Greetings, and welcome to The Chefs' Warehouse second-quarter 2019 earnings conference call. As a reminder, this conference is being recorded. I would like to turn the conference over to your host, Alex Aldous, general counsel, corporate secretary, and chief government relations officer. Thank you. You may begin.

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 second-quarter 2019 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 report on Form 10-Q, which are available on the SEC website. Today, we are going to provide a business update, go over our second-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 second-quarter 2019 earnings call. Following a solid first quarter of 2019, strength in both top line and gross-profit dollar growth continued in the second quarter. Our teams across CW delivered strong margin performance during the quarter resulting in improved operating leverage as measured by gross-profit dollar growth over adjusted-operating-expense growth. During the quarter, we continued to make progress on operational and market expansion initiatives, and we strengthened our center-of-the-plate leadership team with several key hires. We look forward to continuing to add talent to help us build our platform through category and geographical expansions, as well as operational improvements. A few highlights for the second quarter include 4% organic growth in net sales. Specialty sales were up 5.1% organically over the prior year, which was driven by unique customer growth of approximately 4.4%, placement growth of 3.5% and specialty case growth of 2.4%. Organic pound growth in center-of-the-plate was 1%. While specialty organic revenue was as expected and consistent with our guidance of mid-single-digit organic growth, year-over-year case growth was lower than 4% to 7% range we have averaged over time. This was driven by a comparison to an extremely strong, 7.5% case growth in the second quarter of 2018, as well as product mix, primarily a shift from higher volume dairy category cases to lower volumes, higher revenue per case categories such as chocolate, pastry, and bakery products. On a two-year basis, second-quarter specialty case growth averaged approximately 5%, and specialty organic revenue growth averaged 7.4%. Center-of-the-plate pound growth was impacted by attrition of some higher volume, lower margin placements. Gross profit margins increased approximately 71 basis points. Gross margin in the specialty category increased 44 basis points as compared to the second quarter of 2018 while gross margin…

Thank you, Chris. And good afternoon, everyone. Our net sales for the quarter ended June 28th, 2019, increased approximately 11.1%, $411.4 million from $370.4 million in the second quarter of 2018. The increase in net sales was a result of organic growth of approximately 4%, as well as the contribution of sales from acquisitions, which added approximately 7.1% to sales growth for the quarter. Net inflation was 2.3% in the second quarter, consisting of 2.6% inflation in our specialty category and inflation of 1.9% in our center-of-the-plate category versus the prior-year quarter. Gross profit increased 14.2% to $106.5 million for the second quarter of 2019 versus $93.2 million for the second quarter of 2018. Gross profit margins increased approximately 71 basis points to 25.9%. Our teams did an excellent job of driving margin improvement across categories. Specialty inflation continued in cheese and pastry with center-of-the-plate category showing a mix of moderate inflation and deflation. While sequentially higher versus the first quarter of 2019, overall inflation remains within the ranges we expected in the context of our full-year guidance. Total operating expenses increased approximately 16.2% to $90.9 million for the second quarter of 2019 from $78.3 million for the second quarter of 2018. On an adjusted basis and as a percentage of net sales, operating expenses were 19.6% for the second quarter of 2019 compared to 19.4% for the prior year's second quarter. The majority of the year-over-year increase in operating expense as a percentage of revenue is attributed to distribution-related expenses, primarily continued investment in Texas growth, and compensation. This was partially offset by lower general, administration and selling related costs as a percent of revenue. We are pleased with our team's execution and delivering a positive gross-profit dollar growth to adjusted operating expense growth spread of approximately 200 basis…

Great. Thank you. [Operator instructions] First question is from Andrew Wolf from Loop Capital Markets. Please go ahead.

Thanks, good afternoon. So Chris...

Hey, Andy.

Hey, gentlemen. A little more on the case growth in specialty. I understand it was -- the comparison, obviously, played a part. But Chris, you also mentioned that you deliberately got out of some low-margin cases or case types or customers? I wasn't sure if I picked that up accurately?

Yeah. We're always – we're always cycling out some business, Andy. And we're a margin company, we want to sell expensive boxes, and we're not trying to sell to everybody. But over the past four, five years, we picked up some lower-margin business, mainly through acquisitions, and periodically, we know we're going to shed some of that willingly or just by raising prices. So I think this quarter actually was a kind of like a lineup of we want to sell more expensive boxes, and we did. And so the team really executed on that strategy. At the same time, we did shed some low margin business, and I guess, it's in a quarter when you look back, last year, we grew 7.5%. So I think the comp was really bad. Overall, I'm really happy with the quarter. We hit our GP expectations and kind of came in where we expected. Just -- I think it's a little different type of quarter when you wanted to do a comp for last year, same quarter.

And, Andy, I'll just add that it's really driven by mix on the specialty side. As Chris mentioned in his prepared remarks, over the years, shift out of kind of high volume dairy and egg-type of case growth and into higher dollar per box, higher revenue per box, lower-volume product like pastry and chocolate, etc. And so very similar organic growth rate in the first half of the year, roughly 5% mid-single-digit. Very similar to last year, just a different mix. Last year, we had lowered inflation, higher volume. Now it's, given the mix change, it's just slightly different mix very similar organic growth rate.

Yeah. I'll give you another example, too, to get your head around it, Andy. Last year this time, we probably had a group of business that bought a ton of milk, or even half cases of milk, which shows up in the case count growth. So it probably pushed up last year a little better than -- probably, the numbers look better than they were as far as the organic growth. And now as you cycle out that business, your case -- case growth looks a little bit less. But at the same time, our profits there -- because we continue to sell our strategic -- we still -- we executed on our strategy of selling more expensive boxes with gross-profit dollars.

And showing up in the gross-profit dollar growth of 14% versus 11% revenue growth.

Yes. Certainly, your gross profit per case, I can see that, in fact. So I guess, as we look at the third quarter with lower case growth from whatever, whether it's -- regardless of mix, it looks like the comparison gets a little easier, so I would imagine your case growth, you would expect it to be a little better...

The comps do get...

Even after you...

The comps do get a little easier. I think, our case growth was in the 6% range in the second half of last year, but we don't fully lap the mix change really until when you get into 2020. So we'll see a little bit of that in the second half.

Okay, but I mean...

Once again -- our guidance hasn't changed. First half roughly -- approximately 5% organic growth. We see similar organic growth per our guidance for the remainder of the year. Just a different mix.

Okay. If I can just add one other question. It's not really a follow-up. It's just on the earn-out obligation going up to noncash estimated future earn-out obligations. Could you just tell us -- that's a pretty big number, what that indicates? Does it mean some acquisitions coming in better-than-expected?

Yeah, exactly. So every quarter, we assess the probability of -- based on our acquisitions' business performance during the earn-out period, we assess the probability of them reaching the earn-out. Those are based on specific gross profit and EBITDA targets. And so as that liability gets measured up, the purchase price associated with the earn-out piece gets measured up, and then we add it back to adjusted because it essentially represents purchase price.

Yeah. It's actually a good thing, Andy. It means that companies we've been buying are performing.

Yes. That's what I thought, I just double checked. OK. Thank you.

Our next question is from Kelly Bania from BMO Capital Markets. Please go ahead.

Hi, good evening. Thanks for taking the questions. Just maybe to go back to the attrition question. Can you quantify the impact of that on the case growth? It sounds like it's more on the specialty side. But just curious, if you could quantify that, and just maybe help us understand kind of the underlying trends with your core customer.

Sure, Kelly. Again, it's mostly a mix change. So it's a comparison to last year for second quarter. So every quarter – every quarter or every two, three quarters, you kind of have a little shift, so this one was shifting out to last year where we probably had some business we inherited or took on that was lower margin and maybe more cheap boxes so probably drove up the organic case growth. That was 7.5%, so it was really high last year. This quarter, it was more typical of selling the boxes that we want to sell, to customers that we want to sell. So we put -- that's why we put up the GP dollars. The margin moved up and the boxes -- the customers -- our new customer growth was right on target. So it kind of performed the way we were expecting. And the cycling out of maybe the cheaper boxes, I think, you'll start to -- I think, we've always seen that. I think it's just a little more evident this year because last year was so strong with 7.5% case growth.

Hey, Kelly, just to put a little bit more color on it. Chris mentioned kind of our typical range that we've averaged over time on specialty case growth is about 4% to 7%. So about a point and a half of that is comp, maybe two points of that, and then about one point is of the -- case volume growth is the mix change. But once again, organic revenue right in line with, as we expected, approximately 5%. In line with guidance, really just a matter of product mix.

Okay. Got it. And maybe just -- can you speak to just the underlying tempo business for your core customer? And any impact from weather or regional variances, anything that you could speak to there?

Yeah. It was a tough quarter. I mean, the team worked really hard. We opened up a lot of new business. We're selling a lot of our new categories, which are expensive boxes. But the weather definitely did not help between early in the quarter, all the wetness out West, and then we had the heatwave that'd come in. So mother nature has definitely not been of help. But still, we saw a real healthy new customer growth. And our core customers are doing fine.

Great. And then I guess, Jim, just a message on the guidance. Is the message is that there's really not much change? I mean, the changes are so minimal. I just want to make sure we are understanding the message there.

Yes. Well, in terms of the EPS and net income, that's mainly just a change that Andy mentioned, the reevaluation of the earn-out liability, which is about $2.5 million. And then a change to our stock comp based on -- or Omnibus plan that was issued during the quarter. So those are the two effects to that. We just brought the bottom range of revenue and gross profit up very slightly, and we left adjusted EBITDA unchanged. So really, just tightening the range a little bit.

And then just last one for me. Just on the gross margin. Really strong, particularly in the center-of-the-plate. But should we just attribute that most to this customer mix and attrition changes? Or how much of that was kind of company initiatives that are more structural, I guess, with what you're doing? Maybe just talk about that a little bit.

Sure. I think it's a little bit of everything. So cycling out of some of that lower-margin business obviously helps. And most of the new business is at our traditional margins with the more traditional mix. So I think, like I said, you're seeing a quarter a -- if you're trying to compare it to last year, it kind of looks maybe a little more volatile as far as the case growth, but it kind of was more typical of a Chefs' Warehouse quarter where we grew the margin through good management. We also -- it got a little tailwind because we're cycling out some of that low-margin business. So it did bring our margin up, as well.

Okay. Great. Thank you.

Thanks, Kelly.

[Operator instructions] Next question is from Christopher Mandeville from Jefferies. Please go ahead.

Hey, good evening, guys.

Hey, Chris.

Can I ask just on the pound sold in the quarter of about 1%, little bit of deceleration versus what we've seen over the course of the last two, three quarters now. Is there any color you can provide on that line item, whether it'd be in relation to greater inflation in the quarter and the year-on-year comparison that center-of-the-plate protein had on that, or just the lack of demand? Anything you can offer there.

No. I think we mentioned in the prepared remarks, we are lapping -- we just really started to lap this quarter. The loss of -- attrition of some lower-margin kind of higher volume center-of-the-plate business. Chris mentioned, you get certain programs that mature over time and become lower margin, and you trade out of that. And we work over time to replace that with kind of higher-margin street or independent business. And so we will -- we'll start to lap that in the second half of the year, more so in Q4 than Q3. But the first time, we really started to see it was this quarter.

Yeah. So you're really seeing a cycling out, Chris. You see the margin starting to pop, and we continue to open up business to hit our targets. So I'm very pleased what the team is bringing in. And we're executing, bringing in the right customers with the right margin. And I think it's just a quarter where you have either a bad comp. But we are cycling out some of that lower-margin business that we probably inherited over the last few years through some acquisitions.

Okay. And then I guess that maybe just leads me into the back half of the year. So it looks as if we still have pretty wide range on overall EBITDA growing anywhere from 14% to 24% year on year for the back half. Jim, is it still largely going to be predicated on OpEx leverage that we discussed to begin the year? Or now based on some of this attrition that we're seeing in the center-of-the-plate and the performance of gross profit and gross margin in that category, does that now contribute to a greater degree than what we were initially thinking?

Well, our original guidance at the beginning of the year was an improvement in gross profit margin and an improvement in operating leverage. I think we updated it for the addition of Bassian. And that shifted a little bit because Bassian was a center-of-the-plate business, so lower end of the average of margin. So that shifted more to operating leverage into gross profit margin. But I think as we noted in our remarks, really amazing job by our teams in managing margin this quarter. And so I think it's going to come from both. I think leaving the guidance where it is, I think we just will most likely tighten it as we come through Q3 obviously as we're closer. But, no, we feel good about mid-single digit organic growth, really good performance on gross profit margins, and the comps on operating leverage get better in the second half of the year. And we're really excited about the ability to generate 200 basis points of positive spread in gross profit versus adjusted opex this quarter. So I think that's how we think about the guidance for the rest of the year.

Okay. And then just seeing out, Jim, you're now approaching close to 3 times leverage. I know you guys aren't going to do a deal just for the sake of doing a deal because you've got the wiggle room now. But can you or Chris just talk about the quality of assets that are available today? What type of valuations are being requested? I mean, you look in the broad-line community and valuations that certainly prepped up quite a bit in that world. And then just maybe, lastly, on that same subject, speak to your willingness to do something larger versus smaller.

So I would say all of the above. I mean, the one thing that we've learned is to be disciplined and be patient. The most important thing that we own is our brand and our culture, so we're not just going to out and buy someone just for size or we don't see it as a fit or we don't see them having a similar EBITDA profile to us. So there's plenty to buy but with that, you can't make any money. So the pipeline is frothy. I think the stars eventually align, you said we're down to 3 times leverage, so we're in a great spot. And we're talking to tons of people, though we're just -- we're being very picky and very patient. So I think it's going to pay off.

Okay. I'll leave it there. Thanks, guys.

Thanks.

Thanks, Chris.

That concludes the question-and-answer session. I'd like to turn the floor back to Chris Pappas for any closing comments.

Yes. Thank you, very much to everyone for joining our earnings call today. We're very proud of the quarter. We think the team did a great job. We look forward to our next earnings call, and we wish everybody the happy August and the rest of the summer, and look forward to talking to everybody again. Thank you, very much.

Ladies and gentlemen this concludes today conference. Thank you for your participation and have a wonderful day. You may all disconnect.