CHEF (2019 - Q4)

Greetings, and welcome to The Chefs' Warehouse Fourth Quarter 2019 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. Alex Ald

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 fourth 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 Reports on Form 10-Q, which are available on the SEC website. Today, we're going to provide a business update, go over our fourth quarter results in detail and review our 2020 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 fourth quarter 2019 earnings call. Fourth quarter top-line growth was solid amidst a healthy customer demand environment. As we have seen throughout the second half of 2019 products mix shift continued to drive lower volume metrics and a higher inflation or price component of our organic revenue. While inflation continued to trend higher throughout the year, the fourth quarter price environment was particularly challenging with double-digit spikes in the higher-end center-of-the-plate categories. I would like to thank the entire Chefs' team for delivering a strong finish to 2019 and we look forward to continuing our path to future growth in 2020. A few highlights from the fourth quarter include: 4.1% organic growth in net sales. Specialty sales were up 5.3% organically over the prior year, which was driven by unique customer growth of approximately 3.8%, placement growth of 2.5% and specialty case growth of 2.3%. Organic pounds in center-of-the-plate were approximately 2.1% lower than the prior year quarter primarily due to a tough comparison to Q4 2018. Specialty product mix changes continue to drive the changes in unit volume and price. Similar to our third quarter reporting on a year-over-year basis, this represented a shift from higher volume dairy category cases to lower volume higher revenue per case specialty product categories. In addition, specialty case growth compares to a strong 6.5% case growth in the fourth quarter of 2018. The year-over-year decline in center-of-the-plate pounds compares to approximately 5% pounds growth during the fourth quarter of 2018 and continues to cycle through attrition of some higher volume lower margin placements. Gross profit margins decreased approximately 71 basis points. Gross margin in the specialty category increased 36 basis points as compared to the fourth quarter of 2018, while gross margins in the center-of-the-plate category decreased 185 basis points year-over-year. Just a reminder center-of-the-plate gross margins experienced 135 basis point increase in the fourth quarter of 2018. Gross profit dollars grew approximately 5.3% versus the prior year quarter. Jim will provide more details on margins in a few moments. During the quarter our operation teams were focused on implementing, enhanced picking, slotting and loading processes, utilizing our inventory scanning platforms. Initial results in our Northeast distribution center have produced reductions in damages and returns. These process improvements will continue to roll out across our locations throughout 2020. ERP system implementation in Southern Jersey, Philadelphia continued during the fourth quarter and we are on pace to go live in the first quarter. In terms of e-commerce, our team has been focused on developing and rolling out value-added tools aimed at assisting our Chefs' customers with menu design and product selection. We started this off by introducing our online Chocolate Wizard this past month with additional product line functionality to be added in coming quarters. As of January 2020, we estimated online sales represents approximately 17% of total organic revenue and approximately 21% of all specialty orders were placed on our e-commerce platforms. This includes website, mobile and electronic order applications linked directly to a certain customer order system. 2019 was a very busy year for the company. In February of last year, we added the Bassian Farms team and brands to our portfolio in the San Francisco Bay area. We consolidated processing early on and will create additional synergies and opportunities when we consolidate certain operations and distribution centers over the next two years. We also made a significant investment in our U.S. market taxes. We've completed the build-out of a new distribution center in Dallas, began the process of building the team and implemented our ERP system. We're excited to bring the Chef's warehouse array of both specialty and center-of-the-plate products and high-touch service model to both new and existing new customers across the Longhorn state. We initiated the process to further expand in Los Angeles as well with the design and build-out process underway on the new 230,000-foot distribution center that will co-locate specialty produce as well as center-of-the-plate and fresh seafood processing. We are excited to provide our Southern California team with a platform to drive continued growth in this dynamic market. From a financial perspective, we delivered strong results highlighted by 10% top line growth and adjusted EBITDA growth of approximately 15%. In addition, we strengthened our capital structure and balance sheet by executing the $150 million five-year convertible note this past November. This transaction helped set the stage for further investment and growth for our company in 2020 and beyond. Finally, we've continued to promote and grow our CW team as well as our key industry talent to drive both leadership and execution as we enter the next phase of Chefs' evolution and growth. 2020 marks the 35th year of the Chef's Warehouse. We started the year off with two acquisitions that we believe will be important pieces to grow our business in New England and add premium brands categories and talent to the Chef's Warehouse team and family of companies going forward. The Sid Wainer & Son Company is our first major foray into produce. Complementing this acquisition in New England with Cambridge Packing Company provides us a scalable platform to grow the produce category in the Northeast as well as expand specialty and center-of-the-plate sales across the region. Our team has never been stronger more focused or excited about our future as a leading national marketer and distributor to the Chef's-driven customer base that continues to grow with Chef's Warehouse and its family of companies as its partner. With that, I'll turn it over to Jim to discuss more detailed financial information. Jim?

Thank you, Chris, and good afternoon everyone. Our net sales for the quarter ended December 27, 2019 increased approximately 8.2% to $436.5 million from $394.1 million in the fourth quarter of 2018. The increase in net sales was the result of organic growth of approximately 4.1% as well as the contribution of sales from acquisitions, which added approximately 4.1% to sales growth for the quarter. Net inflation was 4.1% in the fourth quarter, consisting of 3.1% inflation in our specialty category and inflation of 5.3% in our center-of-the-plate category versus the prior year quarter. Gross profit increased 5.3% to $107.7 million for the fourth quarter of 2019 versus $102.3 million for the fourth quarter of 2018. Gross profit margins decreased approximately 71 basis points to 25.3%. Specialty inflation was driven by above-average increases in cheese and dairy categories, partially offset by deflation in chocolate and pastry products. Fourth quarter inflation was broad-based across center-of-the-plate categories with double-digit inflation in certain primal categories such as prime and choice tenderloins. Total operating expense increased approximately 5.6% to $89.3 million for the fourth quarter of 2019 from $84.5 million for the fourth quarter of 2018. On an adjusted basis and as a percentage of net sales operating expenses were 18.6% for the fourth quarter of 2019 compared to 19.7% for the fourth quarter of 2018. As a percentage of net sales, lower benefits and compensation-related expense were the primary drivers of operating expense favorability, partially offset by higher warehouse costs primarily related to our investment in Texas and our new distribution center in Los Angeles. Our team delivered positive fourth quarter year-over-year gross profit growth to adjusted operating expense growth which contributed to a full year 2019 positive spread of approximately 120 basis points. Operating income for the fourth quarter of 2019 was $18.4 million compared to $17.8 million for the fourth quarter of 2018. The increase in operating income was driven primarily by increased gross profit, offset in part by higher operating expenses. As a percentage of net sales, operating income was 4.4% in the fourth quarter of 2019 versus 4.6% in the fourth quarter of 2018. As Chris mentioned during the fourth quarter we issued $150 million convertible debt notes maturing in December of 2024. Net of transaction fees total proceeds were approximately $145 million, a portion of which we used to repay approximately $43 million of outstanding borrowings on our asset-based loan facility. Interest expense decreased to $4.4 million for the fourth quarter of 2019 compared to $5.7 million for the fourth quarter of 2018, due primarily to $1.1 million write-off of deferred financing fees during the fourth quarter of 2018 associated with the re-pricing of our term loan and lower effective interest rates on our outstanding debt. Income tax expense was $3.2 million for the fourth quarter of 2019 compared to $3.1 million for the fourth quarter of 2018. Our GAAP net income was $10.9 million or $0.36 per diluted share for the fourth quarter of 2019 compared to net income of $8.9 million or $0.30 per diluted share for the fourth quarter of 2018. On a non-GAAP basis adjusted EBITDA was $28.2 million for the fourth quarter of 2019 compared to $24.6 million for the prior year fourth quarter. Adjusted net income was $12.1 million or $0.39 per diluted share for the fourth quarter of 2019 compared to adjusted net income of $9.5 million or $0.32 per diluted share for the prior year fourth quarter. We ended the fourth quarter of 2019 with $140.2 million in cash. And as of the end of the fourth quarter net debt to adjusted EBITDA was 4.1 times. Turning to our guidance for 2020, based on the current trends in the business and inclusive of our recently announced acquisitions, we are updating our financial guidance to be as follows. We estimate net sales for the full year of 2020 will be in the range of $1.85 billion to $1.91 billion. Gross profit to be between $478 million and $492 million. Net income to be between $26.9 million and $29.8 million. GAAP net income per diluted share to be between $0.86 and $0.95. Adjusted EBITDA to be between $102 million and $106 million. And adjusted net income per diluted share to be between $0.91 and $1. This guidance is based on an effective tax rate of approximately 28% for 2020. Our full year estimated diluted share count is approximately 33.6 million shares. We expect our senior unsecured convertible notes to be dilutive for the full year. And accordingly those shares that could be issued upon conversion of the notes are included in the fully diluted share count. Thank you. And at this point we will open it up to questions. Operator?

[Operator Instructions] Our question is from Nicole Miller, Piper Jaffray. Please proceed with your question.

Thank you. Good afternoon. Appreciate the update. Especially on the top line, could you talk a little bit about the pushes and the pulls of maybe revenue from the perspective of the first half or the second half or maybe even a quarterly cadence? I'm just thinking about some of the things you're lapping and then the new acquisitions of course that are coming on?

Hey, Nicole, it's Jim. Are you referring to the guidance for 2020?

Yes sir.

Sure. So just as it relates to going back to our original guidance that we issued in January. We had mid single-digit kind of organic growth with no acquisitions. And so the adjustment is really just to add the addition of the Sid Wainer acquisition and the Cambridge Packing Company acquisition. In terms of what we're lapping really the only thing I would call out was just in the fourth quarter of 2019, we had the shift in the Jewish holidays in the Northeast into the fourth quarter. And then we had the shortened holiday period, which depressed revenue maybe about 50 basis points, but that's really anything I would call out from a cadence perspective.

So it's going to be a strong start like you said out of the gate and then there's no reason -- it's not going to vary much by quarter.

No. The only thing I would add is is that Sid Wainer has a little bit of more of a seasonal business than traditional ships warehouse businesses and not so much from a revenue perspective, but from a profitability perspective. They have a weaker Q1 and a stronger Q3 given their seasonality.

Excellent. And just a last question that's just very high level. It's interesting to hear about your e-commerce platform and maybe you see this elsewhere, but I would love to know like when you talk about menu design and there was something else you had mentioned in the prepared commentary you're helping chefs with. What kind of trends do you see in food for 2020 that we should be aware of? Thank you.

Well, in terms of -- are you asking in terms of e-commerce trends or food in general?

No. I just I think I'm saying just food in general. I don't know that it comes through your e-commerce necessarily. It could come from any interaction, I guess. So just very big picture the chefs that you're working with today? What kind of big picture -- what things are they doing at big picture we should see moving throughout the really the restaurant industry?

Yes. Well, I think that the trends that have been driving the business is -- the competition is forcing -- it's competition plus all the ability to watch the TV shows and everything that's out there. People have become more and more foodies around the whole country not just the coast. So we're seeing a push for quality. We're seeing a lot of prompt to table still. So we've contracted with many, many local suppliers in each of our markets. We're being asked for cleaner ingredients. We launched a Monterey, a very high-rated Monterey indoor salmon, which we're just getting started with the strategic relationship with the producer, which is going to produce probably at least 15%, 20% of all farm salmon we think consumed in this country. So we have so many different initiatives from sustainability to clean products, GMO-free products, more organic products. So I think those trends are continuing. We've seen the gluten-free and we've seen so many trends come and go. Now it's a plant-based trend. That's part of the reason that we bought Sid Wainer at the beginning of this year. We think that we would like to add more and more fresh green as we say it. I don't know where the whole plant-based burger and plant-based chicken's going. But people are definitely going to eat more and more healthy produce and we want to be a company that can deliver that with our cleaner proteins and all the specialty and broadline products we have. So, we think we're positioning ourselves with diverse portfolio of products to eventually become a one-stop shop for more and more of our customers.

Thank you.

Our next question is from Kelly Bania, BMO Capital. Please proceed with your question.

Hi, Kelly.

Good evening. Thanks for taking my questions. I guess just a question on the guidance. So it sounds like the change in guidance really reflects the acquisitions. So we're adding about $200 million or so and about $7 million in EBITDA. So I'm getting about just over 3% EBITDA margin. So is that accurate? Or any other moving parts? Maybe just help us understand the margin profile of these companies as we're folding these in here?

Yes. Sure. So the center-of-the-plate business we bought is right around our average EBITDA margin. But as you're probably aware produce companies tend to be a lower average EBITDA margin than specialty or center-of-the-plate company. So Sid Wainer comes in which is the preponderance of the revenue add comes in at a lower margin. So what you'll see is versus last year about a 30 basis point increase in full year gross profit margin as produce is a higher gross profit margin average than specialty and center-of-the-plate and then a higher OpEx average given their business model. So as you look out we have a two to four plan to generate $5 million to $8 million in synergies. And over that time frame we will – we'll bring that average EBITDA margin up to at or above our average EBITDA margin.

Okay. Can you expand on the synergies and where that comes from? I think that's a little atypical for your typical – compared to your typical acquisitions.

Yes. Well this acquisition was very strategic. So we've been trying to get into New England for a while. So the way the stars lined up. We did two in one week that we've been working on for a very long time. So it gives us a produce strategy, gives us a protein strategy. And we've already entered that market with our specialty broadline. So it's really a strategy that goes all the way up to Maine and down to Virginia, how we're going to start to sell more and more specialty produce, okay to our customers. And sell more and more specialty proteins and our giant portfolio of products throughout New England, Vermont, Western Massachusetts, Northern Connecticut and how to bring down their expertise into our Metro New York, New Jersey markets and all the way down and through the Mid-Atlantic. So the synergies I mean we have short-term synergies. We have duplication in certain areas duplicate routes that we're hoping to rationalize. So that's part of the short-term [indiscernible]. Then we have the midterm, when we figure out the buildings and how we're going to integrate both sales forces and hypercharge growth, okay into their markets once their people get all our portfolio of products. So it's kind of what we've done in Ohio and other markets where we said we're going to start to hybrid sell. But this is a tremendous opportunity for us really to integrate two – three great companies now throughout a very large territory now. So we have fells in Baltimore as well for protein. So as we look at retrofitting our new buildings and possibly building new buildings, it's really leveraging now the intelligence and the expertise of specialty produce, specialty proteins and the specialty broadliner and really give us continued growth for many. My plan right now is it's a 10-year plan. So I think we will get short-term synergies. We will get short-term integration and hybrid selling. But really the best is to come over the next four to 10 years.

Thank you. That's very helpful. And I guess with produce since that is a big change just how does being able to offer that change the relationship with your customers? And as you mentioned I think Maine and Virginia is that an expansion of the territory that you can service from a specialty produce perspective? Or are you planning to expand the geography that currently is covered by that company in specialty?

Yes. Yes. Well right now they touch a very large territory and our plan really is to access their giant customer base and sell them more products. So, that's I think -- that's the plan for the next four or five years. We're really trying to get the building right because their building is set up as a produce hub. So, we're actually meeting today, trying to see how we're going to execute in the short term to give them access to our products. We've developed really good technology on the cross-stocking and being able to do it in other markets. The second stage really is, keeping the integrity of their produce business. So, we want part of it to stay as a produce business. So there are certain customers just like we do in protein and seafood that want to buy from a particular company. So, we think that there is a pretty large group of customers that are going to want that produce delivery maybe it's a six, seven-day a week delivery that they provide now that you wouldn't want to put into a much larger Chefs' Warehouse truck. But we also know that through experience, through other markets, we do sell some produce in other markets as well. That offering produce not as a produce company, but part of the specialty broadliner to thousands of customers that we already have should give us really good extra growth to our numbers over the next five years.

Okay. Great. Very helpful. And just on the gross margin, it sounds like it was a challenging prime market with some spikes. How did you perform relative to your expectations in that category? And just maybe what are you seeing so far into the New Year?

So, overall based on our guidance that we updated when we reported in Q3, for the full year we came in kind of right down the fairway. So, the quarter we overall performed as we expected. But the -- in the puts and takes, there was definitely a headwind from the spike in prime. Now it started to dissipate as you went into the last month of the quarter. Obviously prices started to come down. But from a year-over-year perspective, they were still 50% higher than the prior year in some of the prime categories. So, it was definitely a headwind. But we had strong margin performance on the specialty side, really executing in a high-inflation market. We continue to see the year-over-year impact of product mix. And so overall, we are happy with the performance in the quarter although it could've been better, if we didn't have such a spike in prime. In terms of -- what we've said before is that, we tend to get a little bit back on the downside. Prices have come down, but that's pretty much all we can say about the quarter.

Yes. They've come down. Thank God. I mean they hit record highs in -- right before December, so the problem was that you had to have inventory. We sell a very premium product that does take time to age. So you already have the product and it's aging. So -- and it was bought at a very high price. So when the market starts coming off, there is a lag time before you could start to get some of that margin back as Jim was referring to. So, give you a market view tenderloins -- prime tenderloins I think went to $20 a pound and they're $10 a pound today. So it was an incredible headwind. The team did an incredible job of trying to get through it and talk customers through it. It's not the first time we've seen it but I think we're getting better and better. And every time we do see some of these markets. We are able to form a lot better. Even coming into this year, we have a much better view of how to handle a -- I call it a hurricane like we saw in the prime tenderloins market. So I'm very excited as I say our team is getting deeper. We have been hiring talent. And exactly for that reason is we bring on more and more expertise to kind of handle particular products like prime. So, we do get better and better as we continue to grow those categories.

Thanks. And I'll maybe just ask one more. Just on Texas, and how that market is ramping from a top and bottom line perspective relative to your expectations? And what you have baked in, in your 2020 guidance from that market? If you can go that specifically.

So in terms of what we've baked in for guidance as I – I think as I said, before or we've said before Texas has been a headwind in 2019. It will not be breakeven in 2020. So we have baked in improvement, but it will still not be breakeven. And we anticipate breakeven in 2021, 2022 time frame.

Yeah. So we're still in investment mode. It kind of reminds me of San Francisco. And most markets that we entered where we had to make the investment first kind of fill the dreams build it and they will come. So I think right now, it's hiring and training hiring and training. And history usually repeats itself, we'll optimistically we'll get a good tuck-in which will kind of speed it all up. Again, Texas is really three different markets in itself, Dallas that San Antonio, Austin market in Houston. So I mean, it's a huge state huge opportunity. We're trying to bite off one piece at a time. We kind of jumped in early because of the opportunity that existed to take over that small company. But I think that's – we go quarter-to-quarter with that keep investing and look for the opportunistic fold in really to really hypercharge our growth eat up our overhead and turn it profitable sooner than later.

Great. Thank you. I'll let someone else ask questions.

Sure, Kelly.

Our next question is from Christopher Mandeville, Jefferies. Please proceed with your question.

Yes. Hey, guys. First off, I apologize if any of this is redundant, because my line got dropped mid-call. So I guess, I'm interested Chris the acquisitions both Sid Wainer and Cambridge taking place in effectively similar markets. Was that just coincidental? Or was there something that maybe compelled these two to ultimately sell themselves. Maybe give me some perspective just with respect to how does top line and margins have been trending over the last two, three years?

Yeah. The two companies we've had a lot of respect for – for years. So I think I've said before a lot of the acquisitions you see us doing now. We've been maybe talking for 10 years. It's just timing of when companies are ready. Or is there a next plan, is there a family coming into the business. So it's just the way the stars aligned. We've been trying to get into New England for a very long time. We entered it through a Greenfield through our own depot coming out of New York, which we know is not efficient. So it was just a tremendous opportunity that came at the same time. So we get a world-class produce company. Sid Wainer is one of the most respected brands in the country. 100 years old tremendous integrity and following and people have in the produce industry have a lot of respect for their – hat they've done with their asset programs and specialty selection. One of the first companies really to bring in specialty – bring in farmers to grow stuff for them and import specialty produce and then combined specialty items as well with it. So – and Cambridge a boutique custom-cut butcher of New England some of the top-top customers throughout New England. We've known them for years and we've wanted them to become part of our protein team with Allen Brothers and Michael's and our other great brands. So now we have access to their clientele. The plan's already being drawn up to see how we can best cross-sell. The trick about New England really is it's very spread out. Boston itself is not a giant city, it's not New York. So now we have access to Nantucket and Martha's Vineyard and Cape Cod and all the Western Massachusetts and lots of Vermont and Portland up in Maine, which is a great restaurant town and even better access to Northern Connecticut and Rhode Island, Newport. So it's a very exciting opportunity for us – for them to join Chef's and to bring more of that expertise down into Metro New York as well. So now we have another facility besides Fells in Baltimore to feed New York with custom cuts. So, we have trailers going back and forth every day so we could do much more just-in-time programs. It's going to give us one, two, three kind of attack that we've been looking for to help the already-existing plan we've had for the Northeast.

Okay. And then just in terms of I guess the cross-selling opportunity more so into your existing customer base. How long will it necessarily take for you to be able to start incorporating produce? And what type of investment is required to stand up a more robust supply chain and cold chain? And how much does that really add in terms of complexity to the model?

Sure. The good part is that we're already doing it. So, New York already has a boutique produce department and we're already selling proteins coming out of Chicago and Baltimore. So, we've already started to the job of getting the specialty produce strategy of Wainer to integrate with Chef's and see how we can help them grow faster. The buildings are always the complex parts. So, we're in the -- first thing now we're really looking at our buildings and seeing how we can reconfigure them to make them more efficient. So, I think for the next year or two, I think what you can expect is we will give both companies good growth into the New York market. And then really after the year three, four, and beyond is how we reconfigure our either additions to the buildings, retrofit the buildings, or add additional warehouse space. So, we can accommodate the growth that I see coming for the next 10 years in those two departments.

Okay. And then just the last one for me. Jim if I heard you correctly you mentioned that Sid Wainer's going to add roughly 30 basis points to the gross margin on a full year basis. Is that right? Or is that -- I guess, I'm just curious if that's Sid net of Cambridge or if that's both Sid and then not including Cambridge?

No. Sorry. So, that's both Chris. And that's compared to the full year of 2019. From our original guidance, I think the midpoint of our original guidance that we gave for 2020 was 25.7%. The new guidance the midpoint is 25.8%, so about 10 basis points above our original 2020 guidance, but 30 basis points to the full year gross profit margin for 2019.

Okay, perfect. Thanks guys.

Thanks.

Thanks Chris.

[Operator Instructions] Our next question is from Todd Brooks, CL King & Associates. Please proceed with your question.

Hey good evening everybody.

Hey Todd.

A quick question on both Wainer and Cambridge. I guess A, are there any specifics from the acquisition details that you can share with us prior to I assume it would be in the end of the year filing. But I'm just trying to get at remaining firepower from the convert issuance if any after those two deals?

Sure. So, yes, Todd, you'll see the details in the 10-K. But just to give you some color the cash purchase price for both businesses -- for the businesses themselves was about six and a half times and then there's about a one-time earn-out for both combined. And then we did purchase some real estate. So, when you see the cash outlay that six and a half times addition to that there was cash related to the real estate purchase for the Sid Wainer acquisition. So, that's how it breaks out and you'll see the details when we release the 10-K.

Okay, great. And then from a more capability standpoint, just -- I know these are long lead-time deals and it takes a while for things to go through the acquisition pipeline. And Chris I'd just love to get your thoughts on -- you work on deals for years, you get two big ones like this at the start of 2020.