The Chefs' Warehouse, Inc. (CHEF) Q2 2013 Earnings Report, Transcript and Summary

Greetings and welcome to The Chefs’ Warehouse Q2 2013 Earnings Conference Call. (Operator instructions.) As a reminder this conference is being recorded. 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 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 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 Q2 results in detail. Then we will open the call for questions. With that now 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 Q2 results and the continued sequential improvements in our business. A few highlights for the quarter include the following: an increase in net sales of approximately 48% over Q2 2012, a gross profit increase of approximately 45% over Q2 2012, and an adjusted EBITDA increase of approximately 41% over Q2 2012. We remain encouraged by the continued improvements in our key indicators. We still expect this to be a slow, steady process throughout 2013. In all though we believe that our core customers, our business and the broader economy are making progress. During the quarter our number of cases sold grew approximately 4.8% adjusted for our 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 during the quarter – 5.7% and 7.9% respectively after adjusting for the estimated impact of acquisitions. Going forward, we will continue to focus on growing in 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 are also very happy with our new greenfield location in Seattle. Albeit small at this stage we are excited about our progress and we will continue to invest in sales personnel to drive growth in that market. We continue to make great progress in integrating our recent acquisitions. We recently began leveraging the operations of Queensgate, Michael’s Finer Meats in Cincinnati, and the surrounding markets. We are also beginning to capture our initial purchasing and delivery efficiencies which are the Qzina acquisition. We still have a long way to go with these initiatives but we are very encouraged about these long-term opportunities. There continues to be a very robust pipeline of attractive acquisition opportunities we are exploring. We are being selective in both markets and product specialties that we pursue as well as the construct of each opportunity. The $100 million in guaranteed senior secured notes that we issued through a private placement in April provides us greater financial flexibility in the event we identify strategic opportunities that may require additional capital. In closing, we are pleased with our progress midway through 2013. We have been very busy and continue to execute against our long-term business strategy by building our core markets and entering new, attractive markets that we believe will hold long-term upside for growth. For the remainder of the year we’ll remain focused on driving organic growth, strengthening our infrastructure and pursuing additional attractive acquisitions. With that I will turn it over to John Austin to discuss more detailed financial information. John?

Thank you, Chris, and good afternoon everyone. Our net sales for the quarter ended June 28, 2013, increased approximately 48.2% to $170.2 million from $114.8 million for Q2 ended June 29, 2012. The increase in net sales was largely due to the acquisition of Michael’s Finer Meats in August, 2012, Queensgate Foodservice in December, 2012, and Qzina in May, 2013, which all added approximately $45.6 million or 39.7% of total sales growth for the quarter. Organic growth amounted to approximately $9.8 million of our net sales growth or 8.5% growth. Inflation was approximately 4.1% for the quarter. While inflation, or deflation as the case may be, was mixed for most of our top product categories, inflation in the dairy category increased significantly year-over-year. Gross profit increased approximately 44.5% to $44.0 million for Q2 2013 versus $30.5 million for Q2 2012. Gross profit margins decreased approximately 66 basis points to 25.9% from 26.5% due in large part to the impact of the mix from the Michael’s acquisition on our overall mix. Excluding the negative impact on gross margins associated with the Michael’s business, gross margin has decreased approximately 13 basis points due largely to the impact of dairy inflation. Total operating expenses increased approximately 50.3% to $33.0 million for Q2 2013 from $22.0 million in Q2 2012. As a percentage of net sales, operating expenses were 19.4% for Q2 2013 compared to 19.1% for the prior-year quarter. The increase in our operating expense ratio is due largely to increased amortization expense related to the company’s acquisitions, duplicate occupancy costs on our new Bronx, New York, facility, and increased compensation-related expenses which were all partly offset by efficiencies in distribution costs. More specifically, warehouse distribution and selling costs increased approximately $7.2 million due mainly to the company’s acquisitions. This includes $371,000 of…

Thank you. We’ll now be conducting a question-and-answer session. (Operator instructions.) Our first question comes from Andrew Wolf from BB&T. Andrew Wolf – BB&T Capital Markets: Hi, good afternoon. Congratulations on a nice quarter. Just on the inflation rate increasing was that all in dairy? And I heard you say deflation – were other categories deflating or could you give us a little more color in that category? Thanks.

Sure. So yes, of our top ten categories for instance, seven of those categories actually showed some modest deflation. Three were inflationary but dairy was the one that was pretty outsized – it was about 13.3% year-over-year increase in revenue per case or our measure of inflation. So that was the one that was probably the most abnormal. Andrew Wolf – BB&T Capital Markets: Okay. And then in regard to the gross margin statement, I think you said it’s sort of a pro forma look on gross margin. Still there was a little contraction – was that due to you couldn’t pass through the full rate on the dairy given that much inflation?

Correct. We think that was mostly dairy, the impact of dairy inflation, correct. Andrew Wolf – BB&T Capital Markets: Okay. And then could you just update us on the build out of the new facility in the Bronx, its schedule – it’s on schedule for the moving and so forth?

Nothing really to update from the last call, Andy. It’s moving along and you know, we expect to be in that building obviously this time next year. And nothing really out of the ordinary to report. Andrew Wolf – BB&T Capital Markets: So that’s on track?

That’s on track. Andrew Wolf – BB&T Capital Markets: Alright, I know it’s an important move for the company. Just one other question then I’ll get back in queue – you were talking a little bit about cross selling and I’ve asked a little bit about cross selling but particularly with Michael’s now that there’s a major center-of-plate offering. Could you update us on cross selling either protein into other customers outside of Michael’s and vice-versa?

Of course. That has started. We have a whole integration team very focused on the whole cross selling between Michael’s and Queensgate and I think it’s going as well or even exceeding expectations; and we’re very optimistic that we’re going to meet all our objectives over the next few years. So that is on target and it’s going very well. Andrew Wolf – BB&T Capital Markets: In regards to getting Michael’s into say New York or Florida do you have to have cut shops close to the Broadline facility or can the product be shipped, or is it too heavy? Can you help us understand that logistically?

Sure. Michael’s has customers all around the country so they are experts at shipping multi units around the country, so they easily supply New York customers or East Coast customers. But our big strategy, you know, Michael’s has tremendous amounts of growth within their Ohio Valley markets and within the 200 mile market that they’re in besides their multi-unit growth. Our long-term growth is to have cut shops strategically located around the country that feed our CW customer base so that is the long-term strategy that we hope to execute to. Andrew Wolf – BB&T Capital Markets: Thank you.

Thank you. Our next question comes from John Marrin of Jefferies. John Marrin – Jefferies : Hey fellas, nice job once again on organic sales growth. I was hoping you could talk a little bit about the drivers behind the acceleration quarter-to-quarter. How much was cross selling, how much was core? And then maybe if you can share with us the cadence of business through the quarter – if you saw any volatility or how the quarter ended.

Yeah, I think that we don’t break out organic growth between cross selling and core organic growth. There’s so many products and pieces of that puzzle. I think the piece, as Chris had mentioned a minute ago, we’re really starting to gain some traction on Queensgate and Michael’s for instance as one of our key opportunities. We’re still very early in that process but we’re starting to see some decent traction there. So I’d say that’s a small component of organic growth today. I think it’ll continue to improve and we expect that to continue to grow.

John, there’s a very healthy amount of growth coming from new customer acquisitions, and again, it is a mixture of customers being introduced to us through the companies we have been buying – [not necessarily] coming through cross selling; and a lot of it is coming through our core process of prospecting and customers who always have been calling us. So a lot of growth comes from new salespeople on the street and new customers that we acquire. On top of that we did see a nice increase in penetration of existing customers and it comes from various sources. Part of it is from new product lines and part of it is from again continuing to educate salespeople. And we have thousands of items in each warehouse so they have the opportunity as they get educated to further penetrate their customers. So we’re seeing really good healthy growth coming from all the aspects of our business. John Marrin – Jefferies : Okay.

You had a second piece to that question, John? John Marrin – Jefferies : Yeah, I was just wondering about the cadence for the quarter, if you saw any volatility or choppiness you can share with us.

Yep, I mean we’re excited about and happy about the cadence through the quarter so I’d say June was a little softer than May but still meaningfully better than April. So there was good continued improvement in all of our key KPIs that we talk about. July was actually right in line with June so we didn’t see a fall off there. I’ve seen some commentary in the marketplace about July being even softer but as far as our year-over-year case growth which is I think the most important one to look at relative to revenue, that actually was still nicely positive.

Yes, even with the rainy June and the extra-hot July and the 4th of July falling on a date that really disrupts the week we were really pleasantly satisfied with the kind of growth we had – all good indicators. John Marrin – Jefferies : That’s great, thanks guys – great color. Let me ask one more question here, just to drill down a bit on gross margin. If you drill down Michael’s and you back out dairy inflation, the gross margin performance was pretty good relative to my model anyway. I mean can you talk about some of the strength in the rest of the business perhaps?

Yeah, again I think the business is holding strong. We did have the inflation in the dairy which did impact margins. But overall you know, we’re hitting the streets. We’re servicing the hell out of our customers and we’re entitled to make a healthy profit and we try really hard to keep the bottom line where we think it should be. So overall I’m very happy with where the margin is and with where things are going. John Marrin – Jefferies : Alright, thanks Chris and John. Thanks.

Okay, thank you.

Thank you. (Operator instructions.) Our next question comes from Scott Van Winkle from Canaccord Genuity. Scott Van Winkle – Canaccord Genuity: Hi, thanks. Following up on the question about the cadence of the quarter, more kind of looking for Chris, can you give us a sense of what the sentiment is of the salespeople? Are they feeling really good about the opportunity more so than they were a couple months ago, a year ago? What’s the sentiment like?

I think we have a lot of positive momentum. Again, what we’re doing hasn’t been done in what I call the high-end casual to the high-end business – buying companies and building culture. So they’re seeing the success; they’re getting excited about having more lines to sell – they’re starting to ask for even more. So we’re really excited with the direction, what we’ve done. And we’re able to execute so people are starting to believe it and you know, success is infectious. So we’ve got buy-in from the sales force and from management and so we’re really going in a good direction. Scott Van Winkle – Canaccord Genuity: When you make an acquisition, any of these three for example and start the integration, is there any material change in how people are compensated? Is there maybe a little more of an incentive base or less or anything of that nature?

Not too much on the sales side. Going in we try not to disrupt them too much. Over the course of time will there be a little bit of uniformity around our sales comp plan? Probably over the course of time but I don’t think it’s going to be a significant wholesale change for these guys.

Yeah, we’ve always been a company that tries to create opportunity for our employees. We’re always trying to find ways to motivate, incentivize so it’s really the opportunity to sell more product to the same customers and acquiring new customers – that’s how everybody makes more money. So creating those opportunities creates the excitement and I think we’re seeing the effects of that. Scott Van Winkle – Canaccord Genuity: Gotcha. And then John, the gross margin you talked year-over-year from mix and inflation impact – how about sequentially? It was up sequentially while down year-over-year. Is that because of Qzina, or can you talk about it from Q1 to Q2?

Yeah, Q1 to Q2 I think when you strip out Michael’s – obviously Michael’s and Praml had a bigger impact. So in Q1,Praml impacted Q1 whereas we lapped that I think April 26th or 28th so that really didn’t have much of an impact in Q2, so that was a piece of the puzzle. We did own Qzina for two months of the year. They’re probably a couple hundred basis points higher than our average but that really didn’t have a huge impact on that front. They’re small enough that it’s really not that big a deal. Scott Van Winkle – Canaccord Genuity: Okay. And then the inventory level, did Qzina come with a lot of inventory? Is that why we see the sequential increase?

They did, yep. Yep, I think that’s an opportunity for us over the course of time. Each of their facilities, they had eight facilities doing roughly $65 million in revenue. So they had a lot of inventory at each location. In the long run one of our big opportunities with Qzina is integrating their operations with our existing operations as we overlap in four markets, so that will help operational costs, it’ll help inventory turns. It’ll help a lot of things.

Yeah, there’s tremendous amounts of SKU rationalization that down the road we will achieve because we do sell many similar types of products. Right now the most important thing was to hold the customers that they have and get their salespeople aboard believing that they can cross sell as well. And over time as that business grows the inventory gets more balanced. So my belief is that the pastry business, we can double it and as you grow your inventory you already have it – you’re just going to turn it faster because you’re such a large importer and you have to carry such a wide SKU base, which is really the attraction for customers who do buy from Qzina because they do have so many different types of products. It is their strength but as that business continues to grow the inventory starts to make more sense. You’ll get more turns. Scott Van Winkle – Canaccord Genuity: Great, thank you.

Thank you. Ladies and gentlemen this is the end of our Q&A portion and our conference call for today. You may disconnect your lines at this time and have a wonderful day.