Vestis Corporation (NYSE:VSTS) Q4 2023 Earnings Call Transcript

Vestis Corporation (NYSE:VSTS) Q4 2023 Earnings Call Transcript November 29, 2023

Operator: Welcome to the Inaugural Earnings Call for Vestis Corporation’s Fiscal Fourth Quarter and Full Year 2023 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode and the floor will be opened for your questions following the presentation. [Operator Instructions]. I would now like to turn the call over to Valerie Haertel, Vice President of Investor Relations.

Valerie Haertel: Thank you, Chelsea, and good morning, everyone. We appreciate your participation in Vestis Corporation’s fourth quarter and fiscal 2023 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 IR section of the vestis.com. Access to the replay and materials related to today’s discussion are also available on the Investor Relations website. Before we begin, I would like to remind you that this call may contain forward-looking statements. And as such — as within 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, Valerie. Good morning, and thank you for joining Vestis’ first earnings call as a standalone public company. We completed our spin-off of Aramark on September 30, an achievement that was only made possible thanks to the hard work of our 20,000 dedicated teammates. I would like to thank the Vestis Nation for their unwavering commitment to our customers, and to each other, as we work together to deliver this tremendous outcome. Every day, our outstanding teammates bring our purpose to life inside the company, delivering uniforms and supplies that empower people to do good work and good things for others, while at work. We are doing important work, work that makes a positive difference in the lives of so many.

Turning now to our Vestis results. We delivered strong financial performance in 2023 with revenue growth of 5% and adjusted EBITDA margin of 14.3%, an increase of more than 40 basis points. As Rick will touch on in more detail in a moment, we delivered this growth and margin expansion as a result of strong performance against our strategic initiatives that are focused on high-quality growth and efficient operations. We saw continued positive performance trends throughout the year, and we have entered 2024 with great momentum as our strategic plan gains traction and operating leverage begins to emerge. We are pleased to share our outlook for fiscal year 2024, a revenue growth rate of 4% to 4.5%, which is well-above our historical norms of approximately 2%.

And we will deliver 50 to 60 basis points of EBITDA margin expansion, which will be offset by the introduction of $15 million to $18 million in public company costs in the period. As a result, we will maintain our FY ’23 EBITDA margin at 14.3%, while absorbing these go forward public company costs. Throughout 2023, we continued to establish a strong foundation for profitable growth through the advancement of our strategic initiatives that we outlined at the Vestis Analyst Day back in September. As a reminder, our strategic imperatives include the delivery of high-quality growth, efficient operations, disciplined capital allocation and a performance-driven culture. We are pleased with the progress we are making against these imperatives. Our top-line results reflect our strategy to grow with existing customers through cross-selling workplace supplies.

And as you can see in our results, we delivered 9% growth across workplace supplies in 2023. We are grateful to our frontline route service representatives for the work they are doing to support our growth and provide these value-added services and products to our customers, with sales activity taking place across 96% of our routes in 2023. This focus on capturing share of wallet with existing customers and driving up the revenue per stop at a customer location, contributes to a higher flow through on revenue, aiding in our delivery of margin expansion. We will continue to deliver top-line growth, while also improving our revenue mix. To that end, we will exit a relationship with a large direct sale customer in FY ’24 and through FY ’25, improving our consolidated margin by approximately 3 basis points on a fully-annualized basis.

We will continue to focus our energy and our resources on high-quality growth, including our key micro-vertical targets we discussed in September at Analyst Day, and we remain focused on optimizing our revenue mix to support density and operating leverage across our network. Our focus on efficient operations has contributed to our margin expansion and it is establishing the foundation for a more disciplined, and modernized operating environment that will serve us well in the years ahead. Our team has activated our plan to optimize our network, to reduce empty miles and lower fuel costs, simply by serving the right customers from the single most efficient location. This will also allow us to leverage latent capacity at our existing locations.

And taken together, we believe we have $30 million to $50 million of potential cost savings or redeployable capacity that will be unlocked across our system over the next five years. This is a tremendous opportunity to leverage the assets we already have in our system and it gives us confidence that we can accelerate growth without a significant capital outlay. In FY ’23, we successfully completed more than 20 last mile optimization events, across our network in support of this initiative. We also organized our team for success in FY ’23 in support of our strategy, which has resulted in lowering operating costs across the company. This proactive initiative has prepared us well to ingest the incoming public company costs as we enter FY ’24 as a standalone public company, while maintaining our FY ’23 adjusted EBITDA margin level of approximately 14.3%.

We are also progressing our efforts to improve the rigor applied against merchandise management or inventory reuse as we call it, which will reduce the amortization costs on our garments over time. Before I turn the call over to Rick, I would be remiss if I didn’t touch on the incredible culture we are building here at Vestis. I am so inspired to come to work every day surrounded by our exceptional teammates. They were highly engaged to deliver against our plan, who are committed to serving our customers with excellence in every interaction, and who are embracing change, while growing and advancing themselves each day, as we teach them new and better ways to do things across our business. I couldn’t be more proud of this team and all that we are accomplishing together, blazing new trails that lead to growth and margin expansion, while building the Vestis brand and uniting around our shared purpose as an organization.

Looking ahead to 2024, we are well-positioned to deliver healthy revenue growth and margin expansion that on a normalized basis is already within the long-term target range that we provided at Analyst Day. We will continue to advance our strategic initiatives to drive high-quality growth and enhance our operational productivity. And as Rick will share, we will deliver healthy and stable cash flows that will allow us to delever, while continuing to invest in our business. I believe our opportunity ahead is significant and our pathway to value creation is clear. I will now turn things over to Rick before we take your questions.

Rick Dillon: Thanks, Kim, and good morning, everyone. Before we dive into fiscal 2023 results, just a quick reminder of the accounting basis for our reporting. Fiscal ’22 and ’23 results are prepared on a carve-out basis as Vestis did not operate as an independent company. These results are different than the segment results reported by Aramark as they include certain allocations of Aramark corporate expenses, additional accounting adjustments and previously eliminated revenue from services provided to Aramark. The allocated costs do not fully reflect the additional costs associated with providing these services, as an independent company. And I will come back to that when we look at the actual estimates of public cost in a moment.

So with that level setting, let’s move on to more details on fiscal 2023. Revenue for fiscal ’23 was $2.800,000,000, up approximately 5% from fiscal ’22. Workplace supplies were up approximately 9% year-over-year, while uniform revenue was essentially flat. Our results reflects our focus on expanding our relationships with existing customers and the strategic shift in our approach to new business. Both years include $26 million in revenue from a temporary energy fee that was implemented late in the second quarter of fiscal ’22 and continued through the end of the second quarter of fiscal ’23. Currency negatively impacted growth by 60 basis points in the year. From a segment perspective, U.S. sales were up 5.2% and Canadian sales were up 4.1%.

The mix of growth between uniforms and workplace supplies was consistent with our consolidated growth across both segments. Moving on to adjusted EBITDA for the year. Adjusted EBITDA was $404 million in fiscal ’23 an increase of approximately 8% compared to the prior year with the US up approximately 9% and Canada down 13%. The operating leverage from sales volume pricing actions and 15 million in structural cost reductions were partially offset by increases in cost of services and other SG&A expenses. Cost of services increased by 3%. Half of the increases associated with higher merchandise amortization costs from increases in circulating inventory during fiscal 2022 to support demand recovery post COVID. The other half is attributable to increased labor and energy costs year over year, while energy costs remained elevated throughout the year, we did see some moderation starting in the back half of the year.

SG&A expense includes an incremental 12 million in structural costs associated with establishing the leadership team and corporate functions needed for a public company. From a segment perspective, US profitability was driven by operating leverage on revenue growth, a favorable mix towards workplace supplies, as well as momentum in our operating efficiency initiatives. The decline in profitability in Canada is attributable to prior year wage of fees and a gain on a property sale that did not repeat in the current year. In addition, investments in rental merchandise inventory to support COVID demand recovery more than offset the benefits from operating leverage on revenue growth, pricing actions, and the impact of operating efficiencies during the year.

Overall adjusted EBITDA margins expanded 42 basis points in fiscal 2023 to 14.3% after absorbing 12 million in incremental public company costs. So let’s look closer at public company costs. As noted, our results include the 12 million in permanent structural costs and we expect to incur an additional 15 million to 18 million in fiscal ‘24, while completing the build out of our corporate structures and our IT infrastructure. That’s inclusive of TSA costs. As we’re completing our separation activities during ‘24, we will utilize a transition services agreement with Aramark to provide monthly bridge support. The support will decline throughout the year as we stand up our own functions. There will, however, be some periods of overlapping costs, but we expect to be fully operational by the end of fiscal ‘24.

So all in, we expect to see public company costs and TSA payments in the range of 27 million to 30 million for 2024, while our permanent structural costs run rate will be about 20 million to 25 million starting and as we enter 2025 post TSA. Moving on to liquidity, we generated 257 million in cash from operations during fiscal ‘23, an increase of approximately 24 million. The increase is primarily attributable to higher rental merchandise ads in the prior year as compared to the current year and lower year over year growth in receivables attributable to timing. The actual investment in in-service inventory or the cash impact was in fiscal 2022, and the increase in amortization impacted results in 2023. Additionally, we saw a use of cash for accounts payable during the year, driven primarily by timing of payables heading into the spend transaction.

CapEx was 78 million for fiscal 23, up slightly from 2022 and just under 3% of our total revenues. Free cash flow was 190 million, up 27 million from the prior year. We entered into a $1.8 billion credit agreement on September 29th as a part of the spend transaction, the facility includes a $300 million revolver and two term loans. On the last day of fiscal ‘23, just before the completion of the spend, we drew on the two term loans, totaling 1.5 billion, 800 million maturing in two years, and 700 million maturing in five years. The revolving credit facility was undrawn ever being the fiscal ‘23. We ended fiscal ‘23 with 36 million in cash on hand, and a net debt to EBITDA leverage ratio of 3.95x, maximum leverage under our credit facility is 5.25x dropping the 4.5x in March of 2025.

We continue to target an optimal leverage ratio of 1.5 to 2.5 by fiscal ‘26. We are mobilizing to refinance the two-year loan in the second quarter of fiscal ‘24. We believe our available cash, future cash generation from operations, existing credit facilities and access to credit markets provide us ample liquidity and the flexibility needed to execute our strategy, reduce our leverage and return capital to shareholders in the form of a sustained quarterly dividend as announced earlier today. I’ll close with a few more details on our 2024 guidance. As Kim noted, we expect revenues to grow between 4% and 4.5%, when normalized for the $26 million impact of the temporary energy fee in 2023. Our ‘24 guidance represents a 5% to 5.5% growth in revenue.

Our adjusted EBITDA margin guidance has absorbing and incremental 15 million to 18 million or 50 to 60 basis points of incremental public company costs in 2024. Depreciation and amortization expense is expected to be $130 million to $140 million. Interest expense is expected to be 115 million to 120 million. We expect CapEx will be approximately 3% of revenue, and our effective tax rate will be approximately 26 million. We estimate we will spend 25 million in fiscal ‘24 on one time spend related costs that are not included in our adjusted margin guidance. This includes approximately 15 million in costs associated with the rebranding of our fleet and signage on our facilities. We expect this process to be completed over the next two years with an incremental 10 million of expenses expected and fiscal ‘25.

Finally, we expect free cash flow conversion to be greater than or equal to a 100% of net income to support the pay down of debt and our quarterly dividend. So that concludes our prepared remarks. Operator, I will turn it back to you to open the lines for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question will come from Stephanie Moore with Jefferies.

Stephanie Moore: Maybe just starting with the guidance for fiscal 2024. I appreciate the incremental color that you provided in terms of the lapping of the fuel surcharge. But could you kind of break out as you think about the components of that organic growth guidance and other revenue growth guidance in terms of what you would expect roughly from pricing, cross-sell, new business wins as well as I think you noted you were walking away from that customer in 2023. So those puts and takes would be helpful.

Kim Scott: Thanks for your question, Stephanie. So we do expect a bend towards volume in FY ’24 as we talked about at Analyst Day, this is not a pricing base strategy, growth strategy. So our aim here is we grow the business in FY ’24 and beyond really is to drive volume in the base through cross-selling. So we expect healthy growth coming from cross-selling as part of our strategy around workplace supplies. We will take pricing appropriately as we offsetted things like inflation and we also take value-based pricing, as Rick referenced earlier as he was giving his discussion around the future for ’24. But we will also continue to protect and grow customers. But as you noted, we will also exit strategically at times customers.

So we’ll see some erosion in the base at times as we exit some of these lower-margin customers while also growing new customers in our micro verticals. So it will be a balance, quite frankly, of cross-selling new business in the micro verticals and modest pricing. Rick, anything that you would add to that?

Rick Dillon: No. In the weighting will lean towards the impact of cross-selling. So you see that same overweight of workplaces lives versus uniforms. Yes.

Stephanie Moore: Got it. No, that’s helpful. And then just as a follow-up to that question, as we think about your you execute your strategy that you outlined at the Analyst Day, particularly with some of those micro verticals that you talked about, should we expect to see the Uniform business maybe accelerate a bit versus what we saw in fiscal 2023 Clearly, we’re making really nice progress on the workplace supplies, but maybe uniform just a little bit lighter. Should we think about uniform kind of stepping up a bit going forward or kind of continue to be outshadowed by the workplace supplies?

Kim Scott: Yes. You should expect that you will continue to see momentum in workplace supplies and a more muted uniforms number, but that is also driven by some of these decisions that we’re making to strategically exit our direct sale business, which will have an impact on the Uniforms number. So just keep that in mind. We are definitely still growing our uniforms business. We’re targeting those micro verticals as well as other verticals and our sales team is actually our sales team that is driving new business is actually quite productive and performing very well. We are just purposely at times exiting some business and also overshadowing that with the workplace supplies. So I would expect you should see a muted uniforms growth rate again in FY ’24, but that is a very purposeful decision to grow very strategically under high-quality verticals and exiting some underperforming business.

Operator: Our next question will come from Andy Wittmann with Baird.

Andy Wittmann : I guess maybe you can comment on the size of the direct sales customer here that’s giving you the 3 basis points of margin just so we can kind of have better context around the magnitude of that have been?

Kim Scott: Yes. Sure, I’d be happy to, and Andy. It’s great to hear from you. So thanks for joining us today. The customer that we’re referring to is on an annualized basis, about $26 million in revenue. So it’s a significant sized customer for us, and we will see that customer transition out. So about half of that will hit the FY ’24 year, and about half of that will hit in FY ’25. So about $13 million in this year and $13 million in the year to come. And at the macro level, that will have about a 222 basis point impact on the uniform’s growth rate on a fully annualized basis, about 92 bps on our total consolidated Vestis revenue.

Andy Wittmann : Got it. That’s super helpful. I was just wondering, do you guys anticipate as you get into reporting your own results as opposed to the carve-out here, right? Do you expect that you’ll be giving an EPS measure in your guidance as well, like an adjusted EPS measure or measure. Do you expect that we’re just going to work on GAAP for now and go that way?

Kim Scott: Yes. We absolutely will. And I’ll let Rick provide some more color here in a moment, but we actually discussed that as we were preparing for our first earnings and we made the decision, given that we had just spun out not to report that in this particular full year result for FY ’24 as we were still a part of Aramark. But we will, in the future, be discussing and sharing information related to EPS. Rick, anything that you’d like to add there?

Rick Dillon: Yes. Fiscal ’23. We will report it for ’24. The ’23 numbers, as Kim said, there were no shares outstanding. And so you’d be reporting an EPS on a pro forma number. So it’s got to be very not indicative as I said about the carve-out. On a go-forward basis, we have a share count, we’ll know the dilution impact, and we’ll start reporting the adjusted EPS for the quarter. To your point, Andy, you can, of course, get there with what we provided, but you will see us report that.

Andy Wittmann : Okay. That makes a lot of sense. And presumably, that adjusted EPS is on the same — includes the same adjustments as the EBITDA. I’m guessing. And then I guess yes. Okay. And then — so then just to follow up on that here, just related to the free cash flow conversion here when you say greater than 100% of net income. In this context, however, you mean this in terms of GAAP net income. Is that correct?

Rick Dillon: Correct.