Chefs’ Warehouse, Inc. — Q2 2018 Form 10-Q
Business and period: The company distributes specialty foods and center-of-the-plate proteins to foodservice customers, primarily in the U.S. and Canada, and also operates a direct-to-consumer business. This unaudited report covers the 13 and 26 weeks ended June 29, 2018, compared with the corresponding 2017 periods. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $370.4 | $331.7 | $689.1 | $619.3 |
| Gross profit / margin | $93.2 / 25.2% | $82.6 / 24.9% | $172.8 / 25.1% | $156.5 / 25.3% |
| Operating income / margin | $14.9 / 4.0% | $12.2 / 3.7% | $20.7 / 3.0% | $15.3 / 2.5% |
| Net income | $6.8 | $3.7 | $7.4 | $2.0 |
| Diluted EPS | $0.24 | $0.14 | $0.26 | $0.08 |
| Operating cash flow | — | $18.9 | $21.7 |
Q2 sales grew 11.7%; management attributed 4.3 percentage points to organic growth and 7.4 points to acquisitions, principally Fells Point and smaller specialty-related businesses. First-half sales rose 11.3%, with 4.8 points organic and 6.5 points from acquisitions. Q2 net income increased to $6.8 million from $3.7 million; first-half net income was $7.4 million versus $2.0 million.
Q2 gross margin improved 27 basis points, while first-half gross margin declined 20 basis points. For the first half, operating expenses fell to 22.1% of sales from 22.8%, supporting operating-margin expansion. Interest expense decreased in both periods, which the company attributed to lower rates on debt. The effective tax rate was 28.5% in 2018 versus 41.5% in 2017, primarily reflecting the Tax Act’s reduction in the U.S. federal corporate tax rate.
Balance sheet, debt and liquidity
- At June 29, cash was $39.6 million, total debt obligations were $316.6 million, and total stockholders’ equity was $256.1 million. Cash was $41.5 million at December 29, 2017.
- Debt included a $286.8 million senior secured term loan and $36.8 million of convertible subordinated notes. The term-loan rate was 6.09%; the term loan matures June 2022.
- The replacement ABL facility increased commitments from $75 million to $150 million. There were no ABL borrowings at June 29; $137.9 million was available after $12.1 million reserved for letters of credit. The company reported compliance with debt covenants.
- After quarter-end, the company borrowed $47.1 million under the ABL and used the proceeds to prepay the same amount of term-loan debt. On July 25, noteholders converted the $36.75 million principal of convertible notes into 1,246,272 common shares.
- First-half operating cash flow was $18.9 million, down $2.8 million year over year. Investing used $17.4 million, including $11.9 million for acquisitions and $5.5 million in capital expenditures; financing used $3.4 million. Cash decreased $1.9 million during the period.
Outlook, risks and notable items
- Management projected fiscal 2018 capital expenditures, excluding acquisitions, of $16–$18 million, for distribution-center expansions and headquarters renovations. No specific revenue or earnings guidance is provided in the filing.
- Management’s growth priorities include territory expansion, customer service, purchasing and product initiatives, operational efficiencies, and selective acquisitions. The company had approximately 1.4 million square feet across 27 distribution facilities; ERP rollout was expected to continue through fiscal 2019.
- Key risks include economic weakness and reduced restaurant spending, food-cost inflation or deflation and inability to pass through cost increases, product availability and supply disruptions, competition and low industry margins, acquisition integration and synergy execution, and fuel-cost volatility. A 100-basis-point increase in market rates was estimated to reduce annual after-tax earnings by approximately $2.1 million, holding other factors constant.
- Acquisitions and earn-outs involve estimates; contingent earn-out liabilities totaled $6.4 million and were measured using Level 3 inputs. The company stated adoption of the new lease standard is expected to materially affect its balance sheet and disclosures.
- The company reported no material change in its stated risk factors, no material off-balance-sheet arrangements, and no material adverse effect expected from ordinary-course legal matters. Management concluded disclosure controls were effective.
Investor verification priorities
- Separate organic growth from acquisition-driven growth and assess whether specialty-category volume and customer gains persist.
- Track category-level gross margins: Q2 specialty margin declined 66 basis points while center-of-the-plate margin rose 129 basis points; first-half specialty margin declined 27 basis points.
- Review working-capital use, particularly the first-half inventory cash outflow of $10.2 million, and the year-over-year decline in operating cash flow.
- Confirm the effect of the July debt refinancing on interest expense, available ABL capacity and covenant headroom, and account for the shares issued on conversion of the notes.
- Monitor acquisition integration, earn-out estimates, planned capital spending, ERP execution and the balance-sheet impact of lease-standard adoption.