The Chefs' Warehouse, Inc.
Q2 2018 Earnings Call Transcript

Published: 1 Aug 2018

[Operator:]

Greetings, and welcome to The Chefs' Warehouse Second Quarter 2018 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Alex Aldous, General Counsel and Corporate Secretary. Thank you. You may begin.

[Alexandros Aldous:]

Thank you, operator. Good afternoon, everyone. With me on today's call are Chris Pappas, Founder, Chairman and CEO; and Jim Leddy, our CFO. By now, you should have access to our second quarter 2018 earnings press release. It can also be found at www.chefswarehouse.com under the Investor Relations section. Throughout this conference call, we will be presenting non-GAAP financial measures, including, among others, historical and estimated EBITDA and adjusted EBITDA as well as both historical and estimated adjusted net income and adjusted earnings per share. These measurements are not calculated in accordance with GAAP and may be calculated differently in other companies' similarly titled non-GAAP financial measures. Quantitative reconciliations of our non-GAAP financial measures to their most directly comparable GAAP financial measures appear in today's press release. Before we begin our formal remarks, I need to remind everyone that part of our discussion today will include forward-looking statements, including statements regarding our estimated financial performance. Such forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Some of these risks are mentioned in today's release. Others are discussed in our annual report on Form 10-K and quarterly reports on Form 10-Q, which are available on the SEC website. Today, we're going to provide a business update, go over our second quarter results in detail and update our 2018 guidance. And then we will open up the call for questions. With that, I will turn the call over to Chris Pappas. Chris?

[Christopher Pappas:]

Thank you, Alex. And thank you all for joining our second quarter 2018 earnings call. We saw solid growth across our network in the second quarter. In addition to continued strength in new customers and placements, we made strategic investments for two small acquisitions in Texas and Pennsylvania, two important emerging growth markets for Chefs’ Warehouse. I would like to thank the entire Chefs' Warehouse team for their contributions in executing our business model and for the strong results in this quarter. A few highlights from the second quarter include, 4.3% organic growth in net sales; specialty sales were up 9.7% organically over the prior year, which was driven by unique customer growth of approximately 5.1%; placement growth of 4.6%; specialty case growth of 7.5%; organic pounds growth in center-of-the-plate was 0.6%; and gross profit margins increased approximately 27 basis points. Gross margin in specialty category declined 66 basis points as compared to the second quarter of 2017, while gross margin in the center-of-the-plate category increased 129 basis points year-over-year. In addition, gross profit dollars grew approximately 13% versus prior year second quarter. Jim will provide more detail on margins in a few minutes. We are pleased with our team's ability to drive solid revenue growth while continuing to focus on delivering robust gross profit dollar performance. We continue to grow in the investments we have made in technology, facilities and people, and are leveraging those resources to improve our operations and drive growth in both existing and new markets. A little bit about our technology investments. We continue to drive adoption of our e-commerce platform and mobile app amongst our customer base. We are now at about $1.7 million of revenue per week run rate going through our Internet platform, and purchases via our mobile app continue to ramp up. Roughly 20% of our online sales in the second quarter came through the mobile app. Our online platform is quickly becoming the preferred tool of communication for a growing number of customers. In addition, the platform drives efficiencies in our sales operations by allowing our sales and customer service teams to focus on growing and servicing our customer base versus keying in their orders. We also recently completed the ERP sales order entry module implementation in the New York and Mid-Atlantic regions, 2 of our largest markets. We are extremely pleased with our team's preparation and execution of this important step in our company-wide rollout. Following our planned third quarter adoption in our Ohio region, approximately 75% of our specialty business will have completed the implementation. Our West Coast region will follow with implementation plan to start in the fourth quarter of 2018. This integration enhances our ability to leverage our digital and mobile platform and provides multiple tools to assist our teams in driving growth and efficiencies going forward. In regards to operations. We continue to focus on driving operating leverage across our business and are pleased with recent gross profit dollar growth as compared to adjusted operating expense growth. Warehouse scanning has been implemented in a number of our facilities, including our East Coast operations and Midwest operations as well as a number of our West Coast distribution centers. We are seeing improvement in labor, shipping, accuracy and inventory management. Truck scanning is in development, and we expect to begin rollout by the end of the year. In addition, the recent acquisition of the Southern New Jersey, Pennsylvania region will provide capacity and distribution benefits in our East Coast markets. Before turning it over to Jim, I'd like to reiterate that we are happy with our team's execution this quarter and the resulting solid financial performance. Our goal at Chefs' is to continue to be growing, enhancing our unique business model as the premier gourmet food and specialty product marketing and distribution company for both our internationally diverse supplier partners and our growing customer base of chef-driven restaurants and upscale dining establishments. And with that, I'll turn it over to Jim to discuss more detailed financial information. Jim?

[James Leddy:]

Thank you, Chris, and good afternoon, everyone. Our net sales for the quarter ended June 29, 2018, increased approximately 11.7% to $370.4 million from $331.7 million in the second quarter of 2017. The increase in the net sales was a result of organic growth of approximately 4.3% as well as the contribution of sales from acquisitions, inclusive of Fells Point, which added approximately 7.4% to sales growth for the quarter. Net inflation was 0.2% in the second quarter, consisting of 2.2% inflation in our specialty category and deflation of 2.3% in our center-of-the-plate category versus the prior year quarter. Gross profit increased 12.9% to $93.2 million for the second quarter of 2018 versus $82.6 million for the second quarter of 2017. Gross profit margins increased approximately 27 basis points to 25.2%. The increase in margin was primarily driven by deflation in certain center-of-the-plate categories, combined with effective margin management by our team and partially offset by year-over-year inflation in certain specialty categories, including dairy and eggs. Total operating expense increased approximately 11.2% to $78.3 million for the second quarter of 2018 from $70.4 million for the second quarter of 2017. On an adjusted basis and as a percentage of net sales, operating expense for the second quarter of 2018 was 19.4%, approximately 8 basis points improvement versus the prior year second quarter. We continue to be pleased with our trend of leveraging our operating expenses as we grow the business. Operating income for the second quarter of 2018 was $14.9 million compared to $12.2 million for the second quarter of 2017. The increase in operating income was driven primarily by increased gross profit, offset in part by higher operating expenses, as mentioned earlier. As a percentage of net sales, operating income was 4% in the second quarter of 2018 compared to 3.7% in the second quarter of 2017. Interest expense decreased to $5.4 million versus $5.9 million for the prior year second quarter, due primarily to reduction in the interest rates charged on the company's outstanding debt, offset in part by higher market floating interest rates. During the second quarter, we entered into a new asset-based loan facility that provides for an increase in potential availability from $75 million to $150 million as well as lower fixed interest rate spread to LIBOR than our previous arrangement. Subsequent to the second quarter end, we funded approximately $47 million of the new facility and prepaid the company's term loan for the same amount, thus lowering the fixed component of our interest expense on a pro forma basis. In addition, subsequent to the second quarter end, our 36.75 million of convertible notes maturing in 2021 and the related accrued interest were converted into approximately 1.25 million common shares of the company. Please note, these shares were already included on our fully diluted share count within our 2018 guidance. Income tax expense was $2.7 million for the second quarter of 2018 compared to $2.6 million for the second quarter of 2017. The increase in income tax expense is due to higher pretax income, partially offset by the reduction in our effective income tax rate resulting from tax reform passed in the fourth quarter of 2017. Our GAAP income was $6.8 million or $0.24 per diluted share for the second quarter of 2018 compared to net income of $3.7 million or $0.14 per diluted share for the second quarter of 2017. On a non-GAAP basis, adjusted EBITDA was $21.5 million for the second quarter of 2018 compared to $18 million for the prior quarter second year -- for the prior year second quarter. Adjusted net income was $7 million or $0.24 per diluted share for the second quarter of 2018 compared to adjusted net income of $3.7 million or $0.14 per diluted share for the prior year second quarter. We continue to benefit from strong cash flow and ended the second quarter of 2018 with $40 million of cash on the balance sheet. Pro forma net debt to adjusted EBITDA was 4x at the end of the second quarter of 2018. Factoring in for the reduction of debt due to the conversion of our outstanding convertible notes post quarter end, pro forma net debt to adjusted EBITDA is 3.5x. Turning to our guidance for 2018. Based on the current trends in the business, we are updating our financial guidance to be as follows, we estimate that net sales for the first -- for the full year of 2018 will be in the range of $1.41 billion to $1.45 billion; gross profit to be between $357 million and $367 million; net income to be between $20 million and $22.5 million; GAAP net income per diluted share to be between $0.69 and $0.78; and adjusted EBITDA, we expect to be between $75 million and $78.5 million; and adjusted net income per diluted share to be between $0.71 and $0.80. This guidance is based on an effective tax rate of approximately 28.5% for 2018. Our full year estimated diluted share count is approximately 28.9 million shares. Thank you. And at this point, we will open it up to questions. Operator?

[Operator:]

[Operator Instructions]. Our first question is from Chris Mandeville from Jefferies.

[Christopher Mandeville:]

If I could just start off really quickly on the organic growth. Really solid number on 4.3% on top of last year's 10%. But how are things trending quarter-to-date? And then, Jim, as it relates to center-of-the-plate deflation, has that become a little bit more pronounced in Q3 versus Q2?

[James Leddy:]

So your question is really about, so far, in Q3, cadence in Q3 and then deflation in center-of-the-plate in Q3? Just so I'm clear.

[Christopher Mandeville:]

Correct, yes.

[James Leddy:]

Yes. I mean, I think in terms of organic growth, while it's early in the quarter, we haven't seen anything that we would call out specifically versus Q2 and -- in terms of organic growth. And in terms of deflation, if you recall, last summer, really at the end of Q2 and then going into Q3, we did see significant inflation in certain prime categories. I would say that in Q2, we definitely saw more normalized pricing in a lot of the prime categories. And we are not seeing the kind of spikes that we saw last year as we are -- although we are very early in Q3.

[Christopher Mandeville:]

All right. that's helpful. And then, Chris, just thinking about the opportunity in Texas, if you will, longer term, how do you expect to scale in that market? Maybe if you can give us a sense of if there's any idea on capital requirements over the next 12 to 24 months. And really, what is that long-term opportunity there?

[Christopher Pappas:]

Yes. Well, we're really early. I mean, Texas was really on the horizon for maybe 2019. And we just got the opportunity to buy a unique specialty company that kind of really fit into the Chefs' family of companies. So it was opportunistic. It was very small. Really, we're putting together the long-term plan, which -- I think Texas is top 3 market for Chefs'. The data we have and being in the market and seeing how many unbelievable restaurants are -- and the amount of people moving to Texas every day, Austin, San Antonio, Dallas, Houston, the frequency that people eat out, it's a very, very exciting opportunity for us. So as far as CapEx, still early, early stages of really looking at that, I think Jim can go further into it, but we think there's real opportunity in the acquisition front. Again, we just acquired a very small specialty company, kind of putting a flag in each of the 3 major markets. And now it's looking for the future and saying, how much is going to be organic and how much will be through acquisition. but I definitely think, over the next 5 to 6 years, Texas becomes a really big growth vehicle for Chefs'.

[James Leddy:]

Chris, I'll just add that you'll notice in the Q that we re-guided CapEx up just a couple of million dollars, and a part of that is some later year facility investments slated for Texas.

[Christopher Mandeville:]

Okay. Really appreciate that. Last one for me. Just in terms of the cross-selling opportunities, Chris, where do we stand right now with the ability to service various markets with center-of-the-plate like with the Del Monte offering?

[Christopher Pappas:]

Yes. Again, it's still -- it's a work in progress. We've just finished converting New York onto our Oracle system, sales order process, which was a major, major concern. This had to go right. It was one of the big projects of the year, converting the -- actually, the Mid-Atlantic and New York at the same time. So happy to say that went great. A lot less bumps than I expected. The team did an unbelievable job. So with that behind us, focusing on -- we're always focused on cross-selling, Chris. But when you look at organic case growth in specialty of over 7.5%, I attribute a lot of that tremendous successes because of the way we go to the market in our cross-sell, having the -- especially with the Allen Brothers brand in many markets and the Michael's brand in San Francisco, Del Monte and Chefs' teaming up together. So I would say, if I can grow 7.5% plus case growth every quarter, I would be extremely happy to the next 10 years. And I think a lot of it comes because of the way we go to the market with our diverse offerings.

[Operator:]

Our next question is from Ryan Gilligan from Barclays.

[Ryan Gilligan:]

Just following up on that, how soon can the New York and Mid-Atlantic markets get one-screen ordering?

[Christopher Pappas:]

They have the ability right now, Ryan, to go through our Internet screen and have one screen. The capabilities of really having -- so our closest for New York, it's really Fells Point, which is available to ship into the market. So really, what we're doing right now is duplicating inventories. We are stocking a lot of the products that we know we're going to sell, and that's all on one screen. And I would say, the ability to access both companies if you had to is probably late next quarter. So it's not that far off.

[Ryan Gilligan:]

Got it. So is it fair to say that most of the sales force will have one-screen ordering available to them some time next year, just given where you guys are with the ERP roll-up?

[Christopher Pappas:]

I think it's safe to say yes.

[Ryan Gilligan:]

Okay. That makes sense. And then just on pounds sold, just how we should think about that for the rest of the year? I'm guessing that should accelerate just with Fells Point, that fill being cycled. And then also, I'm guessing that you're going to start shipping more custom [indiscernible] into New York. Is that fair?

[Christopher Pappas:]

I think it's fair to say that we are making progress on all fronts building that team. We have a lot of wins. We still have a lot of work to do. And optimistically, over the next few years, we think that, that business is definitely going to ramp up as far as pounds. I think short term, right now, it's -- every day, we get a little better, and we start to move the ball forward. So I would say that you'll continue to see incremental improvement.

[Ryan Gilligan:]

That's helpful. And just lastly, on gross margins and operating expenses, your ability to leverage them in the second half given decelerating inflation and harder comparisons, do you still expect to kind of get 10 to 20 basis points of gross margin expansion and be able to leverage operating expenses in the second half?

[James Leddy:]

Yes. I mean, we feel good about our guidance. So our guidance implies 10 to 20 basis points improvement on gross profit margins and also on up leverage. And as I mentioned on the first quarter call, it's going to be a different cadence versus last year just given the comp [indiscernible]. And then we have a little bit of a tougher comp on OpEx in Q3, but for the full year, we're still on pace for the -- through the midpoint of our guidance.

[Operator:]

[Operator Instructions]. And our next question is from Kelly Bania from BMO Capital Markets.

[Kelly Bania:]

I was curious if you could talk a little bit about some of the trends you're seeing maybe in specialty. Just the case growth are really strong there. Just any regional trends or category trends that you can share with us?

[Christopher Pappas:]

Not to give away all our secret sauces. I think that, again, we have a really healthy robust sales force that continues to add customers. We think we're gaining great market share in customers that do open. The restaurant business has lots of openings. So I think when you look at the 7.5% case growth in specialty, it basically is telling you that we are getting a really good share of who's opening and what products they want to use, which are higher quality. Again, it's a blend of local, organic and, again, our 1,700 suppliers in 40 countries. The menus continue to be -- you have, I call it, upscale casual continues to grow very healthy. And then on the high end, you still have, I call it, upscale casual, great restaurants with international menus. And then we have the Brooklyns of the world, the Pittsburghs where lots of boutique, little 7,000 feet restaurants with a lot of local ingredients that we do a great job sourcing and stocking and greater for last mile delivery. So I think the trends continue to be people want interesting food. They want healthy choices as well as wonderfully marbleized steaks. we're seeing everything grow. So we're really pleased with where we're at.

[James Leddy:]

And, Kelly, I'll just add that going back to Chris' point about the cross-sell, we're seeing really nice specialty sales into protein customers, especially in our Midwest region, which -- there are a number of our fastest-growing markets in kind of what we call the Ohio Valley. And so that's just an example of where we're seeing specialty growth, leveraging off of our center-of-the-plate customers.

[Kelly Bania:]

Okay. That's helpful. And I guess you guys have kind of been rather immune to some of the challenges going on in freight markets. But there's some others talking about late deliveries and some challenging fill rates. I'm just curious if you're seeing any of that at all or if you're just able to mitigate it. Doesn't appear that you're seeing that, but maybe if you can just help us what you're hearing from your vendors.

[Christopher Pappas:]

I think that it's not an easy environment. I think the great results we have is a compliment to the team that we have at Chefs' that are overcoming a lot of these difficulties. So we really have not great weather. Freight is a headwind. Labor is a headwind. So you really have to use basically every tool you have and the people you have to figure out a way to overcome it, and that's what we're doing. So we hire ahead. We try to hire the best. And we try to work with companies that can come through in tough times. And it is a tougher environment. There's no secret. I think you heard from some of the other earnings calls that labor is tight and freight, too. And you just have to learn how to deal with it, and that's really what we're focused on.

[James Leddy:]

Yes, Kelly, we are a little less reliant on the third parties than some of the bigger guys. So that helps us in this environment.

[Kelly Bania:]

Okay. And then I think a couple of months ago, you talked about some new pricing tools maybe in the protein part of the business, maybe helping starting in the back half. But with the strong performance there, I was wondering if that came in earlier or if that's just due to deflation and just where you stand on those tools overall.

[Christopher Pappas:]

Yes. I still think we're in the first inning of a baseball game, and it's a seven series. So there's so much upside for us as we do implement these tools, build the team. We have a new leadership, and that team continues to build. Daily, we're recruiting. I call it the best-in-class people, and we're putting them to training programs and teaching how to go to the market the way specialty does. So we sort of -- we did see a nice margin improvement. Some of that came from the market adjusting. We had a much better favorable prime market than we did last year, which is a big headwind. You had some deflation in choice. So overall, I think it's a little bit of both, good management and a friendlier market.

[Kelly Bania:]

Great. And then maybe can you just comment on how the reps are embracing the online ordering tools and maybe some efficiencies that maybe you're seeing with some of the good reps that are really utilizing that?

[Christopher Pappas:]

Yes. again, I think that's still very early in the game. I think our run rate now is about $1.7 million. Jim...

[James Leddy:]

Close to $90 million on an annual...

[Christopher Pappas:]

Run rate. So our goal is $100 million. So every day, more and more people -- physically, every day, more people go online. And I think that the big jump is going to be when -- I think the next stage of improvements that we give the online system to give some of the customers that are maybe more reluctant to use the tool, I think that's going to really be the big -- the inflection point when we can get that last bit of -- always improving, and so you see the last bit. But I think the next improvement, understanding more what the customer wants now and is able to use it. And the salespeople gain a lot of confidence. I mean, they're starting to gain confidence, seeing more and more of their customers go online. They know that's the future. And the people that really embrace, they are spending more time in the streets, seeing their margins and their sales grow up. So it's not going to be a hard sell, I think, what the next improvements that we add to the online capabilities.

[Kelly Bania:]

And just last one for me. With you raising the sales guidance for the year, it looks like inflation maybe came in a little lighter, at least than maybe we had thought. Should we think about just that a little bit of a weaker inflation environment for the back half but -- with the guidance suggesting the case growth remaining still very strong? Is that the way to think about it?

[James Leddy:]

Yes. I think the center-of-the-plate deflation really impacted us in Q2 in terms of organic growth. And I think organic growth would have been about 1 point or 1.5 points higher, if we ex that deflation. In terms of the guidance, we upped the revenue really to reflect not just the good performance that we've seen in the first half of the year but also the smaller acquisitions and the second half impact of the small specialty acquisitions that we did in Texas and Pennsylvania and up to a GP as well. And then on the rest of the guidance, there were a couple of different moving parts in terms of interest expense with the work that we did on the ABL and the convert coming off the balance sheet and a couple of other puts and takes.

[Christopher Pappas:]

Yes. I think Kelly is also asking, Jim, your expectation of inflation, deflation for the second half of the year.

[James Leddy:]

Oh, sorry, Kelly. Yes. In terms of deflation, inflation, I would say that we're expecting kind of normalized inflation on the specialty side, kind of in the range that we're seeing right now. And then in terms of -- if you look at the comp versus last year, we had pretty significant inflation at center-of-the-plate in the third quarter of last year. So we would expect to see more moderate inflation or flattish kind of inflation at center-of-the-plate.

[Operator:]

Our next question is from Andrew Wolf from Loop Capital Markets.

[Andrew Wolf:]

I joined the call a little late, so hopefully, I'm not going over too much territory you've covered. Is there any linkage here between the specialty gross margin contracting and the acceleration in the organic case growth, either by the kind of customers you picked up or are new customers inherently a little less profitable even on the gross margin side? Or is there some pricing -- not issues, but was there some pricing in there? Is there any linkage? Or was it something else?

[James Leddy:]

No. Andrew, this is Jim. There's really 3 kind of components to the year-over-year in specialty margins. We saw pretty significant close to double-digit inflation in dairy, eggs and cheese categories such as that. And when you have that kind of inflation, you always have -- generally, you have a little bit of margin compression. And then we also saw a very broad-based inflation across -- well, more moderate across all of our specialty categories. So usually, in a typical quarter, we might have 5 or 6 categories that are inflationary and maybe 3 or 4 categories deflationary. But every category across specialty, we saw a year-over-year inflation. So I think that was a little bit of it as well. And then we're actually comping against a pretty strong gross profit margin in Q2 of 2017 versus last year. So overall, we're actually really pleased with where we're pacing from a full year margin perspective. I think we still feel good about our guidance. And it was really just some noise within the quarter.

[Andrew Wolf:]

Okay. Great. That's helpful. And the other question I wanted to broach, which I don't know if you've brought up either, is just what's going on for you guys in the labor market in terms of cost inflation there to keep people or to train and get good people you need or just plain old availability from the warehouse to the sales to drivers. How is that labor, supply and cost?

[Christopher Pappas:]

It's been tough through 30 -- I think 35 years since I'm in business, so I don't know it's ever been easy, Andy. And it's just -- I think you got to be -- you got to say this is the market you live in, and you got to be very creative and a great employer. We are attracting people. It's hard. You have to work hard at recruiting and filling positions and getting new talent into the business constantly, but I think the Chefs' staff does a great job on it. And I think you could see with especially specialty, 7.5% case growth, you need people to pick it, you need people to deliver it, you need people to sell it. So it's tough, and I don't expect it to get much easier. You just have to be creative on how you attract good talent.

[Andrew Wolf:]

Okay. And I know you don't report cost per case type of metrics, but I'm sure you track that. Are those -- obviously -- is that something that you're controlling pretty well? Because, obviously, you're leveraging all the fixed costs, like you said you were in the business, the fixed cost structure. Looks like...

[Christopher Pappas:]

Yes. I think we're continuing to get reward for all the investments we've made the past so many years as we started to really grow and be acquisitive. We put a lot of tools in. We've invested a lot in the software, world-class IT department, world-class operational team now. And we continue to implement scanning. We still -- I would say, we're in the third inning of that game. So lots of upside still. We get more efficient, less dumps and damages, better inventory control. So OpEx leverage is all coming from implementing the technology, using it correctly and having people -- having less people be able to do more work. And that's really the key to this, and I think we're executing.

[Operator:]

[Operator Instructions]. If there are no further questions, I'd like to turn the floor back over to Mr. Pappas for any closing comments.

[Christopher Pappas:]

Great. Well, happy summer to everybody. Hopefully, it's a healthy, happy summer for all listeners. And we had a great quarter. I congratulate the team at Chefs', very proud of them and their accomplishments. And we look forward to a great second half of the year and speaking to everybody on our next earnings call. Thank you very much.

[James Leddy:]

Thank you.

[Operator:]

This concludes today's teleconference. You may disconnect your lines at this time. Thank you again for your participation.