlin in the past. That is a segment that is new to the organization, the Amusement Park segment. We've opened and are operating our first 4 facilities in the U.K., and we're very pleased with how that development is going. But otherwise, I'd say the business is experiencing very broad-based performance and -- across both domestic and international operations.

[Ian Zaffino, Oppenheimer]

Okay. And then just as a follow-up, can you just talk about the margin cadence? How are you getting to -- exiting the year in the mid-6%? And then also just on the subject of rationale, walk me through the three and half times leverage ratio you guys are talking about? And sort of how are you getting there? How is that the optimal level? And then why would it be the same for, let's just say, 2 different types of businesses?

[Thomas Ondrof, EVP and CFO]

So I guess I'll, Ian, start with the 6%. As a reminder, I think it's important for folks to go back to '19 and look at the seasonality of our margin in a "normal year." And you can see that both Q1 and Q4 are the higher-margin periods, Q4 being the highest.

So there is a bit of seasonality that's taking that mid-6s up from where we've been as we've traditionally done. But as I mentioned before, as a percent of '19s margin, we continue to progress and that rise to the mid-6s will be further progression back towards '19 levels compared to the last three or four quarters.

So it's just not rising because the seasonality is rising as we make our way back to those '19 levels. In terms of the 3.5x, it's -- as we said at Analyst Day, no particular magic to it. We feel that, that's a threshold that we need to get to. From there, we'll see. It could go, as was pointed out on Analyst Day, lower, based on acquisition opportunities and certainly new business, organic growth opportunities or we could have some good opportunities in front of us between now and '25 that could keep it around that 3.5x. But I think it's a target for us to strive for. And then once we get there, we'll see where we are.

[John Zillmer, CEO]

Ian, I would just add that we are obviously very comfortable operating at higher leverage levels. We recognized that the investment community would like to see us with lower leverage, so we're being respectful of that desire in that inclination, but the organization is extraordinarily well equipped to operate in this higher debt environment.

As interest rates rise, we recognize the desire to go ahead and pay down interest to reduce our interest expenses. I'm not sure what the optimal debt level is. And I think over time, the investment community will help educate us to give us the optimal capital structure, but we know that we can achieve 3.5. We're focused on and committed to delivering on that level, and we'll see where that leads us going forward.

[Operator]

Our next question comes from Andy Wittmann with Baird.

[Andy Wittmann, Baird]

Yes, Great. I guess given the synergies that are available and a strategic combination of the Uniform Rental business, can you talk a little bit about how you came to the conclusion that the spin was the best outcome for shareholders at this point in time?

I guess one of the things that might have been a consideration was the business is tax basis. I know this has been something that's been discussed in the past. And can you just maybe talk, Tom, a little bit about what happens to AUS' tax basis in the tax-free spin? Does that get stepped up or anything that might have future benefits to the company?

[Thomas Ondrof, EVP and CFO]

Well, we'll -- again, as we go through the transaction, we'll provide more details on it and more clarity on leverage. On tax basis, a lot to do in terms of the carve-out financials and again, getting Kim and the team equipped them up and running. So I don't mean to abate, but certainly more to come on the details around the tax basis and the debt structure and everything else around the spin.

[John Zillmer, CEO]

Yes. The primary reason for doing the tax-free spend historically, this business has had a relatively low tax basis and an outright transaction or sale of the entity would have been significantly value destructive for our shareholders. So that was not an option that we considered.

This is, I think, the best option for the shareholders ultimately to receive these shares on a tax-free basis and then to make an independent decision about whether or not they want to continue to be invested in both the Food business and the Uniform business or make a trade-off for one or the other.

We think optimally, this gives the investment community a much greater degree of flexibility and a much higher degree of clarity around their investment decisions. We feel very strongly about the performance of the business. These are both great businesses. And so absent the desire to optimize shareholder returns, there's really no reason to go ahead and sell this business because we believe the performance will continue to improve or to spin this business. But we think this does create value for shareholders in the long run, and that's why we've gone ahead and chosen this path.

[Andy Wittmann, Baird]

Okay. That's helpful perspective. And then just on the Union Supply Group acquisition, I guess, it's a little bit different than just a normal tuck-in of a business that you're already doing. So I'm trying to understand how this fits in?

It sounds like it's a warehouse distribution play. So is this a margin play? You're giving us a $250 million revenue. Are they a supplier to you or part of your supply chain today that you'll have intercompany revenues on this? I'm sorry, I'm just trying to understand how this fits in strategically. So just looking for a little bit more color on that.

[John Zillmer, CEO]

Yes. This is really a commissary services company that provides services to the corrections community. They are a competitor today, and we provide commissary services as well. we use a model that's an on-site model for the institutions that we serve and the customers that we serve. They use a distributed model that is a different segment of the marketplace.

So this is really expanding our reach to a new set of customers for a service that we already provide and giving us scale in that marketplace that would have been difficult to achieve, by either selling new accounts or growing the business organically. So this is an expansion of capability into a business we already run.

[Thomas Ondrof, EVP and CFO]

And allows us -- gives us a platform with the distributed model and in essence, a pick-and-pack capabilities that could serve other parts of our business.

[John Zillmer, CEO]

Yes, there is opportunity on the retail side and other businesses for them to deliver to those components as well. So it is an extension of the capabilities that the company has.

[Operator]

Our next question comes from Heather Balsky with Bank of America.

[Heather Balsky, Bank of America]

I wanted to ask about inflation. I was hoping you could help us understand the guidance a little bit more in terms of the level of inflation that you're assuming for the rest of the year? And then thoughts on if the environment, I think, has been worse than people had originally anticipated when the year started, the levers you have, if inflation is higher than it even is right now? Sort of kind of where you can go from here? And I guess, help us understand also as well as the pricing on the education side, when we could start seeing that flow through, given the delays in timing?

[John Zillmer, CEO]

Sure. We'll both tackle this question. I'll start off with the education component. As you know, Board plan pricing is set by universities, the semester or the year before. So it's difficult to raise prices on a college freshmen when they're already on campus and have already paid for the Board plan that they're consuming. So those prices lag by a period of at least a semester and sometimes a little bit longer.

So as we negotiate those new Board plan rates for the fall semester, that's when we'll see the benefit of that cost recovery. We can price on campus. We can price both the retail business and the catering business, on a more active basis, and we take advantage of those opportunities. So there are 2 different elements on the pricing side for higher education.

Obviously, we believe that the inflation environment -- we're making the assumption that we'll continue through the balance of this year. A lot of focus on cost recovery as a result of pricing and a lot of cost reduction as a result of menu engineering and menu flexibility. So we've got multiple levers that we can employ to go ahead and mitigate those higher costs that are affecting our frontline operations.

There is also -- beyond inflation, there's also the supply chain availability issue, which has been rather dramatic in certain parts of the business and certain commodities and proteins. So we continue to work through those challenges as well.

I think the fact that we have been able to demonstrate hitting our earnings target for the quarter was a very strong performance, recognizing that the teams have overcome significant inflation in both food and wages during that time period. And we believe that we'll continue to be able to recover. We have the contractual flexibility -- the operational flexibility to continue to recover those cost increases going forward.

[Thomas Ondrof, EVP and CFO]

Yes. And I guess in terms of our outlook or -- at the beginning of the year, we were really looking at the time at sort of 4% to 5% at the beginning of the year and then it easing in the second half of the year. Conversely, it's now moved into the sort of 7% to 8% range for the second half of the year. So that gives you that order of magnitude on sort of what we expected at the beginning of the year and then where we've gone to here for the second half.

The one other thing I'd mention, to add to John's comments, is we do have higher ed that is got timing issues beyond that, We've got like sports and some others that are much more real-time and then everything in between. So we continue to manage the inflation and increases account-by-account, business line by business line.

The U.S. is quickly getting up to speed with it. The international business, much more part of their DNA and their landscape traditionally to have inflation be a part of the mix. And so I think they've been able to respond more readily and more consistently to inflation.

[Heather Balsky, Bank of America]

And I'm just curious, on the sales side, are you seeing -- I guess, should we think of inflation as a tailwind for companies or -- to do self-op converts? Are you seeing more demand in this inflationary environment?

[Thomas Ondrof, EVP and CFO]

I think that's true. We've had a number of things in the last couple of years, probably not wished upon anybody that have helped self-ops convince themselves that maybe they shouldn't be doing it themselves. The pandemic, obviously, was a big driver. And I think inflation and the supply chain disruption has been another reason for people to rethink, whether that's something that they're in a position to do or should they outsource. So I do think that, that's a helpful tailwind as well.

[Operator]

Our next question comes from Andrew Steinerman with JPMorgan.

[Andrew Steinerman, JPMorgan]

I just wanted to confirm that you said mid-4s operating margin for the third quarter. And with that, being overall, I was wondering if you'd be willing to make a couple of segment level margin comments for the current quarter, the June quarter?

And then I also know I heard you when you said, hey, don't forget fourth quarter has seasonal lift. And 200 basis points of seasonal lift is obviously very typical seasonality for third into fourth quarter for Aramark. But I was also kind of struck by your comment that the higher than previously expected gross wins will weigh on margins. And I assume that's disproportionately a fourth quarter -- or fiscal fourth quarter dynamic?

[Thomas Ondrof, EVP and CFO]

I'll start with your second question. And that is sort of offset by the underlying strength of the margin. So as I said, another way, without the new business wins, which we wouldn't want, we believe we could be a little bit stronger even in the fourth quarter as we exit into '23. So it is that combination of seasonality in that lift, but also the recovering base volumes with the higher incremental margin as well as us continuing to drive efficiencies in the business.

I always respect you asking and about more detail on the margins by sector, but that's we'll just leave it at the 4.5% for the overall company at the moment -- for the third.

[Operator]

Our next question comes from Toni Kaplan of Morgan Stanley.

[Toni Kaplan, Morgan Stanley]

I wanted to ask about international, really good quarter this quarter. Just what are you seeing in terms of differences compared to the U.S.? And Also, you mentioned Europe and Canada experiencing improved business activity, but I wanted to ask about sort of the outlook for Europe.

[Thomas Ondrof, EVP and CFO]

Yes. I think there's 2 things internationally. I mean, they are doing very well, and credits to Karl and the leadership throughout the business, really just sort of rising to the challenges in front of them.

They, as I mentioned before, deal with inflation more as a part of their everyday year in and year out. And so I think their ability to react to it was probably quicker than the rest of the business in terms of its recognition, particularly in the Latin America businesses, where they see that quite consistently.

The other benefit for them is -- and we talked about this as an overall driver of the model is they've had consistent new business wins for a number of years. And so their maturity of their business they won two, three years ago is paying dividends. And so in a way, it's sort of covering up their start-up cost of new business, Merlin being a slight exception for them given its size.

But when you have a model where you're winning business consistently, those older contracts are maturing and then you're also used to inflationary environment, that sort of has mixed together with -- to allow them to really sort of do well through this environment.

[Toni Kaplan, Morgan Stanley]

Great. Wanted to also ask as my follow-up on competition. You mentioned that the self-op conversion has been helped by inflation. Wondering if sort of the inflationary environment has impacted the competitive environment in terms of does it become harder for maybe smaller companies to compete? Just any sort of changes in the competitive environment due to the inflation dynamic?

[Thomas Ondrof, EVP and CFO]

Yes. I mean, my guess here and it's still a little bit early to tell, because as we've talked about, hello contract for a lot of self-ops and other conversions can be years. So while we think it's a tailwind, and we've seen tailwinds out of the pandemic. Not quite sure whether inflation will deliver that, but the suggestion would be it would.

And I think it will favor the bigger companies. I mean, right now with the supply chain complexities, the bigger voices are winning and I think more leverage to deliver and so smaller folks, smaller suppliers and the businesses are struggling a bit more with limited supply and rationalization. So I think it will help, but probably a little early to tell yet.

[Operator]

Our next question comes from Shlomo Rosenbaum with Stifel.

[Shlomo Rosenbaum, Stifel]

I just wanted to start out a little bit with the nature of the new wins, the raised $100 million guidance. Is this kind of broad-based or concentrated in one sector? And how much of the pressure on the March is coming from the start-up costs from the new wins? Or is this really tangential and think about it as overwhelmingly from the inflationary pressures, and this is just kind of a tangential pressure?

[Thomas Ondrof, EVP and CFO]

It's probably a little bit more than tangential just as we're coming off a standstill start like we talked about at Analyst Day. I mean, we really didn't have any net growth for a number of years, really experienced our first start-up of substantial material new business last year and really in the second half of last year and then this year.

So probably a little bit more than tangential, but that will wane as we move into '23 and then certainly into '24, provided we consistently continue to deliver the net growth. And that's our goal. The inflation is a big driver at the moment in terms of our guidance in the range between the 5% and the 5.5% that we started out with. So -- and the timing lag that we talked about with that. So of the 2, I'd say the inflation is tipped in the scale a little bit more than the start-up costs at the moment.

[John Zillmer, CEO]

That's right. But both components are significant. I think the start-up costs, as Tom indicated, as we set this engine going, we expect that we'll have significant start-up costs year-over-year and that we'll eventually kind of lap that phenomenon in an average sales year will have somewhat average opening costs.

But it is new to the P&L this year as a result of both the magnitude of the wins last year, and frankly, the magnitude of the wins we've already achieved this year. So a very good phenomenon to have. We like this as the alternative. And we know we have the flexibility and the capability to work through getting past these costs and bringing this business into very profitable accounts for the organization.

So we're pleased in terms of where we are to date. And we're also pleased with the company's ability to go ahead and recover those inflationary cost increases by way of the various mechanisms that we've described before.

[Shlomo Rosenbaum, Stifel]

Okay. And then also, just how much is Aramark on the foodservices side, a customer of Aramark on the Uniform side? Is that something that we should consider in terms of the spin that there'll be some kind of long-term contracts set up or how material is that?

[John Zillmer, CEO]

Yes, that's a great question. And yes, Aramark is a large customer of Aramark Uniform Services, and we expect to continue to be and that we will have a long-standing commercial relationship that will survive the spin in many, many years to come. We would have the expectation that we will probably always be a customer of AUS.

And they'll have -- as a business, they'll have to perform to serve the needs of their Aramark customers just like they do every day for every other customer that they operate. But I think this whole -- that question raises a good point.

It's very important that everybody understand that we're undertaking this spin because we believe that the two companies will perform better separate that -- separately, that the ability of the management teams to focus on their respective businesses will be enhanced the ability of the Board to focus on that individual business will be enhanced and that ultimately, it leads to stronger performance by both organizations.

And that's really the primary reason for the ultimate spin. There's -- we think there's value accretion as a result of the transaction. We think there's also significant value created as a result of creating equity that's focused distinctly on its business. But ultimately, it's about the performance of the company, the management teams and their ability to manage the business more effectively in a very focused way. And that's the ultimate reason for the spin.

[Operator]

Our next question comes from Jaafar Mestari with BNP Paribas.

[Jaafar Mestari, BNP Paribas]

Just wanted to go through some of the new business numbers, if that's okay. So your upgraded guidance of $650 million to $750 million, that's net. And then I think you also said retention is broadly maintained at last year's level, which I think was 95.5%.

So is my math correct that to get to the new guidance, you're going to sign around $1.4 billion of gross new signings for the full year? Just curious how much of that is signed, how much of that is in the H2 expectations because that's a very big number?

And then related to that, how do we understand the impact of the contract start-up costs? Is there a rule of thumb if there is indeed $1.4 billion of gross signings? And how many dollars do you have to spend in year one to reach $100 of those contracts before they're ramped up? Just trying to separate those start-up costs from just inflation impact.

[Thomas Ondrof, EVP and CFO]

Your math is right. That's the trajectory we're on. We've got a good deal signed at this point. Again, I want to stay away from disclosing quarter-by-quarter what we're booking because it does tend to vary year by year and doesn't necessarily always come in the same quarter.

So we have signed a good bit. And then based on our pending bids and our remaining pipeline, feel very confident about that gross number. And again, that would be another record year for us. So we're well on our way.

In terms of start-up costs, the -- I wish I could give you a rule of thumb. There's not really -- the only thing that's driving true is the bigger the account, the more of the start-up costs. So that's why we like the smaller accounts, that is the bread and butter. And understand that underneath the Merlin's and the Purdue's and the Miami's, Ohio's and whatnot, there are recoring -- there are a lot of $1 million, $2 million, $3 million accounts, which are really the bread and butter and the ones we like to get. They have less in terms of start-up costs. The complexity is less. The understanding of those operations comes a little quicker.

So that's probably the rule of thumb is if you're seeing a lot of big, big accounts, there's going to be heavier start-up costs. If there aren't the bigger accounts, then there'll be less.

[John Zillmer, CEO]

Yes. That's a great answer, Tom. I wish there were a rule of thumb. It would be easier to predict. But every account is different, every circumstance is different. And they are somewhat differentiated by size, the bigger and more complex they are, the higher the opening costs.

But we have a very -- we have sold a very broad base of business. We've had a couple of very large accounts this year like Merlin. And as Tom indicated, we've got hundreds of accounts that are -- the smaller bread and butter accounts that are related to kind of the lifeblood of the business. So we don't focus on just the big ones, we focus on a big range of accounts. And it's also somewhat differentiated by the line of business.

And the opening costs can be somewhat determined by the contract type as well, whether it's a management fee or a P&L. So a lot of variability there, but it's something that, as we said, as you have an engine that produces significant net new business year-over-year, ultimately, those opening costs are just part of the normal operating cycle and the fact that we've gone from 0 to 60, and now we're going from 0 to 100 this year, it makes that phenomenon more impactful in the year.

[Operator]

Our next question comes from Faiza Alwy with Deutsche Bank.

[Faiza Alwy, Deutsche Bank]

So I was curious on pricing. You mentioned that inflation was 7% to 8%. So I'm wondering where you are on pricing at this point in time? And sort of where do you expect 4Q pricing to be? Or do you expect pricing and inflation to be aligned? Or is there more incremental pricing that we should expect as we get into fiscal '23?

[Thomas Ondrof, EVP and CFO]

Well, again, I would say there was a straightforward answer. It depends a lot on the client contracts. It depends a lot on the timing lag and just our ability to sit with our customers and understand what operational adjustments they might want to make to help offset the cost, whether the contracts are cost-plus for P&L, obviously.

So there's a lot of factors that are going into the pricing. So it's really hard to give just a straight answer on a broad brush across what pricing is versus cost. We continue to get pricing. And we're trying to, again, always demonstrate value to our clients that we're able to mitigate those increases better than if they were on their own or with someone else. So again, it's a combination of things. The pricing ultimately hopefully is never what you would read in the headline because we've done a good job of mitigating costs. And again, therefore, the client sees the value equation.

[John Zillmer, CEO]

Yes. And ultimately, what we expect is that pricing and inflation are relatively neutral, and that we were able to offset inflationary pressures through the -- through a number of mechanisms, pricing being one of them, and one that's, obviously, in today's environment, more important than normal.

But we're always looking to match those 2 things. We never want to overprice because we want to make sure our consumers are protected and our consumers continue to want to frequent our operations. And so we're always carefully managing price to value, and we're also carefully managing menu in order to mitigate the impact on the consumer. But make no mistake, we are pricing to go ahead and recover those added costs, and we expect over the long run for those inflationary pressures to be neutralized by price as well.

[Faiza Alwy, Deutsche Bank]

Okay. Okay. Great. And then just on the -- at Investor Day, you had talked about an ongoing sort of long-term growth rate of 5% to 7%. I'm curious if you were able to talk about a growth framework for Uniform versus the remaining business? And as part of that, if you're at all willing to comment on how you thought about the relative valuation of the 2 businesses as you were evaluating various strategic options at your disposal?

[John Zillmer, CEO]

We'll get into -- as we begin to formalize the spin structure, the spin details, we'll be able to present a framework that highlights what the 3-year plan is for the business.

I want to be very careful. Today, we are focused on creating the environment for the spin on putting the team against the project and really detailing the story, if you will, and the plan, if you will. And that will take some time over the next few months as we work to do the separation.

So I think it's a little premature to go ahead and give relative valuation kinds of metrics. But again, we really believe that these businesses will be served well by the separation, that they'll each be able to focus on their optimizing their strategic focus and their flexibility and that each management team will be able to really focus on what's best for their operations from both a capital strategy as well as an acquisition strategy.

There's just a number of benefits that we've highlighted. But ultimately, we think the performance of both organizations will be enhanced. And we will, over the next several months, have an opportunity to meet with the investment community to talk about what the spin looks like and what the forward-looking plans are

[Operator]

Our next question comes from Rishi Sabadra with RBC Capital Markets.

[Unidentified Analyst]

This is John filling in for Rishi. How should we think about the volume recovery in some of the lagging areas, such as B&I, retail, catering conference?

[Thomas Ondrof, EVP and CFO]

In terms of their ultimate recovery, I think things have been pushed out to the right a little bit. Certainly, when we started the year, we felt like a lot of the white collar B&I, the technology finance base would be back by first of the year.

Omicron variant set in, and that's pushed things out. So we continue to see a steady recovery in that category, and I think that will continue throughout the summer and then into the fall. So we're confident that the progress of recovery continues in that segment.

I think you'll see the same in the convention and conference center business. That's remained slow, I think, through the various variants, are slower than we thought through the winter and spring. But I think as we get into the fall, that also -- and into calendar '23, that will also continue to pick up.

Concert activity, I know is picking up quite a bit as we get into the summer, particularly the outdoor venues. The hospitality, the linen side of uniforms and the hospitality, particularly the smaller restaurants, continue to have a little bit of a stop and start.

So all of that remaining COVID index, as we said, has moved along about as we thought, maybe a little bit better. But we continue to see progress and feel as though as we move into the balance of this year. And certainly into '23, we'll continue to see some recovery of those volumes.

[Operator]

Our next question comes from Harry Martin with Bernstein.

[Harry Martin, Bernstein]

I just wondered if I could ask a question really about the targets that you gave at the CMD. You've said you're sort of happy with that commentary. Based on the commentary you've given about the separation having benefits, you have more focused management team, being able to accelerate that growth.

Can we expect ultimately to get the sum to be more than the parts in terms of financial performance? And any sort of early commentary you're willing to share on how quickly we can sort of start expecting that improvement to come sort of post-2023?

[John Zillmer, CEO]

Well, I would certainly say that we can expect the sum to be greater than the parts. That we honestly believe that the performance of both organizations will be enhanced -- the ability to grow improved margins will be enhanced as well. So it's our expectation that both companies will see performance improvement as a result of the spin, and that we're on a very favorable trajectory right now.

The business is showing improvement year-over-year, making significant progress. And again, we'll detail our expectations for the 2 companies separately going forward. But I would say that our expectation is for the -- for both businesses to show significant improvement.

[Harry Martin, Bernstein]

Great. And then just a follow-up on new business. I guess, a second sort of consecutive record year for you. How do you feel about how much of that is the new normal versus some of those market impacts from supply chain and from inflation sort of accelerating some outsourcing for today? Or can your sort of run rate guidance for new wins actually also come up over time if we carry on seeing quarters such impressive performance?

[Thomas Ondrof, EVP and CFO]

Yes. No, we're very happy with what the progress the teams have made over the last 18 months, really, again, coming from a standstill start. I think the performance is more to do with our reinvestment and our focus on growth than on any of these tailwinds, "on the pandemic" and first-time outsourcing. Those are great. I said that before.

They're great to have. Inflation may add a bit more and we love the opportunity to take this big pile of self-operated business that's within our total addressable market, $500 billion, and have people come to market and consider outsourcing.

But we believe so strongly in this market and the growth rates, even without that, even if that return to normal, that we still believe this mid-single-digit growth rate is very sustainable for a very long time as long as we remain resolved and focused on growth and keep that front and center as the lifeblood of the company.

So again, I said over and over again, I said at Analyst Day, I don't want people to think that this spike up this increase in that growth is just due to first-time outsourcing. This is fundamentally how strong and how fertile this contract food service environment is for growth.

[John Zillmer, CEO]

That's absolutely right. It's really the change in culture and the investment we've made in both growth resources and the management teams that are driving this performance. We have an expectation that we'll continue to see improvement year-over-year.

This year's results were planned to be better than last year's, and we expect to plan that next year's will be better than this year's. And we have an expectation that we'll continue to see an improving trajectory for long-term growth for the company. That's the model that's been built, and that's the commitment of the management team. And it's the kind of culture that we've been able to recreate to drive that performance.

[Operator]

Thank you. And our last question comes from Neil Tyler with Redburn. You may proceed. Your line is now open, Neil.

And I will now turn the call back over to Mr. Zillmer for closing remarks.

[John Zillmer, CEO]

Terrific. Well, thank you very much, everybody, for your time this morning. This is an exciting time, really a historic day for Aramark. We're extraordinarily pleased with the results for the quarter, and we're also very pleased with the trajectory of the company.

I want to acknowledge the performance of the entire organization. I think both Aramark Food and Support Services and AUS. These teams have been hyper-focused on doing what's right in terms of serving our customers day in and day out, and the results of the company -- or the results of the company has been able to demonstrate the results of their hard work and effort.

So thank you to all the Aramark team members and again thank you to all of you for attending this morning. Take care.

[Operator]

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