Hello, and welcome to the Vestis Corporation Fiscal Second Quarter 2024 Earnings Conference Call. I would now like to turn the call over to Bryan Johnson, Chief Accounting Officer. Please begin.

Thank you, and good morning, everyone. We appreciate your participation in Vestis 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 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.

Thank you, Bryan. 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 Vestis' customers, shareholders, and the communities we serve. We continue to bring our brand purpose to life here at Vestis following our spin-off 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 Vestis is strong, and we continue to position the company well for long-term success. With the spin and transition to a stand-alone 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 costs. 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 FY '23. Our top line growth was also impacted by a deliberate decision to moderate pricing while we enhance 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 FY '24. 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 and this outlook for the full year, we remain confident in our long-term strategy and the value creation opportunity ahead for Vestis. 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 actions 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 sales 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 the opportunity to win new national accounts, but we have the 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 cancellations 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. 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 plan. 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 FY '23 that are impacting our volume in FY '24. These losses from FY '23 include two large national account customers that represent approximately 60 basis points of revenue growth headwind in the full year of FY '24. Our customer retention performance trend for recurring revenue is trending upward this year and returning to historical norms. Fiscal 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 opportunities 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 FY '24 year-to-date, we have not ramped to the sales levels planned for the year and needed to overcome the rollover losses from FY '23. 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 teams 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 rates 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 7, this scorecard depicts our rating of how we are doing against several key initiatives. We 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 Vestis 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 FY '23. As a result, we are seeing improvements in logistics efficiencies in areas such as fuel consumption. We intend to introduce a metric in FY '25 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 used 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 FY '24. We also remain focused on capital allocation with delevering 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.

Thanks, Kim, and good morning, everyone. I'll start with more details on the second quarter results and then walk through drivers of the changes in our full year 2024 guidance and what it means for the back half of the year. So let's start with the second quarter revenue bridge on Slide 9. 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 the contribution from new sales up 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 continue to take annual pricing increases, 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 Uniforms 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 million 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 2020, down from approximately $18 million last year. Last year's results included $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 2-year term loan with a 7-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 3.82x. We remain confident in our ability to get to our targeted leverage level of 1.5 to 2.5x 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 4x. As a reminder, our leverage covenant levels are 5.25x through March of 2025 and reducing to 4.5x 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 guidance. 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 our 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 are 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 months 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 million to $8 million for the quarter as we near the exit of the TSA and in keeping with our estimate of $15 million to $18 million for the year. And lastly, we expect Q4 margins will benefit from a lower level of incremental public company costs.

Thanks, Rick. Before we open it up for questions, I also want to provide a quick update on our Chief Operating Officer search. We have engaged an external recruiting firm to support us with our search and are very pleased with the quality of candidates we have been presented and interviewed thus far. We are making progress with the search but also taking our time to ensure adequate due diligence to vet candidates and to ensure we find the right skill set and leadership style to support the advancement of our strategy and financial goals while also helping us solidify our desired performance-driven culture. Once the COO is in place, I will continue to work closely with the new leader and our commercial and operations teams to ensure no interruption in our performance as the new leader onboards and integrates into Vestis. In closing, while today we shared that we are mobilized to address some short-term challenges that have resulted in an updated outlook for the year that is lower than expectations, we remain committed to our strategy and resolute in the opportunity to create value here at Vestis. We are building on our customer-first culture by improving our service efficacy in order to strengthen customer loyalty and improve retention rates with our first priority aimed at protecting and growing the lifetime value of our customer base over the long term. Our cross-sell logistics and operational initiatives are driving results. These teams are operating at a high level of performance, and we will go faster where we can to accelerate value creation in these areas. We will continue to pursue our strategy, and we remain confident in our pathway to value creation. I want to thank you all again for joining us today, and we will now open the line for questions. Operator?

Our next question comes from Shlomo Rosenbaum with Stifel.

Kim, could you explain to us what the service gaps are just from a practical perspective that are resulting in the decision to moderate the pricing? It sounds like this is a change that happened inter-quarter, something was discovered that you didn't necessarily see beforehand and was significant enough that you feel that you need to make a change in the plans of pricing. Can you just give us some idea of what these service gaps are, how widespread they are? And how long do you think it's going to take to fix them?

Shlomo, thank you for your question. I appreciate you joining us today. So as we have been evaluating the lost business and really digging in to understand the root causes of that lost business, it's led us back to service efficacy. So as we look at the causes for customer quits and the feedback that we're receiving from them, we're finding very specific areas we can action around. So we're looking at on-time delivery, making sure that the load arrives to the customer at the time and on the day that it is expected. We're implementing telematics. We've rolled out telematics across our fleet now, so that we can put processes in place to measure that delivery and ensure that delivery happens. So we expect that this will continue to improve in the coming months, and we should see benefits from that in FY '25 as the telematics have now been installed in the trucks, and now we're building reporting and capability to use the insights from that data. We also see opportunities around things like shortages, to make sure that we have a process to verify that the truck has been loaded accurately and that all of the product that needs to go to our customer is, in fact, being delivered to our customer. So those are opportunities around the perfect truck and loading processes, and we've got folks out in the field now working through programs to address those things. We feel very confident that we've isolated these challenges and opportunities, and we have very clear, deliberate actions around specific things like on-time delivery and preventing shortages and delivering full loads to customers. The great news is that our culture is in a great place as it relates to wanting to do a great job for the customer and our teammates are serving our customers really well in terms of the relationship and the experience. But we just need to tighten up our processes on being on time, being complete, being fully loaded and putting metrics around that, so that we can ensure that we're delivering consistently to the expectations that our customers have for us.

Can I just squeeze in one more? Just what does it mean that you're not executing as expected on new wins? Does that mean that you're not getting the volume of new wins? They're not starting up in the way you expected? I'm just trying to understand what that means in terms of the volume?

Yes, absolutely. So it is volume related, and it really comes back to the way that we're measuring our sales performance in terms of revenue dollars per sales teammate. So we had expectations that the revenue dollars per sales teammate would continue to ramp and increase throughout the year. We are not seeing that ramp to the degree that we needed and expected. And so this is really about improving the close rate and also improving the amount of revenue per deal closed.

Our next question comes from Andrew Steinerman with JPMorgan.

I wanted to ask about the price elasticity of your client base. As you articulated, your plan had been just a couple of months ago for a targeted in-year price increase and then you pivoted to a price decrease. I surely caught that you're saying the clients are claiming it's about service. My question is, might it also be about price? I'm talking about price versus other uniform services providers.

Thanks, Andrew. I would take this one. I would say, as Kim discussed, our service efficacy and price sensitivity go hand-in-hand. And as we've spent the time analyzing the reason for quits and the magnitude of the carryover losses, we made the determination that we would deliberately moderate the pricing to focus on retention and customer efficacy. So when you ask if this is about price sensitivity or price elasticity or if it is about service, we view those as tied closely together. As Kim described, if we improve customer efficacy, we will have much less sensitivity to pricing, and we can return to a more normal pricing environment. I would add that we do continue to take our normalized annual pricing; some of that's surgical, more specific regarding value-added activity and certain product categories. We will get back to that as we work on customer efficacy.

Our next question comes from Andy Wittmann with Baird.

I guess I wanted to understand a little bit more about the revenue outlook here. I understand the comments that you made about the sales not ramping as much as you previously forecasted. But some of these 23 lost customers that were significant in nature are actually a tailwind to your second half growth. Obviously, you still have the direct sale headwind. I guess, are you factoring in more risk from some of these national accounts that you had to reprice lower as a factor into that second half? Or are there known losses that are coming that haven't been disinstalled yet? Maybe you could just talk about some of the moving pieces to get you to that flat to down revenue outlook in a little bit more detail.

As we transition from the first half to the second half of the year, we are managing the final billing for customers we have exited. Most of this impact has already occurred in the first and second quarters. Moving into the second half, we will fully experience the consequences of those losses, including some national account losses mentioned earlier. This contributes to the increased impact from lost business in the latter half of the year. However, we do not anticipate additional losses affecting our guidance for the second half. Our retention rates are aligned with our expectations, and the improvement we achieved, around 93% in recurring revenue retention, reinforces our confidence that this situation does not solely stem from lost business, and we are on track with our projected figures for lost business entering this year. We also noted the large direct sale national account, which is excluded from our retention calculations, influencing revenue in both halves along with seasonal fluctuations. While we are concentrating on lost business, we believe our initiatives are enhancing retention. The known losses for 2023 are already accounted for, and we will continue to address these losses as we approach the end of the year, influencing our operations beyond the exit costs in the latter half.

Kim, just as it relates to the service quality, you mentioned things like the perfect load and you're not there today. How much are operational things like this or how much can they be attributed to things like doing very complicated reroutings of those trucks and loading them differently today than maybe they've been done in the past? Or have these service shortfalls been there the whole time, and you're just starting to realize them more as you've rolled up your sleeves? I guess I'd just like to understand the source and the genesis of some of the service issues that you're talking about today.

Yes, absolutely, Andy. And thank you for your questions and for being with us today. So I can definitely confirm that these service opportunities are not related to the logistics optimization and rerouting of customers. These challenges have been in our business for quite some time, and I've dug in quite deeply into these root causes of quits to really understand how to get to the root of this and improve customer retention. It requires going very deep and far to get to the right answer. As I've explored this and listened to customer feedback, it is clear that we are not strict enough on our processes related to the disciplined loading of trucks, delivering on time, delivering full loads. The good news is these are processes that can absolutely be improved and our people can be trained on these processes to do a great job. Our teammates want to do a great job, so they'll be happy to follow new processes and adopt better procedures. I believe these issues have persisted in the business for quite some time and have not been recognized or addressed until now. The telematics implementation is an example of our commitment to address this. However, I've spent an extensive amount of time evaluating root causes at the grassroots level down to our market center focusing on what levers we can pull to make Vestis even better, and that's what we're doing.

We'll take our next question from Stephanie Moore with Jefferies.

So maybe, Kim, given such a change in tone here in the last 90 days since you reported 1Q, I think including in the short period of time an erosion in national account business and now a reversal in pricing capabilities. How do we get comfortable that you have your arms around the operations and can meet this revised guidance for the year?

So Stephanie, we feel very confident in the strategy. We remain committed, and we know that there is a value creation opportunity for Vestis this year. This is about improving some service processes to ensure that our service experience with our customers is outstanding because improving retention is the heartbeat of this model. Our strategy is built on keeping loyal customers and enhancing lifetime value by cross-selling them. We feel it's imperative to continue enhancing our processes and improve the retention experience. As we drive up that experience and it continues to improve, more customers will remain loyal, it just fully supports our cross-sell initiatives and our desire to penetrate those customers and cross-sell other products and services. We feel incredibly confident that we are on the right path and that making these corrections around service efficacy will further strengthen our plan. As it relates to sales, there is certainly an opportunity for a more high-performing sales team. We have great people who absolutely want to do a great job for the company and drive sales, but we need to support them with better enablement tools. We need to have more sophisticated processes around how we go to market. We are doing things like improving sales collateral, working on onboarding, recruiting the right profile of teammate who will thrive in this environment, but also training them and providing them with the right tools and resources to sell effectively. These are very known and understood opportunities, and we're very mobilized around them. But I do want to reiterate, Stephanie, we believe in this plan. We believe in the value creation opportunity, and we have no doubt that there's going to be great value generated here over the long term.

Got it. And then just as a follow-up. It does sound like many changes are being implemented, and you noted that we should start to see the benefits in fiscal 2025. So does that mean we should expect to return to revenue growth in 2025, maybe in line with the targets you provided at your Analyst Day? And how will pricing factor into that since it looks like you'll probably be a decent comp on the pricing front as we look to 2025?

Yes. So regarding growth, we absolutely intend to return to positive growth in FY '25. We'll discuss what those growth rates will look like when we guide for the year. But we are definitely accountable and expect to achieve growth in FY '25. You can count on that happening for sure, and we'll discuss those rates as we exit '24 and provide guidance for '25. As it relates to pricing, we are confident that we can take more price right now if we wanted to. However, we believe it is important to improve service efficacy and ensure that we are not taking price in the short term only to jeopardize customer retention rates in the long term. So we will return to the ability to take more pricing, and we believe that in inflationary environments, we can pass that price through as appropriate and that price will stick. We will definitely continue to address pricing and feel that we will improve our ability to take more price as we enhance our service processes and customer experience. Additionally, we are taking price this year and want to be clear that we have annual price increases and off-cycle price increases. We continue to take our normal annual price increases, but we're moderating our subjective discretionary off-cycle price increases. We will still be surgical and take price in certain areas as it relates to multiple stops in a week or customers that are largely underpriced compared to the average in the market. Pricing will remain an important part of our strategy.

Our next question comes from Oliver Davies with Redburn Atlantic.

So just two for me. Firstly, volume growth in the quarter was about 50 basis points lower than Q1. Can you talk through the cadence through the months leading into the latest quarter? And then secondly, probably one for Rick. Can you talk about the level of underlying costs and labor inflation and how you see that playing out through the rest of the year?

Sure. So from a volume perspective, when you look at Q1 to Q2, as I mentioned earlier, there is a step-up in absorption of lost business in Q2 from Q1, and that's just moving past some exit billings. Additionally, we do have a meaningful step down in the direct sale business. Direct sales are down 17% from Q1, which is attributed to the seasonality of that business. The combination of absorbing the full impact of those rollover losses, direct sales seasonality, and as I mentioned, we did see greater erosion of pricing in the front half, consistent with our discussions around back half pricing and customer sensitivity, contributed to this decline. You typically see some pricing erosion given the magnitude of our back half pricing. This was a bit more than we planned, and we opted to throttle back that Q2 pricing that we discussed on our last call. Now, on cost inflation: Labor is coming in as expected, approximately 5% year-over-year hourly or frontline labor increase, and we have locked in around 3% for salaries. So that's up, but in line with expectations. I previously mentioned that we saw some favorability in energy in the quarter driven by natural gas, and we're seeing the rest of the energy rates flatten out as we look to the back half. The front half favorability should decline, but it will still be somewhat favorable in the back half. From other cost perspectives, we aren't seeing significant impacts inflationary-wise for the remainder of the year.

Our next question comes from Manav Patnaik with Barclays.

I just want to take a bit of a step back. Some of the reasons you're calling out for the shortfall and what you're doing sound reasonable, but I'm just curious, you were at the company for almost two years under Aramark. You guys presumably did all this work going through IR Day, and your confidence the last two quarters was pretty solid as well. So I'm trying to understand on the margin, what changed in the last 90 days or 60 days that caused this significant revision?

Yes, absolutely. Well, let me start, Manav. Thank you for your question. We remain highly confident in the strategy. So the confidence that you heard about this opportunity at Analyst Day and prior earnings discussions has not wavered. So we are completely confident in this strategy and our pathway to value creation. What we have done is spend significant effort analyzing how to create long-term health in this business; the best thing we can do is ensure that we have great retention rates. The entire strategy hinges on cross-selling the base and improving lifetime value with our customers. We've spent a lot of time over the last few months very aggressively digging into reason codes related to the customer experience. As we've done that, we've identified opportunities to better serve the customer with improved processes. Many of our customers are still experiencing great service because we're cross-selling them, and we're seeing great success in gaining more penetration. It's essential to note that these are isolated reason codes, very specific delivery matters related to on-time delivery and shortages in loads. We are isolating these by market center and addressing procedural gaps, improving procedures by location where we have shortcomings related to service. We've been proactive in evaluating this over the last few months, leading us to make a strategic decision to pause, ensure our services are in order before returning to pricing levels as appropriate. This was a deliberate decision aimed at improving service efficacy and customer loyalty for the long term.

I would just note that as we consider what changed, we saw the anticipated effect of the lower retention rate. As we moved through Q1 and Q2, we recognized the positive impact of the higher retention rates, resulting in fewer losses for the year. Our decision, as Kim described, focused on customer efficacy, and understanding the link between higher pricing and lost business prompted us to make a strategic choice to throttle. I want to emphasize the connection between customer efficacy and our intentional pricing decision. What has changed is pricing and its importance to the top line and margin due to not experiencing the expected increase in sales.

Our next question comes from George Tong with Goldman Sachs.

I just wanted to dive into the visibility of the business. The revenue guidance you issued just a quarter ago was brought down quite a bit. How much visibility is there, especially regarding your ability to win new business? Specifically, what changed over the past quarter that you didn't foresee previously?

There are a couple of things. It's good to hear from you, George. First, as I mentioned, we expected continued acceleration in revenue generated per sales teammate, which has not occurred to the degree we had expected. That's the first aspect that has changed; that ramp was supposed to continue to happen. You may recall, I previously spoke a lot about measuring revenue dollars per sales headcount, and we have been monitoring that regularly. We have visibility to that and had expected it to ramp upward to the level needed to deliver the back half numbers; that ramp is not occurring. I discussed the need to enhance the sales tools and enablement, recruiting and training—all necessary to help our sales teammates succeed. We are actively implementing many of these initiatives to drive this performance level up. Another factor influencing our decision to moderate pricing involves the visibility we gathered delving into why customers choose to leave Vestis. Although many are opting to stay, we're appreciative of those loyal customers. We completed a diagnostic around those who are leaving, identifying actionable root causes regarding service experiences connected to our procedures. We must address these operational issues before we can reestablish higher pricing levels over time.

Our next question comes from Michael O'Brien with Wolfe Research.

One quick question. You mentioned that the service shortfalls are incremental and not related to the route optimization efforts you've discussed in Analyst Day. Were these shortfalls long-standing? Or are they related to being a new company now, with spin issues? If they have existed for a long time, why haven't they been caught before the separation?

So they're not related to the spin; I'll be clear on that. Yes, there could always be a transition period where things may be changing, but that is not affecting our service. This is really about adherence to our service processes. We have service processes and procedures that have been in place for a long time. The insight we're seeing is that we need to follow these processes more closely, as well as provide our teammates with better tools. I've discovered upon joining that we did not have telematics in our fleet, which is typically standard in a B2B route-based business. Therefore, we've implemented telematics in our trucks, and we expect to quickly leverage that technology to use insights for on-time delivery and routing efficiencies. Many of these issues have been present in the company over time as underlying opportunities. However, we've begun addressing some as I keenly evaluate the root causes since we have spun out, especially during the past few months post-COO departure. I've explored this extensively to find ways to improve our operations. This is about understanding the levers we can pull to enhance Vestis's performance, and that's what we're focused on.

We have time for one more question today. Our final question comes from Scott Schneeberger with Oppenheimer.

I appreciate it. I guess I'll make it a quick one for you, Rick. Working capital management seems very strong. It sounds like inventory management is trending nicely year-to-date, above what you indicated at Investor Day regarding free cash flow conversion to EBITDA. How is that going to look in the second half of the year? Regarding your strong cash position, are there any other considerations for its use?

Thanks. Yes, we expect free cash flow to remain strong for the year, consistent with our previous discussions. We believe our model and efforts will allow us to continue generating cash as we have in the front half, despite reductions in EBITDA. We will maintain focus on working capital, which will drive improved receivables collections, days sales outstanding, and continue our sales and operations planning efforts as well as used fill rate from a rental product perspective. We're on track toward a $10 million gain in inventory metrics and feel positive about our opportunities in the back half to boost free cash flow. When we consider cash usage, we plan to spend about 3% of revenue on CapEx, and we will continue this investment. We also expect to pursue voluntary debt repayments in the back half, leveraging our strong free cash flow while remaining committed to paying dividends quarterly.

This concludes the Q&A portion of today's call. I would now like to turn the floor back over to Kim Scott, President and CEO, for closing remarks.

Thank you. I'd like to thank everyone for joining the call today. And I want to close by reiterating that we remain fully committed to our strategy, and we are confident in the long-term value creation opportunity here at Vestis. So thank you for joining.

Thank you. This concludes today's Vestis Corporation Fiscal Second Quarter 2024 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.