Chefs' Warehouse Inc (CHEF) 2018 Q1 法說會逐字稿

Greetings, and welcome to The Chefs’ Warehouse First 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. Please go ahead, sir.

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 first 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 first quarter results in detail and update 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 for joining our first quarter 2018 earnings call.

Despite some challenging winter weather across our network, especially in the Midwest early in the quarter and the 4 named winter storms that hit the Northeast and Mid-Atlantic in February and March, we continued to see solid organic growth across our network and amid a supportive economic backdrop and continued strength in independent restaurants.

A few highlights from the first quarter include: 5.5% organic growth in net sales; Specialty sales were up 8.4% organically over the prior year. This was driven by unique customer growth of approximately 3.5%, placement growth of 3.1% and specialty case growth of 4.5% or 5.5% net of expected attrition in Chicago; Organic pounds growth in center-of-the-plate of 0.3%; Gross profit margins decreased approximately 73 basis points, including specialty margins, which were effectively unchanged as compared to Q1 2017 and 146 basis point decrease in center-of-the-plate margins.

We are extremely pleased with our team's performance on maintaining strong specialty margins despite approximately 3.8% inflation.

Although we saw positive growth in center-of-the-plate volume, it remained a challenging quarter in terms of price volatility. We experienced roughly 10% year-over-year inflation in certain categories such as choice tenderloins in February and March. However, we are seeing some price moderation in early second quarter.

We are pleased with our continued solid top line performance despite some challenging weather-related headwinds across our network. We continue to remain focused on top line and gross profit dollar growth, complemented by prudent operating cost management and capital discipline. Chefs' continues to grow and solidify our position as the unique marketer of artisan quality food products ingredients to menu-driven independent restaurants across our expanding footprint.

Moving on to the technology and operation area. In the technology arena, we are extremely pleased with the adoption of our e-commerce platform and mobile app among our customer base. We are now at over $1.2 million revenue per week going through our Internet platform, and purchases via our mobile app continued to ramp up. Roughly 12% of our online sales in the first quarter came through the mobile app.

In regards to operations, we are very pleased with the 130 basis point reduction in our adjusted operating expense ratio during the quarter. We saw improving operating leverage both in operations and leveraging our corporate infrastructure.

We are focused on generating continued operating leverage via 3 main areas: Deploying technology enhancements across our commercial operating and support functions focused on generating efficiency and scale as we grow while providing our customers with a superior customer experience; driving strong top line growth and leveraging the strategic infrastructure investments we have made in key markets across our platform; and capital deployment focused on supporting both new and existing market growth, funding accretive fold-in acquisitions and driving productivity through technology, operational improvements and structural cost management.

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

Thank you, Chris, and good afternoon, everyone.

As noted in our press release, beginning in the first quarter of 2018, we have altered slightly the way we report certain performance-related metrics related to organic growth, inflation and changes in gross profit margins. These metrics were previously reported on a legal entity basis as protein, referring to the 4 protein entities we acquired since 2013, and specialty, referring to our specialty distribution entities. Going forward, we will report these metrics using a product category basis as center-of-the-plate and specialty. Center-of-the-plate will encompass all sales of protein products across Chefs’ Warehouse, while specialty will encompass all remaining sales not related to center-of-the-plate. This change is driven by factors that have evolved over the last 2 years, including merged regional leadership, combined sales forces, certain shared facilities, growth in product transfers between entities and a combined go-to-market platform.

While we will continue to maintain the strong regional and local markets and brands of our protein entities, we are focused on growing and enhancing our position as the premier partner to chef-driven restaurants by offering our expansive line of international specialty food products and industry-leading center-of-the-plate capabilities to all of our customer base.

We have provided the revisions to the comparable metrics for prior periods within the Exhibit A of our press release for your information and analysis.

Turning to our results. Our net sales for the quarter ended March 30, 2018, increased approximately 10.7% to $318.6 million from $287.7 million in the first quarter of 2017. The increase in net sales was the result of organic growth of approximately 5.5% as well as the contribution of sales from the Fells Point acquisition, which added approximately 5.2% to sales growth for the quarter.

Inflation was 2.8% in the first quarter, consisting of 3.8% inflation in our specialty category and inflation of 1.5% in our center-of-the-plate category versus the prior year quarter. Inflation in the quarter, especially in our specialty category, continued to outpace our expectations.

Gross profit increased approximately 7.6% to $79.5 million for the first quarter of 2018 versus $73.9 million for the first quarter of 2017. Gross profit margins decreased approximately 73 basis points to 25%.

We are pleased with the solid performance by our team in maintaining specialty margins despite approximately 3.8% inflation. As Chris mentioned, lower margins in our center-of-the-plate category were partially driven by price inflation in various center-of-the-plate categories.

Total operating expense increased approximately 4.2% to $73.8 million for the first quarter of 2018 from $70.8 million for the first quarter of 2017. As a percentage of net sales and on an adjusted basis, operating expenses were 21.2% for the first quarter of 2018 compared to 22.5% for the prior quarter in 2017.

The 130 basis point decrease in the company's adjusted operating expense ratio is due largely to better utilization of the company's selling organization, which decreased approximately 10 basis points, and lower year-on-year compensation and benefit-related costs in our management infrastructure, which improved by 82 basis points.

Operating income for the first quarter of 2018 was $5.7 million compared to $3.1 million for the first 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 1.8% in the first quarter of 2018 compared to 1.1% in the first quarter of 2017.

Interest expense decreased to $5.0 million versus $5.9 million for the prior year first quarter due primarily to a reduction in interest rates charged on the company's outstanding debt as well as the reduction in outstanding debt balance due to deleveraging completed in 2017, offset in part by higher market floating interest rates.

Income tax expense was $0.2 million for the first quarter of 2018 compared to an income tax benefit of approximately $1.2 million for the first quarter of 2017. The increase in income tax expense is due to higher operating 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 $0.5 million or $0.02 per diluted share for the first quarter of 2018 compared to a net loss of $1.6 million or a loss of $0.06 per diluted share in the first quarter of 2017.

On a non-GAAP basis, adjusted EBITDA was $12.1 million for the first quarter of 2018 compared to $9.3 million for the first quarter of the prior year. Adjusted net income was $0.8 million and adjusted net income per share was $0.03 per share for the first quarter of 2018 compared to adjusted net loss of $1.4 million or a loss of $0.05 per share for the prior year first quarter.

We continue to benefit from strong cash flow and ended the quarter -- the first quarter of 2018 with $45 million of cash on the balance sheet.

Pro forma net debt-to-EBITDA was 4.1x as of the end of the first quarter of 2018.

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 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 $19.5 million and $22 million; GAAP net income per diluted share to be between $0.68 and $0.77; adjusted EBITDA we expect to be between $74.5 million and $78 million; and adjusted net income per diluted share to be between $0.69 and $0.78.

This guidance is based on an effective tax rate of approximately 28.5% for 2018. Our estimated diluted share count is approximately 29.5 million shares.

While the convertible shares were not dilutive in the first quarter, currently, we do expect outstanding convertible notes to be dilutive for the full year and, accordingly, those 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 with Barclays.

Can you just start with talking about how sales trended throughout the quarter and into the second quarter?

Yes. Well, we came out of, obviously, a pretty ugly winter, challenging -- I can't even name all the storms. What we saw really coming into the second quarter, especially in May, more normalization of what we expected. In our forecast, the sales team healthy about where we thought they would be, our customers seemed to be doing great business and new business keeps coming in. You can see from our reports. So we're pretty optimistic.

Ryan, this is Jim. I would just add that we estimate that the weather cost us about a point of organic growth in Q1.

Got it. That's helpful. And -- so obviously, organic growth is strong and new customers are strong, but placements slowed pretty sharply from the mid- to high single-digit growth rates we're accustomed to seeing from you guys for the last several years. So I guess, can you just talk about what drove that deceleration? And maybe give us your latest view on health of independent restaurants and same-store volumes?

In terms of the placement number, I'll go back to the weather that cost us about a point. So if you add that back in, we're closer to where we would kind of normally be in Q1. Q1 is our weakest quarter from a growth perspective, just from a number perspective.

Got it, okay. And then, just on pounds sold, obviously, with the restatement, the fourth quarter growth rate was pretty solid and then the first quarter was flat. So is the first quarter number -- well, can you I guess just clarify if the fourth quarter number included Fells? And if it didn't, can you just talk about what drove the deceleration there?

No. So with the restatement, that is -- that doesn't include Fells. So that was comparing to Q1 '17 and we did not -- we didn't have Fells at that point. No, it was -- we had some challenging weather on the West Coast in our Del Monte business, significant rains. So it was -- some of that was weather. I mean, overall, we are pleased to see about just under 2% organic growth. Some of that is inflation, but it was a challenging quarter from a pounds-sold perspective.

Our next question is with Chris Mandeville with Jefferies.

Kind of starting off real quick on the reclassification, I think it was largely just the charcuterie. Can you just reference how much that reclassification impacted specialty margins in the quarter?

We don't disclose the breakout. The charcuterie was really just moving from center-of-the-plate into specialty. So you'll see in Exhibit A, when we talk about the overall percent of revenue, that was -- we used to classify that as center-of-the-plate or lumping it in as protein, when really it's a specialty product. So that was just a classification. It didn't really have an impact on the overall specialty margins.

Okay. And then in terms of the M&A picture, you guys have a good $45 million in cash now, and leverage is quickly approaching 4x. So how much of an interest do you guys have to look to acquire something right now? And what's the level of quality that you're seeing out there, since the other day, one of your larger peers did mention that they've kind of walked away from a few recent opportunities after they have had the chance to look under the hood?

Yes. I think we continue to be extremely careful. It's a frothy pipeline, but we don't need really to do much M&A. I mean, it's part of our strategy. We're constantly looking at companies. We prefer to do fold-ins or end market fold-ins, unless there's something that we really think fits into the Chefs' culture, something really interesting. So yes, the pipeline is frothy, we are looking and we're being very selective.

And if nothing comes to, would the idea here be to simply be more aggressive on debt pay down?

Yes. I mean, we expect that we'll be able to use a lot of that cash for accretive acquisitions. But yes, from a capital allocation perspective, I think we would look at further deleveraging versus return of cash to shareholders at this point in our growth phase.

Okay. And then, just the last one from me. Where do we stand today in terms of capacity utilization in the Midwest?

Midwest, you mean specifically Chicago?

Chicago, specifically, yes.

Yes. We have plenty of capacity on the CW side, a little constraint in our Allen Brothers side. But CW, we have, I believe, the ability to double our business in that facility. So plenty of space to grow.

Our next question is with Andrew Wolf with Loop Capital Partners.

So Chris, on the change in the good results with your expense ratio and I guess, most of it coming on a lower compensation. Could you give us a little sense of, a, the sustainability of that as you go through the year? And is that sort of -- yes, so is that headcount related or sort of more salary bonus accrual? Just a sense of what went behind that.

So this is Jim, Andy. Yes, so the 130 basis points, obviously, very happy with that from a year-on-year perspective. So that was really spread across our operations. And we called out selling and the improvement there, and we started to see some leverage on our selling organization. But a good part of that was also the comp versus last year. We had some comp and benefits-related expenses that didn't repeat, so that was a portion of it. So what I would say is, is that if you look at the midpoint of our guidance, it implies about 150 -- I'm sorry, about 20 to 40 basis points of adjusted operating expense improvement for the full year. So we expect to meet that or even potentially beat it, but it won't be the level of 130 basis points that we saw this quarter.

But Andy, I think if you go back and you look at, especially the last 4 quarters, but even going back for a few years ago, I said, once we get to a certain start, we start to leverage growing into a larger public company, we should start to get the leverage on our operating expense. And I think for the last 4 quarters, you're starting to see that, and we expect that to continue.

Yes, absolutely. Okay, so that helps out a lot. So at a recent conference, I think you were talking about entering smaller markets that are probably good markets for you like Nashville, let's say. And just kind of curious about the selling process, like when you do that, does the company's reputation precede it through the networking at Chefs'? Or is it sort of a greenfield sort of virgin sales effort? Or is it somewhere in between? I'm just curious about that process.

Yes. So our brand is growing. We do spend -- we have a great history. Our best marketing tool is our -- the chefs that we sell, they move around. So you're absolutely right, when we entered Nashville -- we do, obviously, hire sales staff and go to the market aggressively. But the brand is known. A lot of the chefs -- especially in some places like Nashville, which is booming as a food town, a lot of the chefs have worked either in San Francisco, New York, Chicago and they do know Chefs’ Warehouse. They know our original specialty company, Dairyland. So I just finished visiting just about all our markets, so I spent a lot of time in the field with our managers and sales staff. And I was really, really excited to see how the brand of Chefs’ Warehouse and our protein brands are being -- are growing and stamped quality. So places like Nashville and Pittsburgh, we absolutely get a bump from the brand.

And just one last question. It's -- kind of related into that is on the gross margin, was that -- especially in specialty, I understand the gross margins can move around a lot within the protein world, but is that where you expected it to be? Some of the other companies who are having better gross margin results, kind of mix driven basically. But was your specialty within a reasonable distance of what you expected?

Yes. I would say, specialty, unchanged year-over-year at a very -- at a really strong level, was really a good result for us, especially with just under 4% inflation across specialty. Of the 70 basis points decline that we had total company, about 50 basis points was kind of what we called out in our prepared remarks, around certain center-of-the-plate categories really in our Midwest business. So besides that, we're very pleased with our gross profit margin performance in the quarter.

(Operator Instructions) Our next question is with Kelly Bania with BMO Capital.

Also wanted to just talk a little bit about gross margin more on the center-of-the-plate categories. I guess, your guidance, I believe, for your gross profit dollars seems to imply that gross margins get better as we progress through the year. So maybe can you just help us understand how you think about that, the inflation impacts on the margin and really what drove -- you mentioned kind of some of the high inflation in certain meat categories, but what really drove that? Was it just inflation? Were there any execution -- any impact from sales point? So just help us understand that center-of-the-plate inflation.

Sure, yes. Well, actually, Fells performed extremely well. So it's really -- we have a group of customers, it still is a very small portion of our business, but it's big enough to move that needle, that buy particular products. And when the market -- sometimes you can get upside down or -- you have to carry inventory in the protein business. So it depends on some of those contracts. And it's still a small part of our business, but it's big enough -- we're still small enough that it can affect the margins as it did the first quarter. And again, being such the slowest quarter of the year, our weakest quarter, has a larger effect. You saw that we tightened up our guidance, so we're pretty confident in our forecast and our ability to execute to the yearly forecast. So it's not something I'm terribly worried about. Second quarter already, we saw a little bit more of a -- we saw some relief in those particular categories. But as Chef grows, really, our goal is to grow protein to look more like our specialty business. And that's really done by bigger mix of customers, so lots of smaller customers who buy a little bit of everything from Chefs'. So that kind of starts to mitigate that kind of risk with concentration, and basically having a tighter regional management team, which is really our focus, giving more of the responsibility regionally, though we look at it -- we try to buy the big products centrally, but giving the regional managers control to be able to protect margin. But when you get a quarter like the first quarter, where you have rapid inflation sometimes of $1, $2 a pound an item, you really start to look at more protecting your gross profit dollars, Kelly, because your basic overhead is not increasing. So it's not costing you more to really move that box, so really, it becomes more protecting the gross profit dollars. And that, I think, that we're getting better and better at. But the pricing teams are really getting to focus on protein now. We've been talking about our pricing teams the last few years, and you can see the benefits with specialty margins really performing. And we think we can take that focus and that metric ability to measure and kind of pass it through to the selling teams. We think that we'll just get better and better in managing margin in protein.

Kelly, I'll just add on that. Our midpoint of our guidance implies about 10 or 20 basis points of gross profit margin improvement for the full year. I think we still feel pretty good about landing in that range. And I'll just reiterate what Chris said about -- that we're focused on the gross profit dollars growing at a faster pace than adjusted operating expenses. And we had a good performance in Q1 on that, and I think we feel good about meeting what our guidance implies around that for the full year as well.

Okay, that's helpful. And then maybe, Jim, just another one back on expenses. So I think you said the -- about 80-or-so basis points of the operating expenses was the compensation that was somewhat onetime in nature. So if you kind of take that out, I think operating -- expenses would have been up about 8% for the quarter. Shouldn't we, I guess, expect that run-rate to improve as we get into the back half? And you've kind of fully cycled Fells Point, is that the right...

Yes, let me clarify this. What I meant to say was about a portion of that 80 basis points was a one time, it's not the full 80 basis points. We did have some workers' compensation related and health insurance costs that did not repeat. It wasn't the full 80 basis points. So what I really meant to say was the 130 basis points, while I don't think we would have expected that, part of that is on the year-over-year comp. I do expect to meet our full year guidance, which would imply 20 to 40 basis points on a full year basis. So if you look at last year, we had a higher watermark in first quarter and kind of got better throughout the year. It will level off the remainder of the year. We won't see 130 basis points every quarter for the rest of the year, but on a full year basis, I expect us to meet our guidance or even potentially beat it.

(Operator Instructions) Our next question is with John Ivankoe with JPMorgan.

Actually, my question was exactly on the compensation difference, the 82 basis points that you talked about for the first quarter. Obviously, there's, I mean, a decent component of that, that's variable related to your sales force, but when we think about that line, longer term, is that one of the places that you do expect to get leverage in the business, specifically on the OpEx side or on the compensation side? Or do you expect to get more fixed cost leverage in operating expenses? Maybe you're kind of talking about the variable and the fixed component of operating expenses, not just in '18, which is what I think you just talked about, but also longer term as well?

Yes, John. With do you expect to continue to leverage our OpEx expense kind of like the tank, as -- the tank is there. So as you fill it up, you don't -- you're not paying for another tank. So as we do more and more business in the facilities that we built the last 2 years, we start to ledge OpEx. We did talk about for the past few years, we added a lot of routes in that big growth spurt we had. And as those routes fill up, you start to get the leverage. Trucks and drivers are extremely expensive. So I think we're going to start to get the benefit as we continue to grow on OpEx. On the sales side, we continue to invest in adding salespeople. They get more productive. That's why we try to make sure that we're hiring the right type of people who will stay because year one, they cost you, as a percentage, more money. And as they add business, they start to cost you less of a percentage. But the real key to lowering sales expenses is the e-commerce tools and the technology that we're implementing. So as more orders start to come in online, we think that'll free up salespeople. We're starting to see the leverage of online, where the salespeople have more time. So I think that's adding to the impressive growth we have with new business coming in. And we think it's less demand on phone calls and customer service. So there's the expectations. As we grow and become a larger and larger company, you will get some leverage on the sales cost.

And I know it's kind of a tricky question, especially as you are adding salespeople, so you're adding fixed cost, if you will, some into the organization. But is there, I guess, an easy way or kind of a -- your rule of thumb that we should think about in terms of the percentage of your operating expenses that is fixed versus variable as we really try to start to hone in our '19 and '20 models?

Yes. I mean, it's an interesting question. You can look at the cost of people as either fixed or -- there's a big component of it that is variable. So while we don't disclose or break it out, I will say that as we've been building our 3- to 5-year model that we've communicated to The Street, which is $2 billion in revenue and 7% EBITDA margin, a big part of that model is -- I'll go back to what Chris said, is leveraging our growing size and scale. And it's not just looking at each individual major bucket, whether it's our distribution centers, our selling organization, our transportation platform and our corporate infrastructure, and not just to grow headcount at a slower rate as we grow, but to look at ways to leverage our size on all of our indirect spend across the company. And so...

John, it's kind of like a Goldilocks, I mean, not too hot, not too cold. It's really spread out. So we should get a little leverage in purchasing, we should get a little leverage in logistics, we should get a little leverage in sales cost, we should get a little leverage in operating facility costs. You get -- so we are counting. And we see that -- you're seeing our performance the last 4 or 5 quarters that we're starting to get a little bit better and better and better and more efficient, and we expect that to continue.

Ladies and gentlemen, we have reached the end of our question-and-answer session, and I would like to turn the call back over to Chris Pappas for closing remarks.

Yes. Well, we thank everybody who have joined us for our earnings call.

We are happy that better weather is upon us, and we wish everybody a wonderful day and look forward to you joining us for our next earnings call. Thank you very much.

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