Aramark

Good morning and welcome to Airmark's third quarter fiscal 2023 earnings results conference call. My name is Kevin and I'll be your operator for today. At this time, I would like to inform you that this conference is being recorded for rebroadcast and that all participants are on a listen-only mode. We will open the conference with questions after the conclusion of the company's remarks. I will now turn the call over to Felice Cassell, Vice President of Investor Relations and Corporate Development. Ms. Cassell, please proceed.

Thank you and welcome to Aramark's third quarter fiscal 2023 earnings conference call and webcast. This morning you'll be hearing from our Chief Executive Officer, John Zilmer, as well as Chief Financial Officer, Tom Androff. As a reminder, our notice regarding forward-looking statements is included in our press release this morning, which can be found on our website. During this call, we will be making comments that are forward-looking. Actual results may differ materially from those expressed or implied as a result of various risks, uncertainties, and important factors, including those discussed in the risk factors, MD&A, and other sections of our annual report on Form 10-K and other SEC filings. Also, 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 will now turn the call over to John.

Thanks, Felice, and thanks to all of you for joining us today. This morning, Tom and I will review our third quarter results, which reflect a strong focus on growth across the organization and momentum in our return to normalized margins. We will also share an update on the significant progress we've made on the uniform services spinoff transaction. We will then turn to our raised financial expectations for this fiscal year with just one quarter to go before opening a line for questions. We believe that our performance driven culture and all that it represents has created substantial opportunities that we expect to capitalize on in the months and quarters ahead. Before I get into the results, I want to acknowledge a tremendous loss the Aramark family had a few weeks ago. John Orobono, our senior vice president of supply chain, lost his hard-fought battle with cancer. As many of you know, John returned to Aramark in October of 2019 and was with the company for almost 40 years in total. He was a true inspiration, a dear friend to so many of us, and a visionary who changed the way supply chain is managed, first for Aramark, and then throughout the food service industry, establishing a true gold standard. True to his focus on doing everything he could for Aramark, he left a strong, capable team and a solid succession plan. Our hearts are heavy, but we have full confidence in those who learn from all John so generously shared. I will now turn to the quarter. Aramark's organic revenue grew over 14% compared to the same period last year. global food and support services consisting of the FSS U.S., FSS International, and corporate reportable segments contributed year-over-year growth of more than 16%, and uniformed services increased by approximately 5%. Within global FSS, the U.S. segment grew organic revenue nearly 15% year-over-year, led by continued momentum from net new business, strong per capita spending, and increased event attendance in sports and entertainment, and continued favorable trends across the business and industry sector as a result of greater return to work activity at client locations. International organic revenue increased more than 20% versus the comparable period last year. Performance was driven by robust net new business performance, a busy sports and concerts calendar in Europe, particularly in Germany and Spain, as well as strong mining activity in South America. Global FSS continues to add broad-based new business contributions from all sectors and geographies with retention rates maintained above 95%. Since last quarter, just to name a few, our student nutrition team won DC public schools and within BNI, we expanded our relationship with Walmart to serve their new headquarters and add micro markets and vending locations across the country. Collegiate hospitality has been active during its typical selling season and was recently awarded Towson University and the College of William and Mary, among others. The international segment also gained new clients in higher education, including Kingston University in the UK and Ridley College in Canada, and had ongoing success with other bread and butter wins across the portfolio. One of the most important developments of the quarter that Tom will review more in detail was our work with customers in the education sector and corrections business. As we have said in the past, the margins in these businesses have been artificially compressed due to the sudden and significant inflation not seen in this country for decades. We're very pleased to report that our clients have recognized our strong service levels and the cumulative effect of many quarters of outsized inflation. And they've recently agreed to meaningful price adjustments that will bring us a big step closer to normalized margins. The benefit from this will occur partially in the fourth quarter and more fully in the first quarter of fiscal 24 and beyond. The progress and spirit of partnership we've seen in this quarter makes us more confident than ever that our return to normalized margins is proceeding apace and we fully expect will inevitably be achieved. The meaningful progress this quarter is a gratifying proof point of the strength of our bond with our clients and their satisfaction with our service to them. Organic revenue growth in uniformed services was driven primarily by pricing actions and growth in adjacency sales, partially offset by the rollback of an energy surcharge that was implemented in the third quarter last year that represented approximately 80 basis points. We're pleased to have uniformed services leadership well in place and the strategic growth plan is underway with early signs of success coming from improved analytics, portfolio targeting analysis, and adjacency sales. We expect this underlying momentum to build into next year and well beyond. Regarding the spinoff, our collective teams have made significant progress related to the operational, regulatory, and financial logistics. We expect to complete the spinoff at the end of our fiscal year, subject to customary closing conditions and based on the current macroeconomic and capital market environment. A few key milestones as we work towards execution of the transaction. Just this morning, we announced the future board of directors for uniforms as an independent public company composed of a strong mix of industry expertise public company experience and diverse perspectives. This impressive and highly qualified group will provide helpful strategic insight to the uniforms leadership team and their mission to drive significant value. The board will be chaired by uniforms industry veteran Philip Holliman. former president and chief operating officer of Cintas, with over two decades of experience in the industry. The Uniforms Board will also include other seasoned leaders who have strong, relevant backgrounds in uniform and similar route-based businesses. AUS is finalizing terms on approximately $1.8 billion in financing through banking partners, consisting of $1.5 billion in term loans and a $300 million revolving credit facility. Given the attractive cash flow attributes of the Uniforms business, the interest rates are anticipated to be comparable to Aramark's most recent refinancing. With these proceeds, SpinCo is expected to transfer approximately $1.5 billion to Aramark, maintaining neutral net leverage for the total company, all with an eye to continue a path of delevering for both Aramark and AUS. Finally, Kim and her team will host an analyst day in New York City the morning of September 13th. Think. excuse me, September 13th, which will also be available via webcast to review the strategic plan for uniforms and the next phase of value creation. This will be a great opportunity for you to meet the strong team of executives, including exceptional new hires from leaders within the industry. And we'll share more details with you soon. We're excited about the potential and strategic benefits of both businesses operating as independent companies. Before turning the call to Tom, I'd like to highlight a few key accomplishments related to our ESG and DEI initiatives, reflecting our ongoing commitment to positively impact people and the planet through our Be Well, Do Well plan. These initiatives remain highly important to us, as well as our clients, partners, and shareholders across the globe. First, we've taken another step forward in our sustainability efforts. Just last month, we received confirmation from the Science-Based Targets Initiative of our goals to reduce our carbon footprint according to their net zero standard. These targets follow and complement our existing ESG commitments. Also, I'm proud of our recent recognition as a best place to work for disability inclusion and perfect 100% score on the Disability Equality Index once again. We continue to be focused on creating a welcoming and inclusive culture across the organization, and diversity, equity, and inclusion will continue to be a top priority for us. We believe that our focus on our people has become a key differentiator for the company that has led to tremendous outcomes. I could not be more proud of what our team has been able to achieve. Tom?

Thanks, John, and good morning, everyone. Our performance in the third quarter reflected continued strong top and bottom line momentum across the portfolio. As John mentioned, Aramark reported consolidated revenue of more than $4.7 billion in the period. representing year-over-year organic growth in excess of 14%, underpinned by 6% pricing and strong contributions from net new business as well as continued recovery of the base business. Operating income in Q3 was $203 million. Adjusted operating income of $240 million was 34% higher on a constant currency basis compared to the same quarter last year. AOI margin of 5.1% increased 75 basis points year-over-year, and was more than 40 basis points higher than the second quarter, which typically has similar margin levels. As a reminder, AIM Services, which historically contributed 15 to 20 basis points to total company AOI margin, is not included given the sale of our non-controlling stake at the beginning of April. Across all segments, higher year-over-year profitability in the quarter was driven by operating leverage from higher revenue and the maturing of new business for prior years. as well as improved supply chain economics and disciplined above-unit cost management. Organic revenue in AOI and global FSS increased 16% and 47%, respectively, year over year on a constant currency basis. Organic revenue growth was led by contributions from strong net new business and pricing actions, as well as base business growth coming most notably from higher per capita spending in sports and entertainment business and return to work activity in the business and industry sector. Global FSS AOI margin increased 86 basis points compared to the third quarter last year, and 27 basis points sequentially versus the second quarter. On a constant currency basis, uniformed services organic revenue increased 5%, and AOI grew nearly 13% compared to Q3 last year. AOI margin was up approximately 80 basis points to 11.1%, reflecting a nearly 140 basis point sequential improvement compared to the second quarter. As John mentioned, revenue growth in the period was impacted by 80 basis points due to the rollback of an energy surcharge put in during the third quarter last year. The segment's significant margin expansion versus prior year was driven by the initial benefits from implementing a sales strategy focused on a more balanced revenue mix, including adjacency and add-on services. as well as early savings related to efficiency initiatives, including the organizational restructuring earlier in the year. Across the portfolio, supply chain normalization continues to be a key contributor to growing profitability this year, and we believe will be a significant future opportunity for the business. As John and I have mentioned before, a few of our food services businesses experienced a lag in recovering inflation due to a more periodic pricing, generally once a year, including collegiate hospitality meal plans, student nutrition, and corrections. These businesses account for roughly 25% of our total company revenues. Over the past few quarters, the teams have worked hard with our customers to attain significant pricing actions across these business lines, much of which will be implemented during Q4. At the same time, we've seen inflation moderate over the past quarter. While we obviously cannot control the precise path of inflation going forward, we feel good about our ability to recover this price-cost lag, which, coupled with our normal year-end seasonality, gives us confidence in the expected upward margin inflection during Q4 and further benefit rolling into next year. Turning to the remainder of the income statement, net interest expense was $113 million in the quarter, reflecting $630 million of debt repayment, and the adjusted tax rate was approximately 27%. Our quarterly performance resulted in earnings per share of $1.29, which included the net gain on sale of equity investments, and adjusted EPS of $0.36. On a constant currency basis, adjusted EPS was $0.37 in the quarter compared to $0.25 in the same period last year, representing a year-over-year increase of 48%. With regard to cash flow, net cash provided by operating activities was $23 million, and free cash flow was a use of $80 million in the quarter, which is consistent with the typical seasonality of the business. The $16 million year-over-year free cash flow improvement was driven by stronger net income results and favorable working capital, partially offset by higher capital expenditures, which at 3% of revenues year-to-date is still lower than historical levels. At quarter end, Aramark had over $1 billion in cash availability. Net cash provided by investing activities included approximately $635 million in combined proceeds from the sale of our 50% equity stake in AIM Services and a portion of our ownership position in the San Antonio Spurs NBA franchise. We also took another big step forward in strengthening our balance sheet with a proactive $1.1 billion refinancing of the company's 2025 term loan B to extend the debt maturity by more than five years to June 2030. We are pleased with the outcome of the transaction that was completed at attractive terms, adding a run rate of just $2 million per quarter in interest expense and is net leverage neutral while maintaining a comparable fixed to floating debt ratio. We will continue to be opportunistic in enhancing our capital structure and financial flexibility. Let me finish up with our current outlook for fiscal 23. We are raising our expected organic growth, revenue growth, to near 15% compared to greater than 13% previously. This growth is anticipated to be comprised of global FSS at nearer 17% compared to approximately 15% in our last update, and uniformed services remaining around 5.5%. We are also lifting our expected AOI growth to approximately 33% compared to approximately 32% previously. This growth is anticipated to be comprised of global FSS at 46% compared to approximately 45% previously, and uniformed services raised to 8% from approximately 7% previously. We continue to expect free cash flow to be around $475 million before payment of the $64 million FICA payment completed in the first quarter, and the anticipated cash flow impact of approximately $100 to $120 million related to restructuring charges and transaction fees associated with the uniform spinoff. After these specific items, we expect our free cash flow to be approximately $300 million. And finally, leverage ratio at the end of the fiscal year continues to be projected at less than four times. I'm pleased with our performance in the quarter and the momentum we are building. The spinoff transaction continues on pace, and we believe strongly in the many opportunities ahead for both companies. Our teams across the globe continue to control what can be controlled with a sharp and resolved focus on delivering great service to our clients and growing the business profitably. Thanks for your time. John?

Thank you, Tom. I'm extremely pleased with our performance this quarter and remain confident in our ability to close the year strong. The fourth quarter is historically our highest margin and free cash flow period and we're laser focused on delivering strong results. As I said last quarter, we set a high bar for ourselves as a company and have a lot to accomplish in the coming months. And I'm confident in the Aramark team to get the job done with a focus on being the most admired employer and trusted hospitality partner. I'm excited about the opportunities ahead to further our success and drive top and bottom line growth into the fourth quarter, fiscal 24, and well beyond. Operator, we will now open the line for questions.

Thank you. We will now begin the question and answer session. If you have a question, please press star then 1-1 on your touchtone phone. If you're using a speakerphone, you may need to pick up a handset before pressing the numbers. In order to accommodate participants in the question queue, please input yourself to one question and one follow-up. To remove yourself from the queue, please press star 11 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Harry Martin with Bernstein. Your line is open.

Hi. Good morning, everyone. Hope you're well. Three questions from me. The first one, I think on the international organic growth, that acceleration, certainly sequentially, if you look versus 2019, up over 30% organically. I think there has been some acceleration in inflation in those markets. But can you dimension how much of that is from new wins and market share gains and what's driving that continued success in the international business? The second question I have is you made quite a few comments about the ramp up of new business wins contributing to margins. So I wondered if you could give a little bit more specific commentary on some of the vintage contract wins from 2020 and 2021 that are starting to hit that two to three year maturity level that you spoke about at the investor day. Are margins in those contracts ramping? and starting to be accretive to the group level, even with some of the accelerated cost inflation. And is there a lot more to come in terms of inflection in the next six to 12 months? And then the final question is just on the disclosure of your major shareholder that they're looking to reduce the stake in Aramark and give up the board seat. I wondered if you have any

um sort of early comments on the relationship with mantle ridge and where you see that going in the future thanks very much um this is john i'll answer the question on the 13d first you know first of all i think the form speaks for itself i think they were very explicit with respect to what their intentions were or are You know, Paul and his team at Mantle Ridge have been great thought partners. As I think the 13-D described, the Mantle Ridge General Partner will continue to be invested for the long term, but the 13-D also does indicate the fact that the fund will be winding down. So I think the form speaks for itself, and they would have to comment, I think, any further on that. You know, with respect to international growth, you know, we're very pleased with the performance in the international group. We've had a lot of bread and butter wins and new account sales over the course of the last couple of years, and most of those accounts have been What I would characterize as mid-sized accounts, they ramp to profitability more rapidly, and they've grown very nicely. So retention rates remain high in international as well as domestic, so we're seeing that really impact the growth line. Plus, we've had strong performance in the sports entertainment sector year over year and in the concert season. That has contributed significantly to that year over year growth as well. So, Tom, I'll leave it to you to answer on the individual account ramp up.

Yeah, the maturity on new business continues to move along very much as we expect. Some of the bigger accounts that we've won, Corning comes to mind back in 21, Purdue. Of course, Merlin continue their efficiency and maturity ramp. I think overall it's fairly linear. We don't expect any significant jump as we move forward, but just a continued move forward. And the key for us going forward, as we've mentioned many times before, is just to continue to deliver a consistent net growth number so that we don't have you know, years where there's really nothing and then years where there's a lot. So that maturity is moving as we would expect, and we're very pleased with it.

Great. Thanks very much.

Thanks, Harry.

Our next question comes from Andrew Starterman with JP Morgan. Your line is open.

Hi. It's Andrew. Two questions. Sorry about the static. The first one is, Tom, if I did my math right, I see the implied middle-of-the-range AOI margins are about 6.9% for the fourth quarter. Is that correct? Again, 6.9% for the fourth quarter is what I got in the implied fourth quarter. And then secondly... With the price increases that you talked about in the areas of education and prison for the fourth quarter, does Aramark feel all caught up with underlying input cost inflation at this point?

Yeah, I'll trust your math on the margin, Andrew. It's usually better than mine. And then on the price increases, I don't think we are fully caught up. I think it continues to be a journey. As John mentioned, inflation hits hard and fast. And in these three businesses, K-12, higher ed, corrections, it's been a journey over the last 18 months to get on the right side of that, and the teams keep chipping away at it. Big July 1st or thereabout, and then in September for higher ed, They've made a big step in the direction, but I think there's still more to come in the next year.

Thank you. Our next question comes from Heather Bulski with Bank of America. Your line is open.

Hi. Thank you for taking my question. Two questions for you. First, can you talk about the, I guess, underlying leverage that's planned for the uniforms business? You talked about the $1.8 billion, but I think we're all kind of backing into what EBITDA may be for uniforms. So can you help us there in terms of what the leverage ratio is? And then separately, just on the margin topic, with regards to your midterm goal, with what you're seeing with pricing, this inflationary environment, Are you still thinking that you'll end up at the low end, or is there a change in view there? Thanks.

On the leverage, the idea here is to come out roughly four times. The companies will split at parity, ideally. So I think that's the math that you can work off of to get the underlying EBITDA for AUS. On the margin in the midterm, yeah, I mean, we're tracking. There are two adjustments over the past two years, I think, to the margin flow for us. One, of course, is the divestiture of AIM, which, as I said before, is about roughly 20 basis points to the total company margin. And the other, if you were putting the two companies together a couple years from now, In FY25, the public company costs for AUS would also be a factor. So, you know, with inflation we talked about before, a step, you know, really ramping up post the analyst day, we were trending towards the lower end of that range. And then with those two adjustments that I just mentioned, you know, we still feel comfortable that we're moving forward. We'll progress to and through. the margin we had in 19 and, you know, should feel pretty good about getting into that range we indicated on the analyst day.

Great. Thank you.

Our next question comes from Ian DeFino with Oppenheimer. Your line is open.

You know, congratulations on the quarter, firstly, and great to see the great guide. You know, as far as what that guide now means, how should we be thinking about your return or at least the pathway of your return to pre-COVID margins? You know, does this now accelerate when you thought you were going to get back? And, you know, as buy side and sell side, how should we think about the cadence on the return back to pre-COVID? Thanks.

Yeah, you know, again, the margin will progress and we will, like I just said, get to and through the 19 margin. We really have a lot of confidence in that. The timing of it, you know, again, we can't predict the pace of inflation and what will happen. You know, we've had significant margin progression this quarter and will this year, you know, up 75 basis points. We expect to move it forward quite a bit into 24, and we'll update you on that outlook in November. We continue apace, so to speak, to progress the margin, and it will continue in a fairly linear way. I'm loathe to step out in front of the margin. uh at this point from a guidance standpoint uh given that you know the uncertainties that with inflation and and and whatnot so um but again the overall business um and what we see going forward and the progress we've made and the progress we have in sight we continue to progress the margin significantly you know in the quarters ahead

Okay, understood. And then also on the SPIN, it seems like the board is pretty stacked there. You've had some really great additions or appointments. Can you tell us maybe what's driving that? What are some of these members seeing that's really attracting them there? Thanks.

Sure. You know, I think we have assembled a very dynamic board for AUS, and it was a a work over many months between me and Art Winkle-Black, our NOM and GOV chair who began the selection process more than a year ago to build what we wanted to be a very dynamic and high energy board that could add significant value to the new code, to the SPIN code. And so we frankly targeted very significantly several individuals who we thought would be great and we were able to attract all of them based on the opportunity that exists at AUS and what they see as the future potential of the business and a strong management team that we have in place. I think all of them were very eager to work with Kim and to move forward in the business and saw it as a great opportunity for value creation for the shareholders, for the employees. and just an opportunity to participate in what would be a terrific board. So, yeah, we're very excited by all the appointments. We've got a great group of people, seasoned executives with very relevant experience, very diverse viewpoints and perspectives, and so we are very excited about it.

Okay, thank you very much. Thank you. Our next question comes from Tony Coplin with Morgan Stanley. Your line is open.

Thanks very much. I was hoping you could give some additional color on the new business wins from the quarter or on the pipeline. You know, anything incrementally different versus last quarter in terms of the strength of the pipeline? You know, also, I know you've given the gross new business in past quarters and maybe also just focus on education as well.

Yeah, I think it's been a very active selling season and still underway in all the businesses. We have a very robust pipeline with lots of opportunities, both domestically and internationally. So we feel very good about another strong year of net new performance. And so, you know, I think the The specific accounts individually, many of them have been awarded and yet contracts haven't yet quite been signed and we're not operating them. So we'll be a little bit more hesitant about naming names yet at this stage while we're working through some of those processes. But yes, we feel very good about a third year of very strong net new and solid business performance. So Walmart, a great addition in terms of their corporate headquarters. And, you know, we've also had significant wins in higher education, both domestically and internationally. And, you know, so I'm very pleased with the results and very pleased with the level of pipeline activity. As you know, as a senior leadership team, we review these results on a monthly basis with each of the business units. So the momentum is there, the focus is there, and, you know, we feel very good about the overall results for the organization.

Great. And hoping you could talk maybe a little bit about international, very strong quarter there. I guess maybe thinking about the different regions, how is the UK faring? Any strength to call out across the different geographies or challenge areas? Thanks.

Yeah, I would, I would say we've got, um, you know, good actually strength across all sectors, uh, and all geographies, uh, you know, leading to that, uh, significant performance year over year. So, uh, you know, in, in specific call outs, I would say, uh, obviously the sports entertainment season in Europe has been very strong in particular, uh, in Spain and in Germany. Uh, and you know, that's been very robust. The concert season, uh, has been terrific. strong mining performance in Chile, and, you know, strong results in Canada as well. So it's very broad-based, and I wouldn't characterize any region as being, you know, below our expectations. So we're very pleased with the overall results from international.

Thanks a lot. Our next question comes from Shlomo Rausenbaum. Stiefel, your line is open.

Hi, thank you very much for taking my question. I want to focus a little bit more on things that have been inflating and deflating. A lot of the food staple items have really been deflating, just not even slowdown in inflation, but actual deflation. Can you talk about how this is impacting the gross margin currently? Is this more of a benefit than you were expecting to see at this point in time? And should we see a really strong margin you know, going forward if this kind of continues? And then, you know, what about the wage deflation part of the package? Is that slowing down as much or, you know, is that kind of offsetting still some of the food staple items that are deflating?

Yeah, I would say, first of all, there are certain commodities that have come off significantly year over year. And that is certainly benefiting us from a supply chain perspective. But keep in mind that even though it is moderating, it is still higher year over year. And so we are recovering through pricing the impacts of that inflation. Food away from home index still running a little higher than the original expectation. So while certain commodities are breaking down and having an impact, overall net in the business we're still working to recover the total inflationary pressures on the food side. Making significant progress, no doubt about it. And if we continue to see the trend moving forward, there will be an enhanced margin impact as a result of that. So just hard to predict the exact timing of it when it all flows through. The higher energy prices over the course of the last few weeks, as you see the oil price begin to shoot back up again, can be an impact item on transportation, which could affect food cost inflation as well. So we see a moderating trend. We're very pleased with that. We anticipate that it'll continue to improve, but really not in a position to call the precise pathway, if you will. From a labor perspective, we are seeing moderating inflation and pressures in labor as labor availability continues to improve very slowly. Overall, we feel very comfortable in our ability to recover both wage pressures and food cost inflation over the course of the next 12 months as it moderates. As Tom said, we're still working, still pricing, still managing every day in the middle of the P&L to optimize for our customer locations and our client expectations. and having, I think, significant success. And we're looking forward to the results in the fourth quarter and the ramp into next year.

Thank you. Our next question comes from Neil Tyler with Redburn. Your line is open.

Yeah, thank you. Good morning, John. Good morning, Tom. A couple left from me, please. Firstly, the price adjustments that you've achieved in education and corrections, the During the negotiations around that, is there anything different in the structure or it's been altered in the structure or terms of those contracts that might mean more immediate price adjustments if costs decline significantly? That's the first part of that question. And the second is, might these negotiations have any knock-on effect on on retention. I'm thinking more positively than negatively, but I'd appreciate your thoughts on either. And then just a sort of a smaller question relating to your comments on the strength of the entertainment in activities in international. Should we think about that as a slightly sort of abnormally high base? I know it's not a big number in the scheme of things, but the concert season in Germany and Spain, is that sort of especially strong and unusually strong? You know, so I'm just wary of not wanting to sort of cast off the wrong number for next year. Thank you.

Yeah, no, I'll take the last part first. You know, first of all, I wouldn't say it's abnormally strong. I would say that it's stronger than the prior year based on, you know, improved overall performance you know, customer opportunities and improved attendance. So, you know, you still had last year somewhat of a lag from COVID that was impacting some of the sporting events and some of the concert seasons. So it's really more back to normal would be the way I would characterize both the concert and soccer seasons in Europe. So I wouldn't call it out as being abnormally high. just higher than prior year due to that circumstance. Yeah, so I think that's right.

And, Tom, do you want to take the – Yeah, and I'd just add to that comment, Neal, that it's sort of like playoff baseball or weather or whatever. I mean, we're not going to call that out. It's just these things ebb and flow, and you take the good and the bad in each year and you just build upon it. So, you know, it's not something that I would call out as an exceptional – pricing negotiations, you know, changed contracts, not really where it's a, you know, existing client in the middle of a term. Certainly we're using the last year and a half as an experience and a way to modify new contracts going forward so that, you know, the old escalators and some of the contract language that we had in the past, you know, when there's 20 years of Benign inflation isn't particularly going to work anymore. So where we've had opportunities, obviously, with new contracts, but then with renewals and retention efforts, we've worked to change language so we have more flexibility. But if it's just midterm and we're just getting a pricing exception for those contracts, I don't think it's really changed the contract language much. And then impact on retention. If I'm following the question, not really anything notable there.

Okay. I just wondered if you were able to use the opportunity to extend any contracts.

Yeah, I would say, I would add that, yes, we have taken the opportunity to extend and use the negotiation process, not only to recover costs for the near term, but as I've said many times before, we look at these contracts as annuities. And that's why in many cases we were willing to wait to get appropriate pricing because we didn't want to put the contract at risk by pushing it out to bid because we were in a tough profit situation in a given year. So we look at these as long-term deals, long-term relationships, average contract life close to 20 years. As we've worked through these negotiations, we've done it very carefully with an eye towards keeping that customer for the long term and solving for cost recovery as well. So I would say no impact to retention from a negative perspective, and I would say proactive extensions included with many of those renegotiations.

That's great. Very helpful. Thank you very much.

Thank you. Our next question comes from Leo Carrington with Citi. Your line is open.

Leo, your line is open. You can ask your question. Again, Leo Carrington, your line is open. You can ask your question. One moment for our next question. Our next question comes from Pfizer with Deutsche Bank. Your line is open.

Yes. Hi. Thank you. So I wanted to talk about the increase in organic guide for FSS. I think when you initially guide it for the year, it was a mix of, you know, new business growth around four and a half to five percent sort of pricing and the underlying recovery in COVID volumes. It sounds like where we are now, is it primarily just incremental pricing that has helped you increase that guide? It sounds like maybe there's better recovery of COVID volumes as well. So just wanted to get your perspective on disaggregating the various factors that have helped you increase the outlook.

Yeah. At the end of the year, in November, we'll recap the year by components once the dust settles and we've got a good picture of it. But I'd say if I'm looking at this point three-quarters of the way through the year against those original assumptions, I would say the pricing had to have been higher than we thought. I think, as we talked about at the beginning of the year, inflation has persisted all year. or longer than we thought at the beginning of the year. So I think pricing has probably been a slightly oversized driver of the overperformance. But, you know, the realized net growth has been strong. And I think less so the COVID recovery, a little bit better. But I'd say pricing is the bigger driver with the other two slightly overperforming expectations.

Understood. And then just to follow up, you know, how do you think about, you know, your sort of market share? Um, are you continuing to see sort of increased trend and outsourcing? Um, or, or do you think you're still continuing to, you know, win share? I know you've previously talked about a combination of both, but you know, how has your thinking evolved there?

Yeah, I don't think it's really changed from our beliefs about the, the, uh, you know, the normal kind of run rate in the business. Um, We are focused on growing the business. The total addressable market is huge, and so we continue to be focused on delivering net new from both organic new account wins from both competitors as well as self-op conversions. We see that self-op conversion trend continuing this year. So we, you know, overall, we don't really measure it in terms of share shift between the competitors. You know, we look at the gross business wins and our net new as being the drivers and the things that we can manage and the opportunity set that we pursue. We look at closure rates and we look at ultimately that total addressable market. So You know, I would say we continue to get our fair share of new opportunities. We continue to see increasing self-op conversion and overall, you know, terrific opportunities ahead. So, yeah, we're very pleased with overall performance of the organization as it relates to growth, and we'll continue to focus on it.

Great. Thank you so much.

Our next question comes from Leo Carrington with Citi. Your line is open. Thank you. Good morning.

If I could ask two, just firstly on, I appreciate you'll sort of square that organic growth bridge towards the end of the year, but when it comes to thinking about pricing specifically, can you indicate sort of the pricing levels in Q3 and just presumably when it comes to thinking about pricing and to into the end of the year and maybe more FY24, will this fade in importance as it catches down to CPI? Or do you think the price recovery will continue to be a growth driver or a margin driver into 2024? And then secondly, maybe a follow-up question on that in terms of In terms of the uniforms margin specifically, Q3 was obviously pretty strong, I think, as good as the best quarter in 2019. Is this all underlying? Is there anything to sort of call out that was favorable? Or is this just the impacts of the actions you've taken and perhaps the energy impacts fading away?

Yeah, no, on the AUS question, I think it's underlying. I mean, it's the impact of, you know, the management team has been in place coming on two years. The focus, the ability of the team to, you know, to drive the performance of the business forward, the revenue line is shifting, if you will, As they look at the client base, more emphasis on adjacencies and add-on services, continue to build the selling machine. Andy Panos has come in to lead the sales group here in the last couple of quarters. So I think that will start to shift and move forward as we lap this energy surcharge that's artificially holding down the year-on-year growth optics. I think they'll deliver good momentum as we move into 24 and beyond on the top line. Bottom line, again, Kim and Rick and the team have really focused in on making the business more efficient this past year in anticipation of the spin. I think they'll talk more about what the opportunities that they have ahead of them on a profit perspective. you know, as they speak next month and then, you know, post the spin. So I know they're excited about both the top and bottom lines opportunities that they have going forward. In terms of pricing, I mentioned it was 6% in the quarter. So that's roughly where we were last quarter as well. Those benefits will carry into next year. We typically have not been able to price for margin, but just for cost recovery. But as the inflation cost dynamic trends downward and that pricing stays in place, and we're quite confident that it will, I think that that recovery of that price inflation lag will become more apparent as we move into 24 and beyond. How important a piece of the puzzle it is to our revenue growth going forward totally depends on inflation. I mean, if we revert back to the sort of 2% norm that we had for 20 years, it becomes much less of an impact. If it stays elevated, you know, it would be more prominent in the revenue numbers.

Okay. Thanks, Tom. Appreciate that. Our next question comes from with RBC Capital Markets. Your line is open.

Thanks for taking my question. Maybe just a couple of quick clarifying questions. One was just on the surcharge in the uniform business, the 80 basis point headband. Is that the right level that we should think about for the next three quarters? And then on the pricing side, how should we think about the pricing and uniform business going forward? How was it trending and how should the trend going forward? Any color on those fronts would be helpful. Thanks.

Yeah, I would say, first of all, the impact in this quarter was approximately 80 basis points. The impact in the fourth quarter is actually a little bit higher year over year with respect to the field recovery fee that's been eliminated. So it's nearly 2% in the fourth quarter. So that would, you know, that would... normalized starting in the first quarter of next year, so there's a little bit of a lag yet as the anniversary of those fuel recovery fees that are now eliminated. But their pricing in the rest of the business has been robust. They've been able to recover their costs as demonstrated by their improving margin performance, both coming from both improving pricing recapture and improving cost leverage. uh you know i would expect that pricing leverage to continue going forward um and the comps will get better uh just as the anniversary that fuel recovery fee that's now uh no longer in place that's very helpful thank you our next question comes from josh chan with ubs your line is open we're asking a very good corner guys um thank you thank you

Yeah, hi. So I guess, Tom, when you mentioned the pricing dynamic into next year and then moderating inflation, how should we think about your margin seasonality in 24 as compared to normal when you seem to have those two favorable dynamics kind of moving into the start of the year?

Yeah. Again, we'll give you sort of more of a look or a little bit more granular when we get to November around 24. But by and large, it's not going to change the shape. We'll still have the U-shaped margin dynamic as we move into next year. Any dynamic on pricing, outpacing, inflation as we go through the year next year would be around the edges. But the true shape is still going to hold. and not be materially affected.

Okay, that's fair. And then on the retention side, you mentioned that retention continues to be very strong. I guess underneath that, are you seeing any more desires from customers to kind of shop around now that we're past the supply-constrained environment? Just anything there, recognizing that you continue to maintain very strong retention rates? Thank you.

Yeah, no, I would say it's a pretty normal level of activity from a rebid perspective. I mean, some years are higher than others based on kind of structural impacts to the business. As you know, the USDA has very strong requirements with respect to rebid activity in the K through 12 sectors. So there's kind of years where you have heavier retention and some years where it's lighter, just dependent upon where school districts are in the cycle. But by and large, I think the activity level is very consistent year over year. Um, and the, you know, the pipeline, uh, is, you know, very, very strong. So I don't, uh, I don't see a higher degree of propensity for change, uh, across the industry. I think it's just kind of at its normal level. Uh, and so we always, we always are pursuing new opportunities. Uh, we're always working aggressively against a targeted list of prospects. and some are scheduled rebids and some are unscheduled. We just work aggressively against that target list of prospects and work to grow the business. So I would say not a change in customer behavior that I could identify.

Great. Thank you for the caller and thanks for your time.

Our next question comes from Pat Nyack with Barclays. Your line is open.

Hi, good morning. This is Ronan Kennedy. I'm from Manav. Condolences on the passing of your colleague. Thank you for taking my question. As a follow-up, I think, to Leo's question on pricing, and the confidence that you've expressed in it sticking, can you just kind of give insight or articulate how and why prices will stick, whether it's a function of the contract structure, the value, and high-level service provided to clients, et cetera? And then also just a reminder on where we stand in terms of percentages of contracts that are P&L, cost plus, or management fee, and how you see there being benefits to each through the expected moderation of inflation?

Yeah, I would say, first of all, our expectation that pricing sticks is based on the history of the business and based on the way it's operated as an industry. It's very rare for us to take pricing down except maybe on a particular commodity that's had an unusual price spike that may have some artificial pricing approach. Think back to the days when coffee was impossible to get and coffee prices were elevated. moved up and then moved down when that particular commodity had an impact. That's not the way the business gets priced anymore. We really price across a market basket of products. It's rare for us to move a price down once a consumer has already begun to pay that price for the product. Pricing is, I would say, highly sticky. And remember, you're pricing to the consumer, not to the client. So these aren't contractual prices buried in the client relationship. They're consumer-based prices that the end user is paying. With respect to pricing, I think we all believe it will be very, very sticky. Okay. and that we'll continue to be able to price to recover costs going forward, as we've discussed. And I'm sorry, what was the second?

Contract types.

Oh, yeah, go ahead.

So, yeah, we continue to move back towards P&L. I mean, the changes still reside primarily in B&I, where the volumes aren't fully recovered, and that's really the driver of converting, you know, to a P&L or running a P&L is having adequate volumes. So, not quite you know back to where we were in 19 but but you know continuing to move towards that the inflation dynamic and pricing dynamic with each contract it does have its plus and minuses um you know no pun intended on that uh the cost plus is obviously a a immediate pass-through to the client but does have a a margin uh headwind uh again if we were billing them a hundred dollars Previously, now we're billing them $120, but we're still getting our $10 fee on both. So it depresses the margin even though it increases the revenue. When prices fall, you lose the revenue on a cost plus contract, but your margin goes up. So that dynamic is cost plus typically are a lower risk scenario for us, and it ebbs and flows on the top line as pricing moves up and down. P&L is the dynamic we really like because we control the cost component. Pricing in an inflationary environment accrues to us, and as John just mentioned, we believe it will stay in place and be sticky. And then we can also manage through the cost components so that we don't have that headwind against the margins. typically that we might have with a cost plus contract that limits our profitability in most cases. So, you know, we like the P&L format. And in an inflationary environment, we'd be happy to continue to move, you know, back to that P&L cost plus mix that we had prior to the pandemic to take advantage of that.

Thank you. Appreciate it. Our last question comes from Harold Antor with Jefferies. Your line is open.

Good morning. This is Harold Antor on for Stephanie Moore. So just on the new business wins, could you provide us an idea of what it represented in the quarter and then just give us an understanding on the size and shapes of the new business wins and the industries that you won them in and then provide any insight on Were you winning this business from regionals or some of your competitors?

Yeah, we'll give you more update at the year end on it as we typically do on net growth, on all those factors, on the contribution to the year, where we're winning it from. But suffice it to say that it's moving along, as John said, very solid. year for us continues to be a third year of significant growth versus what we were prior to the pandemic. And the source of wins continues to be pretty broad-based, both where it's coming from and where we're winning it geographically. So overall, continue to be pleased with the growth engine within the business. and give you further updates when we get to year end.

Got it. And I guess for my last question, with you having such a lot of the contracts locked in and high confidence in the pricing, what could help you achieve or exceed the guidance on the revenue and operating income for the quarter and for the year? Thank you.

Yeah, I would just add that I think if inflation continues to moderate and we don't see any unexpected economic consequences, we see continued improvement going into the fourth quarter, as we've discussed. We see continued improvement going into next year. It really is an exciting time inside the company. We feel very good about the results for the quarter and feel good about the trajectory for the fourth quarter for the year. And, um, you know, we're very resolved, uh, in terms of delivering very strong results. So, uh, you know, I would say the inflation outlook is improving and, uh, that has a potential, uh, uh, impact opportunity going forward. So, um, I will summarize the call basically by saying, thank you very much for your support of the organization. We're excited about what's going on inside the business. We feel good about the third quarter. We feel very good about the opportunity to go ahead and get the spin completed at the end of the fiscal year. We've made very significant progress around a range of activities, the balance sheet, improving profit performance, improving margin performance, and solid growth. So we're pleased with where we are, have a lot of work to do, and we are committed to delivering for our shareholders. So thank you very much, everybody.

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