Chefs' Warehouse Inc (CHEF) 2018 Q4 法說會逐字稿

Greetings, and welcome to The Chefs' Warehouse Fourth Quarter 2018 Earnings Conference Call. As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, Alex Aldous, General Counsel, Corporate Secretary, and Chief Government Relations Officer. 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 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 similarly titled non-GAAP financial measures used by other companies. 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 are going to provide a business update, go over our fourth quarter results in detail and review our 2019 full year 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 2018 earnings call. Our team delivered solid revenue and gross profit growth in the fourth quarter. We experienced strong year-over-year case growth in specialty and center-of-the-plate pound growth continued to build momentum.

I would like to thank the entire Chefs' team for producing strong financial results in 2018 while continuing to grow and enhance The Chefs' Warehouse brand and service model within our growing customer base and expanding geographical presence.

A few highlights from the fourth quarter include: 5.4% organic growth in net sales, specialty sales were up 6.5% organically over the prior year. It was driven by unique customer growth of approximately 5.9%, placement growth of 4.4%, specialty-case growth of 6.5% and organic pound growth in center-of-the-plate of 4.9%.

Gross margins increased approximately 20 basis points. Gross margins in the specialty category declined 93 basis points as compared to the fourth quarter of 2017 while gross margin in the center-of-the-plate category increased 135 basis points year-over-year.

In addition, gross profit dollars grew approximately 11.2% versus prior year fourth quarter. Jim will provide more detail on margins in a few moments.

In regards to technology and operations, we continue to focus on improving our service model. During the fourth quarter, we expanded our team that focuses on customer experience, and we implemented several enhancements to our mobile app, including push messaging, barcode scanning and multiple account capabilities. These enhancements not only provide improved communication between our sales reps and customers, but also a more efficient ordering process for our customers.

Sales through our e-commerce and mobile platforms increased from approximately 8% of total revenue in October '18 to approximately 10% of total revenue in January of '19. Additionally, we have seen a 20% increase in mobile app utilization since our third quarter 2018 reporting.

We completed the initial phases of several important technology and process enhancements during the fourth quarter. They include the implementation of off-truck scanning in our Mid-Atlantic specialty distribution center and truck camera technology in our Northeast markets. Adoption in additional markets such as Chicago, Florida and North California will follow in '19 with additional sites added in 2020.

We also completed testing on an upgraded warehouse management system and process in our San Francisco center-of-the-plate facilities and expect to go live in the first quarter of '19.

During the fourth quarter, we completed the retrofit of our Houston facility and the expansion of our distribution center in Portland, Oregon. In '19 we plan to complete the buildout of our new facility in Dallas and begin expansion projects in Los Angeles and South Florida.

2018 was a great year for Chefs' Warehouse in so many ways. We expanded our footprint as we added depth in the Mid-Atlantic with our purchase of BK Specialty Foods. We invested in new market expansion with our entry into Texas and continued category expansion and fresh-cut fish with the acquisition of Chicago-based Wabash Seafood during the fourth quarter of '18.

We deepened our relationships with our customers and acquired new customers as we grew both organically and through acquisition. We reached the 75% completion milestone in the final phase of our specialty ERP sales order process implementation inclusive of 2 of our largest markets, New York and the Mid-Atlantic as well as the Ohio Valley.

We drove strong financial performance, including year-over-year double-digit revenue growth, gross profit margin improvement, and improved operating leverage, despite the industry-wide headwinds in labor and transportation cost inflation. We also generated approximately $57 million in free cash flow as determined by full year 2018 adjusted EBITDA less capital expenditures. And we strengthened our balance sheet to provide a stronger financial foundation for CW as we continue to grow our business model and geography.

Turning to 2019 and beyond, we remain excited about our runway for growth. We remain focused on increasing penetration with our existing customers, increasing the number of unique customers and establishing new market and product categories. We will also continue to expand our product category offerings, including more fresh seafoods and produce. Importantly, we will continue to focus on our team members providing them with opportunities for growth in category expertise, operations, support functions, and delivery. In addition, we aim to provide them with a technology and service platform to deepen their relationships and enhance our customers' business and experience. With that, I'll turn it over to Jim to discuss more detailed financial information. Jim?

Thank you, Chris. And good afternoon, everyone. Our net sales for the quarter ended December 28, 2018, increased approximately 10.3% to $394.1 million from $357.1 million in the fourth quarter of 2017. The increase in net sales was a result of organic growth of approximately 5.4% as well as the contribution of sales from acquisitions, which added approximately 4.9% to sales growth for the quarter.

Net inflation was 0.5% in the fourth quarter, consisting of 0.2% inflation in our specialty category and inflation of 0.9% in our center-of-the-plate category versus the prior year quarter.

Gross profit increased 11.2% to $102.3 million for the fourth quarter of 2018 versus $92 million for the fourth quarter of 2017. Gross profit margins increased approximately 20 basis points to 26.0%. The increase in margin was driven primarily by improved cost in margin management by our center-of-the-plate team, partially offset by product mix changes and significant inflation in certain specialty categories such as bakery products and chocolate.

Total operating expense increased approximately 10.3% to $84.5 million for the fourth quarter of 2018 from $76.6 million for the fourth quarter of 2017. On an adjusted basis, as a percentage of net sales, operating expenses were 19.7% for the fourth quarter of 2018 compared to 19.6% for the fourth -- for the prior year fourth quarter. Year-over-year increases in warehouse labor costs and fuel costs as a percentage of revenue were the primary drivers of cost headwinds in the fourth quarter. This was offset partially by lower general administrative costs as a percent of revenue.

We are pleased with our sales and operating teams' ability to drive positive year-over-year gross profit dollar growth as compared to adjusted operating expense growth in the fourth quarter. This contributed to a full year of 2018 positive spread of approximately 145 basis points.

Operating income for the fourth quarter of 2018 was $17.8 million compared to $15.3 million for the fourth quarter of 2017. The increase in operating income was driven primarily by increased gross profit, offset in part by higher operating expenses. As a percentage of net sales, operating income was 4.5% in the fourth quarter of 2018 compared to 4.3% in the fourth quarter of 2017.

During the fourth quarter, we repriced our $239.7 million term loan maturing in June of 2022. We reduced the coupon from LIBOR-plus 400 basis points to LIBOR-plus 350 basis points, reducing our ongoing annual interest expense related to this debt by approximately $1 million, inclusive of the financing fees associated with the transaction.

In addition, due to the change in the mix of lenders participating in the repricing, we wrote off a portion of deferred financing fees to interest expense in the period. Interest expense increased to $5.7 million versus $5.3 million for the prior year fourth quarter, due primarily to the write off of $1.1 million of deferred financing fees associated with the term loan repricing. This was partially offset by lower effective interest rates charged on the company's outstanding debt and the conversion of the $36.75 million of convertible notes maturing in 2021 during the third quarter of 2018.

Income tax expense was $3.1 million for the fourth quarter of 2018 compared to $0.6 million for the fourth quarter of 2017. The increase in income tax expense is primarily due to the impacts of tax reform in the prior year quarter, which generated a one-time income tax benefit of $3.6 million in the fourth quarter of 2017.

Our GAAP income was $8.9 million or $0.30 per diluted share for the fourth quarter of 2018 compared to net income of $9.5 million or $0.35 per diluted share for the third (sic) [fourth] quarter of 2017. On a non-GAAP basis, adjusted EBITDA was $24.6 million for the fourth quarter of 2018 compared to $22 million for the prior year fourth quarter. Adjusted net income was $9.6 million or $0.32 per diluted share for the fourth quarter of 2018 compared to adjusted net income of $6.2 million or $0.23 per diluted share for the prior year fourth quarter.

We continue to benefit from strong cash flow and ended the fourth quarter of 2018 with $42.4 million of cash on the balance sheet. Pro forma net debt-to-adjusted EBITDA was 3.3x as of the end of the fourth quarter of 2018.

Turning to our guidance for 2019. Based on the current trends in the business, we are providing our financial guidance to be as follows: We estimate that net sales for the full year of 2019 will be in the range of $1.52 billion to $1.57 billion; gross profit to be between $390 million and $400 million; net income to be between $27.2 million and $30 million; GAAP net income per diluted share to be between $0.90 and $1; adjusted EBITDA, we expect to be between $86 million and $90 million; and adjusted net income per diluted share to be between $0.91 and $1.01. This guidance is based on an effective tax rate of approximately 27.5% for 2019. Our full year estimated diluted share count is approximately 30 million shares.

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

(Operator Instructions) Our first question is from Andrew Wolf from Loop Capital Markets.

I wanted to ask about the gross margin contraction in specialty, kind of, 3 quarters in a row, is it? I remember last quarter was the same issue, I think, certain categories had rapid inflation, was that also the situation in second quarter? So should we kind of expect one more quarter of this and then it cycles? Can you give us a little more color on what's going on there?

Sure, when you said second quarter, Andy, you're referring to the fourth quarter?

Well, I'm saying this is 3 quarters in a row where there was a lot of gross margin contraction. So obviously, this quarter was the highest but it was also high in the third quarter and second quarter.

So if you -- yes, I mean, overall, we're really, really pleased with the gross profit margin improvement. The volatility versus center-of-the-plate and specialty is mainly driven by the comp. So if you look at Q3 and Q4 of last year versus Q3 and Q4 of 2018 -- of 2017 versus 2018, it basically in center-of-the-plate is normalization of prices. And in terms of specialty, we actually had a gross profit margin profile very similar to what we would expect in the fourth quarter. But we had a very strong Q4 2017, I think we had a 70 basis point increase and we had similarly a decrease on the center-of-the-plate side. So overall, very happy with it. I mean within that just to provide you a little more color, I -- in the prepared remarks I already mentioned that we had pretty spiky type inflation in bakery and chocolate and some other categories. And we had a bit of an impact from mix as we had growth in dairy and eggs and they come in at a lower gross profit margin profile than our average specialty categories. So overall very pleased with the contribution of Q4. They contributed to a full year 10 basis point improvement 2018 over 2017. It's really just the comps that are driving the volatility.

Okay, that's helpful. So we should look for some normalization in the specialty margins unless some categories...

Yes, I think what you'll see with the comps in 2019 are really the kind of reverse. So we'll have tougher comps on operating leverage in the first half and easier on gross profit margins. And it kind of reverses in the second half and that's just driven by the cadence in 2018.

If I can just add one more before I go in the queue and Chris you mentioned how the penetration of mobile ordering's going up. I think you referred to customer experience team. Are these programmers? Or are these -- can you just give us a little elaboration of what they're doing? Or is it a little more broader than that? And also could you just kind of related or personnel related, are you adding salespeople as well on the territory type managers?

Yes. Well, I think -- I'll start with the last one. So we're always adding sales people, Andy. I mean, we're a growth company, so we're constantly hiring new territories. We got new categories. And again, we're still very small in lots of the cities that we've opened in. And even in our biggest businesses, we -- you feel there's tremendous opportunity to continue to grow. So we're constantly carefully adding to -- it takes time to train properly. We sell a lot of items. We sell a lot of incredible ingredients that you need a lot of knowledge. So it's an ongoing -- it's constantly ongoing. So we've added people to the team that's going to take us to the next level in online ordering, in the online experience of -- I've challenged them with at best-in-class performance and what we're putting out there. And really what we're doing is speaking to our customers more. So we do have a team that's analyzing the information, all the data that keeps coming in from all the applications we're adding and all the analysts we have. So we've beefed up that team, no pun intended. And really trying to make it a world-class experience when you come to Chef online so whether you want to speak to us or you want to communicate online, we think the experience should be similar. So we've kind of beefed up that department.

Our next question is from Renato Basanta from Barclays.

So first I just wanted to touch on 1Q sales for a bit because I think last year you had some things that were sort of one-off in nature with the weather and so on. So I think it could be helpful to just get a better sense of trends as you exited 4Q, sort of, what you're seeing year-to-date? And then maybe just remind us of the cadence of sales in 1Q last year?

So last year in 1Q, I think, the weather impact was more towards the last end of the -- the back end of the quarter, kind of the March timeframe. We had a number of storms in the Northeast, and we had a storm very early in the quarter as well in early January. So in terms of Q -- where we are right now, I mean, we saw sequential good organic growth through the year that continued into the fourth quarter. Obviously, there's been some weather in the Midwest in the middle of January and then early in February. I mean, I think, everybody's aware of that, the polar vortex. But other than that, we saw solid momentum coming out of the fourth quarter.

Okay. And then just a follow on that. Can you remind us how much March is, as a percentage of sales? Or EBIT? And then if you are expecting any impact from Easter -- the Easter shift?

We don't disclose the percentage of an individual month, but obviously, March, I think, for the entire industry is -- it's generally a 5-week fiscal month and is generally the largest portion of the first quarter. And some of that is due to the -- you coming out of that -- generally coming out of the weather from January and February.

Anything on Easter?

Don't have anything on the Easter shift right now.

Okay. And then just last one from me. It seems like OpEx came in a little higher than maybe what some folks were expecting. Is there anything that sort of caught you by surprise in the quarter? And then sort of given the guidance for leverage in '19 and some easy compares early on, how should we be thinking about the cadence of expenses throughout 2019?

Sure. Just on your first question, I would say, overall, our business performance, in terms of OpEx, was really as we expected in Q4. I think from a percent of revenue metric, we're generally flat and that was given a quarter with essentially no inflation, whereas we were comping against the quarter with pretty decent inflation last year. So the percent of revenue metric, it would have been better. We did have a few corporate type expenses that were higher than we expected. One related to health care claims and the other related to a legal settlement that we didn't expect. But other than that, we're really happy with the fourth quarter. I think in my prepared remarks I mentioned that we had another quarter of positive gross profit dollar growth above adjusted OpEx growth and that contributed to the full year just under 150 basis points. If you look at your 2019 guidance, we're guiding to continued operating leverage, despite we're forecasting very moderate and to flattish type inflation. So overall, I think, look, we're going to continue to scale and we're going to continue to drive operating ledger. A few points of inflation will certainly make it better from a percent of revenue metric, but we're focused on the gross profit dollar to adjusted OpEx GAAP. And as I mentioned earlier, just given the way the comps played out, our operating leverage was heavily weighted to the first half of 2018 and so the comps would reverse from an easier and tougher comps perspective in 2019. So we would expect that we would have tougher comps in the first half, still, expect to generate operating leverage but not the level of what we did in the first half of 2017 from a year-over-year perspective. And then it would be more heavily weighted to the back half of the year, just given the way the cadence of 2018 worked.

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

Just a couple of questions. Wanted to ask, I think you mentioned a seafood acquisition in the quarter. Just wondering if you can talk about that? What that brings to Chefs'? And I thought I heard you mention produce, so can you comment on what you're looking at in terms of produce?

Sure. So we had the opportunity to add a fantastic small company in the Midwest. It's -- it was really sweet -- we didn't really call it out really because it's pretty small, so it was not anything significant. But what it did add is some very talented people. We have a seafood division coming out of the Ohio Valley, so those kind of ties now as we tried to merge the talent from Chicago into the Midwest and we have a growing team in Chicago. So we think that we can really grow this division. And it goes well with our protein division. So we're really excited about it, but it is small, Kelly. So it's just the -- it's in the infant stages, but it will grow. Produce, we do sell some produce. It is part of our long-term diversifying our product mix. Everybody eats produce. You see it on most food companies' trucks, so we do very little. But we're looking at how it fits into the Chefs' Warehouse mix, especially as we build our new buildings. We did launch a small department in New York, which is going really well. So I would say stay tuned, but I think that it works really well especially the specialty produce. We're not looking to be a big commodity produce company. So we think it fits very well into our specialty division.

Okay, great. And I think last month you talked about kind of flat to 1-ish overall inflation. Just curious if anything's changed there or I guess a lot depends on what's really underlying that between the categories or specific categories. So anything that you're seeing to call out as we kind of think about modeling margins and what expectations are for inflation this year?

Sure, Kelly. So, that's about right. We're kind of forecasting, kind of moderate flat to 2% type of specialty inflation. And really around flat could be slightly deflationary to inflationary but think about flattish type of center-of-the-plate. And that gets you to, kind of, a flat to 1%. Very kind of similar to what we saw on a full year basis in 2018, so not too dissimilar. And as you mentioned, it's very category specific. So as we've come out of the fourth quarter, we've seen some really mix bags. Some categories in specialty are deflationary, like dairy and categories like that, whereas we're still seeing inflation in some of the bakery products. And then within the center-of-the-plate, it's a mix bag as well. We saw inflation in some of the lower meats like Choice in Q4 and we see that continuing and we see a little more deflation in some of the primals and we saw that in Q4. So it's really a mixed bag, so we're -- it's kind of averaging out to that 0% to 1%.

Okay, perfect. And in terms of wages, I mean, everybody's talking about the driver shortage of wages and just curious what kind of inflation you are seeing there? And what you're planning for in your plan for 2019?

Yes, not to jinx us but I think we did get out ahead of it pretty well. The ops team did a great job in recruiting and is constantly recruiting. So it's making us a better a company. We really understand that it's got to be a place people want to work, there's lots of competition for people especially with a CDL license. So we're just trying to make it a safer job, as safe as possible. It is a hard job. It's not just driving, it's -- you got to go up and down the stairs and deliver a lot of heavy merchandise. So we're really working on safety. We're working on our benefit packages, but we built-in a lot of that expense, Kelly. We did start increasing what we pay. And especially, in the markets that we saw shortages, we did get ahead and start increasing as much as possible to be competitive -- as competitive or more competitive than the people we're up against. But as they say, people don't quit really for -- they quit people, they don't quit companies overall. So we're just making sure we have the right managers in place to recruit and to retain. One of our primary sources that differentiates us is our great drivers. So I think we're okay right now.

Okay, that's helpful. And then maybe just last one for me. You -- I think you mentioned the upgraded WMS system that's going live, I guess, now. Can you just talk about what that will do and other plans to roll that out? Is that going to all the facilities or can you just explain that?

Yes, sure, Kelly. So it's really kind of a further integration of our center-of-the-plate facility, some of our center-of-the-plate facilities to some of the technology and processes around pick and packing and distribution that we have really matured and grown in the specialty -- legacy specialty facilities and businesses and it's really just a continuation. And we will be rolling it out over the next few years to all of our facilities and it's just taking what we've done on the specialty side and driving some of that efficiency into some of the facilities that we've acquired through acquisitions over the last few years.

(Operator Instructions) And our next question is from Chris Mandeville from Jefferies.

This is [Blake] on for Chris. On your debt and interest expense, you talked about your leverage now, you've got it down to 3.3x and your free cash flow continues to be healthy. On the interest expense guide, wondering what kind of debt paydown that assumes? Anything to call out on the interest expense guide? And then maybe how much debt should we expect you to pay down this year? Is there a target leverage ratio you're trying to get to?

Thanks, [Rick.] No, we didn't assume in the guide on the interest expense. We didn't assume any further debt paydown. So we delevered pretty significantly a lot of that due to the convert coming off. But in 2017 and in 2018, we paid down some debt. It's really flowing through the repricing that we did. We baked in a moderate increase in LIBOR. I think we averaged about 50 basis points over the course of the year, just from assumption perspective. And that's really it. So we haven't -- our use of cash is generally earmarked for acquisitions. We will have higher level of CapEx than we had in 2018 and 2019, as we invest a little more in building out some facilities in Texas, LA, and Florida. We still anticipate to stay around that 1.5% of revenue type of range. But it will be an elevated level. Within that, if you take the midpoint of our adjusted EBITDA guidance and our -- what we expect for CapEx, we would still come in with free cash flow growth in 2019 over 2018.

So the ratios get that -- naturally get better as EBITDA goes up, Chris. So that's really the focus, keep driving EBITDA up and the leverage ratios take care of themselves.

All right. And then I was curious on the acquisition front. It sounds like you're ready to do acquisitions now. It sounds like, do you need your leverage to get down any further before your feel comfortable doing anything bigger? And then if you could comment on valuations, are they still kind of elevated?

You know, again, the pipeline has always frothy. We're really taking our time, being extremely choosy. We've great organic growth, great case growth. We've gotten our arms around our protein division. It's getting better and better. So for us to do an acquisition, it's got to fall in our guidelines, in our comfort zone, in our -- what we're willing to pay. So I think if I had a crystal ball, you're looking at it and I think deals will close, but I think they'll -- any deals that do close are going to be in our comfort zone. I could tell you, I mean, we're looking at some big stuff but it's -- I think it's way in the future. So I think, my guidance from last year is we'd love to do really tuck-ins that are accretive. So nothing has changed there. So a strong category addition, but it would be accretive. So I think that takes care of the leverage ratio because anything we really look at is accretive at this point.

Well, we -- I'll just add [Greg], well, we might be adding debt or a mix of debt in equity to do acquisitions, we wouldn't anticipate significantly adding leverage from a ratio perspective.

Okay. And then lastly, it's nice to see the e-commerce and mobile platform continue to get good uptake. Is that something you would say is helping you win new customers? And then I was wondering if you're in a position yet to share maybe exactly how much we can expect that to start impacting margins or the average order? Anything like that?

Yes, well, again, when we built our forecast, we really didn't build in any major upside from e-commerce. So we did say that customers that come online tend to order more and the margin was a little better, but really to build out in the forecast is way too soon. What we're seeing is our sales staff having more time to go out and hunt and visit customers and show them new categories to increase business. So really more the focus right now is if we can continue to grow at the rate we're growing and not have to add the amount of people we would normally add. Historically, it's going to give us better leverage on our operating expense and really that's our focus. I think the rest will kind of take care of itself.

This concludes the question-and-answer session. I would like to turn the floor back over to Mr. Pappas for any closing comments.

Sure. Well, great. Well, thank you everybody for joining our fourth quarter call. We look forward to you joining our first quarter call. Very proud of our team. It was a great '18. We're very proud of the fourth quarter and the efforts are -- our team put forward. And once again, I thank you for joining our call. Look forward to our next call. Have a great, great day.

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