Vestis - Q4 2023
November 29, 2023
Transcript
Operator (participant)
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 open for your questions following the presentation. If you would like to ask a question at that time, please press star one on your telephone keypad. If at any point your question has been answered, you may remove yourself from the queue by pressing star two. So others can hear your questions clearly, we ask that you pick up your handset for best sound quality. Lastly, if you should require operator assistance, please press star zero. I would now like to turn the call over to Valerie Haertel, Vice President of Investor Relations.
Valerie Haertel (VP of Investor Relations and External Communications)
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 website. 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, 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 SEC, 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 (President and CEO)
Thank you, Valerie. Good morning, and thank you for joining Vestis' first earnings call as a standalone public company. We completed our spin-off from Aramark on September 30, an achievement that was only made possible thanks to the hard work of our 20,000 dedicated teammates. I'd 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 an 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%-4.5%, which is well above our historical norms of approximately 2%.
We will deliver 50-60 basis points of EBITDA margin expansion, which will be offset by the introduction of $15 million-$18 million in public company costs in the period. As a result, we will maintain our FY 2023 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.
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 2024 and through FY 2025, improving our consolidated margin by approximately three 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.... 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. Taken together, we believe we have $30 million-$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 2023, 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 2023 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 2024 as a standalone public company, while maintaining our FY 2023 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'm so inspired to come to work every day, surrounded by our exceptional teammates who are 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. 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'll now turn things over to Rick before we take your questions.
Rick Dillon (EVP and CFO)
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 2022 and 2023 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'll come back to that when we look at the actual estimates of public costs in a moment. With that level setting, let's move on to more details on fiscal 2023. Revenue for fiscal 2023 was $2.8 billion, up approximately 5% from fiscal 2022.
Workplace supplies were up approximately 9% year-over-year, while uniform revenue was essentially flat. Our results reflect 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 2022 and continued through the end of the second quarter of fiscal 2023. 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 2023, 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...
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 waiver 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-$18 million in fiscal 2024 while completing the build-out of our corporate structures and our IT infrastructure. That's inclusive of TSA costs. As we are completing our separation activities during 2024, we will utilize a transition services agreement with Aramark to provide monthly bridge support. This 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 2024. So all in, we expect to see public company costs and TSA payments in the range of $27 million-$30 million for 2024, while our permanent structural costs run rate will be about $20 million-$25 million starting and as we enter 2025, post TSA.
Moving on to liquidity. We generated $257 million in cash from operations during fiscal 2023, an increase of approximately $24 million. The increase is primarily attributable to higher rental merchandise adds 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 spin transaction. CapEx was $78 million for fiscal 2023, up slightly from 2022, and just under 3% of our total revenue. Free cash flow was $190 million, up $27 million from the prior year.
We entered into a $1.8 billion credit agreement on September 29 as a part of the spin transaction. The facility includes a $300 million revolver and two term loans. On the last day of fiscal 2023, just before the completion of the spin, 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 at the end of fiscal 2023. We ended fiscal 2023 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 to 4.5 in March 2025.
We continue to target an optimal leverage ratio of 1.5-2.5 by fiscal 2026. We are mobilizing to refinance the 2-year loan in the second quarter of fiscal 2024. 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 will 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 2024 guidance represents a 5%-5.5% growth in revenue.
Our adjusted EBITDA margin guidance has us absorbing an incremental $15 million-$18 million or 50-60 basis points of incremental public company costs in 2024. Depreciation and amortization expense is expected to be $130 million-$140 million. Interest expense is expected to be $115 million-$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 2024 on one-time spin-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 in fiscal 2025.
Finally, we expect Free Cash Flow Conversion to be greater than or equal to 100% of net income to support the paydown of debt.
... to open the lines for questions.
Operator (participant)
The floor is now open for questions. At this time, if you have a question or comment, please press star one on your telephone keypad. If at any point your question is answered, you may remove yourself from the queue by pressing star two. Again, we ask that you pick up your handset when posing a question to provide optimal sound quality. Our first question will come from Stephanie Moore with Jefferies.
Stephanie Moore (SVP Equity Research)
Hi, good morning. Thank you for the question.
Kim Scott (President and CEO)
Hey, Stephanie. Good morning.
Rick Dillon (EVP and CFO)
Good morning.
Stephanie Moore (SVP Equity Research)
Morning. Maybe just starting with the guidance for fiscal 2024. 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, you know, the components of that organic growth guidance or the revenue growth guidance in terms of, you know, what you would expect roughly from pricing, you know, cross-sell, new business wins, as well as I think you noted you were walking away from a customer in 2023. So those plus and takes would be helpful. Thanks.
Kim Scott (President and CEO)
Thanks for your question, Stephanie. So we do expect a bend towards volume in FY 2024. As we talked about in Analyst Day, you know, this is not a pricing-based strategy, growth strategy. So our aim here as we grow the business in FY 2024 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 you know, we offset things like inflation, and we also take value-based pricing, as Rick referenced earlier, as he was giving his discussion around the future for 2024. 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'll 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 (EVP and CFO)
No, and the weighting will lean towards the impact of cross-selling. So you see that same overweight of workplace supplies versus uniforms. Yeah.
Stephanie Moore (SVP Equity Research)
Got it. No, that's helpful. And then just as a follow-up to that question, as we think about, you know, you execute your strategy, like you outlined at the Analyst Day, particularly with some of those micro verticals that you talked about, you know, should we expect to see, you know, the uniform business maybe accelerate a bit versus what we saw in fiscal 2023? Clearly, just making really nice progress on the workplace supplies, but maybe uniforms just a little bit lighter. Should we think about uniforms kind of stepping up a bit, going forward or kind of continue to be overshadowed by the workplace supplies? Thanks.
Kim Scott (President and CEO)
Yeah. 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 some of 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 that is driving new business is actually quite productive in performing very well. We are just purposefully, you know, at times, exiting some business and also overshadowing that with the workplace supplies.
I would expect you should see a muted uniforms growth rate again in FY 2024, but that is a very purposeful decision to grow very strategically under high quality verticals and exiting some underperforming business.
Stephanie Moore (SVP Equity Research)
Got it. Well, thank you so much.
Kim Scott (President and CEO)
Thank you.
Rick Dillon (EVP and CFO)
Thank you.
Operator (participant)
Our next question will come from Andy Whitman with Baird.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Oh, great. Thanks for taking my question. Good morning. I guess, I don't know, maybe you can comment on the size of the direct sale customer here, that's giving you the three basis points of margin, just so we can kind of have better context around the magnitude of that headwind.
Kim Scott (President and CEO)
Yeah, sure. I'd be happy to. And Andy, it's great, 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 size customer for us, and we will see that customer transition out. So about half of that will hit the FY 2024 year, and about half of that will hit in FY 2025. So about $13 million in this year and $13 million in the year to come. And at the macro level, you know, that'll have about a 222 basis points impact on the uniforms growth rate on a fully annualized basis, about 92 basis points on our total consolidated Vestis revenue.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Got it. That's super helpful. I was just wondering, do you guys anticipate as you get into reporting your own results as part 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? Do you expect that we're just gonna work on GAAP for now and go that way?
Kim Scott (President and CEO)
Yeah, 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 2024, 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 (EVP and CFO)
Yes.
... Fiscal 2023.
Kim Scott (President and CEO)
Yeah.
Rick Dillon (EVP and CFO)
We will, we will report it.
Kim Scott (President and CEO)
For '24.
Rick Dillon (EVP and CFO)
Right, first quarter for 2024. The 2023 numbers, you know, as Kim said, there were no shares outstanding.
Kim Scott (President and CEO)
Right.
Rick Dillon (EVP and CFO)
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 could, of course, get there-
Kim Scott (President and CEO)
Mm-hmm.
Rick Dillon (EVP and CFO)
with what we provided, but you will see us report that.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Okay, that, that makes a lot of sense. And I presumably that Adjusted EPS is on the same, includes the same adjustments as the EBITDA, I'm guessing.
Rick Dillon (EVP and CFO)
Yes.
Andrew Wittmann (Managing Director and Senior Research Analyst)
And then, I guess-
Rick Dillon (EVP and CFO)
Yep.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Yep. Okay. Then, so just to follow up on that here, just related to the free cash flow conversion here, when you say it's greater than 100% of net income. In this context, however, you mean this in terms of GAAP net income. Is that correct?
Rick Dillon (EVP and CFO)
Correct.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Okay. Okay, so then I guess, stepping back, my last question, you, you know, there's, there's a lot, Kim, that, that you're doing, to, to kind of, you know, move the margin profile, in a lot of different ways. If- as you look here over the past three months or so, what are the kind of key initiatives where you're really focused on today, that, you know, your employees are feeling in terms of, you know, how they're going to talk to their customers or changes that they're seeing in the routes or in the plant? What are the, what are the real things that, you know, today that you're working on?
Kim Scott (President and CEO)
Well, thanks, Andy. I appreciate that question. So, you know, cross-selling the base is a very attractive margin-accretive activity. So we're hyper-focused on growing share of wallet with existing customers, and we've already incurred that fixed cost. We already have route drivers serving them, plant assets tied to those customer locations. So one of the single most important areas of focus that our whole team is rallied around is cross-selling existing customers so that we can capture share of wallet and leverage fixed assets and get that flow-through on that revenue. And I would say our team is fully mobilized. As I mentioned, when I was speaking earlier, we had selling activity on 96% of our routes.
I shared with you guys during Analyst Day that we were not leveraging our fantastic frontline teammates to sell our customers, to cross-sell our customers, when I joined the company a couple of years ago. So to be able to share now that we have 96% of our routes containing sales activity is tremendous momentum, and that does take the entire organization coming together. So service managers, frontline teammates, general managers out in market centers, as well as sales teammates supporting them and marketing with collateral. So that is a full-on team effort that everyone is mobilized around. The other really very large initiative that requires the whole company to move in the same direction is our building up a center of logistics excellence.
So this notion of rerouting customers and conducting flow optimization across these market centers requires a tremendous amount of collaboration between facilities. As we are rerouting customers, we're working very diligently to ensure that is a seamless and invisible process for the customer. So it requires all hands on deck out in the field working together, not just to remap it from a logistics perspective using great technology and tools, but it is also a large change management undertaking that requires all of us to work together to get that done. So if I had to really choose two key areas of focus for us, I would say it is cross-selling workplace supplies to existing customers and leveraging those fixed assets and optimizing our network from a logistics perspective.
Andrew Wittmann (Managing Director and Senior Research Analyst)
Thank you very much.
Kim Scott (President and CEO)
You bet. Thanks for your question.
Operator (participant)
Our next question will come from Andrew Steinerman with J.P. Morgan.
Andrew Steinerman (Equity Research Analyst)
Hi, hi, all.
Kim Scott (President and CEO)
Hey, Andrew. How are you?
Andrew Steinerman (Equity Research Analyst)
Hi.
Kim Scott (President and CEO)
How are you doing, Andrew?
Andrew Steinerman (Equity Research Analyst)
Good, good. Could you, could you please comment on recent trends in add stops, net new, and client revenue retention?
Kim Scott (President and CEO)
Add stops, net new, and what was the last one?
Andrew Steinerman (Equity Research Analyst)
Retention.
Kim Scott (President and CEO)
Got it. So obviously, we continue to focus on creating an amazing customer experience, and we talked a lot about some of the things that we're doing to enhance that experience, you know, from training our frontline teammates and our territory managers with playbooks around how to do a great job taking care of the customer, to also providing, you know, our route drivers, our frontline teammates with tools to let them know when there's an opportunity to improve with the customer, and then also to launching our customer portal, which we're getting great feedback on. So we feel really good about the momentum around protecting and growing our customer base. We are seeing really, really great feedback from our customers around these initiatives.
and so we feel very, very good about the establishment of a service excellence culture across the company. We also continue to deliver retention rates that are above 90%, as we stated in our Form 10. We continue to emphasize that greatly.
Andrew Steinerman (Equity Research Analyst)
Add stops and net new?
Kim Scott (President and CEO)
Add stops and net new, so we haven't given out those metrics specifically, but we obviously continue to add new business. We're pleased with the progress that we're seeing from our frontline sales team to do that, and we continue to see growth in our business. We're not really using the-
Andrew Steinerman (Equity Research Analyst)
Have added stops.
Kim Scott (President and CEO)
I'll be quite clear, Andrew.
Andrew Steinerman (Equity Research Analyst)
Have our stops held up?
Kim Scott (President and CEO)
What's that?
Andrew Steinerman (Equity Research Analyst)
Have add stops held up?
Rick Dillon (EVP and CFO)
“Have add stops held up?” is not a metric.
Kim Scott (President and CEO)
Oh, we don't actually use the metric of add stops. And I think it's also important to note on your question around net new that we actually are communicating and we're shifting away from that net new metric that we were using at Aramark as well, because it doesn't reflect growth in our base. So that net new metric is a discrete metric around customers who are with you and who then leave and are no longer customers, and it does not reflect the growth in the base, which is our key focus area.
So you're gonna see us shift away from the conversation around net new and talking about that metric, and you're gonna hear us talk more about macro-level growth that includes cross-selling and adding products and services to existing customers, and that's not reflected in that net new number.
Andrew Steinerman (Equity Research Analyst)
Okay.
Operator (participant)
Thank you.
Kim Scott (President and CEO)
Thank you, Andrew.
Operator (participant)
Our next question comes from Shlomo Rosenbaum with Stifel.
Shlomo Rosenbaum (Managing Director)
Hi, good morning. Thank you for taking my questions. You, you've been focused a lot on the efforts to improve the cross-sell, and you talked about 96% of the routes are selling now. Where do you think you are in terms of, you know, making the shift in the culture to a more sales-oriented culture and selling across the base? Do you think, like, you're really humming along? Do you think you're, like, 50% there? Because it's a significant change from, you know, the way that the company had operated for literally decades. And maybe you could talk about where you are now and how long do you think it would take to really be, you know, kind of firing on all cylinders.
Kim Scott (President and CEO)
So I think we still have work to do. I'm pleased with the way the team has embraced the everyone sells culture and mindset that we're working to create, Shlomo. But I think your question is a really important question that we are constantly focused on here because it is a massive culture shift to move a company to a mindset of growth. And that is the opportunity that we found when we came here. You know, when I joined a couple of years ago, it was very clear that that obsession with growth was not present in this organization. So I think that we've made great strides, as evidenced by, you know, 96% of our routes having sales activity and teammates beyond dedicated sales teammates helping to sell and grow our business, particularly harvesting the base and capturing share of wallet with existing customers.
But I would tell you that I think that we have a long way to go, which is encouraging because we're seeing great results, well above our historical norms. You can see that reflected in our guidance as we're projecting 4%-4.5% growth, when historically this business was growing at a meager, you know, 2% or so. And you also know we're shedding some unprofitable business at the same time, so that growth rate is even healthier than it appears. So I'm pleased with where we are, but I think we can do so much better. And so we continue to bring tools and resources, and, and really encourage and arm the team with the right, the tools that they need to get out there and grow the business.
So I'd say I don't want to gauge it at 50%, but I'd say we are maybe halfway there, maybe, honestly. And that excites me, so I don't say that as a criticism. I say that as we're doing a great job, I'm pleased with the progress, and there's so much more yet to come. But our teammates are responding well. They're excited. They're proud to be a part of growing this business. I think they're recognizing now the latent potential that is untapped, that hasn't been unleashed here, and people are pretty fired up about bringing that to life. So, more to come on the culture front.
Shlomo Rosenbaum (Managing Director)
Great. Thank you. And then maybe this one is for Rick. Can you talk a little bit more about the sequential margin improvement? You know, obviously, there's a pretty good cadence over here. And can you talk about what changed from, like, June to September? And you know, is this gonna be, like, a consistent grind forward? Obviously, I understand the TSA and the additional public company costs, but maybe you could talk about if there's some key items that drove that margin expansion, and then maybe if there's a few other ones that we should be looking towards for the next several quarters and over the year.
Rick Dillon (EVP and CFO)
So from a quarterly progression, Q3 to Q4, there were quite a few kind of moving pieces driving that activity. And so, you know, you have, in our fourth quarter, you have all types of things around benefits, around customer closeouts, around contests that kind of drive that Q4 increase in profitability. And it's a normal cadence. If you go back and look the last two, three years, we see that normal Q1, Q2, Q3, Q4 glide path. And so we expect to see that going forward in terms of your question about how you should be thinking about it. We, of course, are guiding the quarters. We did include in the earnings release the quarterly history, so you can go and take a look at that.
But the movement from Q3 to Q4 reflects also having a full quarter of our cost out actions being reflected in our results as well.
Shlomo Rosenbaum (Managing Director)
Great. Thank you.
Operator (participant)
Thank you. As a reminder, that is star one to ask a question. Our next question will come from Oliver Davies with Redburn Atlantic.
Oliver Davies (Equity Research Analyst)
Yeah, good morning, guys.
Kim Scott (President and CEO)
Good morning.
Oliver Davies (Equity Research Analyst)
Just one from me. On margin, can you just talk about sort of the current cost inflation you're seeing, I guess, across labor, materials, and fleet, and sort of how you see that evolving into 2024?
Kim Scott (President and CEO)
Sure. I'll start, and then I'll kick it over to Rick for some more detail. But from a labor perspective, and we've, we've talked a little bit about this in the past, we actually have pretty good predictability around labor because we have a unionized workforce. And so the CBA negotiations, the collective bargaining agreement negotiations, are very predictable for us, and we have history as a guide to determine where we think those negotiations will land and what that will equate to in terms of increased wages. So we anticipate about 5% wage inflation across the 5-year period, 5% on an annualized basis across the 5-year period as we, as we look at our strategic plan. And that's actually fairly predictable for us, and, and that has played through over the last couple of years.
So, that's what we're assuming in FY 2024 as we put this guidance forward. We're seeing muted energy costs. I'll let Rick kind of touch on that here just in a bit, but we're seeing muted energy costs, and generally a very predictable supply chain forecasting activity because we're purchasing inventory in advance, and then we're issuing it over a period as we grow new business and advertising that, you know, over a couple of years. So we have pretty good forecasting capabilities as it relates to all of our key cost drivers in the business, and we're not seeing anything surprising or unusual as we move through kind of building out the FY 2024 plan. Rick, anything that you would want to add there?
Rick Dillon (EVP and CFO)
On the energy costs, as I noted, we did see moderation. That's moderation relative to 2022-
Kim Scott (President and CEO)
Mm-hmm.
Rick Dillon (EVP and CFO)
which was kind of at some of the peak highs. So when you looked at our energy, for 2023, we obviously saw high energy costs in the first half. We saw those costs year-over-year kind of moderate in the back half. The view forward is a bit choppy. And so in our guidance, we've assumed we stay elevated, so kind of at that on average for 2023, and our position to take whatever actions we need to should we see another spike. So we haven't forecasted we continue to get better, which you saw us talking about. You see it actually in the Q4 results. But we kind of took that average cost and assumed we hold that line during the year.
As you and we monitor energy costs and, you know, on any given week, the forward view is up or down, depending on economic factors.
Oliver Davies (Equity Research Analyst)
Great. Thanks.
Kim Scott (President and CEO)
Thank you.
Operator (participant)
Our next question comes from Manav Patnaik with Barclays.
John Kennedy (Graduate Analyst)
Hi, good morning.
Kim Scott (President and CEO)
Good morning.
John Kennedy (Graduate Analyst)
This is John Kennedy on for Manav. Hi, good morning. Thank you for taking the questions. I guess as a follow-up to that, on the assumptions for wage and energy inflation, how would you characterize, you know, the macro environment and the demand backdrop now? Anything to call out demand-wise within your eight key verticals versus, you know, in terms of stronger or weaker demand? And then Rick just touched on the expectations for energy, et cetera. What are you assuming from a broader macro outlook standpoint for 2024?
Kim Scott (President and CEO)
So from a demand perspective, you know, we've been very focused on cross-selling existing customers in products and services that they're currently self-serving for themselves today. So for us, there's plenty of demand that can be created. We are seeing in our retention numbers as we look at customer trends, we are seeing some closures of business. We're seeing sale of businesses taking place and that business changing hands, and that feels pretty stable, so nothing erratic to report there as it relates to kind of customer behavior. We're pretty well diversified, as you guys know, across many different end markets. So we feel pretty comfortable that we're insulated around any kind of one particular segment or industry that might be declining.
And if we continue to harvest share of wallet with existing customers, there's plenty of space here, regardless of what might be happening from a macro environment perspective. I mean, you guys will recall, I'm sure, in Analyst Day, you know, we sized this market out at a $48 billion market across all of the products and services that we offer. So there's a lot of room to find places to grow as we're looking at various trends across the end sector. So we feel pretty good about that from a macro perspective. We feel good about having a solid understanding of the cost drivers in our business and what we think is happening from a macroeconomic perspective related to those drivers, whether that be energy or labor or other supply chain costs related to our garments.
We think we've got a good view of that. So, we see a pretty steady path forward for us through FY 2024, with a good understanding of, of the things that might be headwinds that are facing us. We think we've got great plans to, offset any of those headwinds through good operational efficiency actions that we're taking. And also we've demonstrated our ability to price as appropriate as we may see those, those inflationary impacts emerge. Rick, anything that you would add there?
Rick Dillon (EVP and CFO)
I think I would just say we haven't assumed in the plan broadly a market downturn,
Kim Scott (President and CEO)
Yeah.
Rick Dillon (EVP and CFO)
Or certainly not a looming recession.
Kim Scott (President and CEO)
Right.
Rick Dillon (EVP and CFO)
And so all of the things that Kim described is kind of how we would respond to... We're not recession-proof, but we do like our mix in that environment of workplace supply, more or less employee-centric, still actually more margin accretive. So we feel good about where we're positioned, but we take all the necessary actions, as Kim described, to preserve profitability should that occur.
Kim Scott (President and CEO)
Yeah. I mean, we'll be agile and monitor closely what's happening in various end markets, and adjust our kind of targeted sales activity, to move and flow where the demand exists.
John Kennedy (Graduate Analyst)
That's very helpful. Thank you. Then, if I may, as a follow-up, can you just reconfirm with regards to the progression through the targeted margin expansion out to 28%, how we should think about that kind of sequentially year to year, and the key contributors, if it's, you know, initially it would be leveraging that sales growth until you start to see more benefits from the field and the workforce optimization or the operating efficiencies, et cetera?
Kim Scott (President and CEO)
... Yeah. So, you know, as we, as we've talked about before, we didn't, we didn't build this thing as a hockey stick, so there's no massive kind of betting on the come in the back two years and assuming that we're gonna, you know, generate 500 basis points of margin in two years. This is a slow and steady wins the race base hit game for us. In FY 2024, which is really the first year of our five-year plan that we've articulated to the market, as I mentioned earlier, we are ingesting our public company costs, and we're ingesting that very effectively, and we plan for that. So we're really pleased to see that we are going to, at a minimum, hold the line on margins from FY 2023 through FY 2024 while absorbing those pub co costs.
But what you'll also see is there's some really good, strong underlying performance taking place here with 50-60 basis points of margin expansion happening to the underlying business, and we're using that to offset the ingestion of those Pub Co costs. But if you look at what's happening, you can definitely see margin, margin coming through, and you can see operating leverage emerging in the business as we are taking advantage of cross-selling the customer base and leveraging fixed assets. And so we are getting flow-through on that revenue. That revenue is creating margin expansion, and we're also working very steadily around our flow optimization and driving efficiency through these logistics initiatives that we've talked about.
All of these things are in motion, so there's not new initiatives that need to gain traction or that will start taking place three years from now to help deliver that plan. All of the initiatives required to get to that FY 2028 margin are moving now. So we are optimizing flows, we are cross-selling the customer, and it just gets stronger and stronger as we add revenue to every stop. We just continue to leverage those fixed assets and get the flow through. So, you should think about this as a very, slow and steady wins the race, base hit, base hit game, and you're gonna continue to see us just churning away in these initiatives, and the margin is gonna continue to flow, and the operating leverage will continue to open.
So you'll see, again, it's muted in 2024 purposely because we're ingesting the PubCo costs, but the underlying performance is there, and you'll see that just continue to move through 2028.
John Kennedy (Graduate Analyst)
Thank you very much. Appreciate it.
Kim Scott (President and CEO)
Yeah. Thank you for your question.
Operator (participant)
Our last question will come from Scott Schneeberger with Oppenheimer.
Speaker 10
Hi, good morning. It's Daniel on for Scott. Thank you for letting us ask a question here. Just a quick one on the trends you've been seeing in small to medium-sized enterprises versus national account. Can you please discuss recent trends there and how you see that develop into next year? Thank you.
Kim Scott (President and CEO)
Thanks for your question, Scott. It's good to hear from you. So, we are very focused on both, both groupings of customers. As we've talked about earlier, they both add great value. So our national account customers can really form the backbone of your supply chain and create density. So we've got a team out there hunting and harvesting national account customers. And those customers, as you know, stay more than 20 years with us, so they're very valuable customers, and, and the lifetime value is great. But we also know that small to medium enterprise customers are very margin accretive, and there's great propensity to cross-sell the base once you bring those customers in, into your house.
We continue to focus very heavily on the experience and creating an outstanding customer experience with those SME customers so that we can not only retain them, but we can cross-sell the base. We are analyzing reason codes when we're losing customers in that segment. In the small to medium enterprise segment, we typically get that data through our inbound call center, and we're able to, you know, tie reason codes to that. I would say trends in the SME space, about a quarter of those inbound calls when we're losing customers on the SME side of the business are tied to business closures or they're tied to business sales. So I find that to be an interesting trend that we're observing and continuing to monitor as we're seeing transitions taking place with SME businesses.
But some of that is related to selling the business, not closing the business. And so we're able to win those customers and retain them, but it's an interesting trend that we're keeping an eye on. Otherwise, I would say the trend is great, that SME customers are very open to outsourcing additional workplace supplies. And so we are seeing a tremendous response as we're out cross-selling the existing customer base. We are seeing a tremendous response for outsourcing related to these workplace supplies and services that we're, we're very actively focused on. So there's a real willingness to give that up and allow others to do that so that our customers can take care of their core business and focus on what matters most to them.
Speaker 10
Thank you.
Kim Scott (President and CEO)
You bet. Thanks for your question.
Operator (participant)
This concludes the Q&A portion of today's call. I would now like to turn the floor over to Kim Scott, President and CEO, for closing remarks.
Kim Scott (President and CEO)
So thank you for joining our call today and for your interest in Vestis. We are really pleased with our FY 2023 performance and the great progress that we are making against our strategic plan. The opportunities for us are tremendous, as we move forward, and our future remains bright. Thank you for joining us today.
Operator (participant)
Thank you. This concludes today's Vestis Corporation fiscal fourth quarter and full year 2023 earnings conference call. Please disconnect your line at this time and have a wonderful day.