The Chefs' Warehouse, Inc. (CHEF) Q4 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the Chefs’ Warehouse Fourth Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Alex Aldous, General Counsel and Corporate Secretary of Chefs’ Warehouse. Thank you, Alex. You may now begin.

Thank you, Operator. Good afternoon everyone. With me on today’s call are Chris Pappas, Founder, Chairman and CEO; and John Austin, CFO. By now you should have access to our fourth quarter 2014 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 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 estimated financial performance. Such forward-looking statements are not guarantees of future performance, and therefore, you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from what we expect. Some of these risks are mentioned in today’s release. Others are discussed in our Annual Report on Form 10-K and Quarterly Reports on Form 10-Q, which are available at www.sec.com. Today, we’re going to provide a business update, go over our fourth quarter results in detail and review our 2015 guidance. Then we will open the call for questions. With that, I would like to turn the call over to Chris Pappas. Chris?

Thanks Alex, and welcome to all who are listening today. The fourth quarter was another strong top line quarter for the company with revenue growth of 18%, which included 8.8 percentage points of growth from acquisitions. We did however continue to see very high inflationary pressure in many of our key categories. However, compared to the third quarter we did a much better job of managing that inflation. During the fourth quarter, our number of unique customers grew approximately 10.7%, placements grew approximately 5.7% and case growth was approximately 3% versus the prior years fourth quarter all adjusted for acquisitions. This growth was relatively broad based, with double-digit growth continuing in the western and southern regions of the country. While the weather has not been helpful in the New Year our KPIs related to growth have held up reasonably well and [be it on] [ph] weaker comps in the last years poor weather. As I mentioned, we continued to see inflationary pressure during the fourth quarter primarily in the dairy and protein categories both meat and seafood categories. We managed that much more successfully and saw a 21 basis point increase in gross profit margins in our core specialty categories. While our overall revenue was strong, gross margins were slightly lower than we anticipated particularly in our pastry category as we prepare to consolidate certain warehouses and transitioned out a large pastry customer. Moving on to acquisitions, in January we announced that we entered into a definitive agreement to acquire Del Monte for approximately $191.2 million. Del Monte was founded in 1926 and supplies high quality USDA inspected beef, pork, lamb, veal, poultry and seafood products in Northern California. In addition, Del Monte’s staff of high-skilled butchers are able to provide fresh, portion-controlled products to satisfy customers’ needs on a fresh, cut-to-order basis. Del Monte is one of the best companies I have seen in this category with an experienced management team and a group of dedicated associates. The culture, diverse customer base and extensive, experienced sales force and protein expertise is a perfect fit and complement to our entire organization. It will allow us to further strengthen our West Coast presence and build a West Coast protein strategy particularly in a key culinary market like San Francisco. Mr. John DeBenedetti, the CEO and principal owner of Del Monte will be named Executive Vice President of our Protein division, and will also be joining the Company's Board of Directors post-closing. We expect that he and his team will expand our center of the plate offerings and strengthening our existing protein businesses. Last week, we received HSR approval and still expect to close the transaction near the end of the first quarter of 2015. Moving on to Allen Brothers, we continue to consistently build that business as the most prestigious national high-end brand in protein and continue to see significant traction in our other markets with Allen Brothers product lines. The performance of Allen Brothers improved sequentially from the third quarter due in part to the seasonal contribution from the B2C component of that business. However, the year-to-year over to impact from the mix of protein continue to dilute margins somewhat. The combination of Del Monte, Allen Brothers and Michael's brings us closer to a national platform we are looking forward to building. So all our specialty companies can start to pull from our protein suppliers creating what we call a family of company options to our customer base. Lastly, our integration of Euro Gourmet which was announced in October of 2014 is going very well. As a reminder, Euro Gourmet is based in Beltsville, Maryland and was founded in 1999; they are a wholesale specialty distributor of import and domestic products in the Mid-Atlantic and we folded them into our Baltimore/Washington facility. We believe that this acquisition both complements our already extensive product selection and expands our customer base in that market. While not a particularly large acquisition for us, we continue to look for complementary fold-in opportunities like this. Moving on a little bit about other facilities, our Chicago warehouse is getting ready to open, we just receive our certificate of occupancy and are extremely excited to attack this market. We continue to add top industry talent in the Chicago facility and believe that Chicago market has a long-term potential to be one of our largest markets for our company. It will also give us the opportunity to consolidate one of the Qzina branches and the Allen Brothers storage facility into our CW Warehouse. In addition, our move into the new Bronx facility is progressing and we continue to expect to be fully operational in the first quarter of 2015. Over the past few weeks we’ve consolidated the Qzina New Jersey branch into our Bronx facility. We are scheduled to move the balance of our product categories in over the next month ultimately going from three operating facilities to one in the metro New York area. We also have plans to move into our new warehouse in San Francisco in mid-2015, which will accommodate one of the Del Monte branches as well and allow us to consolidate the Qzina San Francisco facility. This is included in our guidance for 2015. We also expect to complete construction of our new Las Vegas facility later this year which provide us ample opportunity for continued growth. This facility will also include a new culinary center which will enhance our sales and marketing efforts. So as you can see we have a lot going on. We are happy to have 2014 behind us and are excited about the prospects of growth. And with that, I will turn it over to Mr. John Austin to discuss more detailed financial information. John?

Thanks, Chris and good afternoon everyone. Our net sales for the quarter ended December 26, 2014 increased approximately 18.0% to $228.2 million from $193.4 million for the fourth quarter ended December 27, 2013. The increase in net sales was the result of organic growth as well as the acquisition of Allen Brothers during late 2013 and to a much smaller degree the acquisition of Euro Gourmet. Acquisition growth accounted for approximately $17.1 million of our net sales growth for the quarter and organic growth contributed the remaining $17.7 million or 9.2% of our growth over the prior year fourth quarter. Inflation increased to 125 basis points sequentially and was approximately 6.9% for the quarter. We particularly felt the uptick in inflation in the dairy category in the meat and seafood categories. While our overall outlook for 2015 is in the 3.5% range, protein prices are expected to remain high particularly in the first half of 2015. Gross profit increased approximately 15.5% to $56.9 million for the fourth quarter of 2014 versus $49.3 million for the fourth quarter of 2013. Gross profit margins decreased 55 basis points to 24.9% from 25.5%. This was due in large part to the greater mix of protein business as we lap the acquisition of Allen Brothers. And Allen Brothers relative performance even though it improved sequentially also contributed to this decrease. As Chris noted earlier, our gross margins in our pastry category were also softer than we expected. However continued focus on managing inflation resulted in a 21 basis point increase in margins in our core specialty categories, which partially offset these margin headwinds. Total operating expenses increased approximately 15.7% to $45.2 million for the fourth quarter of 2014 from $39.1 million for the fourth quarter of 2013. As a percentage of net sales, operating expenses were 19.8% for the fourth quarter of 2014 compared to 20.2% for the prior year quarter. The decrease in our operating expense ratio is attributable to lower amortization expense, investigation costs related to our previously disclosed Michael’s inventory issue and [deal] [ph] related costs, as well as a higher reduction in contingent earnout liabilities. All these were offset by higher warehouse labor costs, and higher net shipping and catalog costs at our Allen Brothers subsidiary. In a little more granular detail branch level operating expense which consisted warehouse distribution and selling costs increased approximately 57 basis points due in large part to the company’s acquisition of Allen Brothers and related higher freight and promotional spending at Allen Brothers. Warehouse labor costs also influent and our protein business is also contributed to that increase. G&A expenses decreased to approximately a $11.1 million for the fourth quarter of 2014 compared to $11.2 million in the prior year quarter, due in large part to the lower amortization expense, investigation costs and deal-related costs I just mentioned offset by the reduction in contingent earnout liabilities. Adjusted for these items, G&A cost were flat as a percent to sales. Operating income for the fourth quarter of 2014 was $11.7 million compared to $10.2 million for the fourth quarter of the prior year. Interest expense was nearly flat at $2.1 million versus $2.2 million in the prior year fourth quarter. Income tax was $4.4 million in the fourth quarter of 2014 compared to $3.2 million in the prior year which the current year included a $519,000 charge related to a New York state tax audit for the periods 2010 through 2012. Net of the associated federal tax benefit from that tax issue. Adjusted for this charge, our effective rate for the fourth quarter was [approximately 41.5%]. Net income was $5.2 million or $0.21 per diluted share for the fourth quarter of 2014, compared to $4.8 million or $0.19 per diluted share for the fourth quarter of 2013. On a non-GAAP basis, adjusted EBITDA was $12.2 million for the fourth quarter of 2014 compared to $13.4 million for the prior year fourth quarter. Modified pro forma net income was $4.9 million and modified pro forma EPS was $0.20 for the fourth quarter of 2014, compared to modified pro forma net income of $5.4 million or $0.22 per share for the fourth quarter of the prior year. With that, operator we’ll turn it over for questions.

Thank you. At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Thank you. And our first question comes from the line of Mark Wiltamuth with Jefferies. Please proceed with your question.

Yes, good afternoon guys. It’s actually Chris Mandeville on for Mark.

Hey, Chris.

How is it going? I just wanted to started off real quick on the gross margin decline, I was curious if I can get some additional color in terms of maybe buckets as it relates to the product mix shift, the performance of Allen Brothers and then the pastry margin decline?

Yes, let’s see. So most of that 55 basis points of margin and compression was related to the protein space. That was a combination of the overall mix, so obviously we are lapping the acquisition of Allen Brothers which we did half way through December last year and now we got a whole quarter and Allen Brothers performance. On a relative basis I don’t know the split, I’ll come back to you on the split of that 55 basis points. The impact from pastry was much smaller, we actually had a slight lift in margin in our specialty business. We had about a 21 basis point improvement in gross margins in our specialty business. So most of the 55 compression was from the protein side of the business.

Okay, and then in regards to the Allen Brothers entity I am curious if I could get your take on what your expectations are and what’s kind of built into 2015 guidance as it relates to the performance to that side of the business.

Yes, when we initially gave guidance that topic came up too, so we do expect to significantly improve Allen Brothers performance, it won’t be all the way back to - we didn’t plan for it be all the way back to where we think it should be, but there is some meaningful improvement. I know we called out the performance of Allen Brothers last quarter as it was such a big driver of our results. For 2015, I prefer not to get into individual operating company performance, but qualitatively we are going from a loss to making a little bit of money, but it’s not - we are not planning for it to be where it ultimately will be.

Yes, we’re expecting sequentially it gets better and better.

Okay, great. And then lastly, so I saw sequentially that your case volumes slow at a little bit presumably that’s due in part to the significant inflation that you are realizing, but I was wondering if there is anything else within that number that would have caused a decline and then as we look to kind of the first half of the year given your commentary on how bad the weather has been in the Northeast and should we more or less try and attempt to be quite conservative in regard to our sales growth in the first half of the year?

Yes, I think there’s maybe a couple of data points I think that are important. I think our overall case growth was probably a little softer in the fourth quarter mostly related to Qzina. I think we are still seeing nice case growth, double-digit case growth on the West Coast, we’re still capacity constrained in New York, so we are not fully operational again in our new Bronx facility or we are hopeful that obviously will give us capacity then generate a little bit higher case volume, but New York was still positive. I think the cadence of case growth throughout the quarter December was a little softer than October and November. Again not alarming but it definitely softened a little bit in December; the things I would probably point to or you want to think about in relation to the model we are basically forecasting a mid single-digit case growth number for 2015. Weather is probably not great, the good thing is this is the first quarter, it’s not our strongest quarter anyway, but weather is not ideal right at the moment. I think what we are seeing right now is relatively decent comps versus last year, now last year had lousy weather in the first quarter too. So I wouldn’t consider it robust, but it’s the comps are reasonably good. The other thing I’d probably keep in mind is relative to quarterly cadence, we are still going to be cycling - Allen Brothers actually performed okay in the first quarter last year where this year they are still in a little bit of turnaround mode. So that has an impact just on kind of the quarterly year-over-year piece, but…

Yes, we’re seeing pretty good case growth with where we don’t have a foot of snow. We’re actually seeing a very healthy case growth.

Yes. Thanks guys.

Thank you. And our next question comes from the line of Scott Van Winkle with Canaccord Genuity. Please proceed with your question.

Hey, guys its Mark Sigal for Scott. So with respect to the core business you commented you drove about 21 basis points of improvement in gross margin, the last couple of quarters I think you know 40 basis points or so in decline in the core business. Can you talk about the specific elements where you are managing inflation more closely; is it better procurement, are you able to pass through pricing a bit more easy, a combination of all the above?

I think you got it. It’s a combination of all the above; it’s the new norm. People are accepting that meat prices are high and a lot of food products have gotten more expensive. So I think as a management team we really focused on it and I think we’re starting to get the benefit of it of being able to manage it pass it on better different sources of supply. So obviously coming out of a year - last year where we had record inflation in most of our major categories put a big emphasis that we get our arms around it and start to manage it better in case it just doesn’t, we don’t get any relief in the commodity markets.

Yes, I think maybe add a little color on that as well. In the last quarter where we had the 40 basis point compression in our core specialty business, we had a lot of hyperinflation, dairy was crazy, meat, seafood. We saw actually the same actually a little bit higher inflation overall, but those same categories were still highly inflationary versus the prior year quarter. But when you look at kind of how we were able to pass those through. I think the general premise I think that we’ve always talked about is modest inflation is good, you can pass it through relatively quickly; when things are really volatile or there is hyperinflation that’s hard to pass it through as quickly as you really need to. So that’s why you probably saw last quarter we did not get that passed through as much as we - I think we did a good job as we probably could with that hyperinflation, this quarter I think you see us catching up to that and we were able to get it passed through.

Okay, yes, that makes sense. And then on Allen Brothers, are you able to quantify at all the seasonal lifts to gross margin you got with Q4 benefiting from the strong B2C business?

I’m not sure we can quantify it exactly for you just because I don’t want to talk about individual profitability of operating companies, but our percentage margin was weaker this year, the gross margin was weaker this year at Allen Brothers than it was in the fourth quarter last year. And part of the reason for that is last year we by the time we closed, we closed right before the holidays. So a larger portion of their mix was in the B2C space, where this quarter you had a full quarter of wholesale business plus the B2C. So we were down year-over-year. I think last year we’re at about a 33% margin at Allen Brothers on a gross margin basis, and this we’re about a 22%, that 22% a sequential improvement from the third quarter.

Okay, yes, that’s what I was trying to get the sequential lift and trying to quantify that.

Yes.

Okay, and then just lastly pending the close of the Del Monte deal, you’ll gain significant expertise in specific category management on protein. What are the types of things the new capabilities or new processes for category management and protein that you pickup with incorporating the new Del Monte team?

Yes, well again, I think we said that there was many reasons why we thought Del Monte would make a great acquisition in part of Chefs' and part of it is their leadership team and what we - their CEO is going to become our EVP of Protein he is also joining our Board, so we get a very strong leader, we are going to improve our purchasing which is very important in a category - very expensive category of beef. So getting our arms around that being able to have his purchasing power and expertise, we are accounting that benefiting this around the country. Our strategy is to be to the final restaurants upscale casual a solution sell. So having the plethora of products that we’ve already put on our trucks and that Del Monte brings the combination now with the managements skills and understanding that business better than our existing specialty food. Management team I think obviously we’re expecting to do great things together.

All right, thanks.

Thank you. And our next question comes from the line of Kelly Bania with BMO Capital Markets. Please proceed with your questions.

Hi, this is Lucy Hong on for Kelly. Thank you for taking my questions. I am just wondering we track restaurant industry sales data and we noticed a very strong sales trend in the last few months especially in January. So I am just wondering if you are seeing any of that at all and quarter to date performance wise as if you are seeing strong results?

Yes, well I think the weather again we’ve had such crazy weather pattern for this first quarter, but what I could say is that - where the weather doesn’t affect the business we are seeing exactly that, we are seeing strong business, its double-digit growth in many of our markets we hear from our operators that business is pretty strong. So we have a pretty optimistic view that our hard core customer is doing well and should have a great year.

Okay, thank you. And one more question more about B2C components of Allen Brothers, would you talk more about how you’re expanding that e-com online platform and the customer response to that and if you have plans to develop that further? Thanks.

Yes, we have been pretty pleased with the B2C platform and most of this past year was really getting our arms around it and building a better system to operate it and expand it. And the plan right now is to strengthen it and to continue adding Chefs’ Warehouse specialty items to the portfolio that we feel associated with the brand real well. The customer of Allen Brothers online, somebody who really appreciates the best steaks that you can buy in the country. So we are matching the portfolio of products to really compliment that and as we get more comfortable we’ll start to expand that business and really take it to the next level. But we are pretty pleased where it’s at this point.

Okay thank you.

Thank you. And our next question comes from the line of Karen Short with Deutsche Bank. Please proceed with your question.

Hi, it’s actually Ryan Gilligan on for Karen.

Hi, Ryan.

Can you guys comment on how you expect the new facilities will impact margins in the near and long-term?

Yes, I think there is couple of things there is certainly some benefit associated with consolidating multiple warehouses into one, [indiscernible] or offset to that is, they are typically the new facility has adequate room for growth. So it’s a bigger footprint very often and has a higher cost per square foot. So I think I wouldn’t bank a ton of benefit in the first year, I think where that pace down the road is ample room for growth. So you can continue to grow and as you leverage that facility and fill it up that’s where you get paid.

Yes.

So it makes sense.

Yes it does. So it’s more of a volume story initially then it is a margin story?

I mean you got a little bit better efficiency around being in one warehouse than multiple warehouses, but your cost per square foot goes up and…

Right, so you are not moving boxes twice you are on one system sales management can better manage together. So long-term we expect to do what we’ve done through our history, when we done these building moves is usually as a period of getting the management team on the ground consolidated and then get them focused on growing the business and we’ve done that very successfully over the history of our company and our growth.

Got it, that makes sense. And can you guys maybe just talk about the purchasing opportunities that are available to you guys as you get larger in size?

Yes, well again our focus right now is to get Del Monte as partnership warehouse, consolidate a lot of that purchasing power and expertise. So that strategy is we plan obviously as soon as Del Monte comes on for that strategy to be in effect. And as we consolidated our warehouses right now on the cuisine side we expect to get better control of the inventory and better control of being able to manage the margins and how those products go to market. So I would - optimistically as we grow sequentially you get more efficiencies logistically and that should add to our margin especially in year 2016 and 2017 as we grow into our facilities.

That’s helpful, thanks. The last quick question on CapEx. I’m not sure if you guys provided it, but do you have expectations for what CapEx will be this year?

Yes, I think it will be around $20 million to $22 million as what we are expecting. We’ve got a little bit of cost left to finish the Bronx and cost to finish the Las Vegas facility. So our view is the maintenance component of that number is probably around $5 million in that relative order of magnitude and then we’ve got a little bit of CapEx to finish those two growth projects.

Great, thanks.

Thank you. [Operator Instructions] Our next question comes from the line of John Ivankoe with JP Morgan. Please proceed with your question.

Hi, guys this is Jason on for John. How are you doing?

Hi, how are you doing?

Great. First question I have was on your total interest expense plus the Del Monte acquisition. Are you guiding to a specific total number in addition to that new debt?

Yes, the total number we’ve guided to is $13 million to $14 million.

Okay.

So for today we are running a little over $8 million then we’ll fund the Del Monte acquisition as about $125 million or $130 million of cash needed close and then there is a convertible note that also has about a 2.5% coupon. So that will add into that numbers.

Got it. Okay, that’s helpful. And then one more was - so your 10.7% addition on unique customer base that looks pretty strong this past quarter, could you provide any further color on where you are seeing the growth specifically and if you had any surprises there?

Yes, it’s pretty broad, we’ve been investing in sales people and sales management. So I think its - we are getting the return on what we have invested and the strategy has always been since we do have a certain amount of attrition every year due to just the nature of the business, so putting out the continuous force in the sales force our strategy is always been to continue to open new restaurants and obviously adding new territories gives us the opportunity for more customers and as we add new categories that adds to that the process of opening up the new customer base. So I think where we expected to be.

Okay, thanks. That’s helpful. End of Q&A

Thank you. [Operator Instructions] Thank you. We have no other questions in the queue at this time. We would now like to turn the call back over to management for any closing remarks.

Okay, well we thank everybody for joining us especially on the snow East Coast who’s able to make it and we look forward to much better weather here in the East Coast and look forward to speaking with you again in our next earnings call. Thank you very much.

Thank you. This concludes our teleconference at this time. You may disconnect your lines now. You may have a great day. Thank you.