The Chefs' Warehouse, Inc. (CHEF) Q4 2015 Earnings Report, Transcript and Summary

Greetings and welcome to The Chefs’ Warehouse Fourth Quarter 2015 Earnings Conference Call. At this times, all participants are in a listen-only mode. A 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. Thank you. 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 2015 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 maybe calculated differently in other company’s 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.gov. Today, we are going to provide a business update, go over our fourth quarter results in detail and review our 2016 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 our fourth quarter 2015 earnings call. As we wrap up 2015, we enter the New Year with much of the footprint and infrastructure in place to create the dynamic national food service marketing and distribution company that we envisioned when we went public four years ago. We are very pleased with our results for the fourth quarter. We are beginning to see the efficiencies, as we bring new capacity on line and complete major IT projects, enabling greater transparency to manage our business much more effectively. We finished the fourth quarter with approximately 31% sales growth, aided by the acquisition of Del Monte. In addition, our organic growth continued to lead the industry, which during the quarter, amounted to 6.1%. Our specialty division led our organic growth, driven by unique customer growth of approximately 5.5%, placement growth of approximately 7.1% and case growth of approximately 8.9% versus the prior year's fourth quarter. During the quarter, we experienced modest inflation overall, driven primarily by our meat division, offset in part by seafood. So far in 2016, we have seen deflation on the protein side and slight inflation in our specialty business. John will discuss our outlook for commodities in a few moments. However, we continue to be very pleased with our ability to manage in both inflationary and deflationary environments. Managing margin is a major focus of our team, and during the fourth quarter, we proved again that the focus is paying off. During the quarter, on a consolidated basis, we saw a 74 basis point increase in gross margins. In our core specialty business, we saw a 12 point basis increase and realized a 366 basis points increase in our protein business. Moving onto a few specific business updates. In 2015, we are acquired Del Monte and achieved a significant improvement in gross margins for the Allen Brothers business. Both of these factors contributed to our improvement in gross margins in our protein division. The integration of the Del Monte business has gone very smoothly. Our integration team is in the midst of converting our back-end systems. So far we have converted three Del Monte branches with a fourth scheduled for this weekend. We expect to complete this IT integration in the first half of 2016. We believe that our protein division is very well positioned for growth. Bottom line is that the best is yet to come for the protein business. Cross-selling our specialty core products to our protein customers and vice-versa is going very well. Our regional VPs have been very focused on making sure those businesses are working together to provide our customers with excellent service in a comprehensive offering. Moving onto our facility update. We opened a brand-new specialty market with our Chicago facility and now have a 28-person team based in Chicago, who have been working tirelessly and making great progress on building up our customer base in the Greater Chicago area. We have also opened our new Bronx and Las Vegas facilities. While we still need to complete the office portion of the Bronx, both facilities are up and running and will continue to gain efficiencies as their teams get more accustomed to the larger space. And our final new facility opens in San Francisco at the end of this month. This location will allow us to consolidate one more casino warehouse. We expect that the integration to be completed in the first half of 2016. All of these facilities enable us to pursue complementary fold-in acquisitions to further leverage that capacity. As we complete these projects, we are beginning to generate free cash flow. While it’s just a start, we have and will be able to deleverage at a faster pace going forward. Lastly, we are making meaningful progress on our goal of delivering a 19% operating expense ratio excluding D&A. Adjusted for one-time items, our ratio was approximately 18.7% in the fourth quarter compared to 19.4% in the prior year’s quarter. While the new facilities have increased our occupancy costs, we are beginning to better leverage the investments we have made over the last couple of years. To wrap up before turning the call over to John, we have a very solid foundation for future growth. We have a well-managed core specialty business and protein business as well and state-of-the-art facilities with capacity for growth. We could not be more excited for the business going forward. 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 25, 2015 increased 31.3% to $299.7 million, from the $228.2 million for the fourth quarter ended December 26, 2014. The increase in net sales was primarily the result of organic growth, as well as the acquisition of Del Monte in April 2015. Acquisitions accounted for approximately $57.6 million of our net sales growth for the quarter, while the organic growth contributed the remaining $13.9 million, or 6.1% growth over the prior year quarter. Inflation decreased approximately 30 basis points sequentially and was approximately 1.6% for the quarter. As we mentioned in January, we expect approximately 3% to 5% deflation in our protein categories and very modest of inflation in the balance of our product classes for 2016. Gross profit increased approximately 35.2% to $76.9 million for the fourth quarter of 2015 versus $56.9 million for the fourth quarter of 2014. Gross profit margins increased approximately 74 basis points to 25.7% from 24.9%. This increase was due primarily to the increase in margins in both our core specialty and protein businesses, with the improvement in protein margins largely driven by improvements in the operating performance of our Allen Brothers subsidiary and the acquisition of Del Monte. Total operating expense increased approximately 36.8% to $61.9 million for the fourth quarter of 2015 from $45.2 million for the fourth quarter of 2014. As a percentage of net sales, operating expenses were 20.6% for the fourth quarter of 2015, compared to 19.8% for the prior year quarter. The increase in the company's operating expense ratio was largely attributable to increased amortization expense related to the company's acquisition of Del Monte and the prior recognition of a benefit related to the non-cash change in fair value of contingent earn-out obligations. In addition, occupancy costs and healthcare insurance, offset in part by reduced fuel and freight costs, as well as marketing expenses, contributed to the slight increase in operating expense ratio compared to the prior year quarter. However as Chris had mentioned, we are making steady progress toward our long-term target of 19% operating expense ratio after excluding D&A. Operating income for the fourth quarter of 2015 was $15.1 million compared to $11.7 million for the fourth quarter of the prior year. As a percentage of net sales, operating income was 5.0% for the fourth quarter of 2015, compared to 5.1% in the prior year's quarter. The decrease in operating income as a percentage of net sales is driven by increased gross margins, offset by the increases in operating expenses I just discussed. Interest expense increased 74.6% to $3.7 million versus $2.1 million for the prior year fourth quarter, due primarily to the increased levels of debt used to fund the Del Monte acquisition. Income tax expense was $4.7 million in the fourth quarter of 2015, compared to $4.4 million in the fourth quarter of 2014. Our effective tax rate was approximately 41.4% during the quarter. Net income was $6.7 million or $0.25 per diluted share for the fourth quarter of 2015, compared to $5.2 million or $0.21 per diluted share for the fourth quarter of 2014. Note that all 2015 diluted EPS numbers adjust for the dilutive impact of the convertible notes issued in part to fund the acquisition of Del Monte. On a non-GAAP basis, adjusted EBITDA was $20.8 million for the fourth quarter of 2015, compared to $12.2 million for the prior year fourth quarter. Modified pro forma net income was $7.0 million and modified pro forma EPS was $0.26 for the fourth quarter of 2015, compared to modified pro forma net income of $4.9 million or $0.20 per diluted share for the prior-year fourth quarter. Based on current trends in the business, we are providing the following financial guidance for 2016. We estimate that net sales for the full-year 2016 will be in the range of $1.15 billion to $1.20 billion. Adjusted EBITDA will be between $72.5 million and $77 million. Net income will be between $21.5 million and $23.5 million. And net income per diluted share will be between $0.80 and $0.86 per share. And lastly, modified pro forma EPS will be between $0.81 and $0.88. Note that fiscal 2016 includes a 53rd week in our fiscal calendar. We expect this extra week to contribute approximately 1% or slightly more than 1% to our sales growth. This guidance is based on an effective tax rate between 41.5% and 42% for 2016, and an estimated diluted share count of approximately 27.5 million shares. As a reminder, on a long-term basis, we expect the following. We expect to achieve 26% gross margins. Operating expenses as a percentage of net sales to be down around 19% of revenue, resulting in an EBITDA margin of approximately 7% on a go forward basis. Also CapEx, which has been as significant drain for us over the last year or two with the opening of our new facilities, we expect the completion of the Bronx facility - office space we expect to complete that in 2016 and total CapEx to be between $13 million and $15 million. Once these facilities are up and operational, we expect normalized long-term maintenance CapEx to be in a $8 million to $10 million range. And with that operator, we’ll turn it over for questions.

Thank you. At this time will be conducting a question-and-answer session. [Operator Instructions] One moment please while we poll for questions. Our first question comes from line of Mark Wiltamuth from Jefferies. Please go ahead.

Yes, hi. Good afternoon. It’s actually Chris Mandeville on for Mark. Gentlemen, can you actually help provide us with maybe the make-up of the protein margin gain between possibly the improved execution within Allen Brothers, and maybe just simply the product cost falling whereby you’re still keeping kind of similar margin dollars or anything else to which had benefited in the quarter?

Sure. Let me take that, Chris. So there is a couple of things going on there. One, we actually showed a slight inflation in our protein business for the fourth quarter, which is different than, I know, a number of others have reported in the industry. Again we measure average revenue per pound and revenue per case as our inflation measure as opposed to cost. So we showed slight inflation. I think the split between Allen Brothers and our other businesses, while we are not going to break out specific performance by operating company, most of that was driven by Allen Brothers, although I will say Del Monte - and we said this I think back when we first acquired Del Monte. Their average margins are - while they are slightly less than our average, their margins, because of their customer mix was better than both Allen Brothers and Michael’s. So that also contributed a little bit to that margin improvement year-over-year, but the lion's share of that 366 basis point improvement was from Allen Brothers.

And actually trending now to a more normalized margin where they should be. So if you remember coming out of ‘14, we said that we expect that margins to return to a more normal level and I think that's what the numbers are showing.

Okay. And then, could you just kind of discuss maybe the cadence within the quarter on a monthly basis. I know there was potentially some noise in the Northeast as it relates to whether possibility, if there is any ability to quantify that, and then looking forward in the coming quarter if there is anything to which you can provide as it relates to Easter falling in March versus April of last year I believe?

I think again the fourth quarter was very strong. October, November were good. December was even better. So we saw our customer base experienced a good holiday season. Looking forward - I mean I think January and half of February already gone. We are tracking to our internal budget, so we haven't seen anything that we are really aware of that which - yes, that would bring any alarms in. So as far as the March/April with Easter, I don't think we're there yet.

Yes, it’s too tough to tell.

Right. We are trying to get through the first quarter.

Okay. And then just finally for me. As it relates to your balance sheet, you guys had alluded to the fact that you plan on basically utilizing your free cash to pay down debt. With that in mind, I guess, I'm just curious about your ability and your appetite to further consolidate in the industry?

Yes, I think couple of things. As it relates to our balance sheet, on a pro forma basis, as of the fourth quarter, we are about 3.9x total leverage, so about 3.4x senior. So that gives us a little bit of capacity, I mean not a ton. We couldn't do another Del Monte acquisition today, but most of our focus right now is on organic growth and we'd love to do some fold-ins and some of the capacity - fill up some of the capacity we've added thinking about New York, Chicago, Vegas and Francisco. So there is an opportunity to leverage some of that infrastructure. Those new facilities do have a higher occupancy costs, so that is a little bit of a headwind for us but nonetheless we are still very focused on filling up that capacity.

Yes, I think you got to look at ‘16. Obviously there is plenty of opportunity in the pipeline. It’s still very frothy but we've put ourselves into position adding capacity in the major markets to really grow our business. So we spent the lot of ‘14 and ‘15 in that building stage and adding sales people and adding management to put us in the position right now that really the focus is on organic growth and we'll go quarter by quarter and obviously we’ll look at acquisitions, but as the focus is on as the organic growth.

Okay. Thanks guys.

Our next question is from Mark Sigal from Canaccord Genuity. Please go ahead.

Yes, hi. Good evening. Thanks for taking the question. There has been some chatter out about restaurant traffic trends have been generally positive, but perhaps as in late have moderated incrementally. It sounds like from your commentary to one of last questions, you’re not experiencing this but just looking for you to confirm that.

Again, our predominant customer is the independent restaurants. What we saw coming out of the fourth quarter - the first quarter had just started obviously some whether around the country, so kind of the numbers aren’t crystal clear. But our historical experience, our independent customer does pretty well, even in there is some market turbulence I would say you don't need a mortgage throughout the dinner. We are serving the top 10% earners in the world. Our customer is very strong and we haven't heard anything about business not tracking to what we expect. So we are very optimistic.

Okay. And then it's probably still little early in the cycle to make a definitive statement, but can protein deflation have any significant stimulative effect with your customers and ultimately the end consumer?

Your mean, will meat sales accelerate because it's come down in price. Is that the question?

Yes.

Yes. Again our customer because they are not locked in, so you have chain customers, very large groups that lock in for a long time. Our customers, they go daily market menus. They have a tremendous amount of flexibility, so their menu and their menu choices - so if meat becomes more affordable, I think you might see more meat on the menu but that would take away from something else. And our focus and the reason why we are so diversified and have such a plethora of products is really coaching and guiding our sales force to a dollar amount that their goal is for the week and the month to achieve and it's really the makes. So whether they are selling beef or chicken or seafood or more pasta and olive oil, we run the country - we run the company very metrically driven, and somehow the mix always plays out because of the way we manage it. So we are not that focused really on, are they going to buy a little bit more meat and less fish.

Got you. Okay. And then just lastly, can you give us an update on Chicago and where that operation is relative to your expectations?

Yes. Well, Chicago is tracking to expectation. We've continually added sales people and routes, which is the key to adding business. So we remain extremely optimistic. We think it is going to be our second or third top market in the country, and they are growing daily and we expect great things to happen.

Thank you.

[Operator Instructions] our next question comes from Andrew Wolf of BB&T Capital Markets. Please proceed with your question.

Hi, this is actually Jeremy Henrard on for Andy today. Thanks for taking the question. I want to ask, have you seen customers trading up in deflating categories, for example restaurants demanding better cheeses because prices are down?

I don't think it's anything significant. Again we are serving a clientele that’s already serving a premium product. So I don't think in our sector that would be as much of a change as you go down market to more downscale, more casual, I think that would be a bigger influence. But I think at our level, where they are charging $20 to $30 to $40 entrée, I don't think there is much of a change.

Okay. Thank you. And just another question. It appears that your overall gross profit per case increased. Was that the case for both the core business and the meat business, or was it mainly driven by a recovery in profitability in protein?

Yes, I think - to be honest, I don't have the gross profit per case number in front of me Jeremy. But yes, we did see an expansion in margins in both specialty and protein, so I'll come back to you on that.

I think we did have an uplift in certain sectors of our protein business which did help the profit per case.

All right. Thank you.

[Operator Instructions] Our next question comes from Kelly Bania from BMO Capital Markets. Please go ahead.

Hi good evening. Thanks for taking my questions. First, just wanted to clarify the extra week impact. John, I think you said it was 1% to sales.

Correct. Yes, slightly over 1%.

Okay. And then, so I guess the impact to EPS is pretty minimal. Is that fair?

It really isn't that much. So it's an odd week that gets added, that 53rd week. So it doesn't have particularly strong sales days in it anyway.

It’s just not like adding an extra week of New Year.

Yes.

Got it. Okay. That's very helpful. Then I guess your guidance for 2016. I think it's a range of maybe 5% to about 14% earnings growth. I guess pretty wide range. Curious as you think about the kind of puts and takes, obviously you're talking about some protein deflation may be accelerating through the year. I don't know if that's one of the big factors in just how you manage that or just how you see kind of expenses tracking through the years, but maybe just kind of what do you see getting you to the high end of that range versus the low end of the range. Any things that we should be to thinking about as you’re moving through the year?

So surprisingly enough I know it goes kind of 5% to 15%, but it's only about a $2 million spread. So when you really think about the bottom line dollars, it’s really not that bigger spread when you think about a $1.2 billion company. It's a pretty small relative to...

So being as small public company, $2 million creates that type of spread.

Right.

So do you think - I guess, do you think you can leverage expenses next year or I mean…

Yes, we will. I mean I think we are kind of planning for a slight margin uptick, not a big gross margin uptick. Expenses will probably be flattish. We do have some additional occupancy cost which is a little bit of a headwind. So I think feeling that up and focusing on organic growth particularly in those markets and/or some fold-ins in those markets will be good, but we are very comfortable with where we are heading from an overall scale, obviously your objective now is to fill up our capacity.

Right. And that's exactly right, Kelly. It's leveraging. We’ve built them, right. We’ve staffing up on - we've staffed up on them and now it's really driving sales through the excess capacity that we've added. So the more successful we are of driving more volume and gross profit dollars to those facilities, a lot of it falls for the bottom line. So again what we've built the last few years and we've added the expenses and we've added the staff and built these modern facilities, now it's really just - we called blowing up the balloon.

Got it. And then I guess, just another one on inflation and deflation. Any color on kind of the cadence of how you expect that to track through the year? What you're already seeing early in the years sounds like meat has gone a little deflationary really in the year. Is that correct?

We've seen a little bit of deflation in the protein space in January. I mean, obviously we are only partway through February, but it's so hard to know. I mean we've seen a lot of different reports. Some reports will say if we are not going to have deflation and reports you see that our deflation [indiscernible] planning on.

Yes, I believe this week beef prices were firming up again especially in prime. So again it's really hard to guess the market. So I think our guidance is conservative and pretty much - again, we sell lot of protein, it’s cents per pound. So it kind of insulates us, okay, from gross profit dollar disappearing. So I think that's a good way to look at it, where a lot of our core specialty business is more margin based, a lot of the meet that we sell is cents per pound. So I think we've insulated ourselves from any downdraft in gross profit dollars.

Got it. That's very helpful. And then I guess just last one. Your case growth 8.6%. I think that's the strongest that I can see, just going back at least four years. I’m wondering are you seeing some of those cross-selling initiatives really start to work there. I guess that's one. And two, what kind of just underlying trends are you seeing products categories that are working the best in this environment?

I think it's all of the above. I think we see all of the above. You're starting to see cross-selling be successful. You're starting to see the investment in sales and sales people and sales management pay dividends, so I think business was pretty good. So I think you have a combination of a decent market and good execution and the investment in sales starting to pay the dividends and that's why you have such a wonderful case growth in our business.

Got it. And any color on the trends?

Well, we are reporting fourth-quarter. It's only mid-February so...

No, I mean just that trends category-wise, or not quarter to-date trends, just trends…

Again we have category managers, so we put the people in place to grow us to I would say the number - we are looking at - the next number is $2 billion. So categorically we have managers that are managing categories and they're incentivized and paid on their growth. So we are trying to grow very balanced. Obviously some categories grow stronger in some quarters or happy year, but we are really balanced with our sales for us to kind of grow categorically. So, I mean, people are eating proteins. I think some meat sales overall maybe down a little bit, but new steakhouses open every day, so I think it's a luxury meal, so that's growing wonderfully. And our independent restaurants have got a very balanced menu, so we get a really balance of products that sell, and I actually was just reviewing it today and I think when you see that case growth, it's a pretty well-balanced categorical growth.

Got it. Thank you.

[Operator Instructions] Our next question is from Karen Short from Deutsche Bank. Please proceed with your question.

Hi guys, it's actually Ryan Gilligan on for Karen. Just as a quick follow-up to Kelly's question. I know you guys mentioned you're being conservative with the guidance, but can you comment on what is embedded in guidance for organic sales growth, because if I back out 1% for the extra week and then call it $50 million to $60 million for Del Monte I'm getting the 2% to 7% organic growth for the year which seems pretty low in the low-end. Is that just conservatism, or is my math wrong?

Yes, I think there is probably a little bit of math going on there. We are planning on mid-single-digit case growth and basically flat inflation. We've talked about very modest inflation in our specialty business and probably 3% to 5% deflation in our protein businesses. So net-net, planning on about flat inflationary growth. So you should come back to about mid-single-digits on your case growth.

Got it. That's helpful. Thanks. And then, do you guys still expect to start seeing benefits from the new facilities in 2016, or do you need to get a tuck-in acquisition done first in order to realize the benefits?

Well, I think we are already seeing the benefits of - we are more efficient. You saw our case growth. So I think we are already getting the benefits of having more efficient space and the ability to add more items in more categories. So anything we do, a tuck-in would be gravy, but I think we have a really good organic plan at this point.

I think you guys in the past have mentioned that the margin benefits would be kind of good in 2016 and great in 2017, or maybe I'm off at the...

Yes, that's correct. As we fill up our - again we’ve added capacity, so lot of far costs are fixed. So as we add more volume, we expect our profitability to continue to improve with a lot of the costs being fixed. So yes, ‘16 we expect to be great, and obviously you want to be optimistic ‘17, ‘18, our trends have been pretty on as far as our growth. So our margins are good. Case growth is good. So as we eat up that expense, we expect the numbers to show it.

Got it. That's helpful. Thank you.

Thank you. I would like to turn the floor back over to Mr. Pappas for any closing remarks.

Great. Well, we are very proud of our fourth quarter and we think our team has done an exceptional job executing, and I think we are starting to see the benefits of our investments and we are looking forward to a great ‘16. And we thank everybody for joining us today, and we look forward to you joining us for our next call. Thank you very much.

This does conclude today's conference. Thank you for your participation, and you may disconnect your lines at this time.