Chefs' Warehouse Inc (CHEF) 2015 Q3 法說會逐字稿

Greetings, and welcome to The Chefs' Warehouse third quarter 2015 earnings conference call. At this time all participants are in listen-only mode. A question and answer and session will follow the formal presentation.

(Operator Instructions).

As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mr. Alex Aldous, General Counsel and Corporate Secretary. Thank you. Sir, you may now begin.

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 third 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 proforma net income, and modified proforma earnings per share. These measurements are not calculated in accordance with GAAP, and may be calculated differently in other companies similarly titled nonGAAP financial measure. 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.gov. Today we are going to provide a business update, go over our third 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.

Thanks Alex. And welcome to all who are listening today. We are very pleased with our results for the third quarter. During the quarter our organic growth in net sales was approximately 5%. This was particularly strong in our core specialty business, which was driven by unique customer growth of approximately 7.7%, placement growth of approximately 6.6%, and case growth of approximately 6.8% versus the prior year's third quarter. Our top line growth was muted somewhat as we shed some business in our Allen Brothers unit, as we returned the business to profitability. The year-over-year inflation accelerated sequentially from the significant inflation we saw in late 2014 and early 2015.

We continue to see relatively high inflation in certain protein and chocolate categories, which were offset somewhat by deflation in dairy, cheese and seafood. However, we continue to be very pleased with our ability to manage that inflation. During the quarter on a consolidated basis we saw a 103 basis point increase in gross margins. In our core specialty business we saw a 40 basis point increase, and realized a 547 basis point increase in our protein business. Much of that improvement in protein comes from our turnaround efforts at Allen Brothers, which continues to make progress in becoming the world class company we believe it will be.

Moving on to a few other specific business updates. In regards to Del Monte, integration of that business has gone very smoothly. Our integration team is in the midst of converting our back end systems. So far we have converted the Sacramento branch, which includes Del Monte's headquarter functions, with two more branches scheduled for the fourth quarter. We expect that process to be completed in the first quarter of 2016. Moving on to our facilities. We now have a 22-person team, 15 in the sales function, based in Chicago, who have been working tirelessly and making great progress on building up our customer base in that market. Year-to-date we have invested over $1.1 million in start-up costs which is slightly ahead of plan.

We continue to believe that the Chicago market has the long-term potential to be one of our largest markets. We have continued to increase our capacity and accelerate our case growth at our new Bronx and Las Vegas facilities. Both facilities are fully operational, with the exception of the Bronx office space. And are beginning to improve operational efficiencies. We look forward to continuing to build sales volume in those markets, to better leverage that occupancy cost. Our new San Francisco warehouse is still set to open by the first of the new year. This location will facilitate the consolidation of an additional Qzina warehouse, as well as one of the Del Monte facilities.

Now that we are near completion of all of these capital projects, we are once again generating free cash flow. While it's just a start, we do expect to continue deleveraging our balance sheet over the coming quarters. We continue to be presented with many acquisition opportunities, and are actively looking at those that meet our criteria. We believe that there are meaningful additional attractive opportunities for us to capitalize. To wrap up before turning the call over to John, our core business is performing well. Our protein business has continued to improve. And with almost all of our new facilities up and running, we feel that we are positioned very well for the future.

With that, I will turn it over to Mr. John Austin to discuss more detailed financial information. John.

Thanks, Chris. And good afternoon, everyone. Our net sales for the quarter ended September 25th, 2015 increased approximately 33.4% to $277.5 million, from the $208.1 million for the third quarter ended September 26th, 2014. The increase in net sales was the result of organic growth, the acquisition of Del Monte, and to a much lesser degree, the acquisition of Euro Gourmet last October. These acquisitions accounted for approximately $59.3 million of our sales growth for the quarter while our organic growth contributed the remaining $10.1 million, or 4.9% growth over the prior year quarter. Inflation continued to moderate sequentially, and was approximately 1.9% for the quarter.

As Chris had mentioned, inflation in the meat and chocolate categories continue to be very high year-over-year, while the dairy, cheese and seafood categories were deflationary versus the prior year quarter. Our overall outlook for inflation for the full year 2015 continues to be in the 3% to 3.5% range. Gross profit increased approximately 39.0% to $70.5 million for the third quarter of 2015, versus $50.7 million for the third quarter of 2014. Gross profit margins increased 103 basis points to 25.4%, from 24.4%, which as Chris pointed out was due to both strong margin improvement in our core specialty business, as well as the continued operational improvement at Allen Brothers. Total operating expense increased approximately 38.3% to $57.6 million for the third quarter of 2015, from $41.7 million for the third quarter of 2014. As a percentage of net sales, operating expenses were 20.8% for the third quarter of 2015, compared to 20.0% for the third quarter of the prior year.

The increase in our operating expense ratio is primarily the result of increased amortization expense related to the acquisition of Del Monte. The prior year recognition of a $1.5 million gain from the settlement with the sellers of Michael's Finer Meats, which we had bought in 2012, and additionally, increased occupancy costs, insurance and bad debt expense, offset in part by lower fuel and freight costs negatively impacted our operating expense ratio. More specifically G&A expenses increased approximately $17.1 million for the third quarter of 2015, compared to $10.5 million for the prior year quarter, due primarily to the increased insurance and bad debt expenses I previously mentioned, as well as amortization expense related to the Del Monte deal, and the prior year gain associated with the settlement with the sellers of Michael's Finer Meats.

Operating income for the third quarter of 2015 was $12.9 million, compared to $9.0 million for the third quarter of the prior year. Interest expense increased 106% to $3.9 million versus $1.9 million in the prior year quarter, due to the increased debt associated with the Del Monte acquisition. Income tax expense was $3.7 million in the third quarter of 2015, compared to $2.9 million in the third quarter of 2014. Our effective tax rate was 41.6% in the third quarter of 2015, compared to 41.0% in the prior year quarter. Net income was $5.2 million, or $0.20 per diluted share for the third quarter of 2015, compared to $4.2 million, or $0.17 per diluted share for the third quarter of 2014. On a non-GAAP basis adjusted EBITDA was $17.6 million for the third quarter of 2015, compared to $10.6 million for the prior year third quarter. Modified proforma net income was $5.5 million, and modified proforma EPS was $0.21 for the third quarter of 2015, compared to the modified proforma net income of $3.7 million, or $0.15 per diluted share in the third quarter of the prior year.

In regard to our outlook for the remainder of 2015, we're raising our expectations to incorporate our year-to-date results, as well as the trends we're seeing in the business. We estimate that net sales for the full year 2015 will be in the range of $1.04 billion to $1.06 billion. Adjusted EBITDA will be between $64.0 million and $66.0 million. Net income will be between $15.5 million and $16.7 million. Net income per diluted share will be between $0.60 and $0.64 per share. And modified proforma EPS will be between $0.73 and $0.77. This guidance is based on an effective tax rate of approximately 41.5% for 2015, and an estimated diluted share count of approximately 26.5 million shares. With that, Operator, we'll turn it over for questions.

Thank you. We will now begin the question answer and session.

(Operator Instructions).

We will now pause for a moment as callers join the queue. Thank you. Our first question is from Karen Short from Deutsche Bank. Please go ahead.

Hi, it's actually Ryan Gilligan on for Karen. Can you guys remind us why there was a significant step down in D&A this quarter versus last quarter, because it seems like it drove a certain part of the beat for SAR numbers?

Yes, certainly there is a little bit of noise or impact from the amortization expense. There are a couple of things. When we initially estimated what amortization expense was going to be, and we gave guidance based upon that, we were estimating that based on our historic experience with acquisitions, as far as how the purchase price was allocated and what the fair value of each of those intangibles was. As we got through that, we're substantially finished with our valuation. We used an outside valuation firm. They were coming up with a much lower number as far as amortization expense. So that did contribute to a little bit of the improvement versus prior year. But anyway, it's based upon those GAAP valuations, and the valuation firm's results on the fair value of the Del Monte acquisition.

That makes sense, thanks. And I guess just on inflation, how did it impact gross margins in the quarter, and do you expect it to be a tailwind or headwind going forward?

Inflation was about 1.9%, particularly in our core business. I think we feel very good about how we managed that, when you look at our Top Ten categories, which we often talk about on our calls. I think there were four of those categories it that were deflationary. So we're seeing kind of at least a more normalized or return to a more normal environment, where you have some categories that are inflationary, some that are deflationary. We saw some nice margin improvement. Sorry about the background noise. Some of the margin improvement we were seeing, we I think managed through both the inflationary piece and the deflationary piece very effectively, and saw overall about a 40 basis point improvement in our core business in managing inflation. The meat segment or protein segment is a little bit different. There's so much of that improvement in gross margin that's driven just by operational improvements at Allen Brothers, so it's probably a little less inflationary-driven, than it is just operational improvements.

That's really helpful. Thank you.

The next question is from Andrew Wolf from BB&T Capital Markets. Please go ahead.

Thanks. Good afternoon. On some of the better ability to manage pricing when categories pricing is changing, either up or down that you have been referencing the last couple of quarters, the earnings power stabilizing, both with the meat business getting better at Allen Brothers, but also the core business. I guess this is more for Chris, but could you kind of update me and others on the regional management structure that you switched to over the last few years, where that stands. Is pricing and operations really being run regionally now? And is that why the better regional management structure. Is that the root of the change that's helping your operating margins?

Yes. I think we've discussed this a few times over the past few years, Andy. Though we're not a new business, since we went public, and we started to do acquisitions, we had to create a bigger platform and kind of learn how to manage a much bigger company. I think we're starting to get the benefits of more experienced managers putting so many people in place, breaking up the business. So we are centralized, but we have given more power in a decentralized model to our regional Vice Presidents, and to our sales managers, to our operational people. We now have pricing managers, I think that's why you're seeing us being able to control the inflation/deflation much better than we did a few years ago. So I believe we're running a much tighter, better overall business, and I think you're starting to see us finally starting to get the benefits from a more mature team as we grow, and are able to manage the different businesses that we have bought. We always reference core business. Our core business, we have very experienced managers, and that business runs pretty tight, and continues to grow. We had a good quarter in October. We're seeing really good numbers. So I think it's just all starting to come together.

Okay, Chris, thanks. Just a follow-up. And I was really actually referring more to the core business. Just in very simple terms, how many regions did you hire Vice Presidents for? I couldn't quite figure that out?

We have West, Midwest and East Coast. So it's broken up pretty much into those three pieces. And then underneath of that, there's layers of general managers, managers, and then Canada is its own island.

And actually one of the original RVPs became kind of an RVP of Operations, so is supporting more in an operational role than a sales role.

Okay. And now could you give us a quick take on the same idea just briefly on the meat side? Is it all rolling up to the former head of Del Monte?

Yes. It kind of is. There's dotted lines in each region. So protein rolls up to protein. But in many regions, they criss-cross. Our whole model is cross-selling, and I think that's what you're starting to see. That was our vision. As we start to share salespeople, information, share the same customers, we're starting to cross-sell at a much better rate. So there's the direct lines, but there's also those dotted lines to the RVPs, who are involved in making sure that both parts of the business are gelling together. And it seems to be working really well.

Great. Well, it's encouraging. Just let me, a quick housekeeping, back to Ryan's question on the amortization. So $2.2 million this quarter, and on $3.2 million last quarter, which one is the run-rate, or was there an adjustment in either one? Can you just help us out with what to use for amortization? Even you didn't know until this quarter?

I think obviously we refined our estimates for this quarter. Our guidance for the full year for D&A is between $15.5 million and $16 million. I think at the beginning of the year our estimate was between $18 million and $20 million.

Great. Thank you.

The next question is from Kelly Bania from BMO Capital. Please go ahead.

Hi. Good evening. Congratulations on a great quarter.

Thank you, Kelly.

Just first wanted to ask about competition from the broadliners. I think you had called that out last quarter, and it sounds like no discussion of it today. So just curious if that just abated quicker than you thought? Or what you're seeing from the broadliners today?

Yes, again, I think our broadline competition, it's a healthy competition. They're mostly either large public companies, or companies that are going public. So they have trucks. They have people. They have overhead. So I think we compete very well. We're not after most of their core customers. And really, they're not really geared to compete in many of our core customers, which are smaller independents that buy a little bit of everything, which is really our model. So I think there's always going to be competition, Kelly, and I think that we really focus on what we do real well. And I think you see our case growth. It's really healthy. It shows that our model is working, and we continue to work really hard to ensure that we continue to grow. And we continue to add salespeople, and new categories. And I think we each have our space.

Great. That's very helpful. And then I was just curious, as the performance of Allen Brothers kind of rebounds, and it's been improving, where do you see that stabilizing, and can you speak at all to just what the impact of this high protein inflation is having on the Del Monte business, in isolation?

Well, Del Monte performed to our expectation. So it was our anticipation, when we went to buy Del Monte, that we were buying a leader and a team that knew how to navigate in the protein business. And it's proven, thank God, to come true. So they're very good at navigating and managing their business. They brought that expertise to helping us manage Allen Brothers. So I think we said on the last call, we continue to improve at Allen Brothers. We continue to believe that it's going to have a profitable year. And we continue, the best is still yet to come. We had to stabilize it. We had to get our production to the expectation of our customers. We had to restaff it, and add more sales staff. And as we roll out more Allen Brothers throughout Chicago and nationally, inflation/deflation, the market gets used to it. There's little ups and downs, but nothing to what we saw last year, really when we had our issues. More typical is you're up and down a point or so. Not like what we experienced last year. So I think what we're experiencing now is well-managed business. Performing better and better. And now we just keep adding customers. We should get to where we're expecting to get when we bought Allen Brothers. So we're really excited about it.

Great. And then if I could just ask one more. Where do you see that kind of protein inflation, as you look out over the next couple of quarters? Do you see that moderating? And what could be the impact of that? Or how do you manage that in a moderating protein environment?

Well, it's really GP dollars that we are really sensitive to. So the outlook really for beef in general, I think you saw chicken come down, with the threat of the virus kind of, people aren't that concerned that there's not going to be any chicken. And the pork pricing has come down. Cattle futures have come down. So the outlook for especially beef over the next three years is pretty much the herd is replenishing itself, so prices should normalize from their highs, which we're anticipating that it will be healthy for margins. And now it's really managing GP dollars. And the good part of the sector that we're in, we sell more of the expensive parts. Upper choice and Prime. And those cuts are usually pretty much in demand to the better restaurants and steakhouses. And those prices usually don't go, I mean we haven't seen the highs that we have. But I don't think we're going to see that market drop off to ridiculous lows. So I think we're going to start to go back to traditional pricing, and I think the margins are going to normalize to where our margins are. We expected them to be in the mid-20s, and I think that's where the margins will settle.

That's very helpful. And then I guess just for John. John, you had talked about in the past kind of targeting an expense ratio, if you look at OpEx less D&A of close to 19%. Can you just talk about progress towards that timing, how you feel about that goal?

Yes, I think there are a couple of things. So as I had mentioned in my prepared remarks, our total OpEx ratio is about 20.8%. There's a little bit of noise, and obviously on our adjusted EBITDA and adjusted EPS tables that we include in the press release. If you adjust for all of that, and adjust for amortization, there's a fair amount of noise around amortization, that leaves kind of an EBITDA, it's not really an EBITDA ratio but it's about 19.8% when you kind of normalize for those unusual items, compared to last year which I think was about 19.7%. So I think we still have a ways to go, I think, on our 19% target. I think we said about $1.2 billion is where we thought we would get into that

Kelly, as we grow into our New York warehouse, and our San Francisco warehouse, Chicago, that was a build it and they will come. So as we start to fill up and get more capacity in those warehouses, kind of a fixed overhead basically. Rent, power, refrigerators are running. So we anticipate that's going to drive our overhead down.

I think we're still comfortable with that 19% long-term target. I would say we're probably in the middle innings as far as growing into that.

Great. Thank you very much.

The next question is from Scott Van Winkle from Canaccord Genuity. Please go ahead.

A follow-up on that last question. So your existing footprint is what you're targeting $2 billion with. Correct?

Scott, that's a wide question.

Yes, that's a big number. We said $1.2 billion is where we thought we would get into the right scale to be leveraging things. So $2 billion is a big number.

Yes. We've stated that we thought there was about another $700,000 to $900,000 of growth, pretty much within the footprint we cover, with maybe the addition of one or two other markets. So we are anticipating a lot of growth in the footprint that we have, which is organic and fold-ins, and possibly new categories. But obviously we are driving right now to get more capacity, because we make more money. We have a pretty much fixed overhead. Obviously we can add a few more trucks and a few more people, but a lot of our overhead is fixed, and that's what we're trying to leverage right now.

I was folding that into the question of talking about $1.2 billion as kind of your target for hitting your OpEx expectation. That doesn't really assume Chicago is 90% capacity. And I would assume that it doesn't assume that there's significant amount of protein running through the Bronx. That I think the long-term goal is. Is that right?

I have stated that we think that New York over the next four or five years, we could double it. Okay? Maybe six, seven. Chicago, we built that warehouse. We should be able to do, say $200 million out of that warehouse. San Francisco the same. So yes, we will have capacity to drastically drive new business into these facilities, and grow our business.

Okay.

At the $1.2 billion, yes.

When they think about Chicago, obviously you have some business there already. But when you greenfielded the DC market, how long did it take to kind of catch a gear, so to speak? Each incremental dollar was a lot easier to get once you got to a certain point. Is there a precedent or something that we can compare it to?

Well, we're a much more mature, much bigger company, with many more categories. When we greenfielded, say Washington DC, we had much less inventory. We started off much smaller. So I would say this is more like Los Angeles, where it wasn't exactly a greenfield, but we started very small. And San Francisco. So usually what happens is we start to grow. I mean, we have 22 people now in Chicago. And we anticipate to keep adding salespeople, and expand our footprint. And usually what happens is we'll find a fold-in, and we'll add a category. So Chicago is really slated to be our top two/three/four market in the country. And New York is over $300 million. And we think New York should be over $500 million or $600 million. So you could do the math. Where that inflection point comes, it depends on organically, and I think we stated that we expect it to be $75 million over the next few years. So with a tuck-in or two, could it be a $200 million business? Absolutely.

Okay. Then last question, on the protein gross margins, I think, John, your comment was that you kind of expect your margins to look similar to the corn business at some point. Where are we from the standpoint , maybe I should know what that protein margin was, I know it was up obviously 500 basis points year-over-year, but where are we relatively to that target?

It's still a little bit lower than our overall average. I think in the past we probably talked a little bit about protein, and the customer mix that's within protein. To the extent that protein businesses have a mix of maybe some core business and non-core business, it tends to have a little bit lower margin profile. One of the things we liked about Del Monte was it was a much more similar customer base. It was much closer to our average margins. But overall our protein business is a couple of hundred basis points below our average.

That was the performance this quarter?

Yes.

Great. Thank you very much.

The next question is from Mark Wiltamuth from Jefferies. Please go ahead.

Hi. Good afternoon. I wanted to dig in a little bit on the deleveraging opportunity here. How much free cash flow are you thinking you could get to for next year, and how much of that do you think you could put towards debt reduction? Because obviously this is going to influence your ability to do future acquisitions?

I think there are a couple of things. Obviously we haven't given guidance for next year, so I'm going to talk more generally about that. But if you look over the last year or two, we have been spending order of magnitude around $20 million worth of CapEx. Maybe even a little bit north of that last year. And that number should return to a more $5 million to $10 million. $8 million would be a reasonable target for maintenance kind of CapEx. We're always going to have a few additions here and there. But we think that $5 million to $10 million range is a pretty reasonable number. If you kind of run out your models, and organic growth is in that mid to high single digits, you can come up with a contribution from that. But we should be generating $20 million plus of free cash flow, I would think.

Okay. And do you have a debt to EBITDA target that you have in mind? Or do you expect that you will keep bouncing back up again as you do more acquisitions?

I think we've always stated that we're more comfortable anywhere in the 2 to 4 times debt to EBITDA, when you look at on a proforma basis for a full year of Del Monte, we're just above that. We're about 4.25 times in total leverage today. So we're continuing to work our way down, and we'll get there. We'll get back into that more historic zip code.

Okay. Thank you very much.

Great.

This concludes the question answer and session. I will now turn the call back over to the presenters for any closing comments.

So we thank everybody today for joining us on this call. We're very proud of our quarter, and our continued ability to improve both the bottom line of our business and top line. And we look forward to speaking with everybody on our next conference call. Thank you. Have a great evening.

This concludes today's conference call. You may now disconnect your lines. Thank you for participating, and have a pleasant day.