Chefs' Warehouse Inc (CHEF) 2017 Q4 法說會逐字稿

Greetings, and welcome to The Chefs' Warehouse Fourth Quarter 2017 Earnings Conference Call. As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Alex Aldous, General Counsel, Chief Government Relations Officer and Corporate Secretary. Please go ahead.

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 fourth quarter 2017 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 by 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 fourth quarter results in detail and review our 2018 guidance. Then we will open up the call for questions.

With that, I will turn the call over to Chris Pappas. Chris?

Thank you, Alex, and thank you, all, for joining our fourth quarter 2017 earnings call. Despite the devastating fires in California and the unfortunate tragedy in Las Vegas, our customer base remained healthy and we continued our positive momentum into the fourth quarter. Considering these challenges, our business recovered relatively quickly, and we continue to support those in need in those markets. Overall, a healthy business and customer environment supported continued solid organic growth in the fourth quarter.

As a reminder, we are comparing the fourth quarter of 2017, a 13-week fiscal quarter, to the fourth quarter of 2016, a 14-week fiscal quarter, and as such, we'll present certain results both as reported and on a pro rata 13-week comparison.

A few highlights from the fourth quarter on a prorated basis include: 7% organic growth in net sales despite the impact of the California wildfires. Specialty sales were up 8.5% organically over the prior year. This was driven by unique customer growth of approximately 4%, placement growth of over 5% and specialty case growth of over 4.4% versus the prior-year fourth quarter. However, case growth was negatively impacted by approximately 1.4% as a result of our planned attrition at M.T. Food's.

Pounds growth in our protein division fell slightly by 0.6%. However, excluding the impact of the California fires, rose 0.2%. This represents sequential improvement versus third quarter of 2017.

Gross profit margins decreased approximately 20 basis points, including a 70 basis-point increase in Specialty, offset by 190 basis-point decrease in our protein division. We are extremely pleased with our team's performance on the specialty margin improvement despite over 4% inflation. As a reminder, gross profit margins in our protein division rose 84 basis points in the fourth quarter of 2016, and protein experienced 2% deflation in the same quarter. This compares to a continued inflationary environment throughout 2017.

Turning to our capital structure. We reduced the cost of our existing term loan via debt repricing and strengthened our balance sheet by issuing 1.9 million shares of our common stocks in the fourth quarter. Jim will share more detail in a few minutes.

We are pleased with our continued strong top line growth, especially pleased with our ability to deliver solid gross profit margins despite continuing inflation. We continue to provide our customer base with a high-value, high-service model that makes Chefs' the premier partner to independent chef-driven restaurants in the United States today.

Moving on to the technology and operations. In the technology arena, we continued to enhance our e-commerce site. We are now over $850,000 per week run rate going through our internal platform -- our Internet platform, and purchases via our mobile app are ramping up nicely. As an example, 8% of online sales in January came through the mobile app. As of January, the e-commerce platform has been integrated into all specialty and protein locations.

In regards to operations, we are extremely pleased with the 60 basis point reduction in our adjusted OpEx ratio during the quarter. We continue to focus on driving solid organic growth through our existing distribution centers, especially the locations where we have made both expansion and improvement investments in recent years. In addition, we continue to implement both technology and process improvements and are operating focusing on increasing operational efficiencies.

And now a quick update on Fells, which we acquired in 2017.

We continue to be very pleased with how the integration is going. They were already on our ERP system and are brought up with the incredible knowledge and expertise that we actually are using to help train other markets. We launched our Northeast and Mid-Atlantic portion-controlled program late in the fourth quarter, and we look forward to building scale in 2018.

And with that, I'll turn it over to Jim Leddy to discuss more detailed financial information. Jim?

Thank you, Chris, and good afternoon, everyone. Our net sales for the quarter ended December 29, 2017, increased approximately 12.2% to $357.1 million, from $318.4 million, which represents a prorated 13-week net sales for the fourth quarter of 2016. Net sales on a reported basis, 13 weeks compared to 14 weeks, increased 4.1%. The pro rata increase in net sales was the result of organic growth of approximately 7% as well as the contribution of sales from the Fells Point acquisition, which added approximately 5.3% to sales for the quarter.

Inflation was approximately 3.1% in the fourth quarter, consisting of 4.2% inflation in our specialty division, an inflation of 0.7% in our protein division versus the prior-year quarter. Inflation in the quarter, especially in our specialty division, continued to outpace our expectations in 2017, and we are pleased with our ability to produce solid gross profit margins despite this headwind.

Gross profit increased approximately 11.2% to $92 million for the fourth quarter of 2017 versus a prorated $82.7 million for the fourth quarter of 2016. On a reported basis, comparing 13 weeks to 14 weeks, gross profit increased 3.3%. Gross profit margin decreased approximately 20 basis points to 25.8%. We are pleased with the solid performance by our team in driving specialty margins higher despite 4% inflation. As Chris mentioned, lower margins in our protein division were partially driven by the prior-year comparison.

Total operating expense increased approximately 14.9% to $76.6 million for the fourth quarter of 2017 from $66.7 million for the fourth quarter of 2016. The increase in operating expense is primarily driven by the gain recorded in the fourth quarter of 2016 relating to the change in the fair value of the Del Monte earnout liability, offset in part by the additional week in the fourth quarter of 2016 as compared to the fourth quarter of 2017. Fourth quarter adjusted operating expense as compared to the fourth quarter of 2016 on a pro rata 13-week basis increased 8.7% year-over-year. As a percentage of net sales, adjusted operating expenses were 19.5% for the fourth quarter of 2017 compared to 20.2% for the prior-year fourth quarter. The 60 basis-point decrease in the company's adjusted operating expense ratio is due largely to better utilization of the company's warehouse facilities, which decreased approximately 12 basis points, lower overall compensation and benefit-related costs, which improved by 69 basis points, offset in part by higher costs related to the company's distribution and transportation platform of approximately 23 basis points.

Operating income for the fourth quarter of 2017 was $15.3 million compared to $22.4 million for the fourth quarter of the prior year. The decrease in operating income was driven primarily by the gain recorded in the fourth quarter of 2016 related to the change in the fair value of the Del Monte earnout liability and higher operating expenses, offset by increased gross profit, as mentioned earlier. As a percentage of net sales, operating income was 4.3% in the fourth quarter of 2017 compared to 6.5% in the fourth quarter of 2016.

Interest expense decreased $5.3 million versus $6.3 million in the prior-year fourth quarter due primarily to a reduction in the interest rates charged on the company's outstanding debt.

As Chris mentioned in December, we executed a repricing of our $289 million term loan, reducing the fixed spread portion of the coupon by 75 basis points thus, generating approximately $2 million of annual interest expense savings going forward. In addition, we issued $1.9 million of our common shares, which added approximately $34 million of cash to our balance sheet. This further improves our net debt leverage profile. On a pro forma basis, our current net debt-to-adjusted EBITDA leverage is approximately 4.2x.

Income tax expense was a $0.6 million for the fourth quarter of 2017 compared to an income tax expense of approximately $7 million for the fourth quarter of 2016. We recorded a one-time gain in net income of approximately $3.6 million in the fourth quarter due to the impact of the Tax Reform Act.

Our GAAP income was $9.5 million or $0.35 per diluted share for the fourth quarter of 2017 compared to net income of $9.1 million or $0.34 per diluted share for the fourth quarter of 2016. On a non-GAAP basis, adjusted EBITDA was $22 million for the fourth quarter of 2017 compared to $19.9 million for the prior year for fourth quarter. Modified pro forma net income was $6.2 million and modified pro forma income per share was $0.23 for the fourth quarter of 2017 compared to modified pro forma net income of $4.7 million or $0.18 per share for the prior-year fourth quarter.

We continue to benefit from strong cash flow and ended 2017 with $41.5 million of cash on the balance sheet, $34 million, of which was raised from the equity offering in December.

Turning to our guidance for 2018. Based on the current trends in the business, we are reiterating and expanding our financial guidance to be as follows: We estimate that net sales for the full year of 2018 will be in the range of $1.4 billion to $1.44 billion; gross profit to be between $355 million and $365 million; net income to be between $19 million and $22 million; GAAP net income per diluted share to be between $0.67 and $0.77; adjusted EBITDA, we expect to be between $74 million and $78 million; and modified pro forma net income per diluted share to be between $0.68 and $0.78. This guidance is based on effective tax rate of approximately 28.5% for 2018. Our estimated diluted share count is approximately 29.5 million shares. Currently, we expect outstanding convertible notes to be dilutive for the full year, and accordingly, these convertible shares are included in the fully diluted share count for your modeling purposes.

Thank you. And at this point, we will open it up to questions. Operator?

(Operator Instructions) Our first question is with Ryan Gilligan of Barclays.

Can you go over the puts and takes for gross margin in the quarter? You called out higher inflation as weighing on gross margin, but you actually had nice gross margin in core specialty, which is where all the inflation was.

Sure. Ryan, this is Jim. So obviously, you've highlighted Specialty, 70 basis points on 4% inflation. The 190 in protein, about half of that is the comp versus the prior year strength. The impact of Napa, where we actually had a pretty high-margin protein business, was about 25 to 30 basis points as well. And really, we saw continued inflation. It was a bit of a story of 2 worlds on the protein side in terms of inflation. We saw significant inflation continuing in prime, and we saw over 10% inflation in seafood, whereas other categories of prime -- sorry, other categories of protein, we saw either less inflation or actually deflation. So the headline 70 basis points inflation doesn't really communicate that. So that's -- those were the puts and takes on that.

Got it. That's helpful. And then can you just talk about your ability to pass through cost increases to your noncontract customers? And then can you just remind us what percent of sales are contracts?

Yes. So we include a lot in, we call it really core, our core independent customer. And then our groups are -- we kind of lump in our hotels and our GPO business, it's about 20% of our business. So I think we did a really good job passing most of the inflation on again. Where the headwind really was that we just had a really, really incredible headwind in some of the prime products, really that really -- it was a great quarter. It could have been an even better quarter.

I think I would also add that ex Fells, we actually saw organic revenue growth of about roughly 4% on a 13 13-week basis in protein, and some of that was driven by mix. Fourth quarter 2017 versus the prior-year fourth quarter, we had -- we sold a higher amount of higher dollar protein items driven by some of our -- a shift in our customers' mix. And so where we saw the offset there, those tend to be at slightly lower gross profit margin, and we saw the offset in operating leverage, improved operating leverage.

That makes sense. And then just I guess with guidance implying flattish gross margins for next year, does that imply that those prime headwinds that you guys saw in the fourth quarter will go away in 2018?

We don't expect to see the same level. I mean, we can't predict when there are scarcity issues or the hockey stick-like spikes that we saw in kind of Q3, and then there's a little bit of a hangover of that into Q4. We can't predict that, but I wouldn't say that we expect it.

Yes, the experts are -- I mean, if you listen to the experts, they're saying that there will be enough cattle this year that you should not see this kind of crazy inflation that we've been experiencing.

Our next question is with Chris Mandeville with Jefferies.

Chris, so the last several quarters now, you guys have actually been showing a really nice gap between your gross profit dollar growth and your operating percent growth. I'm just curious if you guys, do you view -- or how do you think about your capability or ability to continue to go and expand the gap between the 2 line items as you actually further leverage some of these facilities which you're bringing on incremental sales?

Yes. Well, I think that those -- people who have been following us since our IPOs, you know that we grew real quickly. We did a lot of acquisitions, we built a lot of facilities, and we said, eventually when Chef grows up, it's going to start to get leveraged on its operating expenses. And I think now, for the last few quarters, we're starting to live up to our expectation and I think we should continue. It's a story of -- we got great growth, we have great customer growth. We're getting crossed over growth to our categories, and we're started deleveraging all the overhead that we added on this past few years to build the platform and the facilities and all the trucks that we've added some, the people, the infrastructure. So I expect to continue to leverage the platform and add more volume and more dollars flowing to the bottom line.

Chris, I would just add on that. While extreme inflationary periods can make it a little bumpy in quarters, if you look at our -- the midpoint of our 2018 guidance would imply that, that gap improves over 2017.

That's helpful. And then in -- or even in the press release, it mentioned some of the planned attrition as it relates to Chicago, is there expectations for any incremental attrition in 2018, or is that now behind us?

Yes. Regarding the M.T. attrition, we expect to lap that in kind of Q2, maybe early Q3. Part of that attrition related to the move earlier in 2017, so we probably won't fully lap that until Q2 ['23], but it's obviously declining. The impact was negative 1.6 in Q3, it's 1.4 this quarter, so we're looking forward to building that back.

And as Chicago grows, which it is, obviously, it starts to eat up the attrition that we experienced from last year.

Okay. And then just maybe the last one for me. I may have missed it actually. But did you call out what expectations were on CapEx for 2018?

Yes. We're looking at staying kind of close to that 1% range. Might be a little bit higher, little bit lower, but $14 million to $16 million on CapEx in 2018. That's what we're planning right now.

Our next question is with Kelly Bania with BMO Capital Markets.

Just wanted to first ask about interest expense, your guidance was a little lower there than I would've thought, and I realize you just did the restructuring on the facility there, but any other debt paydown plans? Or what are you assuming for interest rates there, maybe just any color on that?

So obviously, we modeled in the reduction in the term loan rate, the 75 basis points, and we modeled in roughly 4 Fed hikes of 50 basis points -- sorry, 25 basis points over the year. So averaging out to about 50 basis points in the floating component. So still overall, that gets us -- plus you got to remember, we delevered the balance sheet by about $13 million in 2017, so we have a lower level of debt. So that combined with the repricing, and then we've modeled in kind of what the market was predicting on the Fed.

Great. That's helpful. And then some of your distributor peers are calling out some higher inbound freight, mostly on the third party side. Just curious if you're experiencing that or managing that in any different way, because I just didn't hear it called out?

Yes. We -- it's less than 5% of our COGs, and we saw a little bit of pressure in the quarter, but it wasn't anything that would require us to call it out. Where we saw a little bit of pressure was in that 20 basis point-or-so decline or increase in related to our transportation in OpEx, and that was really fuel and a little bit of outbound freight and some geography on leases shifting from depreciation into OpEx, but that was really it.

Great. And then just last one on the sales force. Some of your other peers are kind of growing that. Just curious how you feel about the size of the sales force and plans for maybe this coming year in 2018 and the next couple of years?

Yes. I mean, we continue to invest in sales. I think as an inflection point at a certain point where -- as we do more business online. We rolled out our phone app. We rolled out the online app. We'll continue to improve that and make it a better customer experience. And the plan is that, that will free up sales people to do more sales calls and to do more product presentations, and you'll start to get more leverage on your sales force. You'll be able to get more production. The order entry system will kind of eliminate, hopefully, more of their time behind their desks, which improves their time out in the street, but we continue to add salespeople, especially in territories that we feel we're underserved, and we add specialists because we're starting to cross-sell, so as we introduce new categories, we like to bring in people to just focus on really launching those categories and making it more part of the DNA of that territory. So I think we gave our guidance. It's all -- it's kind of all in there and nothing really unusual or anything that I would say right now is a change in plan.

Our next question is with John Ivankoe with JPMorgan.

The question actually is on e-commerce. I think you said in your prepared remarks that it's currently, 8% of orders, is that correct?

No. What we said on the 8% was that in January -- we launched our mobile app in late November, and in January, 8% of our online sales, which refers to the $850,000 run rate by week, 8% of that came in January through mobile.

Okay. All right. No, thank you for that clarification. I'm sorry for getting that wrong. And you did talk about previously, I think something like $100 million run rate by the end of fiscal '18 that you kind of expect, I guess, I'll just call it broadly e-commerce as opposed to mobile. So let's just call it -- or maybe digital is equally a fair word. So just an update on that. I mean, do you think -- is that a conservative number? Is it an easy number? And if we were to think about what the right mix is for Chefs' Warehouse over time in terms of what is a service-intensive and your professional selling organization versus digital? I mean, what really are your longer-term goals with what digital should be as a percentage of sales for The Chefs' selling platform?

Yes. Good question, John. What we're seeing is that we're still in the very early stages serving so many smaller restaurants. I don't think we're ever going to get to 100%, getting everybody to order on a digital platform. People -- customers that either order late are modeled a little different than the really big national food distributors, so we're much more flexible, easier to do business with, we take orders much past their cut of times. So if I could get to 50% online, I think that would be a great number, getting our very large customers, our large hotels either through EDI or having them enter their orders. So we're still in the process of getting our sales screen onto our enterprise system. So that's taking a little focus away from the big push to getting more and more customers online. I do think there's an inflection point -- I think at a certain point, again, as the younger generation starts to take over more of the ordering in our customers, they'll start to enter their own orders. But right now, we're still seeing a tremendous amount coming over on email and text. And it's a nice migration online, but I think once we're done, really, with our sales screens coming over to the enterprise system, I think that we'll see an acceleration. So the $100 million is still the number that we're going for, for this year, and then I think it starts to exponentially pump up.

And when -- so that sounds like that's a back-end effort. When does that sales screen migrate to enterprise system? I mean, if I'm quoting you correctly, when will that be done, what's the timeline of that?

Well, it started a while ago, so we've been turning on company by company. And right now, we're -- we have go live dates that sometimes get pushed back because we want to do another update as we enter -- we go into bigger companies where you get a tremendous amount of orders really late. So we really want to get it right. So the plan is, by next year, to have just about everybody on the ERP sales platform, but I'd rather go a little slower and really get it right than push it too hard and get it wrong.

(Operator Instructions) There seem to be no further questions. So I would now like to turn the call back over to Chris Pappas for closing remarks.

Great. Well, thank you for everybody for joining us on our earnings call. I'm really proud of our team. They did a great job. And they continue to push and make Chefs' the leading purveyor to the high-end independent restaurants throughout North America. And I look forward to speaking to everybody on our next earnings call. Thank you very much, and have a good evening.

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