Aramark (ARMK) 2008 Q2 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the ARAMARK Corporation's second-quarter 2008 earnings conference call. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers after the presentation.

I will now turn the call over to Chris Holland, Senior Vice President and Treasurer. Please go ahead, Chris.

Thank you. Welcome to ARAMARK Corporation's conference call to review the results of our second quarter of fiscal 2008. Here with me today is Fred Sutherland, our Executive Vice President and Chief Financial Officer. Fred and I will present an overview of our second-quarter and year-to-date results and business operations, after which there will be an opportunity for phone-in participants to ask questions.

I would like to remind you that any recording or other use or transmission of this audio may not be done without the prior written consent of ARAMARK.

As we discuss the results for the quarter, you may want to refer to the 10-Q we filed this morning, which contains our second-quarter and six-month results for our fiscal 2008. This 10-Q can be found on our website at www.ARAMARK.com.

In today's discussion of results, we mention certain non-GAAP financial measures. Schedules we posted to our website this morning include reconciliations of these non-GAAP financials measures to the most comparable GAAP measures, as required by SEC rules.

Our discussion today will compare our fiscal 2008 results to the sum of our results from the predecessor and successor periods from fiscal 2007. Although this presentation of the 2007 results does not comply with GAAP, we believe it provides a meaningful method of comparison. These combined results for the 2007 period have not been prepared as pro forma results and may not reflect the actual results we would have achieved absent the going-private transaction.

Our discussion of operating income during today's call will in each instance exclude the increased intangibles amortization and property and equipment depreciation expense resulting from the going-private transaction, as well as the impact of stock option expense under FAS 123R; the impact of the divestiture of SMG in 2007; as well as certain transaction-related expenses that were incurred in the prior-year period. All of these items are detailed in the schedules posted to our website this morning.

Various remarks that we may make and this call relating to matters that are not historical facts, including remarks about future expectations, anticipation, beliefs, estimates, plans, and prospects, constitute forward-looking statements. 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 Form 10-K and our Form 10-Qs. We disclaim any duty to update or revise such forward-looking statements, whether as a result of future events or otherwise.

I will now turn the program over to Fred Sutherland.

Good morning. Thank you for joining us for our second-quarter 2008 results call. I would like to review our business and operating results and then have Chris cover a few additional details on our performance.

Moving to our results for the quarter, we achieved record sales for the second quarter of $3.2 billion, up 6% from the prior-year quarter and up 4% on or organic basis. Adjusted operating income, which excludes the impact of the items that Chris just mentioned, was up 9% to $147.1 million, of which about 3 percentage points was related to currency translation.

For the first half, sales were $6.5 billion, up 7% over the prior-year period, with organic growth of 4%. Our adjusted operating income was up 14%, to $352.7 million. Our consolidated operating margin improved by about 30 basis points as compared to the prior year. Currency translation also contributed about 3 percentage points of the growth in our consolidated operating income for the first half.

While the competitive and macroeconomic environments continue to be challenging, our levels of annualized new business and net new business, which is net of our losses, are improved compared to the first half of last year, and our retention rates are consistent with our targets.

Now turning first to our Domestic Food and Support Services segment, second-quarter sales were up 3% to $2.1 billion, driven primarily by our Healthcare and Higher Education businesses. Organic sales growth was in the low single digits for the quarter. For the first half, sales were up 4% to $4.3 billion, with organic growth in the low single digits.

Our Business & Industry sector had low single digit sales growth for the quarter and the first half, led primarily by Refreshment Services and offset somewhat by the lower level of activity in our remote camps business in Canada.

The Education sector had low single digit sales growth for the quarter and mid single digit sales growth for the first half, with strong base business growth in our Higher Education Food business offset by the timing of the Christmas break and by some lost business in the K through 12 market. As expected, sector growth was also negatively affected somewhat by the timing of the Easter holiday, which fell in the second quarter this year.

In our Healthcare sector, we realized high single digit sales growth for the quarter and the first half, with solid base business and new business growth in both Food and Facility Services.

Our Sports & Entertainment sector had low single digit sales growth in the quarter and mid single digit sales growth in the first half. Results in the quarter reflected some softness in our arenas, primarily related to NBA events, and in our convention center business.

Adjusted operating income in the Domestic Food and Support Services segment rose 7% in the quarter to $97.9 million, led by the Healthcare and Business & Industry sectors. As expected, segment results were negatively affected by a lower level of activity in our remote camps business in Canada; a decline in Corrections profits due to food price increases as we saw in the first quarter; and the timing of the Easter holiday.

For the first half, the segment had adjusted operating income of $243 million, up 16% compared to the prior year, led primarily by strong profit performance in the Healthcare, Education, and Business & Industry sectors.

Currency translation related to the Canadian dollar contributed about 3 percentage points of the growth in segment operating income for both the quarter and the year-to-date periods.

Overall, we are pleased with the segment's performance so far this year, which has included solid year-over-year margin improvement. While the weakening economic environment will have an impact on some portion of our US and Canadian business, our sector and client diversity should continue to serve us well in these more challenging economic times.

Turning now to the International Food and Support Services segment, second-quarter sales of $661.3 million were up 22%, led primarily by the UK, Chile, and China. For the first half, sales were up 21% to $1.3 billion. Organic growth was approximately 11% for both the quarter and the first half.

Second-quarter adjusted operating income was $23 million, up 10% from the prior-year quarter, with currency translation contributing all of the reported growth. As we expected, the results in the quarter were negatively affected by the timing of the Easter holiday and costs related to the mobilization of a significant level of new business in the UK. We expect this segment to show more normal profit growth in the back half of the year.

For the first half, adjusted operating income was $49.6 million, up 16% over the prior year. Currency translation also contributed about 10 percentage points of the growth in segment operating income for the first half.

In our Uniform & Career Apparel segment, second-quarter sales of $426.9 million were up 5% from the year-ago quarter, led by uniform rental and Galls. Organic growth was in the mid single digits for the segment.

For the first half, segment sales were $873.9 million, up 4% from the prior year. Segment organic growth was in the low single digits, led by rental growth in the mid single digits.

Second-quarter adjusted operating income was $35.5 million, up 13% over the prior year, led by strong performance in rental and Galls, which more than offset the negative impact of higher fuel costs.

For the first half, adjusted operating income was $76.5 million, up 2% from the prior year, with strong growth in rental and Galls being offset by weakness at WearGuard-Crest, particularly during the important first fiscal quarter for them.

Corporate expenses, adjusted to exclude the items that Chris mentioned earlier, were $9.3 million in the quarter, compared to $8.9 million in the year-ago quarter. For the first half, expenses were $16.4 million compared to $18.3 million in the prior year, reflected lower staff spending and other administrative costs.

Summing up the first half's operating performance, we have generated solid operating income growth and consolidated margin improvement in comparison to last year. We've seen an improvement in our level of annualized new business and net new business compared with last year.

We are continuing to be selective in terms of the type of new business we pursue, and we remain disciplined in our deployment of capital to win new accounts.

We are also very focused on managing the business through an increasingly challenging economic environment, with particular emphasis on growth in our less cyclical sectors, and cost mitigation and containment efforts across all of our businesses.

Now let me turn it back to Chris for some additional details on the quarter.

Thanks, Fred. I would like to wrap up our remarks by commenting on our financing, capital structure, and cash flow. Our adjusted EBITDA for the trailing 12 months ending March 28 was $1.079 billion, up from $1.030 billion at September 28, 2007, and $999 million at March 30, 2007.

Interest and other financing costs were $129.4 million for the quarter and $258.4 million for the first half.

At the end of the quarter, approximate 84% of our debt portfolio was at fixed interest rates, with an overall weighted average cost of approximately 7.15%. Total reported debt at the end of the quarter was $5.969 billion, including an outstanding revolver balance of $59 million, which is down from $96 million at December 28.

Based on our EBITDA growth and reduced borrowings during the quarter, we're pleased that we continued to improve our secured debt ratio, which was down to 3.79 times as of March 28.

Net capital expenditures were $72.9 million for the quarter and $140.2 million for the first half as we continue to reinvest in the business, but do so in a disciplined manner.

As we have discussed, the seasonality of our business is such that working capital is a use of cash for us during the first half of our fiscal year. During the first half of fiscal 2008, our working capital requirements were somewhat higher than the prior year due to increased accounts receivable, primarily reflecting strong sales growth in the International business, as well as decreases in accounts payable due to the timing of disbursements.

For the full year, we generally expect historical working capital patterns to prevail, with the exception of the negative impact the 53rd week will likely have on our working capital in our fiscal fourth quarter. Now let me turn the call back to Fred.

Thanks, Chris. In sum, we're pleased with our performance during the first half of fiscal 2008, as most of our businesses have delivered operating income growth and solid margins. While we are certainly not immune to the impact of the overall economic weakness, we continue to view our sector, geographic, and client diversity as important fundamental strengths of the Company, especially in the current uncertain economic environment.

We also see numerous growth opportunities, especially in our less cyclical sectors, and we believe that we're well positioned to seize these opportunities both in fiscal 2008 and beyond.

Thank you again for your time this morning and for your support of ARAMARK. We would now be happy to take your questions.

(OPERATOR INSTRUCTIONS) Reza Vahabzadeh with Lehman Brothers.

Good morning. A couple of questions. The issues in the Corrections business, is that a function of just the costs rising and you having selling prices that are relatively fixed in the near-term?

That's correct. In the Corrections business our contracts typically call for a fixed-price per meal; and the meal itself is very highly specced by the client. As a result, we have more limited ability to raise prices.

Typically we have escalators in the contracts, price escalators; but they are limited. Really, contrary to the other businesses that we're in, we have very limited ability to re-spec the meal.

So as a result of that, that is -- of our individual sectors, that is the sector where we have really suffered the most from food price increases.

We believe we will work through that over time. It just takes a longer period of time because it in many (technical difficulty) discussions in some cases, negotiations with our clients.

Right, and that is what I was curious about. These contracts come up for renewal at a certain time in this calendar year? Or are they even longer than one year? Or are they shorter than one year?

They're really all over the board. They come up at different times throughout the year, so there is no natural cycle to them as there is, let's say, in the college and university market.

They may be one year; they may be two or three years. Typically, they are at least one year.

Okay. So when you say you can work through it over time, that over time would suggest by the end of this calendar year, directionally, or would it take even more than that?

I think the effort will continue into next year, into next fiscal year certainly. But I think that the year-over-year effect that we are feeling will be less next year than it is this year.

Okay. What portion of your FSS business is the Corrections business?

We don't -- I don't think we get into that specifically, but it's clearly the smallest segment.

Okay. Then, what about cost pressures in other businesses? Sort of the Food Services business away from Corrections, is higher food cost any kind of a headwind on that side?

And if you can also talk about energy costs on the Uniform side, please.

This is Fred. Let me take a shot at the food costs, and maybe Chris can jump in on the energy cost. We do have -- we are actively managing our food cost. We do have certain natural advantages in the way our business is constructed. If you take our Domestic Food and Support Services business by way of example, about 25% of our sales are Facility Services sales, where there is no food cost at all.

Of the remainder, about 25% of that are arrangements that are management fee contracts with our clients. So essentially the food cost and the labor cost are direct pass-through to our clients.

The remainder, after you take those two pieces out, is really a combination of channels where we have contracted price -- let's say board plans through a college or a university. But increasingly retail operations, where essentially we would have the same right to increase prices in consultation with our clients as you would see out in the open market.

So, we do have those natural advantages in that a certain portion of our sales are not really subject to food cost increases. We have the ability to raise prices in consultation with our clients.

Then I guess the final thing I would say is that we have become very astute and very effective through our centralized supply chain management function at really giving our frontline managers week to week the tools and the information that they need in order to make menu changes.

We're benefited by the fact that we're not -- we operate a typically broad Food Service operations. We are not limited to one particular ethnic type of menu or one particular type of product, so we have a fair amount of flexibility to move from one food group to another.

Just commenting on the energy side, Reza, which again primarily would impact the Uniform business, as we showed this quarter that business was able to show a very strong operating performance in the face of about a 70 basis point year-over-year increase in their energy costs.

So, they have -- frankly, if you look over the last three to five years, that business has really been able to absorb what has been more a doubling in their energy costs as a percentage of revenue through, frankly, more and more efficient operations, more route productivity, some pricing to help offset those increases as well.

So clearly it is a challenge, it is a headwind, it is something we are very focused on. But again so far, it has been a challenge that we've been able to deal with rather effectively.

The challenge on the Uniform side, is it -- obviously we know about the energy costs. But is growth slowing at all, as may have been implied by one of your competitors in that space?

We are seeing some weakness in our existing accounts, and that is not unexpected at this time of the economic cycle. That, of course, relates to clients who either reduce their headcount or maybe in order to save money may cut back on various services that they get.

So, it is clearly something we have to keep a close eye on as we move into the back half of the year. But notwithstanding that, as we reported in the second quarter, we're pretty happy with the overall growth rate.

Okay. Working capital, Chris, as you mentioned, was a larger use of cash in the first half of this year than in the preceding year. But for the year, is working capital going to still be a wash from a cash flow perspective, give or take?

I think in general, coming into the year, as we said, year in and year out you will see some variability, generally around zero. Although coming into each year we like to talk of it as a modest use of cash.

The one difference this year is that fiscal 2008 is a 53-week year for us, as you know. The way that first week -- effectively that first week in October works, it is a negative cash flow week for us. So this year, everything else being equal, we would expect it to be a modestly higher use of cash for us than in a typical year.

Thanks. Okay. Then as far as tuck-in acquisition opportunities, are those opportunities or your appetite for them increased or about the same as in the past?

I would say our appetite is about the same as in the past.

Okay, thank you much.

Bryan Hunt with Wachovia Capital Markets.

Thank you. You partially touched on this, but I was wondering if you could address it a little bit further. Just given the economy has weakened a little more since your last report, could you maybe detail in which division or channel you've seen maybe accelerating deterioration? You mentioned Uniforms to a certain degree. Is there any other channel or division you are seeing increasing weakness?

Outside of the Uniform business, we have started to see some weakness and Food and Facility Services that we provide to business clients. That would be both in the US and to a lesser extent outside of the US.

So, for example, we have a pretty good business where our clients are financial services entities. I think everyone knows the stresses that most financial services firms are under these days, and they are looking to cut costs where they can cut costs.

So we clearly have seen some impact in certain industries like that. Certain manufacturing industries, where there have been employment reductions or service scope reductions. As we move into the second half of the year, if the economy continues to deteriorate we expect that that would continue.

Now having said that, even in manufacturing, the export-related manufacturers are doing well and are hiring more people. Certainly the college and university market, the K-12 market, the Healthcare market, the Sports business continues to show good performance overall. So a major part of the business is today pretty much unaffected.

Okay. You said also on the last call, give or take maybe 75% of your Domestic business is somewhat sheltered from economic impacts, is that -- do you still feel good about that statement?

Yes, the mix is the same as it's always been.

Okay.

While certain businesses that are not immaterial at all to the total may be more challenged as we move through the back half of the year, the overall diversity of the business in total is and will continue to be the same that it has been.

Okay. Also on the last call, your expectation is for food inflation. You said you expected it to approximately mirror 2007; and you threw like a 4% number around that expectation.

Again, given some inflation in certain products has accelerated going into this quarter, has that expectation changed at all for 4% food inflation? What is your outlook maybe for the rest of the year?

I think our outlook at this point, based on the first six months is -- again while it's hard to predict -- that food cost inflation, food inflation this year will probably be somewhat higher than it was last year. But again, based on the first six months, not terrifically higher. So maybe a point or so, but generally in the same range.

Again, you have to remember that for example, we have -- we sell -- a significant percentage of our volume is in beverages, which hasn't seen the same sort of inflation. So it's also a function of the mix of the food and beverages that we sell.

All right. Just around Corrections, you made a lot of statements around that business. We've seen some initial headlines that some correction facilities are looking to dial back the amount of and the variety of food available to inmates, such as coffees, desserts, etc. Those changes, what type of impact do you feel like they will have on your sales and profitability?

Do you think this trend is widespread, given your business management?

The bulk of our sales in Corrections are, really, as specced in the main three square meals a day; and that is often driven by a certain balance of food groups and a certain caloric content. I guess my guess would be across the portfolio you are not going to see a massive change in that. There may be some cutbacks around the edges.

On the other hand, we've seen trends in the other direction, where a little more options or the ability of inmates to actually purchase food outside of the normal program, because they do have funds and access their funds through accounts that they have. Is -- helps with overall inmate control and keeping inmates a little more satisfied with their circumstances, which correctional institutions like.

So I guess the short answer is that we don't see that being -- having a material impact on the business. It is really more this issue of a fixed-price contract, food cost inflations, and really working through with our clients, which takes some time -- how to adjust our pricing for that.

All right. Two last questions. One, you have the contract, I believe, for the Olympics this summer. What type of benefit do you think you'll see this year relative to last year just from having that event?

Yes, I think the important thing to remember in general about the Olympics is that from a financial standpoint, you shouldn't think of it as a material contract for the Company overall.

Now having said that, its potential impact on our growing business in China we're actually quite excited about. We've been in China now for almost four years. We've made a couple of acquisitions and have a nice growing business that we see our performance on the Olympics contract as being a nice springboard for our presence in that country.

It's also, as you can imagine, a very significant logistical challenge that brings together folks from all across ARAMARK, from around the world. So internally it is a great opportunity for us to deliver at a very high-profile event. And it generates a lot of great enthusiasm within the Company, and again we think a good opportunity for our Chinese business going forward.

All right. Then lastly, from a headline perspective, you have had some protests and walkouts, just some, if you will, labor disruption in Ireland, New York, Canada, and other locations in the most recent quarter.

Was there any measurable impact on cost? Or do you see any measurable impact on your labor rates going forward from this handful of events?

No, no, we don't. I think I should point out that we have had relationships with unions for 50 years. Over, I think by last count, about 40,000 of our domestic hourly workforce are in unions. And we have relationships with about 35 unions in total.

I think what you are seeing is a part of a broader effort by unions across a number of industries -- healthcare, retailing, restaurants, hotels -- to organize service workers.

We're obviously as you can see, not immune to that effort. But we are, really in contrast to some other companies, we're not anti-union. We're not pro-union or anti-union; we are pro-employee. And we expect to continue to have a significant portion of our workforce as members of unions.

But what's critical for us is that those be site by site, locally determined by the employees and with input from our clients. So, so far we've really haven't -- there hasn't been really any financial impact or concern financially going forward.

Do you expect a higher rate of labor rate inflation this year than last year (multiple speakers) these efforts? Or (multiple speakers)?

No, I think we need to be competitive. For example, a very, very small percentage of or hourly workers are at the minimum wage. I haven't looked at it in a while, but I think it is less than 5%, well less than 5%.

So we will continue to be competitive in what we pay in labor rates. We don't see the external economic trends in that area being any different than they have been.

Thank you very much.

(OPERATOR INSTRUCTIONS) Karen Eltrich with Goldman Sachs.

As you mentioned, obviously, in your corporate side of the business you are seeing, particularly in financials, a cutback on services and employees. Is it safe to assume that with your business model you can cut back your costs in a like amount, and we don't see a huge amount of negative operating leverage?

Obviously, one of the good things about the business is a very significant portion of our costs are variable, certainly on the product side, and to a certain extent on the labor side. So we are able to manage through it better than a lot of companies would be able to.

But having said that, there is a certain amount of infrastructure within the businesses, within a given region, and even within an account that we can't perfectly offset it.

But we've got experienced teams who have dealt with periods like this before. I think we are pretty adept at managing the cost side as we work through this kind of environment.

Great. You mentioned your appetite is about the same for acquisition. But in this environment, are you seeing more opportunities and better valuations?

I mean, I think our approach to valuations, frankly, doesn't change. We try to be disciplined and we try to pay prices that we think make sense to us.

If this kind of environment makes us be a little more successful, then that is a good thing. But certainly broadly speaking, there are -- the pressures that we're talking about today on the cost side are certainly pressures that a lot of smaller companies feel as well. In a couple of our sectors, as we've talked in the past, there are a lot of privately-held family-owned companies that you would expect are maybe in this environment a little more inclined to seek a sale than they might be in a more robust economic environment.

Great, and final question. In your opening remarks you mentioned, again, tough economy. But you also highlighted competition. Are you seeing anything unusual on the competitive front? Are people getting more aggressive in their bidding for contracts?

No, I don't think we've seen anything across any of the sectors that would tell us that at this point.

It remains a very competitive environment, always has been. But there hasn't been any overall aggregate change in the level of competition.

Great, thank you very much.

Rishi Sadarangani from AllianceBernstein.

Yes, good morning. Just a couple of questions on your labor costs. You alluded to a little bit of this in a prior question. But I guess my first question, I'm just trying to understand if you are going to see any negative impact from higher inflation or inflationary expectations in terms of your labor force demanding higher wages.

Or are you going to see any positive impacts from, let's say, economic weakness and maybe the unemployment rate going up?

So, how do you think about these two effects? Are these likely to cancel each other out, or is one likely to dominate the other? Any thoughts going forward?

This is Fred. I really think of it, too, as more or less canceling each other out. The level of unemployment, I think the last number that came out, it was expected it would go up by 1/10 of 1%. I believe it actually improved or went down by 1/10 of 1%.

But clearly given the weakness in the economy, in certain segments of the economy, we don't expect there to be increasing pressure on labor rates, as one saw back in the late '90s, for example, when the economy was really superheated. So we don't think those days are here.

Having said that, we also are not counting on any seachange in the increase in wages as a result of any economic weakness. So we are at this point pretty comfortable that what is going on externally is not going to be a big negative or a big positive in the labor front.

Okay. What are the relative increases or the differentials in wage increases in your International business versus your Domestic business?

I think that is hard to answer, because it's really a function of the inflation rates, local inflation rates. I think I would guess on average, across the entire International business versus our entire Domestic business, that we would not be seeing significant differences.

Maybe the International business would be somewhat higher, because I think if you took the weighted average inflation rate of our countries in which we operate and compared it to US inflation, it might be somewhat higher. But I don't think it is meaningfully different.

Okay. Any particular country or region or part of the world where you're seeing wage increases that are outliers or you think are a little troublesome, or --?

No, I don't think so.

Okay, thank you.

That's all the time we have for questions. I will now turn the call back over to Chris.

Well, thank you, everyone, for your participation this morning and we hope you have a terrific day.

That concludes today's conference call. Thank you again for your participation.