Chefs' Warehouse's (CHEF) CEO Chris Pappas on Q3 2016 Results - Earnings Call Transcript

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About: Chefs' Warehouse (CHEF)
by: SA Transcripts

Chefs' Warehouse (NASDAQ:CHEF) Q3 2016 Earnings Conference Call November 2, 2016 5:00 PM ET

Executives

Alex Aldous - General Counsel, Corporate Secretary

Chris Pappas - Founder, Chairman, CEO

John Austin - CFO

Analysts

John Ivankoe - JPMorgan

Brian Gillian - Barclays

Operators

Welcome to The Chefs' Warehouse Third Quarter 2016 Earnings Conference 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 begin.

Alex Aldous

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 third quarter 2016 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 modified pro forma net income, and modified pro forma earnings per share. These measurements are not calculated in accordance with GAAP, and may be calculated differently in 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 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 at www.sec.gov. Today we are going to provide a business update, go over our third quarter results in detail, and review our 2016 guidance. Then we will open the call for questions. With that, I would like to turn the call over to Chris Pappas. Chris.

Chris Pappas

Thanks Alex and thank you for joining our third quarter 2016 earnings call. We are pleased with our third quarter results particularly given the continued softness we are seeing in our broader restaurant space. We finished the quarter with a very strong organic case growth in our specialty division even though this was muted by sequential increase in deflation. We had also made great progress at Del Monte during the quarter which I will talk about in a minute. First a few highlights from the quarter which represents that we continue to take market share from our competitors in this space. We experience 5.1% organic growth in net sales in our specialty division. This was driven by unique customer growth of approximately 5.2%, placement growth was approximately 5.6% and case growth was approximately 5.7% versus the prior year third quarter. Also importantly our gross margins are 11 basis point increase in specialty which increased 50 basis points in our organic base after excluding MT.

We’re also making solid progress in managing margin in our Del Monte business. The team did a great job in managing price and raw product costs, our ERP conversion Del Monte is settling down the team is learning to function more efficiently with the new system. At this point we only have one small branch laughed at Del Monte to convert and expect that to be completed by year-end.

We are now able to shift our focus to rebuilding sales and rationalizing operating expenses as we deliver superior customer service. We're very pleased with the progress we've made and expect our investments and systems and people to further strengthen our position in Northern California as a leading supplier to that vibrant independent color that we’re seeing. As for Allen Brothers we now feel we have the right team to build long term profitability that meets our expectations with a best in class operation the brand is positioned to add significantly more customers to leverage their existing their infrastructure and deliver more gross profit dollars. We remain very excited about our protein division which now makes up approximately 35% of total sales and we believe we are well-positioned for the long term growth in that business. I would also like to give you an update as it relates to our facilities.

We began the significant build out of our new facilities more than a year ago and are beginning to see the benefits of cost efficiencies. Our New York facility continues to do very well and efficiencies are being captured particularly in our warehousing operations. We have hired 42 new employees to run our Chicago operation in the last year and continue to be very pleased with the team we have. We continue to expect to move empty food service into this new Chicago facility in early 2017 and expect to see many cost and revenue synergies with that move. We now have been in our new San Francisco facility about six months and expect to see similar operating efficiencies as they grow into that facility. We believe we are stronger organization now and are confident in our ability to grow profitably serving our core independent restaurant business whose growth continues to outpace the industry and with that I will turn it over to Mr. John Austin often to discuss more detailed financial information. John?

John Austin

Thanks, Chris. Good afternoon everyone. Our net sales for the quarter ended September 23, 2016 increased approximately 7.8% to $297.9 million from the $276.3 million for the third quarter ended September 25, 2015. The increase in net sales was the result of organic growth of approximately 2.2% as well as the contribution of sales from the acquisition of MT Food Service that we closed in fiscal July 2016 which added approximately 5.7 [ph] sales growth for the quarter

Deflation continued to be a headwind an increased sequentially from the second quarter. Deflation was a little more broad based in our specialty division compared to the second quarter and also continued as we expected in our protein division. Deflation amounted to approximately 2.2% which increased probably 98 basis points sequentially compared to the second quarter. While we expected deflation in proteins for the year our core specialty division turn modestly deflationary in the third quarter, we expect this challenging environment to continue in the near term.

Gross profit increased approximately 6.0% to 74.4 million for the third quarter of 2016 versus 70.2 million for the third quarter of 2015. Gross profit margin decreased approximately 43 basis points to 25.0% from 25.4%. Our gross margins in our specialty business improved 11 basis points. However as Chris mentioned specialty margins increased 50 basis points excluding the impact of the MT acquisition. Gross profit margins decreased 191 basis points in our protein division as we expected. However we are encouraged by the sequential improvement we saw at Del Monte compared to the second quarter. Total operating increased approximately 15.3% to 66.1 million for the third quarter of 2016 compared to 57.3 million for the third quarter of 2015.

As a percentage of net sales operating expenses were 22.2% for the third quarter of 2016 compared to 20.7% for the prior year quarter. The increase in the company's operating expense ratio is largely attributable to the company's acquisition of empty food service. In addition warehouse and delivery labor increased 1.3 million and 648,000 respectively. Fleet expenses related to truck rental and freight out increased 738,000 and occupancy costs increased 620,000 compared to the prior year quarter. G&A expenses excluding the impact of the MT acquisition increased to approximately 19.9 million for the third quarter of 2016 compared to 17.7 million for the prior year.

Due mostly to higher depreciation and amortization expense of 1.1 million professional fees of 450,000 and bad debt expense of 375,000 versus the third quarter of 2015. Operating income for the third quarter of 2016 was 8.3 million compared to 12.9 million for the third quarter of the prior year. Interest expense increased to 5.9 million versus 3.9 million for the prior year third quarter due to higher levels of debt associated with the refinancing we completed in June.

Income tax expense was 1.0 million for the third quarter of 2016 compared to 3.7 million for the third quarter of 2015 and our effective tax rate remained flat at approximately 41.6%. Our GAAP net income was 1.3 million or $0.05 per diluted share for the third quarter of 2016 compared to 5.2 million or $0.20 per diluted share for the third quarter of 2015. On a non-GAAP basis, adjusted EBITDA was $14.6 million for the third quarter of 2016 compared to 17.6 million for the third quarter of the prior year. Modified pro-forma income was 1.7 million and modified pro-forma EPS was $0.07 for the third quarter of 2016 compared to modified pro-forma net income of 5.5 million or $0.21 per share in the third quarter of the prior year.

Based on our third quarter results as well as what we are seeing right now we are updating our guidance for the fiscal year 2016. We estimate the net sales for the full year to be in the range of 1.185 billion to 1.195 billion. Adjusted EBITDA between 57.5 million and 61.0 million. A GAAP net loss between 1.0 million and 2.5 million, and GAAP net loss per diluted share between $0.02 and $0.07 per share and modified pro forma net income for diluted share between $0.41 and $0.46. This guidance is based on effective tax rate of approximately 41.5% for 2016 and an estimated diluted share count of approximately 27.25 million shares.

Note that for purposes of calculating the modified pro forma EPS, diluted EPS, the company has assumed that convertible debt will be diluted for the full year and as such we've added back 537,000 of interest on an after tax basis and assumed conversion into 1.2 million shares related to the convertible note and we have included those in our diluted weighted average share numbers.

With that Operator we will turn it over for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of John Ivankoe with JPMorgan. Please proceed with your question.

John Ivankoe

Two related questions if I may, firstly as you see he Del Monte business and the overall trends and some of the success that you're having there and obviously being done with the ERP, I think you said by the end of '16 or early '17. How much of a profit opportunity just for that business alone which I think had revenues of around $200 million or so. Could there be in '17 over '16, in other words how big of an EBITDA swing might be possible in the business based on current trends as you see them?

Chris Pappas

John we bought the business, it had again -- it's a great company had a typical entrepreneurs type overhead. So we scaled up to do the enterprise system conversion and now we’re obviously trying to get the excess out and margin has been trending back to normal. So I can give you a range I hate to give you a number.

John Austin

I'd say probably incrementally $2 million to $4 million over where our run rate is today.

John Ivankoe

And the next question is on Chicago I mean obviously you've hired a bunch of employees, you have facilities, you’ve a fleet -- I assume that the infrastructure has gone ahead of revenue and as you integrated MT end of the system now I mean how much of an opportunity is there for the Chicago facility year on year '17 over '16 if it's a fair question?

Chris Pappas

Yes that’s a great question because we're very excited about putting the whole puzzle together. We'll start to move them in January and putting them into our building and onto our system. So we're going to be a little delayed to get the synergies -- the total synergies for your purpose once we're up and running but you know we took a big building, right now that building is we're not making any money so rolling an MT and really once we get the salespeople integrated and we get the synergistic selling the expectation I mean we haven't put out guidance again for next year. So it's a moving target.

John Austin

It is I think, John I think the incremental piece that's going to come from consolidating MT is really a limiting their warehouse, their facility cost. It's not a huge number right now. You know we really needed to retain all their people and things like that because we really didn't have much volume in our existing building so there's not a lot of consolidation synergies from a people perspective it's really more just the facility overhead, but there's a lot of opportunity for growth as we consolidate those two sales forces and things like that and that's where the payback is going to come from.

John Ivankoe

Should we expect deflation in fourth quarter similar to third quarter consolidated?

Chris Pappas

Given the fact that I was wrong on the last quarterly call, I expect inflation or deflation this quarter to be flattish and it continued to get sequentially more deflationary in specialty. Where we sit today I think it's probably similar to what it was this quarter. I hesitate to think it's going to return to an inflationary environment. I think it's more continued deflation in specialty. And I think protein has been pretty consistent with where we expected it to be, it's been in a couple percent range, three some [ph] change per quarter. So I think that’s probably could be consistent.

John Austin

Right and built into our guidance for the rest of the quarter correct.

Operator

Our next question comes from the line of Brian Gillian with Barclays. Please proceed with your question.

Brian Gillian

How are service levels trending right now at Del Monte?

Chris Pappas

So Del Monte is operating and we are back on the offense opening up new customers. So I'm pleased to say that the real difficult part is behind us and margins are trending back to more normalized they're in the range of where we expected them to be. So you know not to give you too optimistic of a picture that we're going to be at 120% of where we were but we are in much, much better shape. We're starting to grow and we're very excited about next year.

Brian Gillian

And the Del Monte service issues connected to why pound sold were down this quarter or what's going on with the pound?

Chris Pappas

Listen it was a very difficult to try -- difficult time trying to convert you know six facilities in the time frames you know -- we had a certain amount of time to kind of make them stocks compliant. So it was definitely a headwind, everybody was preoccupied and trying to learn the new system. So we're optimistic that the team is motivated and we did lose part of a very large customer so that was part of the poundage, okay, deterioration. We didn't keep the customer we’re just sharing them at this point. So really the management team is focused on having a typical type growth next year the way the rest of Chef grows. They are no different. We have the same team, part of that management team that's managing Chef North Carolina is overseeing and help manage Del Monte. So they basically all have the same goals and we kind of have the same expectations.

John Austin

And Brian one other thing on that larger customer that we exited, that was actually at the beginning of the year which we just haven't lapped yet. So I think we talked about that.

Brian Gillian

And if you could just comment on the cadence of sales during the quarter and maybe how the fourth quarter has turned out so far? Has there been any impact from the election or in the call out? Thanks.

Chris Pappas

I think we finished third quarter stronger than we probably expected to internally. I think that's unfortunately it's masked a little bit by the deflation that you see in specialty but case [ph] growth was actually pretty stronger in the quarter, it was about 7.5% in specialty. You know I think October was a little choppy, the holidays and how they fell related to the Jewish holidays and things like that and created a little noise, the election we think is a little bit of noise it's hard to pinpoint specifically how much that is.

John Austin

Again Brian you know again not having a crystal ball. I'm kind of blending September and October together because the way the holidays fell September was extremely strong, October was choppy and last week was a normal week. We saw the kind of growth that we expected. So we were really pleased with how last week came about. So I think without a doubt the election people watching TV, the debates kind of threw off part of October and we were really glad to see there was no debate last week, we do have the World Series but you know last week was very strong so it encourages us to believe that it will continue through the fourth quarter.

Operator

[Operator Instructions]. Okay. I would now like to turn the call back over to Mr. Pappas for closing remarks.

Chris Pappas

Great. Well thank everybody for joining us on our third quarter call. We are excited with the momentum that we finished the third quarter with and we're very excited to see it continue into the fourth quarter. Our team fought very hard, again a case growth was very pleased on the specially side with over 7% case growth. So I think that shows that our team is taking market share and we're very excited to continue and I look forward to speaking to everybody on our next earnings call. Thank you.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.