The Chefs' Warehouse, Inc. (CHEF) Q3 2013 Earnings Report, Transcript and Summary

Greetings and welcome to the Chefs' Warehouse Third Quarter 2013 Earnings Conference Call. (Operator Instructions). It is now my pleasure to introduce your host Alex Aldous, General Counsel and Corporate Secretary for the Chefs' Warehouse. Thank you. Mr. Aldous, you may 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 Q2 2013 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 projected EBITDA and adjusted EBITDA as well as both historical and projected modified pro forma net income and modified pro forma earnings per share. These measures are not calculated in accordance with GAAP and may be calculated differently than 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 projected 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’re going to provide a business update and go over our third results in detail. Then we will open the call for questions. With that, I would like to turn the call over to Chris Pappas. Chris?

Thanks, Alex. Welcome to all who are listening today. We are very pleased with our third quarter results and the continued sequential improvement in our business. A few highlights for the quarter include the following: an increase in net sales of approximately 37% over the third quarter of 2012, a gross profit increase of approximately 36% over the third quarter of 2012 and an adjusted EBITDA increase of approximately 24% over the third quarter of 2012, the successful completion of our secondary offering of common stock. We continue to be very optimistic about the long-term health of our business and so our improvement in our key indicators in the third quarter. During the third quarter, our number of cases sold grew approximately 5.6% quarter over quarter and 0.8% sequentially adjusted for acquisitions which was consistent with our expectations. In addition, our number of unique customers and placements also grew in the mid to high single digits year over year, 5.2% and 6.7% respectively after adjusting for the estimated impact of acquisitions. One observation regarding current trends is that we did see some softness in our October case volume. While we believe this was influenced by weakened consumer confidence due to the government shutdown, we remain optimistic for historically strong holiday season. Our growth strategies continue to be focused on growing our current markets through increased penetration of our existing customers, adding new customers, and identifying new markets that we believe present opportunities for future expansion. We continue to invest in people, process and products to ensure we preserve our brand as the elite distributor in food service. Our ability to put reps on the street who are better trained than our competition with superior products and efficient processes will be the key to our continued success. As many of you…

Thank you, Chris, and good afternoon everyone. Our net sales for the quarter ended September 27, 2013 increased approximately 36.7% to $170.6 million from $124.8 million in the third quarter ended September 28, 2012. The increase in net sales was largely due to the acquisition of Queensgate Foodservice in December of 2012 and Qzina in May of 2013, and to a lesser degree, Michael's Finer Meats which we anniversaried during the quarter, which all added approximately $35.6 million or 28.5% of total sales growth in the quarter. Strong organic growth amounted to approximately $10.2 million of our net sales growth or an 8.2% growth. Inflation moderated somewhat from the second quarter and was approximately 2.7%. We're seeing more consistent inflationary trends across the broad group of categories, although it was more moderate than in the second quarter. Gross profit increased approximately 35.8% to $44.0 million for the third quarter of 2013 versus $32.4 million for the third quarter of 2012. Gross profit margins decreased approximately 17 basis points to 25.8% from 25.9% due to the impact on sales mix from the Michael's acquisition. Excluding the impact of the Michael's acquisition, gross profit margins increased 44 basis points. Total operating expenses increased approximately 37.8% to $34.5 million for the third quarter of 2013 from $25.1 million for the third quarter of 2012. As a percentage of net sales, operating expenses were 20.2% for the third quarter of 2013 compared to 20.0% for the third quarter -- the prior-year third quarter. The increase in the company's operating expense ratio is attributable to increase amortization expense related to acquisitions, duplicate rent related to the Bronx, New York facility, and higher compensation related expense, offset in part by lower insurance, bad debt and stock compensation expense. More specifically, warehouse distribution and selling costs increased…

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions). Thank you. Our first question comes from the line of Karen Short with Deutsche Bank. Please proceed with your question. Shane Higgins – Deutsche Bank: Yes, hi. Good afternoon, and thanks for taking the question. This is Shane Higgins on for Karen. Yes, just real quick guys. You mentioned the October weakness. Was that pretty broad-based geographically or are there any patterns there that you could point to maybe that was underlying that weakness?

You know, it's really coming out of September which was very strong and we're watching case counts. Something usually has to happen for that to change. And there was no financial crash, there was no big world event, other than the government, all the noise with the government shutting down. And what we heard from our customers across the country was it just seemed like everybody held back just a little bit. Our customers, their outlook for the holiday season was very strong, parties are booked. Nothing really has changed. So the only thing we could, you know, we've seen, you know, maybe a good World Series or other events where people just stay away a little bit. But we're really, you know, we're really a little confused of what happened with October, but we don't really see it as any real major change in our business. Shane Higgins – Deutsche Bank: Okay. And you guys don't, I guess, maybe you don't have enough time that's passed since the government shutdown ended to get a read on kind of what's happened post?

Yeah. Well again, you know, we watch our business daily and we talk to our customers daily. And nobody really seems to be very concerned about what's happening in their business. So we just think it might have been a blip. Shane Higgins – Deutsche Bank: Okay, great. And just on the inflation, it looks like it has been coming down sequentially. It sounds like it's kind of been less volatile here. How should we think about that in the fourth quarter in terms of trend, if that continues to go down? And how does that impact your business or how we should think about margins and sales?

Yeah, I think a couple of things on the inflation piece. One is you're exactly right in that there's probably been less volatility overall, you remember, on the second quarter -- the 4.1% inflation was largely driven by dairy. But I think six of our top ten categories actually showed some deflation in that 4.1% number, whereas in the second -- I mean sorry, third quarter, the 2.7% was a little bit more broad-based. I think eight of our ten -- top ten categories were inflationary but nothing was outlandishly inflationary like dairy was in the second quarter. So we think that's actually a little more normal environment. You know, who knows what a crystal ball will look like. But I would -- we typically plan -- or we're going through this year planning for about 2% to 3% inflation.

Right. Shane Higgins – Deutsche Bank: Okay. So I take it less volatility. I mean you guys like to see probably -- your customers probably like it to be low single digit and stable.

Absolutely, 2% to 3% of inflation is good.

And a lot of up and down. And, you know, besides our protein business which is a little less margin, our overall business actually we took some margins in the third quarter. So we did have a little volatility up and down even though there really wasn't that crazy inflation or deflation environment, it actually worked out pretty well for us. And, you know, looking into the fourth quarter, right now, the only category that looks like it has some inflation is protein. Shane Higgins – Deutsche Bank: Yeah, I saw that with the latest CPI data. Okay. So, modest inflation, low volatility is good, equals good for you guys.

Look, we like a little bit of volatility, but net-net, 2% to 3% inflation is good.

Is a good number. Shane Higgins – Deutsche Bank: Okay. Okay. And just one last, if I can squeeze it in here, it looked like the acquisitions, you guys mentioned $35.6 million in sales growth there. That was actually a little better than we were looking for. Can you just talk about maybe what's been driving that strength and, you know, how we should think about kind of the growth, you know, the run rate of those -- the sales growth in those acquired businesses?

Yeah, those -- that's driven obviously by Queensgate, Qzina and then we lapsed Michael's during the quarter, so really only a half a month of that number was from Michael's. So I don't know how you try to model that. That might be part of the equation too. Shane Higgins – Deutsche Bank: Got it. All right. Thanks guys.

Thank you.

Thank you. Our next question comes from the line of [Mark Milamuth] from Jefferies. Mark Wiltamuth – Jefferies: Hi. Mark Wiltamuth from Jefferies. I wanted to ask a little bit about the organic sales growth trends and how you felt about the case volume improvement. You did improve sequentially, but if you look at a two-year stack chart, still kind of eroding a little bit sequentially. Maybe you could get -- shed some light on that and how you're feeling about the organic sales trends right now.

Yeah, I think in general we feel really good about the trends. You know, if you're comparing it to a couple of years ago, there were some pretty high organic growth numbers in there. But we're -- what we've seen sequentially over the last probably four to six quarters, I think we feel very good about the trends. If you look at first quarter, I think we were at about 3.8%, 3.9% case growth. Second quarter was 4.8%, third quarter was 5.6%. So that to us is a very good growth trend. We did mention a little bit of softness in October, but long term we're --

Right.

-- aim to get back in the high single-digit, low double-digit growth.

Right. And again we look at what's happening with our larger customers, our big hotels, casinos, you know, where a lot of volume is driven as well. And the parties look -- we're hearing numbers are up, heard Marriott report today, and '14 is looking stronger than '13. So all the signs point to we're going in the right direction. Mark Wiltamuth – Jefferies: Okay. And on your -- I guess your guidance in early September, it sounded like there was some inflation pressure on margins and it sounds like maybe only the red meats were a problem here in the quarter. Maybe things abated a little bit in terms of the inflation pressure on margin?

Yeah, I think for sure, and I think, you know, as Chris had mentioned, when you strip away our protein business, we actually had about 44-basis-point improvement in gross margins. So that was a good trend for us. Mark Wiltamuth – Jefferies: Okay. Okay, thank you very much.

Thank you.

Thank you. Our next question comes from the line of John Ivankoe with JPMorgan. Please proceed with your questions. John Ivankoe – JPMorgan: Hi, great. Thank you very much. Your largest competitor within foodservice broadly, not necessarily specialty, there's kind of a lot of conversation in the marketplace about what they've done, you know, with their sales management, what they've done with their product selection that, you know, maybe it's causing some looseness in their [street] business or their specialty account business, their customer business, that you and others could potentially be benefiting from. So if it's an inappropriate question, I apologize, but could you kind of talk about what's happening on a competitive basis and if you could actually kind of quietly be benefiting from some of the changes that are happening elsewhere?

Well, we'd like to benefit, for sure. But we're running a pretty tight playbook and we're just so different than trying to compare us to a typical broad-liner. The way we go to market, we're in specialty in many different categories, you know, over 10,000 items of specialty. So there's not a lot of growth out there, and for us, to be growing, obviously we're taking market share, especially in the new markets we're in. So we're, you know, we're obviously looking at what the competition is doing, but we have a very long-term strategy that we're trying to execute to. And we're constantly changing the mix of what we're selling and how we go to markets. As much as we're looking at what they're doing, we're pretty much -- we've got our noses down and we're trying to take market share and run our playbook. John Ivankoe – JPMorgan: Great. And then separately if I may, could you talk about the integration [stuff] that you had from a systems perspective with some of your recent acquisitions and if all the sales and cost benefit from that integration is currently reflected in the numbers or that could be a little bit of a tailwind from here?

I think there's a couple of things. So the most recent acquisition we did was Qzina. We have not converted systems yet. That was by design. As we probably talked about before, we're in the process of upgrading all of our JD Edwards systems internally and I'd rather wait until that is finished so we don't go through two conversions there. We have had some success with Queensgate which was the deal we did right at the beginning of the year. So they are converted on to our system. And lastly is Michael's kind of prior to that which, given the meat specialty, we decided to wait. So we've got two acquisitions that we have not consolidated. I'd say we will plan in the long run of getting those on our system, and I think that will provide a tailwind for us for sure. John Ivankoe – JPMorgan: And if there's a way to handicap what your type of acquisition that could be upcoming, would it be a geographical acquisition or would it be more product line focused?

I would say right now, you know, there's possibilities in every category, in every geography, from fold-ins to new markets, Chefs' Warehouse is -- we're pretty business. John Ivankoe – JPMorgan: That's great. Thank you.

Thank you. (Operator Instructions). Our next question comes from the line Scott Van Winkle with Canaccord Genuity. Please proceed with your question. Scott Van Winkle – Canaccord Genuity: Hi, thanks. First, any update on timing in the Bronx facility? Anything new we should be aware of?

Nothing is changing there. No, we're still working through all the permitting process and building away.

Yeah.

So it'll be mid next year we're hopeful. Scott Van Winkle – Canaccord Genuity: Great. And talking about the oddity of October, being a little off, last year, was there anything -- and obviously you had the storm that kind of throws off the comparison. Is there anything seasonal we should consider? Obviously it's a big holiday and you talked about your big customers have, you know, good party numbers, etcetera, etcetera -- is there anything else we should think about seasonally or comparison to last year?

I don't think seasonally, you know, Hurricane Sandy was actually a November, fiscal month November event, not a -- didn't impact October. So, no.

Yeah. Just -- Scott, there's just nothing on the radar, you know. We're just here business as usual and was just a little off. So obviously we're always concerned, but I don't think I'm that concerned, I'm seeing the bookings, I'm seeing our core customers extremely busy. So we're anticipating a very good season. Scott Van Winkle – Canaccord Genuity: That's good. And then following up on the question about what types of acquisitions might be in the works, and I understand you got a lot of stuff. And you gave kind of indications of size. Are -- should we expect the size to be kind of stepping up as the company grows? I think the ones you're talking about now are maybe a little larger than, you know, around the time of the IPO. Is that what the expectation is, you know, maybe larger acquisitions going forward?

Yeah. I would say, Scott, right now, there's just so much at Chefs' going on between we have multiple companies in regions that we plan to expand that business and once you consolidate some of that and maybe do some fold-ins, that's -- it's highly, highly accretive. So, you know, we do want to continue to do $10 million to $30 million fold-ins, as well as great specialty companies that are out there that give us new territory that could possibly be fold-ins, to some of the larger ones we're looking at. And we're looking at, you know, from the fold-ins, from the 10 to 30's, to anything from $200 million to $300 million, now is in our ballpark. So we're very disciplined and they have to meet the sell-throughs that we go through to say it could be a great Chefs' Warehouse. But obviously the capital we've raised and our line of credit, we're in a great place to do a large one. Scott Van Winkle – Canaccord Genuity: Thanks. And finally, John, now that you have a protein business with a different margin structure, does the mix stay relatively the same quarter to quarter? Let's forget the volatility of commodity prices and things of that nature, but the mix of your business now that you have different product categories at different margin levels, does that stay pretty consistent quarter to quarter?

I think the relative mix for instance between protein and specialty, yes. They're still serving those generally higher-end customers, so the quarterly cadence of earnings for the protein business is very similar to the specialty business, so I don't think it'll change the mix quarter to quarter, other than acquisitions obviously. Scott Van Winkle – Canaccord Genuity: Okay. Thank you.

Yup. Thanks.

Thank you. Mr. Pappas, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

Okay. Well, we thank everybody for joining us on this call on Halloween, and I don't think we'll get a chance to talk to everybody, so we're wishing everybody a happy holiday coming up, Thanksgiving, and we'll speak to you soon. Thank you very much.

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