Vestis Corporation

Hello, and welcome to the Vestas Corporation Fiscal Second Quarter 2024 Earnings Conference Call. At this time, all participants have been placed in a listen-only mode, and the floor will be open for your questions following the presentation. If you would like to ask questions at that time, please press star 1 on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star 2. To enable others to hear your questions clearly, we ask that you pick up your handset for best sound quality. If you should require operator assistance, please press star zero. I would now like to turn the call over to Brian Johnson, Chief Accounting Officer. Please begin. Thank you, and good morning, everyone. We appreciate your participation in Vestas Corporation's fiscal second 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 Vestas.com website shortly after the completion of the call. Also, access to the materials discussed on today's call are available on the Vestas 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.

Thank you, Brian. Good morning, everyone, and thank you for joining our fiscal second quarter 2024 earnings call. Before I discuss our results, I'd like to thank our 20,000 dedicated teammates for the hard work they do each day to contribute to making a positive difference for Vestas' customers, shareholders, and the communities we serve. We continue to bring our brand purpose to life here at Vestas following our spinoff in October. by delivering uniforms and workplace supplies that empower people to do good work and good things for others while at work. The underlying health of Vestas is strong, and we continue to position the company well for long-term success. With the spin and transition to a standalone public company now behind us, we are able to fully apply our resources against advancing our strategic plan and driving growth across the business. Operating trends are improving with strong free cash flow, demonstrating cost performance, improvement in managing working capital, and the resiliency of our model in support of strengthening our balance sheet over time. Now turning to our results. In the second quarter, we delivered lower than expected revenue growth of 0.9% or 2.8% on an underlying basis when normalized for last year's temporary energy fee. An adjusted EBITDA margin of 12.4%, which is 90 basis points lower than the second quarter last year and includes the absorption of incremental public company cost. Lower than planned revenue growth impacted our performance in the quarter and will also impact our performance in the back half of the year. While we delivered 8% growth in new business wins and customer penetration through route sales, we did not accelerate our ramp to the levels required to offset rollover losses from FY23. Our top-line growth was also impacted by a deliberate decision to moderate pricing while we enhanced our service processes in order to continue to strengthen customer retention. To ramp new business sales further going forward, we are focused on improving the capabilities of our frontline sales teammates while also strengthening our national account pipeline and go-to-market strategies. We also made the recent and deliberate decision to moderate pricing actions in the second quarter and the back half of the fiscal year in order to realize improved retention while we enhance our service processes. While this is negatively impacting our revenue and EBITDA in the second half of the year, we strongly believe that it is the right decision for the long-term health and growth of the business. As a result of these short-term challenges related to sales productivity and deliberate moderated pricing actions, we are updating our full-year outlook for FY24. We now expect revenue growth between negative 1% to flat year over year and adjusted EBITDA margin between 12 and 12.4%. While we are not satisfied with our performance in this outlook for the full year, we remain confident in our long-term strategy and the value creation opportunity ahead for Vestas. We are delivering results against many of our key strategic initiatives while taking swift and assertive action to enhance our sales productivity and service efficacy to accelerate growth. We are also keenly focused on managing and reducing costs across the company. Later in our discussion, I'll provide a scorecard against several key strategic initiatives. Now I'd like to discuss our response. We are taking decisive and immediate action to address our short-term challenges in the year. We are mobilized to improve sales productivity related to new business wins and focus on building a high-performing sales team. I have spent significant time over the past few months assessing our sales team, structure and talent, as well as our processes, from teammate training and onboarding to collateral and go-to-market strategies for our various product lines. We've identified enhancing selling skills and capabilities as well as improving teammate tenure as our highest priorities to support our frontline self-teammates in improving their close rates and deal sizes. In support of this, we have launched improved recruiting, onboarding, and retention programs, as well as enablement tools such as improved collateral and sample kits. We are also strengthening our national account pipeline. I have spent a great deal of time with our national account sales leaders and our customers. It's a privilege to support so many great companies and brands. Not only do we have opportunity to win new national accounts, but we have opportunity to grow share of wallet with existing customers. Our national account team is energized by the support and focus they are receiving from leadership to grow national accounts, as this has not been a priority for past leadership. We are taking actions to enhance our service in order to deliver a higher level of customer satisfaction, loyalty, and retention. This effort will also allow us to revisit pricing as we see customers respond positively to these process improvements. We are conducting assessments all the way to our route service representatives in the field to identify, improve, and retrain on specific procedures that can enhance our customers' experience and garner loyalty. We will also be creating a new leadership role on our team that will be accountable for service across the company. While we work through these improvements, we have deliberately moderated planned price increases we had scheduled for the second quarter and in the second half of the year in order to reduce customer churn, with a focus on improving customer lifetime value while we enhance our service processes. We will continue to strategically and surgically price in a thoughtful way with focus on lifetime customer value. We believe service gaps have driven price sensitivity as fully satisfied customers typically don't leave because they've received a price increase. But the price increase can be a catalyst for cancellation or quits. We are mobilized around this opportunity and see upward trends in customer retention year to date, which I'll discuss on the next slide. We are also taking swift action related to variable labor, accelerating the delivery of operational efficiencies in areas such as logistics, and evaluating our organizational structure. We will be making changes to our structure to better organize our team for success. And in parallel, we are also evaluating the structure through the lens of flattening and simplifying the organization so that we are more agile and able to institutionalize improvements in our business more quickly while also lowering costs. We are addressing these short-term challenges and expect to return to the acceleration of growth and market expansion we have outlined in our strategic plans. We will also continue advancing our strategic initiatives while these opportunities are being addressed. Now turning to customer retention. As discussed previously, we have highly engaged and dedicated teammates that are focused on creating a great experience for our customers. Their commitment has not wavered while we have identified the need to improve service processes. We have been working to overcome and offset a large amount of rollover losses from FY23 that are impacting our volume in FY24. These losses from FY23 include two large national account customers that represent approximately 60 basis points of revenue growth headwind in the full year of FY24. Our customer retention performance trend for recurring revenue is trending upward this year and returning to historical norms. Physical year-to-date, our customer satisfaction score has improved to a 12-month high. I'm pleased to say that national account renewals are performing well this year, with several of our largest customers renewed year-to-date. However, these renewals have also revealed the need to enhance our service and in a few instances have resulted in pricing and volume erosion during the renewal process. Based on reason codes cited by our customers when they cancel service with us, We know that more than 70% of cancellations are due to causes that are within our control. This presents a great opportunity to drive incremental value as we continue to improve retention and it validates our focus on improving service in order to improve customer retention. We are focused on enhancing our service processes in order to continue this upward trend as we see opportunity to continue to improve customer retention and drive value over the long term through these efforts. Now moving to sales. Starting with our new business wins with new customers. While we have delivered 700 basis points of revenue growth from new business wins in FY24 year to date, we have not ramped to the sales levels planned for the year and needed to overcome the rollover losses from FY23. We continue to strengthen our national account pipeline, which over time will bring large incremental volumes to our network and will leverage our fixed assets and idle capacity. We are also mobilized around our eight micro verticals, but we have been slow to gain traction with our sales force. We remain confident in these verticals and are supporting our team in accelerating growth in these sectors. As discussed previously, we are implementing improvements in our recruiting, onboarding, and training programs for sales teammates, while also providing enablement tools such as improved collateral and sample kits to improve sales productivity. Our strategy to cross-sell additional products and services to existing customers in order to drive customer penetration comes with an attractive revenue flow-through and is progressing well and ahead of plan. Our route sales representatives, or RSRs, are doing a great job. Sales per RSR are up approximately 100% versus prior year, and we've seen a 20% increase in the number of routes with sales activity year to date. We've instituted a twice-daily process to manage and measure route sales, and I'm very pleased with the results we are seeing here. We've also seen demonstrated performance from teammates at the levels required to achieve the long-term growth rate in our strategic plan. Our focus is now centered around supporting all of our RSRs in achieving and maintaining these levels of performance. Now let's shift to our strategic plan. We remain confident in our strategic plan, and we will continue to advance it. On slide seven, this scorecard depicts our rating of how we are doing against several key initiatives. We've talked a lot about sales today, and we are undoubtedly focused on accelerating revenue growth through addressing sales productivity. Customer retention is one of the single most important levers in our recurring revenue model and critical to our strategy to strengthen the base, capture share of wallet through cross-selling, to leverage idle capacity and fixed assets, and enhance customer lifetime value. We are hyper-focused on improving retention in support of our strategy as we already see the great progress we are making to cross-sell and gain penetration with our satisfied and loyal customers. Retention is moving back in the right direction, but even when at historical norms, we believe that it's still lower than our peers. This presents a great opportunity for Vestas to create shareholder value as we enhance our service processes and ultimately increase retention and customer penetration. While we are working to enhance our service processes, we will be strategic about how and when we price so that we are building the company for the long term. Now turning to efficient operations. I'm very pleased with our progress related to logistics initiatives. Our team is performing extremely well in this area. We are building momentum and have already completed 22 optimization events in the first half of the year versus a total of 23 for the full year in FY23. As a result, we are seeing improvements in logistics efficiencies in areas such as fuel consumption. We intend to introduce a metric in FY25 that will serve as a barometer for progress against this initiative. We are also ahead of plan related to our merchandise reuse initiative. Year to date, we've seen a 20% improvement in use fill rate and are on track to deliver an approximate $10 million in cash savings and an approximate $4 million run rate cost benefit in FY24. We also remain focused on capital allocation with de-levering as a priority. Rick will talk more about capital allocation in a moment, but I did want to mention the great progress we are making institutionalizing a sales and operations planning process that will further help us to improve inventory management. Our supply chain team is doing a great job here, delivering $34 million in cash generation improvements year-to-date as a result. Now I'd like to introduce Rick, who will take us through the financials. Rick?

Thanks, Kim, and good morning, everyone. I'll start with more details on the second quarter results and then walk through the drivers of the changes in our full year 2024 guidance and what it means for the back half of the year. Let's start with the second quarter revenue bridge on slide nine. Revenue of $705 million increased by 0.9% year over year. The impact of volume growth and pricing was offset by lost business in the quarter. Volume growth, including new customers and expanding our existing customer penetration through cross-selling, provided approximately 8% of growth in the quarter, with a contribution from new sales of 7% year-over-year. Customer losses reduced second quarter revenues by 9% year-over-year, more than offsetting our new business growth. The impact of losses consists of 6% from the known customer losses as we exited fiscal 2023, and 3% from customer losses during this fiscal year. As Kim noted, and in line with our expectations, we have seen a meaningful improvement in our retention rate year-to-date, and that will drive lower carryover losses in 2025. We are adding new business, but we are not ramping at the pace we expected heading into the year. Sequentially, compared to the first quarter, new business revenue is up 3%. Pricing contributed 4% to the top line growth, 3% from prior year pricing actions, and 1% from current year pricing. As we noted earlier, While we continued to take annual pricing increase, the current year pricing impact was less than planned given our decision to moderate off-cycle pricing actions. Excluding the impact of the temporary energy fee, revenue grew 2.8% year-over-year. The fee was discontinued in the second quarter of last year, so this is the last quarter of comparable headwinds associated with the fee. Our direct sales business is down approximately 2 million or 5% year-over-year as we continue to optimize that business. Excluding the direct sales, our uniform business was flat year-over-year and workplace supplies were up 2%. Moving on to slide 10 and the adjusted EBITDA. Adjusted EBITDA was $87 million in the second quarter of fiscal 2024, down approximately $6 million or 6% from the second quarter of fiscal 2023. The operating leverage on new business and flow through on pricing was offset by the impact of lost business in the quarter. The incremental margin on new sales volume was approximately 33%, reflecting the increase in garment amortization on new customer wins and sales commissions on new sales. The approximately 60% decremental margin on lost business was net of final exit billings during the quarter. The elimination of the $13 million temporary energy fee this year had a negative impact on margin that was offset by approximately $6 million in energy cost savings year over year. The fee was favorable for us in the second quarter of last year due to the timing of implementing the fee versus the spike in energy fees. Energy cost savings this quarter were again driven by favorable rates for natural gas consumed in our plants and reduced fuel consumption from our route optimization efforts. Incremental public company costs were $4 million in the quarter and $7 million year-to-date. We continue to expect full-year incremental public company costs of $15 to $18 million. Productivity gains in the quarter, including permanent structural reductions implemented last year and the continued benefits from our network optimization efforts, were offset by the expected increase in labor costs year-over-year. Overall adjusted EBITDA margins were down 90 basis points year-over-year, Excluding the net impact of the temporary energy fee and incremental public company costs, margins expanded 80 basis points year over year. Turning to liquidity on slide 11. We generated approximately $76 million in cash from operations in the second quarter, an increase of approximately 25% or $15 million. Our focus on inventory management with new sales and operation planning initiatives drove a $34 million reduction in inventory year to date. CapEx was approximately $13 million during the second quarter of 2024, down from approximately $18 million last year. Last year's results include $10 million in proceeds from the sale of a real estate property. Free cash flow in the second quarter was $63 million with cash conversion in excess of 100% of net income and 50% of EBITDA year-to-date. As previously announced, we completed the refinancing of our two-year term loan with a seven-year term loan that matures in 2031. We will continue to channel available cash to voluntary loan principal reductions. Year to date, we have made principal payments of approximately $65 million, which includes $45 million in voluntary principal payments in Q2. And we expect to continue to make meaningful voluntary payments in the back half of the year. We ended the second quarter with a net debt to EBITDA ratio of 3.82 times. We remain confident in our ability to get to our targeted leverage level of 1.5 to 2.5 times by the end of fiscal 2026, despite the challenges with the calculated leverage for the back half of the year using our revised EBITDA margin guidance. We believe we will exit the year with a net debt to EBITDA leverage of approximately four times. As a reminder, our leverage covenant levels are 5.25 times through March of 2025 and reducing to 4.5 thereafter. Before I turn the call back over to Kim, I want to revisit the key drivers of our revised guidance on slide 12. We now expect revenue to be down 1% to flat and adjusted EBITDA margin to be between 12 and 12.4%. From a revenue perspective, it's important to note that lost business is not a factor in the lowering of our revenue guide. Again, while we are absorbing losses from the prior year, current year retention is improving in line with our expectations. Pricing accounts for 250 basis points of the guidance reduction, reflecting the decision to moderate pricing in the second quarter and the back half of the year. Volume accounts for 225 basis points, which represents the impact of lower than expected sales productivity in the year. While cross-selling has been strong, new customer wins have not met our expectations. We're expecting sales productivity in the back half of the year to be consistent with the first half of fiscal 2024. The 190 to 230 basis points decline in margin guidance is driven by the loss of leverage on lower pricing and volume in the year, partially offset by 45 basis points from cost performance actions, as Kim previously discussed. From a quarterly progression perspective, we expect revenues to decline sequentially from the second quarter to the third quarter. The decline is attributable to the progression of carryover losses as we move past final exit billings included in Q1 and Q2, offset by a sequential improvement in route sales. We will see direct sales decline approximately $4 million from the second quarter, which includes the impact of the lost direct sale national customer we previously disclosed. We expect Q4 revenue to be slightly higher than Q3 as the impact of net carryover losses moderates in the quarter. We expect the EBITDA margin in Q3 to decline sequentially with the loss of sales leverage. In addition, we expect incremental public company costs between 6 to 8 million for the quarter as we near the exit of the TSA and in keeping with our estimate of 15 to 18 million for the year. And lastly, we expect Q4 margins will benefit from a lower level of incremental public company costs. With that, I'll now turn the call back over to Kim for final remarks.