The Chefs' Warehouse, Inc.
Q1 2015 Earnings Call Transcript

Published: 7 May 2015

[Operator:]

Greetings and welcome to The Chefs' Warehouse First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Alex Aldous, General Counsel and Corporate Secretary. Thank you, sir. You may begin.

[Alex Aldous:]

Thank you, operator. Good afternoon, everyone. With me on today's call are Chris Pappas, Founder, Chairman, and CEO; and John Austin, CFO. By now you should have access to our first quarter 2015 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 modified pro forma net income, and modified pro forma 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 at www.sec.com. Today, we are going to provide a business update, go over our first quarter results in detail, and review our 2015 guidance. Then we will open the call for questions. With that, I would like to turn the call over to Chris Pappas. Chris?

[Chris Pappas:]

Thanks, Alex and welcome to all who are listening today. We are pleased with our results for the first quarter despite the weather experienced in the Northeast and Midwest. During the quarter, we experienced 5.8% organic growth in net sales driven by unique customer growth of approximately 13.2%, placement growth of approximately 6.9%, and case growth of approximately 5.3% versus the prior year's first quarter. This growth was relatively broad based across most of our core specialty markets with the exception of New York which was more severely impacted by adverse weather in the quarter. We estimate the overall impact of the weather in first quarter to be approximately $2.5 million to $3 million in revenue, and between $0.01 to $0.02 a share on the bottom line. In addition to the weather impact as we mentioned on our year-end call, we've been transitioning the Qzina business as we consolidate facilities and transition management responsibility to our Regional Vice Presidents. This transition has slowed our growth in this category. We also continue to experience high inflationary pressure in certain of our key categories, particularly in protein. However, we are very pleased with our ability to manage that inflation during the quarter. Over the last year, we've implemented improved processes to manage inflation and pricing more effectively. During the quarter, we saw a 110 basis point increase in gross margins in our core specialty categories. We continue to see high protein prices in the second quarter but we will be lapping last year's inflationary spike in the second half of this year. Moving on to a few specific business updates. First, we completed our acquisition of Del Monte Meat Company right after the end of the first quarter. There are many reasons we are very excited about this acquisition including the addition of Mr. John DeBenedetti as the Executive Vice President of our protein division. Although he has only officially been a part of The Chefs' Warehouse team for a month, he and his team have already had a positive impact on our existing protein businesses. In addition to purchasing expertise, we also believe John will have a meaningful impact on our production efficiencies, as well as bolster our sales capabilities as we roll out new markets like Chicago. As for Allen Brothers, we are beginning to see meaningful improvement with that business. We continue to consistently build that business as one of the most prestigious national high end brands in protein, and continue to see significant traction in our other markets with the Allen Brothers product lines. The combination of Del Monte, Allen Brothers, and Michael's brings us closer to achieving our goal of being a national specialty protein supplier. 2015 is a very big year for us regarding facilities. Our Chicago warehouse has officially opened its doors in April. We continue to add top industry talent in the Chicago facility and believe that Chicago market has a long term potential to be one of our largest markets. We also completed the move of Qzina Illinois and Allen Brothers third party storage facilities into that new warehouse. This will allow us to more efficiently control our inventory and capture more efficiencies logistically which will help leverage the start-up costs of the new facility. In addition, our move into the new Bronx facility is substantially complete and we expect that facility to be fully operational in the second quarter. The consolidation of the Qzina New Jersey branch went very well, and we have already moved our CW perishable items over to the new facility. Consolidating three operating facilities to one in the metro New York area will allow us to increase our capacity and accelerate case growth once we are fully operational. That growth along with the operational efficiencies of being in one location will help offset the significant investment we have made in the new Bronx facility. We are planning to move into our new warehouse in San Francisco in mid-2015 which will accommodate one of the Del Monte branches and allow us to consolidate the Qzina San Francisco facility. And finally, our new Las Vegas facility is now set to open within the next few weeks. This facility is truly a state-of-the-art facility and will include a new culinary center, which we expect will enhance our company wide sales and marketing efforts. With that, I will turn it over to John Austin to discuss more detailed financial information. John?

[John Austin:]

Thanks, Chris and good afternoon everyone. Our net sales for the quarter ended March 27, 2015 increased approximately 6.3% to $198.9 million from the $187.2 million for the first quarter ended March 28, 2014. The increase in net sales was the result of organic growth and to a much lesser degree, the acquisition of Euro Gourmet last October. This acquisition accounted for approximately $800,000 of our net sales growth for the quarter while organic growth contributed the remaining $10.9 million or 5.8% growth over the prior year quarter. Inflation decreased approximately 280 basis points sequentially and was approximately 4% for the quarter. Inflation in the meat category continued to be very high year-over-year and while our overall outlook for inflation during 2015 is in the 3.5% range, we do expect protein prices to remain high in near term. Gross profit increased approximately 9.3% to $50.3 million for the first quarter of 2015 versus $46.1 million for the first quarter of 2014. Gross profit margins increased 70 basis points to 25.3% from 24.6%. This was due in large part to increased margins in our core specialty categories, offset by weaker margins in our pastry category and the year-over-year impact of our Allen Brothers subsidiary. Total operating expense increased approximately 11.5% to $47.2 million for the first quarter of 2015 from $42.3 million for the first quarter of 2014. As a percentage of net sales, operating expenses were 23.7% for the first quarter of 2015 compared to 22.6% for the prior year quarter. The increase in our operating expense ratio is primarily related to increased labor costs, investments in management and technology infrastructure, increase in bad debt expense, and transaction costs related to the Del Monte acquisition offset in part by lower fuel and freight costs. More specifically, G&A expenses increased to approximately $15.0 million for the first quarter of 2015 compared to $12.8 million for the prior year quarter due primarily to increased IT costs, bad debt expenses, and the transaction cost for the Del Monte deal I just mentioned. Operating income for the first quarter of 2015 was $3.1 million, compared to $3.8 million for the first quarter of the prior year. Other income included a $349,000 gain related to the sale of an excess facility at Allen Brothers. Interest expense decreased 10.8% to $1.8 million versus $2.1 million in the prior year per first quarter. Income tax was $686,000 in the first quarter of 2015, which was approximately flat year-over-year. Net income was $967,000 or $0.04 per diluted share for the first quarter of 2015, compared to $989,000 or $0.04 per diluted share for the first quarter of 2014. On a non-GAAP basis, adjusted EBITDA was $7.6 million for the first quarter of 2015, compared to $7.2 million for the prior year first quarter. Modified pro forma net income was $1.9 million and modified pro forma EPS was $0.08 for the first quarter of 2015 compared to modified pro forma net income of $1.5 million or $0.06 per share for the first quarter of the prior year. In regard to our outlook for the remainder of 2015, we are adjusting our expectations to incorporate our year-to-date results, as well as the trends we are seeing in the business. Given the estimated $0.01 to $0.02 negative impact the weather had on the first quarter results we estimate that net sales for the full year 2015 to be in the range of $1.0 billion to $1.1 billion, adjusted EBITDA will be between $67.8 million and $70.8 million. Net income will be between $15.5 million and $18.0 million. Net income per diluted share will be between $0.56 and $0.65 per share, and modified pro forma EPS to be between $0.69 and $0.78. This guidance is based on an effective tax rate of approximately 41.5% for 2015, and an estimated diluted share count of approximately 27.5 million shares. With that operator, we'll turn it over to questions.

[Operator:]

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today is coming from Andrew Wolf of BB&T Capital Markets. Please proceed with your question.

[Andrew Wolf:]

Good afternoon. Could you give us a little sense on the way you've updated the guidance, it looks mainly like it's just weather affect and how it hit the first quarter, more so than current trends although I think John you referenced that. So, could you give us a sense if you will, of your - what's encapsulated in the sales guidance on the inflation side? Do you see that slowing like - on the outside we see when we look at the PPI and other indexes, and also real sales and what's your outlook there?

[John Austin:]

Yes, I think a couple of things, Andy. We really didn't change the balance of the year much, most of the adjustment that we talked about was the first quarter related to weather which we estimate between $0.01 to $0.02. So there is a couple of slight tweaks we adjusted in weighted average shares slightly based upon the timing of close of Del Monte and some things like that but nothing that materially impacted the balance of the year. So, as we mentioned in our prepared remarks was –inflation we expect to be about 3.5% for 2015. It was a little higher than first quarter, so I think that implies that things will soften just a little bit. I think we are seeing that in April trends, there was a little softer inflation. So, really not much change in our outlook for the balance of year.

[Andrew Wolf:]

Okay. And maybe Chris, if I can address one that hopefully you could shed some light on. If you look at like the Knapp-Track, and I know you guys sell two different types of restaurants and the Knapp-Track tracks. But you know the January through mid-February period was really strong for those types of restaurants, traditional family restaurants, let's say. And then we just fell off a cliff and it seem to have been weather related more than anything. Was that kind of replicated in New York and more in geographies that were impacted by severe weather, and the kind of restaurants and other businesses that you supply? And if so, have you seen any improvement with better weather?

[Chris Pappas:]

I mean, absolutely weather was a headwind. We actually went back and we tracked our budget expectations and days that we did not hit our expectations and you could see it was a direct correlation with the weather. So April looks pretty good, I think what I'm seeing and what I'm hearing from our customers, it's really not anything different than we expected. The best research you can do is, you go out to restaurants and you could see that they are busy. Our customers' up skilled casual, higher end seem to be doing fine.

[Andrew Wolf:]

I just want to follow-up on the slowing inflation, there is actually - in the numbers we look at, deflation at least in some of the parts of the dairy side of the business categories. I know in the past dairy [ph] inflate deflation caused you guys some problems, but you know maybe in a better economy would volume pick up and also on the beef side where we haven't seen any relief, but there is some predicted maybe later this year - would deflation in beef actually be a good thing?

[Chris Pappas:]

Yes, I think there is a couple things, Andy. So when you look at our first quarter inflation and we probably, I think we remembered to talk about is - I don't know if you and I specifically talked about on our former calls. The last quarter too almost all of our Top 10 categories showed inflation. This quarter, we had actually four of our Top 10 categories that showed some deflation, so - it's not massive deflation or inflation, but certainly a little bit of softening trend even in the first quarter. I think were inflation or deflation is becoming really challenging is when you have the spikes. Modest deflation is not horrible environment, actually modest inflation is preferable but it's really the big spike that are hard to deal with.

[Alex Aldous:]

Yes, we have dairy deflation, we were able to grab some basis points on it. So the top line might be a little softer market overall [ph]. With protein, what's been happening, I think we're not expecting any ease up really in the - especially in the beef, outside sales we think it's going to be pretty tight and now it's just managing through it. I think it's like anything else, Andy, people are starting to get - they've gotten used to it, you see menus right now, many have raised prices. So if there was some deflation at a certain point where we expect to capture a few dollars optimistically, absolutely. But right now we're expected just to manage through it and obviously you know with the addition of Monte and the management team, we've got our arms around that much better and we think we can manage to it very well

[Andrew Wolf:]

Great to hear that. One last final, just on the on the beef, on the pricing. Are the restaurants, you know that you deal with, are they experiencing - give the economy in the way, especially in the upper end, the way it's performed so well for top third, let's say in the top half. Is the trade - as the prices go up on fixed higher cut beef and stakes, has the trade-down sort of stabilized so that it's easier to predict what's going to go on with the volumes?

[Alex Aldous:]

Again, smart operators know how to play with the mix unless, so unless you're a steak house and you are tied to the traditional, [ph] New York strip, and Port House, it's always happened then we've seen really that operators. Hamburgers came right now, we are seeing a lot of premium hamburgers, and that's a great sell for us. The Prime Burger, Tanza menus, Tanza - great restaurants and it sells for a premium price, so I think everybody is making money. And the non-steak house, again they play with the menu, lot of steak, a lot of flat iron. So it's really a great mix but they're able to do that because it's more profitable for all of us in those sales, and our traditional customers embrace prices. If you're out there and you're going to the premium steak houses, amazing thing is that most of them are packed. And people are willing to - maybe they are eating a little lunch at home, but when they go out, they are enjoying our delicious steak and they are willing to pay for it..

[Andrew Wolf:]

Great. Thank you.

[Operator:]

Thank you. Our next question today is coming from Kelly Bania from BMO Capital Markets. Please proceed with your question.

[Kelly Bania:]

Hi, good evening, thanks for taking my questions. Just wanted to ask a couple questions about gross margin. I guess first can you explain a little bit deeper what drove the increase in the specialty categories and gross margin this quarter? I guess, that's the first part and then second, just as we think about gross margins going forward, the last couple of years it has come down, we've had some mix pressures, we've had inflation. I'm just curious as we think about forecasting our gross margin longer term, how much of that pressure over the last two or three years should we expect you to recoup or how much of it is more structural? Any color you can provide there. Thanks.

[John Austin:]

Yes, I think there is a couple things Kelly, the specialty area, and we've talked about this as it relates to inflation when you have hyper-inflation, some of what we saw over the last, probably two to three quarters, typically you get squeezed a little bit on percentage margin because it's just hard to pass that cost through quick enough. I think as people get used too as Chris talked about a minute ago, as people get used to that higher pricing, you're able to pass that through, and be able to catch up a little bit on that. So I think we commented that on our last quarterly call and then I think we're also seeing that in this call. So some of it is just our ability to more effectively pass through that increased cost and therefore you recapture some of that margin. As it relates to the structural change in margin, the mix of the beef companies versus our specialty companies, obviously that influenced our overall mix with the addition of Michael's and then the addition of Allen Brothers, obviously the performance of Allen Brothers, which has struggled little bit, over the last couple of quarters has pressured up somewhat. I don't think that overall mix - we did comment on related to the acquisition of Del Monte, given their customer mix, it's really more of a customer mix issue than it is so much a beef versus specialty mix. So we don't expect to see a significant dilution in our margin from the addition of Del Monte because their customer mix is so similar to our mix.

[Alex Aldous:]

Yes, and actually our core - what we call traditionally our core specialty business, I think we're back to all-time highs on our margins overall. So we've been able actually to manage through the last few years of these crazy up and down sites and you know I think we are very stable at this point and hopefully it continues.

[Kelly Bania:]

Thanks, that's very helpful. And then, just curious, you called out and the increased labor. Just curious, if that was any particular region or if that was across the Board. And then I guess related to that, how much are start-up cost for the various facilities there are opening or are about to be opened, how much are start-up costs impacting your results right now?

[Chris Pappas:]

Yes, couple of things. Maybe I'll take the second piece of that first. There really is not a significant drag in the current quarter related to Chicago, that's the only brand new openings, where there is a significant amount of start-up cost. We did build into the balance of 2015 start-up costs there. So right now we just opened the facility in April, we have got a lot going on as far as hiring sales reps and getting that out there on the street and building sales volume. So that dream will happen for the balance of 2015. You know New York and things like that, obviously there is a higher occupancy costs associated with the new facility, as we move into that we'll benefit some from operating efficiencies that will help soften that occupancy cost but really that gets leveraged as we build volume, it's all incorporated in our numbers.

[Alex Aldous:]

And as far as labor, I think we kind of saw what's happening in the marketplace and we're trying to make sure that - obviously, we have a great workforce and we have been slowly increasing, really, some of the hourly people to - I call them more of a living wage. So I think we're kind of ahead of where the rest of the country has been or trying to catch up and maybe has more, more of a space to catch up. I think we've done a pretty good job of increasing piece by piece, increasing what we're paying on the hourly people and we have very little minimum wage in our workforce. So, I think we're pretty - I think we're situated pretty well on the label front.

[Kelly Bania:]

Great, thank you.

[Operator:]

Thank you. Our next question today is coming from Mark Wiltamuth from Jefferies. Please proceed with your question.

[Mark Wiltamuth:]

Hi, thank you. Wanted to get a little more detail on what you're doing to manage through the meat inflation, now meat is 40% of your business. Just wanted to get a read on what you're doing behind the scenes to kind of more effectively control margins and then the inflation spikes there?

[Chris Pappas:]

Again, obviously adding the strength of the Del Monte team into our business, what was one of the key reasons behind choosing to require Del Monte and get the management team and get jump in very on board, I call it as an expert in the field in the business for many, many years. So, I think that's a major plus in managing pricing. And as we said before, the market kind of has gotten used to the high meat prices. So they've adapted and it's the mix really and is being able to market everything else, the premium hamburger and the other types of cuts that have more margin. So right now, we've been improving on a consistent basis, so it gives me confidence to say that we're getting much better at managing business. And as we continue to improve, there is no reason to think that anything will change.

[Mark Wiltamuth:]

And then on the - I was pleased to see the consolidation of facilities happening, is there kind of a margin tailwind that comes out of that or is it kind of being mass right now by the start-up costs for the newer facilities.

[John Austin:]

Let's see, there is a couple of different things. So, the consolidation of the Qzina Illinois facility into our new Chicago facility, that's one of the relatively small facility for Qzina, so it was not a significant amount of cost. So that's really kind of built into the startup of Chicago, New Jersey and folding that into New York, same kind of things, so we've got the new facility that's the kind of getting masked a little bit.

[Chris Pappas:]

But as far as margin improvement, again these facilities, there are more - obviously, we have more rooms, so we're going to function better, we already see the breakage in New York is already declining. But it's obviously it's a very long-term project as we move into these warehouses, labor has to get accustomed to the space you know there is a learning curve so optimistically and why we move our businesses into the more modern space as we think we're going to be more functional and over the next few years obviously reap the benefits of our investments.

[Alex Aldous:]

Right, and that obviously flows through the OpEx line, more so than it does on margins.

[Mark Wiltamuth:]

Okay. And is there any way you can give us some perspective on how much the Allen Brothers product in percentage terms is going through the other regions? Since that was one of your goals is to get Allen Brothers spread out to the other regions

[Chris Pappas:]

I think it's going pretty well. But I don't think we're in a position to actually give you a number.

[Mark Wiltamuth:]

Okay. thank you.

[Operator:]

Thank you. Our next question today is coming from Karen Short from Deutsche Bank. Please proceed with your question.

[Karen Short:]

Hi, just a couple questions. I guess I'm curious in terms of the EBITDA, I mean obviously there is a lot of adjustments that you're making the EBITDA, some I agree with, some I'm not so sure with. If seems like you're keeping the gain on asset sales in your EBITDA numbers. So wondering on that philosophy?

[Chris Pappas:]

I think the asset sales - we typically have small asset sales, all the time. This quarter was probably a little bit bigger but that is something that is normal recurring thing that flows through our P&L. So if you're going to start with net income and add back interest, tax, depreciation, it's in there.

[Karen Short:]

Okay. I don't know that I've seen the stuff frequently but then and then I guess the second question was, I noticed the management bonuses for the completion of the sale of Del Monte. And I haven't seen that for a while, either just wondering if you could comment on them?

[Chris Pappas:]

I think there is a couple of things, I think are our Board evaluated in conjunction with talking with our compensation consultants, what was appropriate. That was a deal that we have worked on for almost a year to the day they consumed a significant amount of managements time. I think it was also identified and developed without any investment bankers and costs associated with external third party. So it felt appropriate to illustrated transactional bonuses related to that so.

[Karen Short:]

There is no investment bankers involved in that transaction at all.

[Chris Pappas:]

No.

[Karen Short:]

Okay. And then on a dairy deflation in general, I guess the senior member in the past when we ventured into deflationary period for Gary, it's been a little more problematic for you from a P&L perspective. Any color and what you're seeing now and why it would be different this time?

[Chris Pappas:]

On the deflation Karen?

[Karen Short:]

Yes and dairy

[Chris Pappas:]

Usually when we have deflation, we are able to capture a little margin on it. So, I mean it's gross profit dollars at the end of the day, but it's usually when we have a lot of - when we have drastic inflation, it causes problems, because that's so fast and we are not able to pass to bid on and sometimes we even make less gross profit dollars. But when you have this type of deflation in it, which usually advantageous for us, we're able to grab a little bit of margin.

[Karen Short:]

Even at your getting less leverage on the topline?

[John Austin:]

Yes, it contributes obviously, it does not contribute as much to the topline, you're right but if you keep the same profit dollars per case, they actually increases percent mark.

[Chris Pappas:]

Right. And that's really what we have been able to do with increased margin.

[Karen Short:]

Okay, thanks.

[Operator:]

[Operator Instructions] Our next question today is coming from John Ivankoe of JP Morgan. Please proceed with your question.

[John Ivankoe:]

Just a couple clarifications at this point. I guess the first is, can you remind us what you do on the fuel side, I mean is that entirely just a surcharge, is it just flows through the customer, is there some sort of profit that you achieve as costs are following, just how do we think about how you're building and maybe lower fuel prices this year relative to last year into the guidance?

[John Austin:]

Yes, a couple of things. So yes, we do employ fuel surcharges obviously in today's fuel environment, we're employing those a lot less. That flows through revenue actually. So fuel costs were somewhat of a tailwind. I think typically we've run about 65 basis points of sales. They were a bit softer in the mid '50s, at 54 basis points, 53 basis points of sales in the first quarter versus prior year. So obviously that fuel is a little bit of tailwind, but you're right. I mean fuel surcharges, when fuel is escalating and things like that, that is a way to pass some of that.

[John Ivankoe:]

John, the CapEx expectation for the year, is that so? I think it was $20 million to $22 million when you previously talked about it, is that still the right ballpark?

[John Austin:]

I think that's the right ballpark.

[John Ivankoe:]

Okay. And then the last question just, you obviously have the Allen brothers B2C business and then on the Chefs' Warehouse website you can order products as well. So, I mean what are your customers asking for in terms of maybe a more robust kind of consumer facing technologies. Is that at all really a priority or is it still more or like the traditional business is done through the phone and that's how it's going to continue for some time.

[Chris Pappas:]

Yes, actually, most of the orders is coming online. So it's a project right now that we're in the middle of trying to upgrade it. I call trigger into the 22nd century. And you know you could be looking for a much more modern up-to-date web site and how we go to market and we have got a whole team, learning the business and basically you know I think they're going to start to move that needle and move it into the direction that we'd like to see that we will really represents, say a premium brand company like Allen Brothers.

[Operator:]

Thank you. We reached end of our question-and-answer session. Let's turn the floor back over to Mr. Pappas for any further closing comments.

[Chris Pappas:]

Okay. Well, we're glad the snow is down, it's a beautiful day here in Connecticut, we thank everybody for joining the call and we look forward to speaking with everybody in our next earnings call. Have a wonderful day. Thank you for joining.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you participation today.