Aramark (ARMK) 2016 Q1 法說會逐字稿

Good morning and welcome to Aramark's first quarter 2016 earnings results 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 listen-only mode.

(Operator Instructions)

I will now turn the call over to Ian Bailey, Vice President of Investor Relations. Mr. Bailey, please proceed.

Thank you and welcome to Aramark's conference call to review operating results for the first quarter of 2016. Here with me today are Eric Foss, our Chairman, President, and Chief Executive Officer; and Stephen Bramlage, our Executive Vice President and Chief Financial Officer.

Our notice regarding forward-looking statements, which is included in our press release this morning, can be found on our website and is detailed on page two of the earnings slide deck. 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 SEC filings.

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

Thanks, Ian. Good morning and thanks to everybody for joining us.

As you saw in this morning's release, we reported a strong quarter and the year is off to a good start. The consistent execution of our transformation strategy continues to deliver a combination of broad based growth, as well as productivity improvement, both of which are leading to solid margin expansion.

And despite some modest incremental currency headwinds, our outlook for the year remains unchanged. Looking at the quarter, adjusted earnings per share were $0.50, a 9% increase from last year on a constant currency basis. Total Company organic sales were up 3% and food, labor, and SG&A productivity gains facilitated an increase in adjusted operating margins to 7.1%, a 30 basis point improvement versus year ago.

In the quarter, we also continued to reinvest in the business as we continue to support technology, capability, and growth initiatives across the organization. Overall, the quarter was consistent with our expectations and it illustrates solid momentum in support of the multi-year growth and margin expansion goals we presented at our investor day in December.

As a reminder, at investor day we committed to a 100 basis point improvement in constant currency adjusted operating margins from 2016 to 2018. We have a very good line of sight on the food and labor cost reductions that will facilitate this margin lock. And while to a lesser degree, SG&A savings are also an important component.

We expect to drive margin improvement over this time period while simultaneously reinvesting in the business, particularly in the area of technology, as we continue to work to create long-term shareholder value. I think our first quarter results demonstrate that achieving balanced sales growth, margin expansion, and simultaneous reinvestment is possible when you have the right strategy in place and are actively managing the business.

Going a bit deeper into growth, retention rates remain strong and are tracking consistently with our targeted mid 90s percentage for the year. North America organic sales were 4% in the quarter, led by sports and education, with notable gains coming from new client on-boarding and strong playoff activity. We also saw good growth across business and industry, leisure, and healthcare technologies.

Our international business grew organic sales by 2%, driven by continued expansion in Europe, mid-single-digit growth in emerging markets, including strong high-teens growth in China. Absent our previously disclosed exit from two small geographies in Latin America, which reduced the international segments growth by a couple percent in the quarter, we saw consistent and stable growth patterns across our international business.

Uniforms continues to benefit from our investments in capacity expansion, which resulted in organic sales growth of 4% in the quarter. We signed a number of new business wins during the quarter, including Capital One Financial Corporation, Lincoln University, Huawei Technologies in China, and the new Odyssey Aquarium in Scottsdale, Arizona.

We look forward to our pipeline in new business as it remains encouraging, which I think bodes well for continued execution behind the multi-year framework. Also on the new business front we had told you previously that we won Yosemite National Park. The largest client win in Aramark's history.

We have made excellent progress in our transition plans for the March 1, 2016 startup retaining almost 100% of the dedicated Yosemite employees who manage overnight accommodations, food and beverage operations, retail sales and a variety of other park activities. We are extremely proud to welcome Yosemite to the Aramark family and we look forward in the coming months with a number of innovations to make the consumer experience at the park even more memorable.

Innovation remains an integral component of achieving the growth goals we have identified. Innovation buttresses our productivity improvement by cementing our right to win new clients and our ability to maintain healthy retention rates, while also creating a more memorable experience for consumers. A few recent examples of notable innovation include our sports partnerships and ongoing focus on health and wellness.

Following our World Series partnerships with both the Kansas City Royals and New York Mets, we continue to fuel championship performances across collegiate and professional sports. Including being a proud partner with the 2016 NCAA football champions, the Alabama Crimson Tide, and this year's runner-up, the Clemson Tigers. Both of these universities have entrusted Aramark for decades to fuel their students and student athletes to excellence in the classroom and on the field.

In the NFL, seven of our 13 teams that we proudly serve competed in the post-season, including our 15 year facilities partner and Super Bowl 50 champion, Denver Broncos, who we congratulate on an outstanding performance. Speaking of Super Bowl 50, for the second year in a row we were selected by the NFL to manage the NFL SHOP. The primary Super Bowl retail store.

Our 35,000 square foot retail store was more than just a store and was designed to entertain fans while they shopped featuring a VIP boutique and customization section, as well as player signings, wine tastings, and music. I want to congratulate our teams and our partners because we drove a double-digit increase and achieved record sales this year on the merchandise front. We're already looking forward to next year's Super Bowl in Houston where we'll manage the full line-up of food and beverage, retail merchandise, and the facility services.

Coming up next we're preparing for the NCAA March Madness, where several tournament games and the Final Four will be played at Aramark venues. Turning to innovative offerings around health and wellness, our initiatives that we launched last year with the American Heart Association continue to ramp up.

For February heart month, we kicked off the Eat Well Challenge to engage consumers at locations across the US and committed to making healthier eating choices. People who accepted our Eat Well Challenge have a chance to win multiple healthy for life prizes like Fitbits and juicers that go to them and/or someone they care about. To make it easier to Eat Well while dining with Aramark, consumers now look for our special healthy for life icon leading them to choices with at least one full serving of fruits, vegetables, whole grains, or lean proteins as well as fewer calories, saturated fat, and sodium than the traditional choices.

Turning from growth to our second strategic must, which is all around activating productivity to reinvesting growth and expand margins. Here we continue to drive meaningful improvement in operating margins to reductions in food, labor, and SG&A expenses across lines of business. During the quarter we grew North American constant currency adjusted operating income by 8%, partially driven by a 30 basis point increase in North America AOI margin. Our international business delivered 7% increase in constant currency AOI, as well as a 10 basis point improvement in margins.

We also saw strong margins expansion across our South America, Mexico, and China businesses. And while uniforms AOI was down 3%, this was expected and relates to our previously announced capacity expansion. Absent this temporary effect, we he estimate the uniform margin growth would have been consistent with business at pre-expansion levels. And additionally, we expect to capacity expansion to subside as we continue throughout 2016.

Our focus on driving a cultural mindset around operational excellence to drive efficiency and productivity across our enterprise remains resilient. Our holistic approach to our operating models globally to address opportunities in food, across supply chain, to lowering our cost to good sold through procurement distribution, as well as the food production process continues.

In labor, we're implement meaning a standardized in unit labor model as well as focused on overtime and agency labor. We also continue to streamline and simplify our above unit organizational structure to ensure we have got clear roles and accountabilities that speed decision making to create a better consumer experience.

Looking at our third strategic pillar, our people, last week we were honored to join our partner at the University of Central Florida to open an innovative therapy cafe, featuring a special harness system allowing people with traumatic brain injuries or strokes the chance to be mobile in the workplace. This creates a safe environment where they can focus on recovery as well as practice communication and cognitive skills and tasks.

On a related note, we continue to earn recognition around the diverse and inclusive environment we provide to our employees. For the second year in a row, CAREERS & the disABLED magazine ranked Aramark amongst its top 50 employers, by providing a positive work environment for people with disabilities. Our recruiting efforts continue to focus on filling the talent pipeline with our on-campus recruiting initiatives as well as continuing to source from a large pool of deserving military veterans.

Before I turn the call over to Steve, one other topic which warrants touching on given the level of uncertainty over the broader economy, and that is the resilience of our business model. There are many facets of our model that provide a significant degree of resiliency in an economic downturn. Our diversified and blue chip client base reduces concentration risks and interestingly no one client comprises more than 2% of our annual sales.

We also have a little over 50% of our sales derived from less cyclical healthcare, education, and corrections clients, which adds just another level of stability. Our variable food and labor input costs allow us to really flex the business model to meet the macro environment.

And while I would add that my comments have no degree of prognostication regarding the trajectory of the broader economy, but as it relates to Aramark outside of energy, we have not noted any unusual disruptions in our clients, in our sales pipeline, or more broadly across the business. And as I have pointed out, our outlook for the year is unchanged and we remain encouraged with our prospects going forward.

And with that I'll turn the call over to Steve for a more detailed look at the numbers. Steve.

Thank you, Eric, and good morning everyone.

As Eric mentioned the first quarter performance was quite consistent with our expectations. Even though we are facing a generally more uncertain global macro economic backdrop, we were able to make demonstrable progress against our longer term financial objectives without compromising our commitment to invest in the business. Furthermore, we augmented our already strong financial flexibility during the quarter in spite of choppy market conditions. Let me begin on slide 4, with the sales reconciliation versus the first quarter of 2013.

Sales on a GAAP basis were flat year over year at about $3.7 billion. Adverse currency trends in the form of a stronger US dollar was the only significant reconciling item year over year, as there was no material M&A impact. For us, the most significant drivers of the $113 million currency sales headwind in the quarter were the Canadian dollar, the Euro, and the Chilean peso, all of which weakened between low and mid double digits on a year-over-year basis against the US dollar.

Organic sales for the Company grew 3% in the quarter with positive contributions from all three reportable segments. Slide 5 reconciles adjusted operating income year-over-year performance on a constant currency basis. Please note, that as we had foreshadowed at the end of 2015 we've conformed our presentation of constant currency results to a format we believe is now more consistent with broader practice. We will no longer be adjusting prior year reported numbers.

In the center of the page first quarter 2016 adjusted operating income was $262 million, approximately 4% higher than prior year's figure of $252 million. The $262 million reported in 2016's first quarter includes $7 million of a currency headwind or about 3% versus the prior year starting point. Therefore, on a constant currency basis our adjusted operating income improved 7% year over year.

Both in North America and international FSS segments reported higher year-on-year adjusted operating income, while uniforms was lower due to the planned capacity expansion work in the quarter on the West Coast of the United States. When complete, which should be by the end of the second quarter, we will have expanded capacity in this part of the uniform business by over 20%, which lays the groundwork for continued multi-year revenue and margin expansion in this segment.

Slide 6 provides the roll-forward to help bridge our adjusted EPS year over year and is presented in the same format as that of adjusted operating income. Our adjusted EPS increased to $0.50 in the quarter versus the $0.47 we reported in the first quarter of 2015, taking into account approximately $0.01 of currency headwind, this is a 9% increase on a constant currency basis.

Slide 7 summarizes our balance sheet position in the quarter. I'm very pleased to report that we continue to make steady progress improving our already strong financial flexibility profile. Our quarter end liquidity remains strong with our cash position and undrawn revolver providing approximately $780 million of available liquidity.

While the first quarter is a significant seasonal use of cash for us, free cash flow, which we define as cash from operations less net capital expenditures, improved by approximately $85 million year over year and that was largely due to a combination of higher EBITDA and lower capital spending, the latter of which was largely timing related.

Our total debt to adjusted EBITDA ratio was 30 basis points lower than prior year at 4.3 times due to both higher EBITDA and approximately $270 million of lower debt levels, thanks to the deleveraging activity in previous years. During the quarter, the Company opportunistically issued $400 million of 8-year fixed rate unsecured notes due in 2024.

This extend the tenor of our debt maturity profile as it's now the longest live piece of debt we have and by the end of the year it will allow us to reduce a commensurate amount of secured short-term financing that matures in 2019. You should expect that we will continue to take advantage of opportunities that present themselves regarding our debt maturity profile over the next several years. We continue to expect that our free cash flow generation in 2016, which is after we have adequately reinvested in the business, will first be applied to servicing the dividend and then directed to further deleveraging.

Slide 8 details our expectations for 2016 and it should look very familiar from our last call. Other than a modest incremental currency translation headwind of an additional $0.02 per share at current rates, which we expect to absorb and offset within operations, our business outlook remains completely unchanged.

We continue to expect adjusted EPS between $1.65 and $1.75 and corporate performance at least on par with our long-term framework. And as a reminder, our framework contemplates 3% to 5% annual organic sales growth, mid-to-upper single-digit AOI growth, and low double-digit adjusted EPS growth. Q1 results are clearly supportive of this framework. The recent bond offering will not change our interest expense assumptions for the year, which should be consistent with 2015 levels.

Our segment expectations for the first half of 2016, which is on the right-hand side of the page, are exactly the same as what we told you in November.

I have two comments related to the quarterly cadence of year-over-year performance in the first half. The first related to the timing of our Yosemite account startup. We did not invest as much as we had anticipated in the first quarter, which will push more of the planned investment into the second. We will essentially incur the full cost of running the account during the entire quarter, to ensure that we have a smooth transition. While we only begin to record revenue in the last month of the second quarter. Secondly, the recent weather events on the East Coast of the US are likely to have cost us the equivalent of a service day or two across several of our lines of business in the quarter.

So to conclude, I would reiterate our expectations for the first half and the full year remain completely unchanged from our earlier comments and consistent with our multi-year financial framework.

With that I believe that Eric has a couple of closing comments.

Thanks, Steve. And I think Ian, I'll just have you open up the call for Q&A, if we could.

(Operator Instructions)

First question comes from the line of Andrew Steinerman. Your line is open.

Hi. Congratulations. This is Andrew. My question is, I was hoping you could just go over the status of the various tech systems implementations. I obviously know you outlined a lot of them over at analyst day. But just give us a status of which systems are helping produce margin expansion now and which systems are really more of an investment that will help margins later on.

Sure, Andrew. Good morning and thanks for your comments. I think as we shared at investor day, we committed to rolling out a variety of tools and technology that will help us as we proceed down that path. Our investments in technology vary from trying to standardized our global field financials, which is well in place.

On the labor side, Chronos is an important scheduling tool. Again, we're fairly far down that path relative to moving from pilot to deployment. I would say where there is still a lot of work in progress is on the food side, whether that be with Prima Web, which helps with our food production process, and then on the sales side. Again fairly fully deployed with tools like SalesForce.com.

My simple answer I think would be if you look at the quarter, about half of our investment went into technology. The other half went into people and capability. That will continue. And I'd say we're fairly well deployed more on the labor tools and the work in progress on the food side.

Andrew, I would probably just add to this, on point of sale we're probably least far along, so which is consistent with what we had communicated at investor day as we start to really roll out that platform across the organization. So that will certainly be something I would not expect significant contribution from in the current fiscal year. It's more in the out years.

And the financial ERP system?

The financial ERP system we're largely an Oracle organization across most of our North American businesses today. We are rolling out Oracle in a couple of the smaller international affiliates. But I think for your purposes, Oracle is really the platform across most of the business already. Great. Thank you.

Thanks, Andrew.

And your next question comes from the line of Andy Wittman. Your line is open.

Great. Thanks. So I guess my first question is, it sounds like sports and entertainment was a benefit. You guys called that out. Can you give us some boundaries as how to think about this in terms of how we compared to last year? And a year from now when we have to talk about this again that we don't have to say that we've got a tough comp here if there is something unusual?

Well, Andrew, good morning. Let me start by saying I think if you think about our growth in the quarter, the best way to characterize that growth would be balanced and broad-based. It came from a combination of strong retention, very good base business growth, some moderate pricing into that base business growth, and as we referenced in the comments, some strong new business wins. So let me start with that.

I think as you look at the performance of the various businesses, education, sports and entertainment led the way in North America. But again I think the revenue connected with, for example, strong playoffs, will vary year to year. But it's not a huge, huge contributor or a huge, huge headwind in any given year or quarter, is the best way I would characterize it, if that's the core of your question.

Yes. No. That is. Thank you. And then for my follow-up I guess I wanted to dig into the uniform segment and the margins in particular. You talked about the capacity expansions being the reason why margins were down year over year. Maybe Steve, if you could give us some of the puts and takes inside of those margins. I guess across the industry we have seen the margin gains slowing here.

But I have to imagine things like fuel were at least a little bit helpful to you, but maybe merchandise cost, maybe some of the key buckets that varied year over year. And then basically, what's the glide path, you said the margins were going to abate -- or the margin headwinds were going to abate as the year went on. What does that look like? Do you think we could see positive margins by 4Q? Just some of our commentary around that would be helpful.

Go ahead.

Let me take a shot at that first. So I think specifically in the first quarter a couple of different questions in there. Our exposure on some of the macro stuff in our uniforms business, energy clients and that sort of thing, I would not label as material. So let me put that aside first.

We clearly did get a modest benefit on year-over-year basis from lower diesel and fuel costs. Probably a couple of million dollars on a year-over-year basis there.

The way I would describe the pressure that we had in the first quarter from the capacity expansion is for a period of time we essentially are running two factories at the same time. We are stating up a new factory and we have hired all the people and we have turned it on and running the equipment. And in the process of transitioning the laundry from one to the other the legacy factory is also up and running. So you are incurring kind of a doubling of costs for a period of time related to that facility.

So that doubling of cost across the West Coast is what drove ultimately the margins to be a little bit down on a year-over-year basis. We certainly, if you look at our guidance for the rest of the year, I would expect uniforms to be positive on a year-over-year basis in the second quarter modestly. And then we will get us to more of the traditional run rate into that business by the second half of the year as it relates to year-over-year margin improvement.

Yes. And just to maybe add a little color commentary, I think as you look at our focus on the margin march broadly it certainly applies equally to whether it's our food or facilities or certainly our uniform business as well, Andrew. It's been a major priority. As you know the last several years we have made significant progress to the tune of 50 bips or better performance year in and year out each of the last three years.

As Steve mentioned, and as we mentioned in the comments, there is headwind due to capacity. That will subside. So I think as we watch the year unfold, you will see margins improve and would expect them to be positive on a full-year basis.

Thank you.

And your next question is going to come from the line of Denny Galindo. Your line is open.

Thanks for taking my questions. Thanks for the color on Yosemite start up cost. I just want to delve a little bit more into that. When I was backing into the revenue lift I was coming to say once it gets up fully running it maybe it adds 150 basis points a quarter.

If that's right, first of all, does that mean the expenses in Q2 would jump up by somewhere around 150 basis points but revenue would only increase maybe 50 basis points? Is that the right way to think about?

I will probably state it in dollars. I think that's a little safer for us in terms of the way I think about it. We will, on a full year basis as Eric had referenced, Yosemite is going to be essentially the biggest new client win that we have had.

Well over $100 million approaching $120 million, $130 million of revenue on a full year basis. We clearly won't get all of that in the fiscal year, but we will get most of the high season based on the -- when the park in the summer is within our fiscal year.

But I would expect us to pick up or to incur a couple of million dollars of incremental operating costs without a lot of revenue to show for it in the second quarter, and then you'll start to see a reversal of that in the third. We would expect to be getting fairly typical profitability in that account as we get into the second and later part of the year.

Okay. That's helpful. And then just detailing what types of costs you are spending there. I mean, usually startup costs are heavy on labor and hiring and training. But I know this one, there has been kind of this issue in the news about Delaware North and their suit over the names of the hotels and the trails.

So maybe you could give us a little color on how much of the startup is labor and traditional startup versus how much is unique startup from this particular kind of conflict you're having. And is that number even known yet or is it still up in the air depending what happens with their challenge of kind of the transfer of ownership to some of those brand names?

Yes, Denny, it's Eric. Let me take that. Let me back up and state a couple of things on our partnership with Yosemite. First of all, I think we're very honored to have been chosen. It's a real privilege and certainly an honor that we take very seriously.

I think as you think about the start-up, the team has been working seamlessly with NPS to create a real seamless transition. The great news is, is unlike a lot of other more intensive start-ups, this one, while it's big in terms of revenue, the degree of difficulty is actually a little bit easier relative to the transition. One of the big reasons for that is we have actually retained and hired about 90% of the plus percent of the employee base.

So to your point, when we talk about start-up costs, I would characterize it as our start-up costs are very traditional investing in capability, investing in capital and other improvements that are needed. And I wouldn't say there is anything of any significance relative to anything unique, to use your term, relative to cost as we look at that.

Again it would be inappropriate for me to comment on some of the things that have been going on from a litigation standpoint. But rest assured I think the NPS and Aramark are going to be long-term partners. We continue to develop innovative programs and services that will create a better experience for park visitors and I think you're going to find this is going to be a great, great client of ours and one that we're very happy to land.

That's it for me. Thank you, guys.

Thanks.

And your next question comes from the line of Gary Bisbee. Your line is open.

Hi, guys. Good morning. I guess the first question, could you give us a little more color at the end market or sub segment level? In your filings you put, you break down revenue by education, healthcare, business, and industry, et cetera, for the North America business. And I know that was difficult last year because of the timing shift and a few other things.

But I am trying to peel that back. It sort of looked like education was the primary growth vehicle and the rest of the businesses didn't do quite as well. That may well just be the extra week. Can you give us some more color there?

Yes, sure. Gary, good morning. It's Eric. Are you talking primarily about North America or are you talking about some of the international geographies as well?

Whatever you would like to comment on. North America food and facilities was primarily what I was thinking about.

You bet, let me say the following. As you looked at our growth in the quarter, I am going to use the same terms, which are balanced and broad-based. Let me break North America down for you into some of the bigger chunks. Education led the way along with sports and entertainment, as we talked about.

We saw good growth in leisure. We saw good growth in business dining, another big segment for us. We saw good growth in our healthcare technology business, which grew.

So I think literally across the board we saw fairly significant growth. I think maybe with the one exception that I would call out which would be corrections. As you know, we exited a client that will impact us a little bit in the early part of the year.

And then as you break down the international growth, again saw really good growth in Europe led by Germany and Ireland and Spain. That was offset by some of the headwinds we're experiencing with the UK offshore business. And then as you get into emerging markets, saw double-digit growth out of China, as I mentioned.

Korea was double-digit. Mexico was double-digit. And as we've talked, as we exit a couple of these unprofitable markets, they are a little bit of a headwind. So it's really broad-based, as is evidenced by my comments.

Great. Thanks. And then a question I've been getting a lot lately, which is somewhat ironic given a year ago it was the opposite people were worried about, but help us understand how we should think about food deflation in your business model? How it impacts the top line margins and I guess whether you've seen it and whether it looks like from run rate levels you might see that later in the fiscal year? Thank you.

Let me start with that, Gary. So our experience year-to-date on food, I would say is generally pretty flat. I don't think we are actually in a deflationary environment in total, but we certainly do not have a lot of inflation at the same time. So if you think of the 75% to 80% of our business that is food related, food is probably 40% or so of our cost of services in that part of the business.

And so to the extent the one-third of that piece of the business, which is more of a traditional kind of a cost-plus or a client interest type of a business right to the extent there is deflation or inflation, we would not benefit or feel the pain associated with that. That would generally pass on to the client's account. So I would tell you not much is passing on one way or the other thus far this year.

On the other two-thirds of that piece of the business, which is really on our own account, obviously we would get the benefit of deflation or lack of inflation. To the extent it ticks up we would have to incur that on our own. By and large, thus far very little to any inflation at all on a net or a gross basis thus far this year.

Thank you.

And your next question comes from the line of Manav Patnaik. Your line is open.

Good start to the year. I just wanted to just go back to your questions on your resiliency in a tough economic environment and the different offsets in less successful sectors you had. I was hoping just on the catering business firstly, if we look back at how you guys did in the 2008, 2009 timeframe, how would you characterize that?

And in terms of what's changed from then to today. Do you have much more exposure to the less [successful gain] did you cost offsets much better position? Any color on that would be helpful.

Thanks. I think in reference to your question, our business has proven to be very, very resilient as well as very predictable, to be honest. I think it's driven by a couple of things.

One is we kind of start with this strong retention rate and ten-year kind of client duration. That plus the fact that 50% of this business rests in less cyclical sectors, like healthcare and education. The fact that the model itself is diversified certainly helps.

And then I think our ability to deal with some of the things that Steve mentioned relative to inflation gives us, I think, some very unique advantages. And so I think if you go back in time, what you'll find over time both in good times and in more difficult economic times, the model is very resilient relative to the margin structure and overall profitability. We feel highly confident in our ability to execute even in more difficult economic times.

And then maybe on the uniform segments somewhat similar, Steve, I think you mentioned oil was not a material exposure. But just generally to think about the exposure to industrial, manufacturing in the context of the pressures in those particular sectors, is there anything to call out in terms of exposures as a concentration?

The only thing -- and I'll let Steve comment. The only thing I would say is our uniform business is our most sensitive business to employment. So that is, I think, a very unique dimension to the uniform business versus some of our others. Steve, you want to add anything?

The only thing I would add is our concentration generally with any individual sector or any individual customer in uniforms is probably the most diffused of any of our lines of business. Most of our accounts are relatively small business type of accounts generally. So our exposure and our concentration to any individual segment is probably de minimis or immaterial from the organization's point of view.

Thanks a lot, guys.

Thank you.

And your next question comes from the line of Stephen Grambling. Your line is open.

Hey, thanks. Good morning.

Morning, Steve.

This is a follow-up on Gary's deflation question. What are the big buckets of commodities that would influence your input costs most, whether that's produce, beef, cheese? And is there a lag time on what you see? Because it looks like most proteins and dairy are pretty far down and some of your distributors even seem to call it out at least as a benefit.

Yes. Let me start. If you look at the waiting, I mean, you touched on some of the larger items, obviously, proteins are important to us. Proteins are probably one-quarter or so of our total index. And you've got your fruit and vegetables, dairy, groceries. So the things that you had mentioned.

I tell you we have -- back to my initial or my earlier comment of a flat overall, we do have some modest inflation in a couple of the categories. There is some inflation in some of the fresh, more fresh products on fruit. Fruit and vegetables, et cetera, offset by a little bit of lower pricing on some of the proteins.

So I would say it's a mixed bag in terms of what we've seen so far for us. And again it's getting back to that flattish kind of experience thus far.

Thanks. That's helpful. Turning to the uniform business, with this 20% increase in capacity as we think about the revenue potential, is that something that was limiting the opportunity from existing customers or is that more of a new customer opportunity?

I think what happens, Stephen, last year was a pretty good example. We ran into situations where it was affecting our ability to supply on the West Coast. And so the need for expansion and additional capacity was very much needed.

And I think you'll see a little bit of that uptick as we add that capacity and now have the flexibility to go out and sell more. We were very, very capacity constrained, I would say, for the last 18 months or so prior to this capital investment.

Great. One last one if I could sneak it in. I may have missed this You mentioned Latin American exit being a couple of percentage points headwind.

What drove that exit? Or could you remind us of that? What was the growth rate in Europe this quarter?

Well, the growth rate in Europe was up -- Europe in total was up low-single digit. I think relative to the South America question, I think we've mentioned before that we were exiting some unprofitable and sub-scale markets.

There were a couple of countries that were just sub-scale. So as a result of that South America was, in total, I think down about 1 point, but it was affected by the exit of those two geographies.

And will that be similar through the rest of the year?

Yes. It will -- we've started that process. We obviously need to respect the existing customer contracts, et cetera. And so I would expect a relatively ratable phasing over the course of the year from those exits.

Very helpful. Thanks so much. I will jump back in the queue.

And your next question comes from the line of Anj Singh. Your line is open.

Hi. Thanks for taking my questions. One on North American adjusted operating margins. Wondering if you could just give a sense of what the margin expansion at Q1 would have looked like if you phased in the startup costs and investments as you had originally planned? Just trying to get a sense of how much of the lift was productively driven versus lower investment.

Yes. Let me take that. I think if you think about what we've termed in the past base productivity, a combination of food, labor and SG&A, efficiency and productivity, that base productivity was up about 50 basis points.

And then I think you can walk from the 50 basis points to the 30 basis points pretty equally relative to about 10 basis points in terms of investments. As I mentioned earlier, split evenly between technology and capability and the other 10 bips on startup costs.

Got it. That's helpful. Then I think you had also discussed at your investor day some technology pilots that you would be rolling out at several client sites in December. Could you just give us an update or some insight on how that fared? Would appreciate any color there.

Yes. I'd characterize it broadly as we're on track. Some of those are just starting up, to be perfectly honest with you. Any time we go into pilot, we'd want to get at least a six-month read before we are beginning to draw any conclusions.

In some instances, it might be a little bit longer than that. I would say everything is on track and in motion. As we get the key learnings just like we did last year, you'll probably see us talk more about that as we get into the latter quarters this year.

Appreciate it. Thank you.

You're welcome.

And your next question comes from the line of Sara Gubins. Your line is open.

Good morning. How are your new business wins pacing? Are they looking like they will about the $1 billion mark for the year?

Yes. I think if you looked at our new business in the quarter, it was pretty much on track. Again we had some strong wins that we highlighted. The pipeline is encouraging. The thing that we can never really tell, Sara, is just the decision-making matrix and timeline.

And so again from where we sit, we're very encouraged. But the timing of those decisions are obviously in the hands of our clients. But I think from where we sit right now we would expect to have a strong year and a consistent new business year relative to the multi-year framework that we've laid out.

Great. And then back to international. Just to make sure we understood, are there more underperforming markets that you're planning to exit throughout the course of the year? And could you help us think about a what that might mean for your margins?

They were up less than what we're used to seeing. I would assume that some of that drag might help margin expansion during the rest of the year?

Yes. I think we're, for the time being, pretty much done with what I would call the pruning of some unprofitable businesses. And you think as the year unfolds what you'll see is, as we exit these unprofitable sub-scale markets, it will be a bit of a revenue headwind and it will be a margin tailwind relative to the pickup as we -- as the quarters unfold in 2016.

Great. Thank you.

And your next question comes from the line of Carla Casella. Your line is open.

Hi. I wonder if we're -- (technical difficulty) opportunistically the bond market this year. Any thoughts on refinancing the next notes that -- as they go callable?

Yes. I'll take that. We'll continue to assess all of the options that we have available to us. We certainly will look at the notes obviously when a call date steps down. Those notes are due a year or two after a significant amount of secured debt that actually has a larger notional amount.

My expectation sitting here is I think we would be more likely to attack near-term maturities given the size of that tower and the fact that gives us more flexibility from a secured debt standpoint. But we will certainly look at the math as it relates to the notes at the next call-down date, as you would expect us to.

Okay. And then you mentioned that your uniform business is the most economically sensitive. But I am just wondering if you have seen any recent either weakness in the volumes at more your business services business or, in the financial industry just given the fluctuations in the stock and bond markets?

No, I don't think so. Again, as I mentioned in my prepared comments, I think where we've seen some disruption is really in the energy sector. And other than that given the broad based performance we saw in the quarter, we continue to see pretty good performance across different sectors, industries and channels.

Great. Okay. Thank you.

And your next question comes from the line of Manav Patnaik. Your line is open.

Thanks again. One quick question. I wanted to follow up again on capital allocation. I know you mentioned it briefly in the call. Just curious. You had done a little bit of a buy backs last year.

I think the market today would like to see companies delever a bit. I think the M&A pipeline might be getting better if the economy keeps hanging in like this. Curious how you guys think about the priorities and how those could move around based on what opportunities arise?

Yes. This is Steve. I think we're thinking the same things that we were thinking previously around capital allocations. It's for sure we would want to continue to delever the balance sheet.

So absent some something from a strategic point of view that gives us a compelling reason to assess whether we would want to spend some of our capital on there, which tends to be very episodic, obviously, and not totally within our control generally anyways. Certainly in the fiscal year you should expect us to continue to delever. We have been very clear that we are targeting in that debt to EBITDA ratio somewhere south of 3.5 times.

So we will need to take the cash we generate this year and apply that to deleveraging to move closer to that 3.5 times number. As we had said on investor day, to the extent that there is a strategically compelling opportunity for us in the market, we would certainly look at that.

And to the extent we would pursue something, we would need to be confident that there was a very clear path for us to maintain progress around deleveraging and a longer term basis. We need to see how we get back on the path that we're currently pursuing. Short-term, the cash will continue to go to deleveraging, absent any additional alternatives.

Good, Steve. Thanks, guys.

And your next question comes from the line of Denny Galindo.

Two quick little ones for housekeeping. Number one, could you tell us what the impairment -- looks like in North America was small, like $1.7 million. Just curious what asset that was referring to?

Secondly in the capacity in California, what city is that capacity going into to or is it broadly spread out? Maybe just a little you color there too as well.

I will do the second one first. A large part of our -- our work is really up and down the West Coast. But the specific locations that we have spent the most time on are in Central and Northern -- or are all across California, really. So I would say greater LA and the greater San Francisco area is where we spent a lot of time and a lot of the money with those facilities.

And the adjustment we made that you referenced earlier, we have a property that's held for sale. As we work through various offers on how we sell that based on market conditions, et cetera, we need to mark that property to market each quarter. So based on current market conditions, we wrote it down by a little over $1 million.

Okay. Thank you very much.

(Operator Instructions)

Your next question comes from the line of Anj Singh. Your line is open.

Hi. Quick follow-up. I know we talked about food and deflation. Hoping we can also just touch on wage inflation. Some of the BLS labor data is starting to show modest wage acceleration.

Hoping to just get your sense of what you are seeing on that front. Are you seeing any similar pressures in your labor costs and perhaps any expectations on that front as we look ahead?

So I'll start with that. I would say we're experiencing general market conditions around labor, labor inflation, at least certainly in the United States. And so our labor -- the way labor inflation impacts us would be the same as food in terms of how much we end up absorbing versus ultimately sending through for client benefits.

So I won't repeat all of that math. But we certainly are experiencing a percent or two of labor inflation broadly across the board. I think that's consistent in both our hourly work force as well as our salary work force in the U.S

Okay. Thank you. Appreciate it.

And that concludes today's Q&A session. We now turn the call back to the presenters for closing remarks.

Thank you very much. Just to reiterate, we think the year is off to a nice start. The business is performing well and our focus is really on continuing to work on how we grow and create shareholder value going forward. So we appreciate you joining us today and have a great day. Thank you.

Thanks to all participants for joining us today. We hope you've found this webcast presentation informative. This concludes our webcast presentation. You may now disconnect. Have a good day.