Vestis Corporation (NYSE:VSTS) Q1 2024 Earnings Call Transcript

Vestis Corporation (NYSE:VSTS) Q1 2024 Earnings Call Transcript February 8, 2024

Vestis Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the Vestis Corporation Fiscal First Quarter 2024 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode, and the floor will be open for your questions following the presentation. [Operator Instructions] I would now like to turn the call over to Bryan Johnson, Chief Accounting Officer. Please go ahead. Bryan Johnson Thank you, Angela, and good morning, everyone. We appreciate your participation in Vestis Corporation’s fiscal first quarter 2024 earnings call. With me here today are our President and CEO, Kim Scott; and our CFO, Rick Dillon. As a reminder, a telephonic replay of this call will be available on the Investor Relations section of the vestis.com website shortly after the completion of the call.

Also, access to the materials discussed on today’s call are available on the Vestis website under the Investor Relations section. Before we begin, I would like to remind you that this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about management’s future expectations, beliefs, estimates, plans and prospects. Such statements are subject to a variety of risks, uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements. Such risks and other factors are set forth in our periodic and current reports filed with the Securities and Exchange Commission. We do not undertake any duty to update them.

With that, I would like to turn the call over to Kim. Kim Scott Thank you, Bryan. Good morning, everyone, and thank you for joining our fiscal first quarter 2024 earnings call. Before I discuss our results, I’d like to thank our 20,000 dedicated teammates for their outstanding work and unwavering commitment to our success as we complete our first quarter as a stand-alone, publicly traded company. Every day, our teammates are focused on taking great care of our customers and each other. We continue to bring our purpose to life here at Vestis, delivering uniforms and workplace supplies that empower people to do good work and good things for others while at work. You may have also seen our filing yesterday that Chris Synek, who was our Chief Operating Officer for a short time, has resigned from the Company for personal reasons.

We appreciate Chris’ contributions to Vestis and we wish him all the best. Now, turning to our results. In the first quarter, we delivered disciplined, high-quality revenue growth of 2.5% and an adjusted EBITDA margin of 13.7%, which is up 60 basis points from Q1 2023 and includes the absorption of incremental public company cost in the period with earnings per share of $0.22 in the quarter. Last year’s first quarter revenue included the benefit of a $13 million temporary energy fee that did not repeat in the quarter. Excluding the impact of this temporary energy fee and impact from foreign exchange rates, revenue growth was 4.5% with a balanced contribution from both volume and pricing on an underlying basis. This demonstrates that our high-quality growth strategy is effective and accelerating our ability to grow well above historical norms.

A corporate office with staff members wearing company branded uniforms.

As Rick will cover in more detail, we continue to remain disciplined and focused on delivering growth that improves our revenue mix and generates operating leverage across our system. We are pleased to see the positive results of our strategy manifest as we deliver growth and margin expansion in tandem while also absorbing new public company costs that entered our system in the quarter. Our results also support our capital allocation strategy, with deleveraging as a priority. As we move through the balance of the year, we expect acceleration in our growth rates that will follow similar patterns from prior years and additionally, we will lap the temporary energy fee beginning in Q3. We are also seeing opportunity for additional pricing actions in the back half of the year.

As a result, I remain confident in our ability to deliver our full year guidance of 4% to 4.5% revenue growth and adjusted EBITDA margin of 14.3%, which, as a reminder, equates to approximately 50 basis points to 60 basis points of margin expansion offset by the impact of new public company cost in the period. During the first quarter, we continued to advance Vestis’ strategic plan which we shared with you during our September 2023 Analyst Day. We are generating great momentum as we execute against our strategic priorities, which include high-quality growth, efficient operations, disciplined capital allocation and a performance-driven culture. Turning to high-quality growth. We continue to prioritize the highest margin growth opportunities, both within our existing customer base and as we target new customers in select verticals.

You can see the positive impact of our strategy in the quarter as we continued to intentionally shift our mix towards higher penetration with existing customers on existing routes, largely through our route service representatives cross-selling workplace supplies to our current customers. Workplace supplies growth was approximately 4% in the quarter, supported by an approximate 25% increase in route sales activity versus this period last year. Our mix shift also includes a purposeful moderation of our lower margin direct sales business and when excluding the impact of this strategic decision, our uniforms business grew approximately 1% this quarter. This mix shift related to direct sales also delivered approximately 3 basis points of margin improvement across our consolidated results.

In parallel, we continue to execute against our efficient operations initiatives. We are delivering a step change improvement in the way we operate, optimizing our network, reducing empty miles and lowering fuel consumption across our system. In the first quarter, we have already completed another 13 route and network optimization events with many more planned for the balance of the year and beyond. This demonstrates great momentum when compared to the 26 events we completed last year. Year-to-date, we’ve successfully deployed new telematics technology across 89% of our fleet and fully deployed new routing and scheduling technology and processes across North America, all a part of our strategy to establish the capability to continuously optimize our network and our routes.

We’ve also accelerated our work on reducing amortization costs through the reuse of existing garments in our system. In the first quarter, we saw improvements in our used fill rate across 103 of our target facilities. These efforts will serve us well in the coming years as existing amortization rolls off and we accelerate the reuse of existing garments across our stockrooms over time. We remain committed to delivering profitable growth that leverages existing capacity across our network, therefore, requiring modest capital investment of approximately 3% across the five-year period. We also remain focused on strengthening our balance sheet position. As Rick will discuss, we are currently in the market on the refinancing of our two-year term loan.

And overall, we seek to operate in a target leverage range of 1.5 times to 2.5 times and maintain a flexible financial position that will continue to allow us to invest in high-return opportunities in the future. So, in summary, this is a fantastic business and we see tremendous opportunity for continued value creation. We are delivering against our plan and our commitments and we remain confident in our full year outlook. We are making substantial progress against our strategic initiatives and we continue to build an amazing and inspiring culture here at Vestis, supported by our incredible, highly engaged teammates who quite frankly are enjoying the thrill that comes with winning. I’m delighted with our progress and excited about what lies ahead for us.

I’ll now turn things over to Rick to cover the financials in more detail before we take your questions. Rick? Rick Dillon Thanks, Kim, and good morning, everyone. Before I jump into the first quarter results, I’d like to remind you that prior year reporting is on a carve out basis and does not fully reflect the additional cost associated with operating as a stand-alone public company. So, turning to the first quarter results, revenue of $718 million increased 2.5% year-over-year, excluding the impact of the temporary energy fee and foreign exchange revenue grew 4.5%. Revenue from workplace supplies is up 4% and uniforms is up 0.2% compared to the prior year with a balanced contribution from volume and price on an underlying basis. As a reminder, uniforms includes our direct sale business which is down approximately 4% year-over-year as we continue to optimize the business as part of our high-quality growth strategy.

As Kim noted, excluding direct sales, our uniform business grew 1% in the quarter. From a segment perspective, U.S. sales grew 2% and Canada sales were up 3%. The mix of growth between uniforms and workplace supplies within the segments was consistent with our consolidated results. Turning to profitability. First quarter 2024 adjusted EBITDA was $98 million, an increase of 7% year-over-year. The U.S. segment increased 13% while Canada declined 5%. The favorable impact of operating leverage from revenue growth with existing customers, $7 million in carryover benefits from workplace optimization actions taking in the back half of fiscal 2023 and lower energy costs more than offset the impact of increased labor costs, increased bad debt expense and $3 million of incremental public company costs.

Lower energy costs were driven by reduced fuel consumption from our route optimization efforts and favorable rates, primarily on natural gas utilizing our plants, which were in line with expectations. The increased bad debt expense year-over-year is because the prior year’s first quarter profitability included the favorable impact of a bad debt reserve, reduction to right-size the reserve or improve collections that did not repeat in the current year. As a reminder, we continue to expect incremental public company costs of $15 million to $18 million for the year inclusive of TFA payments to Aramark as we build out our corporate structure and IP infrastructure. Profitability of our Canada segment was negatively impacted by increased merchandise amortization costs as we made strategic investments to improve product quality for our customers and higher-than-expected fleet maintenance costs.

Overall adjusted EBITDA margin expanded 60 basis points year-over-year to 13.7%. Interest expense on our outstanding term loans was approximately $29 million in the quarter and our effective tax rate was 27% in line with expectations, all combined to deliver an adjusted EPS of $0.22 per share for the first quarter of 2024. Moving on to liquidity. We generated $51.5 million in cash from operations in the first quarter, an increase of $43.5 million. Prior year operating cash reflects an inventory build in early 2023 to support growth and a $16 million payment of deferred payroll taxes under the CARES Act. Capex was $17 million during the first quarter of 2024, up slightly from last year and in line with our expectations. Free cash flow in the first quarter was $34.6 million with cash conversion in excess of 100% of net income.

We ended the first quarter with $48.9 million in cash on hand and a net to debt — net debt-to-EBITDA ratio of 3.85 times. We recently launched a process to refinance our two-year $800 million term loan with the seven-year term loan B and we expect to close the transaction in the coming weeks. The term loan will mature in 2031 and our existing five-year term loan matures in 2028. Once the financing is complete, our new capital structure will continue to provide us the flexibility we need to execute our strategy and support our capital allocation priorities, including achieving our optimal net leverage range of 1.5 times to 2.5 times by fiscal 2026. Before we turn to your questions, I’d like to take a moment to discuss the full year outlook.

As Kim mentioned earlier, we remain confident in our ability to deliver our full year guidance of 4% to 4.5% revenue growth and an adjusted EBITDA margin of approximately 14.3%. As we look forward to the balance of the year, we expect to see revenue growth patterns that are consistent with prior years. So if we look at the quarterly growth rates in fiscal 2023, adjusting for the impact of the energy fee in the first half, growth accelerates as we move through the year. We lapped the temporary energy fee at the close of the second quarter with a $13 million impact in Q2. Our initiatives to drive disciplined, high-quality, profitable growth are gaining momentum, and we look forward to sharing more as we progress throughout the year. That concludes our prepared remarks, and operator, please open the lines for questions.

Operator: The floor is now open for questions. [Operator Instructions] Thank you. Our first question comes from Seth Weber with Wells Fargo Securities. Please go ahead.

See also 20 Big Hotels Where AARP Members Can Get Discounted Rates and 25 Countries where Muslim Population will Increase the Most by 2030.

Q&A Session

Seth Weber: Oh, hey, guys. Good morning. Thanks for taking my question. I guess, maybe Kim, in your prepared remarks, you mentioned something about an opportunity to get more pricing as we’re going through the year. I was wondering if you could expand on that a little bit.

Kim Scott: Yeah, certainly, and good morning, Seth. Thank you for your question. So we do see the opportunity to take some incremental pricing in the back half of the year. We’ve been very thoughtful and I would say somewhat moderated about pricing in the first quarter. You all know we’ve been very diligent about passing through inflationary cost over the last year to year and a half in our business. And so, we’ve been managing that, monitoring it very closely just to see customer attrition and modeling and understanding how customers are responding. So we have some carryover pricing that’s still coming into our business from FY 2023 actions. And aside from that, we took very moderated normal levels of pricing in Q1 related to kind of our typical annual price increase process, but we have been surgically analyzing opportunities to take price more strategically, and I’ll give you some examples around what I mean by that.

What I mean by that is, looking at customer cohorts and identifying groups of customers that may be underpriced on specific products, as an example. So we segmented our customers. We identified customers who may have certain products or services that are below the average as it relates to price. So we will be taking price around certain specific kind of product lines with those customers. We’ve identified customers who may receive more than one stop in a week, but they’re only being charged for one stop. And it’s very appropriate that there would be incremental charges for multi-day service. So we’ve identified that cohort of customers and we’ll be taking price to charge those customers accordingly for multi-day service. And then we’ll also take some more general pricing, but in a very surgical way with a lot of analysis around which customers will be impacted and what the current relationship and state and condition of the relationship is with that customer.

So we definitely see the opportunity. We will be doing that in the back half of the year, particularly towards kind of the end of the second quarter, quite frankly. And then you’ll see some of that roll through in the third and fourth.

Seth Weber: Super helpful. Thank you. And then maybe, Rick, if I could ask a follow-up. Just to call out in Canada the higher investments for new merchandise and kind of elevated fleet maintenance costs, do you expect that to continue through the year or is that more of a first half event or just how should we be — I guess, the maintenance costs in particular, how we should be thinking about that?

Kim Scott: Yeah. So I’ll kind of take that to start with, and then, Rick, you can jump in if needed. So there are really kind of two drivers in Canada, as you heard from us. So you have a driver around some higher amortization costs related to some new product that we injected into the system really for customer satisfaction. Some of it was for new business because you can see those growth rates in Canada. But we also made a purposeful decision to inject some new products into existing customers, really kind of self-funding quality, if you want to think about it that way, in the name of customer satisfaction. So those products carry amortization steps. So you’ll see them with us for a while until we lap the amortization of whatever those particular products was based on their lifecycle.

And then as it relates to fleet maintenance, we’ve actually done a great deal of evaluation related to the Canadian fleet. And we found that historically, before my time and before we brought in new logistics leadership, the Canadian fleet wasn’t really a part of the central procurement strategy as it relates to allocating new fleets and new assets to the field. And so, we found an opportunity to start upgrading the age of the fleet in Canada. And before that opportunity was identified, they were driving more than normal maintenance costs. And so, that’s what caused us to ask the question, “Hey, what’s happening with maintenance costs in Canada?” And as we evaluated that, we discovered that the Canadian fleet was significantly older than the U.S. fleet.

So we recognized an opportunity to inject some more assets. And it’s really not about injecting more capex in our total system. It’s just about redirecting some of the fleet that we would have put into the U.S. into Canada. So they’re slated now to get about 102 new assets in their market in the fiscal year. And over time, that will help improve the age of the fleet and it’ll start lowering that maintenance cost. So it’s hard to tell you exactly when you’re going to see that cost dissipate 100%. But we certainly know that we’re taking the right actions by upgrading the age of the fleet. And you’ll begin to see that maintenance cost roll off over time.

Seth Weber: Appreciate the color. Thank you guys. Take care.

Kim Scott: You bet. Thanks, Seth.

Operator: The next question comes from Shlomo Rosenbaum with Stifel. Please go ahead.

Shlomo Rosenbaum: Hi. Thank you very much for taking my questions. I thought I would just start with what progress you’re seeing in terms of the cross-sell? It’s a major focus for the Company. And are you seeing that kind of progressing, strengthening as the quarter goes on? And maybe just take the opportunity to discuss the overall selling environment and maybe I’ll follow up after that.

Kim Scott: Yeah, certainly, Shlomo, good morning and thank you for joining us and for your question. So, to begin with on cross-sell, which, to remind everyone, is really leveraging our outstanding route service representatives who are servicing our customer on a weekly basis to also cross-sell existing products and services to them that they’re not using today. And if you guys will recall, we called out in the Analyst Day that about our customers are only using about 30% to 40% of the available products and services. So it is a key component of our strategy to cross-sell the base and to gain share of wallet with existing customers, increase revenue per stop. We are very pleased with the way that our route service representatives have embraced this as a new part of our DNA and a part of our go-forward strategy.

So we are seeing momentum build. In fact, you might have heard me call out that when you compare routes that had selling activity on them in Q1 of this year versus Q1 of last year, we’re seeing roughly a 25% increase in selling activity. So we know that we have, earlier in the year than we did last year, more activity around route sales. We’re in the middle, as an example right now of a route sales contest, which is where we get a dramatic lift in revenue per stop with our route service representatives. And we are definitely seeing momentum build around that as we launch the contest, which is a normal part of our cycle and we expected to do. So we feel very good. It’ll be a while before you actually see the number of products and services per customer moved dramatically.

So we’re not going to try to share that metric every quarter because it would be rather static. But probably on an annual to 18-month basis, we’ll relook at the total number of products and services used per customer and use that as a proxy for success as well. But we feel really good about the progress around route sales, and customers are quite engaged around adding additional products and services. Secondarily, to the second point of your question, around the general selling environment, we’re also seeing really good progress with our front line account executives driving revenue up per head. And we’re working very hard to continue to grow new business, particularly in those target micro verticals that we spoke about. And so, we’ve thought about building go-to-market strategies for those eight micro verticals.

They’re all in different stages of their lifecycle, as you can imagine. But auto was the example that I gave in Analyst Day. We’re seeing very good progress penetrating that sector. We’re seeing leads up in that sector, we’re seeing close rate up in that sector. And as an example, we see a 1% improvement in the revenue contribution from automobile dealers now. But we have focused on that vertical, just to give you an example. So overall, we feel good about our progress. We do anticipate a ramp up as we move through the year, very similar to the patterns that you saw last year in our business as you see growth accelerate. And then also keeping in mind that we’ll lap that temporary energy fee at the end of the second quarter.

Shlomo Rosenbaum: Okay, thank you. Just maybe, Rick, maybe you can just talk a little bit. The growth is supposed to accelerate through the year. Maybe you could give us a little bit of a bridge. There’s a couple of moving parts over here you have. In the beginning of the year, I believe there’s a rationalization of the direct sales kind of one-off in the SKUs, you had a strategic exit of a client that’s supposed to go on, and then you have kind of pricing that’s supposed to kick in later. Can you kind of bridge us and how we should think about the cadence of growth through the year and how these different items will impact the revenue for the next three quarters?

Rick Dillon: Sure. So on a prior call, we talked about a direct sale customer that we were parting ways with, and that was $13 million in the back half of the year. And so, we kind of quantified that and you should expect to see that. And that’s in our direct sales. So that will impact — on a reported basis, you’ll see that in uniforms. As we look at how we progress through the year, we’ve got another quarter here in Q2 that has energy free pressure. And so, the growth rate year-over-year, will — that will be a headwind for that growth. What we wanted to make sure everyone understood, because we don’t guide the quarters, but the progression will be very similar to what you saw in prior years and then particularly 2023. And so, we’re reporting 2.5 here.

And then we’ve got another quarter with a $13 million headwind here in Q2, and then — but you’ll continue to see growth rate advance. And then in Q3 and Q4, although you will see $13 million direct sale headwind, we still expect to see accelerated growth in those quarters, because, as we said at our year-end call, we knew that was out there, and our guidance has already factored that in.