The Chefs’ Warehouse, Inc. — Q3 2017 Form 10-Q
Business context and reporting period. The unaudited filing covers the 13 weeks ended September 29, 2017, and year-to-date results for the 39 weeks ended that date, compared with the corresponding 2016 periods. The company distributes specialty foods and proteins, primarily to independent restaurants and other foodservice customers, in the U.S. and Canada. It reported one operating segment.
Key financial results
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2017 | Q3 2016 | 39 weeks 2017 | 39 weeks 2016 |
|---|---|---|---|---|
| Net sales | $325.1 | $297.9 | $944.4 | $850.0 |
| Gross profit / margin | $80.9 / 24.9% | $74.4 / 25.0% | $237.4 / 25.1% | $212.2 / 25.0% |
| Operating income / margin | $10.5 / 3.2% | $8.3 / 2.8% | $25.8 / 2.7% | $24.8 / 3.0% |
| Interest expense | $5.6 | $5.9 | $17.4 | $35.3 |
| Net income (loss) | $2.9 | $1.3 | $4.9 | $(6.1) |
| Diluted EPS | $0.11 | $0.05 | $0.19 | $(0.24) |
- Q3 performance: Sales rose 9.1%; management attributed $21.3 million, or 7.2%, to organic growth and $5.8 million, or 1.9%, to Fells Point. Gross margin declined about 8 basis points, while operating expense as a share of sales improved to 21.7% from 22.2%.
- Year-to-date performance: Sales increased 11.1%, comprising 7.7% organic growth and contributions from MT Food and Fells Point. Gross margin improved about 18 basis points, but operating expense ratio rose to 22.4% from 22.0%; operating margin declined to 2.7% from 3.0%.
- The year-to-date return to profit chiefly reflects lower interest expense: the 2016 comparison included a $22.3 million debt-refinancing prepayment penalty. Excluding that unusual prior-year item, the reported improvement in interest expense is less pronounced.
Cash flow, debt and liquidity
- For the 39 weeks, operating cash flow was $23.2 million, versus $21.2 million. Investing used $39.6 million, including $29.7 million cash paid for Fells Point; capital expenditures were $9.9 million. Financing used $12.6 million. Cash fell to $4.1 million from $32.9 million at December 30, 2016.
- Total debt obligations were $319.3 million, including $289.2 million under the senior secured term loan and $36.8 million of convertible subordinated notes, net of financing fees and other items. The New Markets Tax Credit loan was repaid in April 2017. The term loan interest rate was 5.99% at quarter-end; it matures in 2022.
- No ABL borrowings were outstanding. The company reported $65.5 million available under its $75 million ABL facility after $9.5 million reserved for letters of credit. It stated it was in compliance with debt covenants.
- Current assets were $260.9 million and current liabilities $115.3 million. Inventory increased to $109.9 million from $87.5 million at year-end; accounts payable increased to $83.1 million from $65.5 million.
Acquisitions, outlook and risks
- On August 25, 2017, the company acquired substantially all assets of Fells Point, a specialty protein business, for approximately $33.0 million: $29.7 million cash and $3.3 million in stock. Up to approximately $12 million additional earn-out consideration may be payable, subject to four years of adjusted EBITDA targets; its recorded fair value was $4.5 million. Fells Point contributed $5.8 million in sales and $0.4 million in pretax income in the 39-week period.
- Management estimated fiscal 2017 capital expenditures, excluding acquisitions, at approximately $12 million. The ERP system rollout was expected to continue through fiscal 2017 and 2018. The filing provides no earnings or revenue guidance.
- Management cited Q3 estimated inflation of 5.3% in the specialty division and 5.1% in protein. Protein pounds sold fell 1.2% year over year in the quarter, with hurricanes Harvey and Irma cited as contributing factors. Management also highlighted improved warehouse utilization and labor costs, partly offset by higher management compensation.
- Key risks include food-cost and labor inflation, inability to pass costs through, low industry margins, customer concentration and lack of long-term customer contracts, weather and supply interruptions, discretionary food-away-from-home spending, acquisition integration and execution, and variable interest rates. A 100-basis-point rate increase was estimated to reduce annual after-tax earnings by approximately $1.7 million.
- The company disclosed a potential $5.1 million guarantee related to a former distribution facility mortgage after exiting its sublease; management believes the building value more than offsets the exposure and said the former sublessor was pursuing a full release. Ordinary-course legal matters were not expected by management to have a material adverse effect; no material amounts were accrued.
Important facts for investors to verify
- Whether organic sales and customer growth persist, and whether protein volume recovers after the quarter’s decline.
- Whether inflation can be passed through without further gross-margin pressure, particularly in specialty products.
- Fells Point’s integration, contribution to results, final purchase-price allocation and achievement of earn-out targets.
- Cash conversion and working-capital needs, especially the rise in inventory and the low quarter-end cash balance.
- Debt service and floating-rate exposure, available ABL capacity, covenant compliance, and resolution of the mortgage guarantee.
- The eventual quantified effect of upcoming accounting standards: the company expected the new lease standard to materially affect its balance sheet; the revenue-recognition analysis was still being finalized, including the timing effect for direct-to-consumer sales.