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The Chefs’ Warehouse, Inc. (NASDAQ:CHEF)

Update Conference Call

January 27, 2014 5:00 PM ET

Executives

Alexandros Aldous – Secretary & General Counsel

John D. Austin, Chief Financial Officer and Assistant Secretary

Christopher Pappas – Chairman, President and Chief Executive Officer

Analysts

Andrew P. Wolf – BB&T Capital Markets

Karen F. Short – Deutsche Bank

Scott Van Winkle – Canaccord Genuity, Inc.

John W. Ivankoe – JPMorgan Securities LLC

Operator

Greetings and welcome to The Chefs’ Warehouse Update Call. 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.

Alexandros Aldous

Thank you, operator. Good afternoon everyone. Throughout this conference call, we will be presenting non-GAAP financial measures, including among others estimated EBITDA and adjusted EBITDA, as well as both estimated 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.com.

With that, I would like to turn the call over to John Austin, our CFO. John.

John D. Austin

Thank you, Alex, and good afternoon, everyone. I’m here with our Chairman and CEO, Chris Pappas. And as you can see from today’s press release, we have updated what we expect for fiscal 2013 as follows. We expect revenue between $670 million and $673 million, adjusted EBITDA between $46.2 million and $46.7 million, net income between $16.5 million and $16.7 million, net income per diluted share between $0.75 and $0.76, and modified pro forma net income per diluted share between $0.80 and $0.81.

We’ve not yet completed the fiscal, the financial close process for 2013 and therefore these estimates are preliminary however we are far enough along in that process, we felt an important to provide an update on our expectations. We expect to report earnings before the end of February, and at that time we will provide you with detailed discussions on our financial performance as well as 2014 guidance.

A few comments on the numbers, revenue in our core business for 2013 was towards the lower end of our expectations. For those of you living in Northeast, I don’t have to tell you how severe the weather was in December, we saw that impact the business particularly during the important holiday season.

However, even with the weather issues December was weaker than we had expected. We also witnessed weakening operating performance in our Michael’s Finer Meats subsidiary during the quarter due in part to this severe weather that impacted the mid-west and also to continued margin pressure in the protein category resulting from increases in raw material cost and increased competitive pressures. This was offset somewhat by the acquisition of Allen Brothers, which contributed to the company’s revenue for the fourth quarter of 2013 by approximately $11.4 million, driven largely by the seasonal impact of their direct-to-consumer business.

There are also two other items I would like to call out. First, we determine that an employee involved in the financial reporting process at our Michael’s Meats subsidiary had been deliberately making unsupported adjustments to the subsidiaries inventory balances, which resulted in an aggregate overstatement of inventory of balance at the closing date of that acquisition of approximately 427,000, an increase to an aggregate overstatement of approximately $905,000 as of September 27, 2013.

This overstatement of inventory resulted in an understatement of cost of goods sold. We’re taking non-cash charge of approximately $0.02 per diluted share in the fourth quarter of 2013 to correct these misstatements. Our audit committee engaged outside counsel and forensic accountants to review the actions of Michael’s financial and operating personnel to determine the nature and extent of those unsupported adjustments. We concluded that no other balance sheets were materially impacted. As a result of the Company’s investigation we terminated the employee involved.

We also notified the former owners of that business that were making a claim against escrow under the purchase agreement regarding this matter for amounts related to periods through the closing date of that acquisition, as well as expenses associated with the audit committee’s review of this matter. We obviously take the integrity or financial reporting very seriously and while we’re disappointed in this incident we believe that was an isolated instance and we are now – that is now been corrected.

The second item I’d like to call out is we will also be reporting a non-cash gain of approximately $0.03 per diluted share in our year-end results related to the reduction of a liability, we’ve recorded as part of the contingent consideration for another acquisition as a result of that businesses performance being below the target thresholds for 2013 as outlined in the earnout agreement.

Again, while we’re disappointed with our preliminary results, we may remain confident in the long-term growth strategy of the business. I also wanted to add that we are very committed to integrity and reliability in all of our operations and financial reporting. This view, I review this as an opportunity to continue to strengthen our control environment particularly at recently acquired businesses.

Before we open it up for questions, I just want to let you know that our discussion regarding 2013’s financial performance will be limited to the information I just shared as we’re still wrapping up the financial closing process as well as our year-end audit, while we don’t expect material changes to these results, we need to complete that process before we provide more detailed financial information.

As I indicated earlier, we do expect to report in late February and at that time we’ll also provide guidance for 2014.

Thank you. And operator with that, we will take questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question comes from the line of Andrew Wolf with BB&T Capital Markets. Please proceed with your question.

Andrew P. Wolf – BB&T Capital Markets

Thanks, good afternoon. Just regarding this lower guidance specifically for the quarter, the things that – the adjusted numbers take out the inventory and all that, so could you kind of delineate for us how much of this was from December being weak because of weather and other reasons, I think you said it was going to be weaker than expected or lower than expected even without the weather and then you talked about Michael’s and ongoing margin pressures. So as we’re trying to sort of reconcile between old guidance and new guidance and to figure out what to do for next year. Could you give us a sense of those two and any other things that you might want to add in?

John D. Austin

Yeah, I think Andy, how I look at it obviously we’re still analyzing our results and we will give you more granular numbers I think when we do our earnings call, but I think weather is the significant piece of that puzzle, the margin compression at Michael’s beyond the inventory adjustment obviously we quantified in the release the prior period inventory adjustment that continued margin pressure there, that’s due in part to just competitive pressures and also in part to the fact that 2013 in the fourth quarter just didn’t have the same kind of buying opportunities that we had in 2012, which typically are usual that just didn’t manifest itself in 2013 in the fourth quarter.

I think the – other underlying business was a little soft, some of it was weather if you look at some of our KPIs for instance, case growth in the month of December, we saw nice growth high single-digit, low double-digit growth in most of our markets that were not impacted by weather, but obviously New York, Maryland, Cincinnati, any Midwest and Northeastern business, we actually saw negative case growth.

I think the impact of when Thanksgiving fell in that period has some impact on those numbers, but I think directionally those are all still relevant. So it still gives us confident that the base business is still okay those other markets were actually reasonably good, but markets impacted by weather were meaningfully impacted. So Allen Brothers obviously contributed profitably to the results, but nonetheless it didn’t offset weakness in the rest of the business.

Andrew P. Wolf – BB&T Capital Markets

Okay, and just to follow-up you talked about competitor pressures in regard to Michael’s all right, is that specific to Michael’s or is that something that also could affect Allen Brothers, because – so is it regional or is it just what’s going on in the high end protein business?

John D. Austin

It’s a little confusing Andy; the protein markets have obviously been very tight. So Allen Brothers did I would say fared better than Michael’s did because of their customer mix. Michael’s has a historical group of business that had strong relationship for many, many years and sometimes when the markets don’t treat you that well, you have to help your customers, so again we’re in this for the long picture and servicing these customers for very long time. So I just think because of the buying opportunities were so poor, Michael’s kind of took a little more on the chin than – say you would have to keep the relationships and keep the confidence over the long period of time. So it was a very, very tough market and obviously on top of that the weather didn’t help them. So it was kind of the perfect storm.

Andrew P. Wolf – BB&T Capital Markets

And one last follow-up, I don’t want to hog the question, so just a follow-up on supply, you said it’s tight, and I understand what you are – where you go in that. Is there any projection that you can see that supplies could get better or is it just the prime beef market pretty tight as you look forward?

John D. Austin

We’re watching obviously day-by-day. I think by the time we report in February, we’ll have a much better real outlook for you.

Andrew P. Wolf – BB&T Capital Markets

Okay. Thank you.

John D. Austin

Okay.

Operator

Thank you. Our next question comes from the line of Karen Short with Deutsche Bank. Proceed with your questions.

Karen F. Short – Deutsche Bank

Hi, couple of questions. I guess turning to the Michael's inventory overstatement, maybe can you just give a little more color on how that kind of escaped you guys during the due diligence process, or any – or in general like how your systems wouldn’t have already – wouldn’t have detected this?

John D. Austin

Yeah, I think there is a couple of things; one, we can’t really comment beyond what’s in the release that investigation is still ongoing and we’re pretty far along, but there is still a little bit of work to be done and so we can’t really get into the granular nature of it. On the whole scheme of things as of the acquisition date it was $400,000 on roughly $12 million of inventory. So the misstatement was pretty small as it relates to the opening balance sheet.

Karen F. Short – Deutsche Bank

Okay, that’s helpful. And then internally can you give some color on what you guys were forecasting, the acquisition would benefit your sales in for 4Q, because obviously the $11.4 million is a decent number, it is little higher than what I was looking for, so I was just wondering where you add internally?

Christopher Pappas

Yeah, the $11.4 million is high because of the consumer direct business. Obviously a lot of that falls in the holiday season. So that’s not a good quarterly or you don’t want to annualize half of that number. We still think that business on an annual basis is in $80 million, $85 million range. So, if you remember about 25% of that overall business is consumer direct and probably half of that falls in the full month of December.

Karen F. Short – Deutsche Bank

Great, was the number – was the actual total revenue benefit or impact this quarter higher than what you guys internally expected or we got in line with what you forecast?

John D. Austin

No, I would say it’s probably in line with what we expected from a revenue perspective, I will say margins in that business were probably a little challenges – challenged much like Michael’s to Chris’s point not as challenged, but…

Christopher Pappas

Yeah, little soft Karen, we expected a little more on the margin side, but in hindsight looking again, we were all up against the same buy side and keeping our customers as happy as can be. So in most instances we’re able to pass on the price increases. During their busiest time, market has got to such a point where we thought it was prudent to eat a little bit of the margin and don’t face with our long-lasting customers.

Karen F. Short – Deutsche Bank

Okay. And then last question is on your revised guidance, are you – does that include the gain from the reduction from contingent consideration liability; sorry I haven’t [Indiscernible]?

John D. Austin

It’s in our – in the GAAP numbers as you’ll see that’s on the reconciliation of GAAP to non-GAAP, so we back that back out.

Karen F. Short – Deutsche Bank

Okay, thanks for that guys. Thank you.

Christopher Pappas

Thanks.

Operator

(Operator Instructions) Thank you. Our next question comes from the line of Scott Van Winkle with Canaccord Genuity. Please proceed with your questions.

Scott Van Winkle – Canaccord Genuity, Inc.

Hi, thanks following up on that in the reduction of the contingent consideration. Can you tell us what acquisition – prior acquisition that relates to?

John D. Austin

We haven’t gone into that by specifically, I mean at the end of the day Ohio has been one of more challenging market, so it’s in Ohio not related to Michael’s.

Scott Van Winkle – Canaccord Genuity, Inc.

Gotcha. And then with acquisitions and I apologize may not knowing this I probably should, but in all the prior acquisitions release since the IPO, is it customary for you to have an earnout that hasn’t been mad, I’m wondering kind of what the success rate is of sellers meeting earnouts post deal?

Christopher Pappas

We have had – some of our deals have had earnouts, some do not, lot of it depends on the nature of the seller. This is the only one that I’m aware of that we’ve had one where they didn’t meet the targets.

Scott Van Winkle – Canaccord Genuity, Inc.

Great. And then the commentary about buying opportunities in December or in the fourth quarter in general, was that specific to the protein category, was that more broadly across the business?

Christopher Pappas

Yeah, that reference was really to the protein category.

Scott Van Winkle – Canaccord Genuity, Inc.

Okay, great. Thank you very much.

Christopher Pappas

Thank you.

Operator

Thank you. Our next question comes from the line of John Ivankoe with JPMorgan. Please proceed with your question.

John W. Ivankoe – JPMorgan Securities LLC

Hi, thank you. Just certainly different direction if I may, could you comment about the resin what actually might be opportunities that you may have with consolidations of the two biggest broadline distributors in the industry, I mean, it’s obviously something that that will change broadly foodservice dynamics, but how Chefs' Warehouse specifically might be affected from that positively and negatively, that’s the first question. And secondly, how do you see supply growth of this now you basically you’re servable customer market in 2014 what you might be hearing in the field?

Christopher Pappas

Yeah. Well, anytime two giant companies merged as a – as plenty of fall off. It is an industry that does like choices and in anticipation of what’s to come, we have been gearing up, building up our sales staff, building up our management staff, the phone is ringing. So lots of people will be stepping up to talk to us to see if we’re a good fit either as a primary or secondary supplier. So I think it’s impossible not to be optimistic that there will be a lot of opportunities for a company like Chefs' Warehouse at a national level as this thing goes through, and I kind of lost the second question.

John W. Ivankoe – JPMorgan Securities LLC

I apologize, a new account growth, in other words, the restaurant expansion for some of the higher-end restaurants in the U.S., I would assume would be, maybe a little bit better in 2014 and 2013. I mean, are you seeing significant new account growth opportunity based on new restaurant construction over the next year. I don’t know if you’re aware of many specific projects that might be coming on for example?

Christopher Pappas

Well, again, we have over 20,000 customers, and our focus is on the independent restaurants – restaurants are. And we had been seeing, I think we stated in the last call, we have seen more restaurants opening, more people starting to invest in a second and third restaurant who are already customers. So, again the – I think the fourth quarter be with the weather and everything that impacted our business. The good news when we look through it and especially the areas that did not have bad weather kind of perform to where we thought it would be, and we think we will have good openings in 2014.

John W. Ivankoe – JPMorgan Securities LLC

Thank you.

Operator

Thank you. We have no further questions at this time. I’d like to turn the floor back to management for closing comments.

Christopher Pappas

Yeah. We thank everybody for joining us on short notice for this call. And we do look forward to our earnings call to update and give our outlook and our total findings, and we thank you for your patience and thank you for joining us.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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