Good morning, ladies and gentlemen, and welcome to The Chefs' Warehouse Second Quarter 2023 Earnings Conference Call. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Alex Aldous, General Counsel, Corporate Secretary and Chief Government Relations Officer. Please go ahead, sir.

Thank you, operator. Good morning, 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 2023 earnings press release. It can also be found at www.chefswarehouse.com under the Investor Relations section. Throughout this conference call, we'll 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 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 on the SEC website. Today, we are going to provide a business update and go over our second quarter results in detail. For a portion of our discussion this morning, we will refer to a few slides posted on The Chefs' Warehouse website under the Investor Relations section titled Second Quarter 202 Earnings Presentation. Please note that these slides are disclosed at this time for illustration purposes only. 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 2023 earnings call. As we noted during our first quarter earnings report, the strong snapback in demand coming out of the Omicron variant of the COVID-19 pandemic in the second quarter of 2022 provides a difficult year-over-year comparison to the second quarter of 2023. As we had anticipated, for the first time since the onset of the COVID-19 pandemic, second quarter business activity returned to more normal seasonal trends. While April and May were strong months and came in as expected, in June we did experience some impact from the air quality issues from the Canadian wildfires and extreme heat and severe weather across many of our markets. In addition, volatility in certain protein categories resulted in moderate gross profit dollar pressure. Overall, for the quarter, our team delivered strong year-over-year organic revenue growth and adjusted EBITDA and our recent acquisitions performed well. A few highlights from the second quarter as compared to the second quarter of 2022 include 8.1% organic growth in net sales. Specialty sales were up 11.4% organically over the prior year, which was driven by unique customer growth of approximately 8.7%, placement growth of 11.9% and specialty case growth of 10%. Organic pounds in center-of-the-plate were approximately 5.9% higher than the prior year second quarter. Gross profit margins decreased approximately 43 basis points. Gross margin in the specialty category decreased 70 basis points as compared to the second quarter of 2022 while gross profit margins in the center-of-the-plate category decreased 174 basis points year-over-year. Jim will provide more detail on gross profit and margins in a few moments. In addition to providing the quarter results and the update to our 2023 guidance, we thought it would be helpful to share with our team members,…

Thank you, Chris, and good morning, everyone. I'll now provide a comparison of our current quarter operating results versus the prior year quarter and provide an update on our balance sheet and liquidity. Our net sales for the quarter ended June 30, 2023 increased approximately 36.1% to $881.8 million from $648.1 million in the second quarter of 2022. The growth in net sales was a result of an increase in organic sales of approximately 8.1% as well as the contribution of sales from acquisitions, which added approximately 28% to sales growth for the quarter. Net inflation was 3.6% in the second quarter consisting of 5.7% inflation in our specialty category and inflation of 1.1% in our center-of-the-plate category versus the prior year quarter. Gross profit increased 33.6% to $208.4 million for the second quarter of 2023 versus $156 million for the second quarter of 2022. Gross profit margins decreased approximately 43 basis points to 23.6%. Gross profit dollar growth and margins were primarily impacted by year-over-year product mix changes, partially due to the increase in hospitality related business versus the prior year quarter combined with a sharp decline in certain protein category prices during June of 2023. Selling, general and administrative expenses increased approximately 43.8% to $179 million for the second quarter of 2023 from $124.5 million for the second quarter of 2022. The primary drivers of higher expenses were higher depreciation and amortization and higher compensation and benefit costs, facility and distribution costs associated with higher year-over-year volume growth and the impact of acquisitions. On an adjusted basis, operating expenses increased 42.2% versus the prior year's second quarter and as a percentage of net sales, adjusted operating expenses were 17.8% for the second quarter of 2023 compared to 17.1% for the second quarter of 2022. Operating income for the…

[Operator Instructions] The first question we have comes from Alex Slagle from Jefferies. Please go ahead.

I wanted to ask on the guidance and the cadence of margins this year and with the second quarter back to normal seasonality and EBITDA margin sort of falling right into that range. As I look ahead to the 3Q and think about the typical 5%, 6% EBITDA margin we've seen in the past suggests a pretty big 4Q to get to the guide. So perhaps just some thoughts on that? And I guess also with the Middle East having a different seasonality than the U.S. business, just if that plays any part into the mix?

Alex, thanks for the question. Yes, I think the two large acquisitions that we completed during the quarter as well as the seasonality of Chefs' Middle East combined, those are three big companies that we would anticipate would have an impact on the third quarter. So I think number one, the second quarter coming in where it was, was not too far off of our expectations. We built our guidance on the second quarter coming in kind of in the low 6% range. We missed that by about 20 basis points, 30 basis points. We talked about the impacts of a couple of things that came together in June to take a little bit of froth off of margins, but overall a very strong quarter. So I think the third quarter -- the back half of the year is going to be a little more of a normal cadence, but those three acquisitions will bring up the third quarter a little bit versus what we would have seen in the past.

Okay. That makes sense. And you noted the June activity was a little different and impacted by that smoke and the heat waves in some of the regions. Outside of that, did you see any signs of incremental pullback in demand or a change in trade down dynamics?

No. I mean I think we had a really strong organic revenue and volume quarter, 8% year-over-year organic sales growth and volume growth, very moderate inflation. It was really just a couple of weeks in June, I think the biggest impact was the kind of sudden decline in certain protein categories that took a little bit of an impact on our margin. We had some -- obviously we talked about we're carrying some overhead expenses that compared to the operating leverage that was created last year kind of gives you an outsized difference on the percent of revenue on OpEx. And those things just came together and impacted the EBITDA margin a little bit in the quarter mostly impacted by June.

Thank you. The next question we have comes from Andrew Wolf from CL King. Please go ahead.

Could you give a little color on what's changed in the choppiness in the protein markets? I usually think prime beef, something with the prime beef that's hard to track on the outside with you all, but I know you diversified that into other types of protein.

It was a very abnormal quarter for protein sales. When you look at -- what we look at is the amount of animals coming through the system and the outlook is that there's not enough cattle in the system. Prices will remain high and continue to go higher for the next few years. I think we've been talking about that in the last few calls. And for whatever reason, there was a blip where the market just went the other way and that's what compressed some of our protein margins. It caught the whole market, Andy, by surprise and it's not the first time that this has happened, but it did catch us by surprise and it cost us a little bit of margin compression. Again, as Jim said, we kind of track pretty much to our expectations. We had a pretty good quarter. I mean we had great organic sales, we had great placements, we had customer growth. And it was kind of an odd quarter between coming into July as well with the massive heatwaves and we lost a few days of business with all the crazy smoke coming over from Canada, all the outdoor cafes were closed. So team did a great job grabbing as much business as possible. I think our customers overall, their customer is spending. You've got a lot of travel, right, this past quarter. I mean I think overseas, we've read reports, up to 200% of travel. So a lot of the wealthy clientele of our customers are traveling after being locked up for a few years with COVID. So looking at all that, I mean it was a pretty good quarter with that damn beef market causing a few bumps.

Andy, I'd just add that you really have to put the quarter in the context of the first half of the year, Q1 and Q2 combined compared to last year and then also in the context of our full year guidance. We didn't construct the guidance on delivering the profitability that we did last year. Last year's second quarter was an incredible confluence of extreme demand, really strong rising prices and incredible operating leverage. So the quarter came in kind of right in the range that we expected. If you combine it with the first half of the year -- within the context of the first half of the year, 14% year-over-year organic growth for the first 6 months and 25% year-over-year adjusted EBITDA growth and that's very similar to what our full year guidance implies on a full year basis. So I think it's just the unevenness of the comparison that really caused a little bit of confusion as we came into the first half of the year.

Okay. That's really helpful. I'm going to use a tortured analogy or metaphor, but has the smoke cleared on the beef market in the outdoor cafes?

We're here in Connecticut and the weather is beautiful so we hope it continues. Actually too chilly so really odd and beef prices are starting to firm up. You're starting to see price increases.

So it sounds like the beef market kind of going completely opposite all expectations is what drove you guys a little below your budget. Is that a better way -- more so than some disruption in demand from weather? I'm just trying to -

Yes, I would say that's true. So we expected to come in about 20 basis points to 30 basis points in adjusted EBITDA margin better than we delivered so a couple of million dollars. We did not expect -- the consensus models had us close to 7%. That was built off of last year. We didn't expect to come in there in the context of our full year guidance.

That's completely understandable given I look back at how good last year's second quarter was. I just want to ask about one other question, kind of a follow-up to some of the things Alex was asking about was the back half guidance. I mean the sales are doing good even with June having disruption certainly versus what I expected. So I'm thinking more on the margin. Would it be right to think that to get to your guidance, it's going to be more -- what's the balance going to be between improved sort of -- I know you want me to look at it in halves, but kind of in a short sighted sense. Is the gross margin going to improve a little more because the second quarter had the hiccup or is it going to be a balance between the gross margin and the cost structure?

Yes, it's going to be a balance, Andy. We don't guide by quarter, but the comments I just mentioned about the change in seasonality due to the three large acquisitions. Normally our third quarter would be slightly lower adjusted EBITDA margin than the second quarter. I think the fact that we undershot a little bit on the second quarter, it will be -- the cadence will be more normal. In terms of the fourth quarter, we expect it to be stronger assuming that demand holds up and you'd have a really good fourth quarter like most food distributors do. The guidance implies what the second half will be and we haven't changed it.

Thank you. The next question we have comes from Peter Saleh from BTIG. Please go ahead.

I wanted to ask maybe first on the hospitality business. I know this is maybe one of the segments that was latest to recover post COVID. What are you seeing there? And are you seeing I guess the hotels and your customers that you serve, do they now have the labor to reopen and really be more -- have more service in that business? Just trying to understand how quickly that industry has recovered.

I think it's recovering, but I wouldn't say it's back to 100%. It depends which part of the country and what part of the cities or like Vegas. I think it's more right now. What we're hearing from our customers is after that crazy period last year when everything opened up, you have more normality and maybe too much travel overseas for customers' customers. So you take like Miami Beach, last year was -- the last few years were obviously one of the only places open and everybody was coming and I think the opposite happening this year that people are traveling overseas and other places. So in a way it's giving them a chance to build back labor. I still think they are struggling. We are hearing from certain customers that they still don't have the labor force to meet 100% demand. And I think part of the strategy that we've seen is they're keeping prices pretty high. So maybe there's not the tourism that normally there is in Napa Valley Monday through Thursday, weekends they still get a big crowd. They are keeping prices up to make their bottom line and there's still enough customers willing to pay really high rates for them to be profitable. I mean that's what it looks like from my seat, the kind of strategy from especially the high end. I mean it's very expensive when I see the rates that they're posting for say a Monday, Tuesday, Wednesday in Napa Valley. And they're quieter than they were last year for sure. So I think my best shot at it is the dollars are getting much more spread out. We're seeing a lot of areas do 120% of what we expected and we're seeing other areas do 90% of expectations. And what we hear from our airport customers is the amount of business that they're doing for people leaving is off the charts, but the amount of people coming in is still not back to normal.

Great. And then just on the 2- to 3-year targets that you guys laid out here on the adjusted EBITDA, can you maybe talk about some of the factors that would determine whether you come in at the low end or the high end of that EBITDA margin target? If you make more acquisitions, do you expect it'll be closer to the low end? If you mean less, you'll be at the high end? Just trying to understand some of the factors that will drive us either closer to the 6.25% or the 7%.

Our organic growth of what we always call our core business, that tracks pretty much to our expectation at what we call the higher end of the margin expectation. So you're absolutely right. It really depends who we acquire and we've acquired a lot of companies that are much lower margin than the typical Chefs' Warehouse and it usually takes us a few years to [indiscernible] it. So I always say we could be bigger than our expectation, but margin might be a little lower because we bought more companies that we're fixing; still great EBITDA, but we're still in fix mode. And if we buy less, volume will be less, but probably margin will be higher because it will be more organic growth, which tends to be at a higher margin.

Thank you. The next question we have comes from Kelly Bania from BMO Capital Markets. Please go ahead.

I wonder if we could talk a little bit about expenses for the quarter, just how that came in relative to your plan. I think guidance would suggest that the back half expense dollars need to come down and just curious what buckets that would be in. Maybe just help us think through that line item for the next several quarters?

Kelly, there's a couple of things there. I mean in terms of once again the unevenness, in Q1 we created a really good amount of operating leverage year-over-year because of the comparison and we outperformed in Q1. It's kind of the opposite in Q2 because of the comparison. That's a good portion of the year-over-year difference in operating leverage. We completed two very large produce company acquisitions, one at the end of the first quarter so that was fully in the second quarter and one somewhat in the beginning of the second quarter, and produce companies come with a higher percentage of operating expenses. So that was 20 basis points or 30 basis points or so of that difference right there. And then we had a couple of -- we had a large facility coming online in Florida so we're not adding that back anymore. That's impacting our OpEx and that just goes to the discussion that we are carrying overhead right now that we will fully leverage. We're creating that 30% to 60% capacity that we will grow organically into over the next two, three, four and five years. Going to Peter's question, that's going to be a big driver of us getting to that kind of 6.25% to 7% over the coming years. So those are the three main components of that and we expect that it will come down. Currently we expect that in the second quarter -- I'm sorry, in the back half of the year.

Okay. That's helpful. And just to be clear, were there any other acquisitions beyond Hardie's and Greenleaf? Those are the last two I had that the M&A contribution was a lot stronger than we had thought. So just maybe can we walk through either what's contributing to that or how to think about what is driving that line item?

You have to understand that it's all the acquisitions we completed since the second quarter or since the third quarter of last year. So we did Chefs' Middle East, which is a multi-hundred million dollar company. We didn't have last quarter the three big acquisitions; Chefs' Middle East, Hardie's, Greenleaf; and then we did a couple of smaller acquisitions over that time. We did the Mike Hudson acquisition out on the West Coast, which is a fold-in to our business. We did the produce fold-in last December into our Sid Wainer business in New England and we did the small fold-in in Canada. So there have been some smaller acquisitions that contributed to that as well in terms of the year-over-year contribution.

Yes. But really the organic growth is really driving the top line, Kelly.

I guess maybe just I'll ask another way. So of the announced acquisitions that we've had kind of releases on, has anything changed with respect to your organic adjusted EBITDA outlook for the year?

No. I think we went into the year with our original guidance based on organic growth. We adjusted our guidance when we were reporting Q1 to reflect the Hardie's and Greenleaf acquisitions as well as the upside from Q1. And so no, nothing's really materially changed in terms of our organic growth.

And just one last follow-up. What's driving the higher D&A outlook?

That's acquired growth. So the adjustment to the D&A is primarily higher depreciation and amortization with the acquisition of Hardie's and Greenleaf, which are large acquisitions; higher stock compensation associated with those acquisitions. And then not in D&A, but also impacting EPS is higher interest rates and the higher level of debt that we added to fund those acquisitions.

Okay. Helpful. And maybe just ask a longer-term question just about the new capacity that you're adding, maybe just help us have a little more color on what you're seeing out there in terms of cost and locations and are you finding exactly what you need there or help us just kind of think about how the landscape maybe has changed for some of the costs of these new facilities?

Well, I mean these buildings have been in the hopper for a while, Kelly, pre-COVID basically. So the building which is not up and running yet in Richmond, California, I mean that's a cost that we negotiated I think it was pre-COVID. The building in L.A. was I think pre-COVID we negotiated on that. So I think the buildings that are coming online now, Florida as well was pre-COVID. So the market is very strong. It's actually -- I'll take that back. The market is strong for warehousing. I mean it's gotten very expensive. As of late, we're hearing a little softness. Amazon's subleasing a lot of buildings. I always call it the Amazon effect really drove the price of warehousing to double close to cities. So these buildings they were expensive, but they were prenegotiated really for just the basic rate to rent them. To build them, the costs were a little higher because all the costs went up during COVID, which we're starting to see some normalization as the supply chains come down. So we got L.A. open now, we got Florida open, Richmond will open next year and South Jersey right outside of Pennsylvania is halfway open where we've moved in and now we're finishing that building. So that's the exciting part. We're adding a lot of capacity to be able to accelerate organic growth and to do very creative fold-ins.

[Operator Instructions] The next question we have comes from Todd Brooks from The Benchmark Company. Please go ahead.

Just a couple of quick questions here. One is a follow-up on the last line of questioning. Chris, if you look at the Florida facility or maybe the Southern California facility since it's a little more time that that's been up and running, how fast are those facilities opening up what you had sized as meaningful revenue opportunities to grow in those markets? I'm just trying to get a sense if these new facilities come on, how quick is the revenue unlock from the ability to service more customers?

Well, I mean the revenue is unlocked so they're growing faster than most of our other businesses because they were very constrained on the size of their building. So I would say they're living up to our expectation, growing at a very quick pace and really it's the opportunity to do very accretive fold-ins. I've said that I think for the past 10 years if I could do an accretive fold-in every day, I would because they're really low risk because most of what we're taking is the sales team and the increased sales and we're able to really get rid of a lot of the fixed overhead, right? They're old facilities, a lot of routes we're able to synergize by combining routes and that's the way we make money, right? The more dollars on a truck that can go out every day, the more GP dollars that fall to the bottom line. So my expectation is really L.A. will double over the next four, five years. Florida might triple to quadruple. So I think that that's a great expectation and that's a great ROI on building out those buildings.

And if you look at your M&A pipeline of opportunities, Chris, how does that mix out as far as shots on goal for fold-ins in these type of markets versus either new platforms in different verticals or maybe new market entry? Are there a decent amount of bolt-ons that you're always working on or are there more just with generational changes and some of these firms coming out of COVID and just being ready to sell and move on?

As we expect, I mean last year was extraordinarily busy because of all the buildup of COVID of businesses that we had negotiated on. So I think that was a little too frothy. Right now I think we're being more surgical, Todd. Organic growth is our top priority. We have invested in a lot of talent. Gearing up for the Florida building, we've added I would say 20-plus new sales reps to get ready to hit the streets. So we made a really big investment in trying to build up the team to grow organically, which we know is the most profitable growth and there's always bolt-on opportunities and we're always negotiating them. It really comes down to price and I think being patient is prudent at this point. New markets, I mean we're always looking to finish our map, right? We're not in the Carolinas, in Georgia, we're not in Colorado. I think those are secondary as far as the importance. I mean if there's something great, we've always been opportunistic. But really driving more business into Texas facilities right now, driving more business into Florida and L.A. and wherever we have capacity is at the top of the list because that really is where the biggest flow-through for EBITDA will be and that's what we're trying to do right now.

Jim, one quick one for you and then I'll jump back in the queue. I think the inflation outlook entering this year was kind of plus or minus 5% when you were contemplating the initial revenue guidance. We're two quarters in, we saw continued inflation across both verticals in the second quarter. I guess any surprises about where we've tracked year-to-date from an inflationary standpoint and anything you can share with us on outlook for inflation, deflation that you're thinking about in the second half of the year?

Yes, I think it's kind of played out pretty similar to our expectations. I mean obviously we've said earlier on multiple calls before this that we expected the base effect to drive most of the disinflation in '23 just given the extreme inflation that we saw throughout '22 and you've seen that kind of play out. We reported moderate kind of 3.5% inflation. That was primarily offset by the impact of product mix in the quarter. I mean looking forward I would expect that you're starting to see some deflation in some of the larger commodities that kind of went crazy in 2022 and so I would expect that the disinflation trend would continue. So more moderate year-over-year inflation, but sequential kind of slight deflationary to flattish. Sequentially from Q1 to Q2, we saw low single-digit deflation in specialty prices and we saw low kind of single-digit inflation sequentially in center-of-the-plate prices in aggregate. We did have the sharp decline in a couple of weeks in June, but it didn't cause the overall quarter to be sequentially deflationary because April and May were kind of more normal kind of strong months. So that's kind of the way it's been playing out and we would expect that it's going to continue to play out that way.

Thank you. The final question we have comes from Ben Klieve from LakeStreet Capital Markets. Please go ahead.

Just a couple of quick ones for me. First of all on the acquired businesses, was there anything that you guys have been surprised with particularly on the margin side from any of these kind of more major acquisitions that you've made over the past few quarters that really came to light in the second quarter?

No, not really. I would say that the two big produce companies that we added, we talked about on the Q1 call that they were slightly dilutive for the full year because they came in at an average EBITDA margin that was slightly lower than our average. But in terms of we did two large acquisitions a few months ago, we haven't really seen anything from a margin perspective surprise us. And our Middle East acquisition, which we've had for almost nine months now, has performed really well and just in line with expectations.

I mean the only real big surprise was how the protein markets behaved. I mean that caught the whole industry really by surprise where the sound is there's not enough great cattle and the market is tight and prices obviously are high and then all of a sudden you had a blip where you had a dip in pricing and everybody has four or five weeks of inventory and now you have a margin blip. So I think that's the only thing really that caught us by surprise that kind of hurt our expectations. I mean we track pretty close to what we expected the quarter to be and really the only big surprise was that blip in the protein margins that kind of caught everybody by surprise.

Got you. That's helpful. And Chris, you just kind of touched on what I wanted to ask next around protein. I mean for a long time these kind of short-term spikes in protein categories has come up from time to time and not a big surprise and, frankly, not much you can do about it. I'm wondering the degree to which you perceive the effect of this to have been contained within the second quarter or if you think this is going to bleed into the third quarter results?

I mean if I was that good, I'd be in Bermuda just playing the commodity markets to be honest with you. It's so hard. I mean optimistically, it should turn. I mean it should turn around and prices should go up and we exceed on our expectations of margin. I mean historically, at a certain point it does turn and the margin goes for you. It's like you're sitting at the table, eventually the cards start to come your way. So we've learned, being in this business now for quite a while, to be patient. The business is strong. I mean the most important thing from my seat is are we gaining customers? The answer is yes. Are we gaining placements? The answer is yes. Do we continue to win when we're fighting for new business and new opening? The answer is yes. So when I see our team performing, at that point I know we're going to get rewarded and obviously we know that there are some bumps in the road sometimes. So overall I think the team did a great job. And the protein market, it could be very surprising sometimes when you speak to the packers. So overall I think prices have to go back up because there's just not enough animals. Right now it seems like the animals that the farmers own are very expensive to bring to maturity and they want to get paid for them and packers are waiting for prices to go back up before they start to kill more animals than they're killing right now waiting for prices to go back up in the street. So it's kind of a cat and mouse game.

Thank you. So that was our final. Ladies and gentlemen, we have reached the end of our question-and-answer session. I would now like to turn the call back over to Chris Pappas for closing remarks. Please go ahead, sir.

Thank you. And we thank everybody for joining our earnings call. We're very proud of the CW team across the U.S. and Canada and the Middle East. They did a phenomenal job once again in kind of a squirrelly quarter. But we really did a great job gaining customers and gaining placements and we're very optimistic of all the investments that we are making and we think the team is really geared and built to really perform over the next many, many years. So we thank you again for joining and we look forward to you joining us on our next call.

Thank you, sir. Ladies and gentlemen, that concludes today's conference. Thank you for joining us. You may now disconnect your lines.