Chefs' Warehouse, Inc.: Form 10-Q for the period ended Mar 25, 2022

RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, changes in our financial condition and results of operations. The following discussion should be read in conjunction with information included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 22, 2022. Unless otherwise indicated, the terms “Company”, “Chefs’ Warehouse”, “we”, “us” and “our” refer to The Chefs’ Warehouse, Inc. and its subsidiaries.

Business Overview

We are a premier distributor of specialty foods in nine of the leading culinary markets in the United States. We offer more than 50,000 stock-keeping units (“SKUs”), ranging from high-quality specialty foods and ingredients to basic ingredients and staples and center-of-the-plate proteins. We serve more than 35,000 customer locations, primarily located in our nineteen geographic markets across the United States and Canada, and the majority of our customers are independent restaurants and fine dining establishments. We also sell certain of our products directly to consumers through our Allen Brothers and “Shop Like a Chef” retail channels.

Effect of the COVID-19 Pandemic on our Business and Operations

The COVID-19 pandemic (“Pandemic”) has had and continues to have an adverse impact on numerous aspects of our business and those of our customers including, but not limited to, demand for our products, cost inflation and labor shortages. Despite these challenges, we’ve continued to provide our core customers with high touch service, executed on our cost control measures and have returned to profitability since the second quarter of fiscal 2021. We continue to experience sequential improvement in our business which has contributed to organic sales growth of $176.3 million compared to the prior year quarter.

The extent to which the Pandemic will impact our financial condition or results of operations is uncertain and will depend on future developments including new information that may emerge on the severity or transmissibility of the disease, new variants, government responses, trends in infection rates, development and distribution of effective medical treatments and vaccines, and future consumer spending behavior, among others.

Recent Acquisitions

On December 28, 2021, pursuant to an asset purchase agreement, we acquired substantially all of the assets of CGC Holdings, Inc. (“Capital Seaboard”), a specialty seafood and produce distributor in Maryland. The purchase price was approximately $29.7 million consisting of $28.0 million paid in cash at closing, subject to a customary working capital adjustment, and common stock warrants of $1.7 million.

RESULTS OF OPERATIONS

Management evaluates the results of operations and cash flows using a variety of key performance indicators, including net sales compared to prior periods and internal forecasts, costs of our products and results of our cost-control initiatives, and use of operating cash. These indicators are discussed throughout the “Results of Operations” and “Liquidity and Capital Resources” sections of this MD&A.

Thirteen Weeks Ended March 25, 2022 Compared to Thirteen Weeks Ended March 26, 2021

Net Sales

Organic growth contributed $176.3 million, or 62.9%, to sales growth and the remaining sales growth of $55.6 million, or 19.9%, resulted from acquisitions. Organic case count increased approximately 47.3% in our specialty category. In addition, specialty unique customers and placements increased 29.4% and 41.6%, respectively, compared to the prior year period. Organic pounds sold in our center-of-the-plate category increased 26.0% compared to the prior year. Estimated inflation was 14.9% in our specialty category and 28.5% in our center-of-the-plate category compared to the prior year period.

Gross Profit

Gross profit increased primarily as a result of increased sales and price inflation. Gross profit margin increased approximately 191 basis points due to favorable sales mix towards higher margin specialty products. Gross profit margins increased 213 basis points in the Company’s specialty category and increased 111 basis points in the Company’s center-of-the-plate category.

Selling, General and Administrative Expenses

The increase in selling, general and administrative expenses was primarily due to higher costs associated with compensation and benefits to support sales growth. Our ratio of selling, general and administrative expenses to net sales decreased predominately due to sales growth which contributing to improved fixed cost leverage in the quarter.

Other Operating Expenses (Income), Net

The increase in net other operating expenses was primarily due to non-cash charges of $0.3 million for changes in the fair value of our contingent earn-out liabilities compared to non-cash credits of $1.3 million in the prior year period.

Interest Expense

Interest expense decreased primarily due to lower effective interest rates on our outstanding debt as a result of the $50.0 million aggregate principal amount of Convertible Senior Notes issued on March 1, 2021 which were used to repay higher interest rate debt.

Provision for Income Taxes

The increase in income tax expense is due to pre-tax income in the current period compared to a pre-tax loss in the prior year quarter. The effective tax rate in the current period is lower due to insignificant changes in certain permanent tax differences.

LIQUIDITY AND CAPITAL RESOURCES

We finance our day-to-day operations and growth primarily with cash flows from operations, borrowings under our senior secured credit facilities and other indebtedness, operating leases, trade payables and equity financing.

Indebtedness

The following table presents selected financial information on our indebtedness (in thousands):

As of March 25, 2022, we have various floating- and fixed-rate debt instruments with varying maturities for an aggregate principal amount of $392.2 million.

On March 11, 2022, we entered into a third amendment to our asset-based loan facility ABL Facility which increased the aggregate commitments from $150.0 million to $200.0 million. See Note 9 “Debt Obligations” to our consolidated financial statements for a full description.

Liquidity

The following table presents selected financial information on liquidity (in thousands):

We expect our capital expenditures, excluding cash paid for acquisitions, for fiscal 2022 will be approximately $36.0 million to $45.0 million. We believe our existing balances of cash and cash equivalents, working capital and the availability under our asset-based loan facility, are sufficient to satisfy our working capital needs, capital expenditures, debt service and other liquidity requirements associated with our current operations over the next 12 months.

Cash Flows

The following table presents selected financial information on cash flows (in thousands):

Net cash used in operations was $10.3 million for the thirteen weeks ended March 25, 2022 consisting of a net income of $1.4 million and $14.3 million of non-cash charges, partially offset by investments in working capital growth of $5.4 million. Non-cash charges decreased $9.0 million primarily due to a $5.5 million increase in deferred tax expenses and a $1.6 million increase in changes in the fair value of earn-out liabilities. The cash used for working capital growth of $6.3 million is primarily driven by the Company’s reinvestment in working capital to support sales growth.

Net cash used in investing activities was $42.2 million for the thirteen weeks ended March 25, 2022, driven by capital expenditures of $14.2 million which includes the purchase of our distribution facility in Columbus, Ohio and $28.0 million in cash paid for the Capital Seaboard acquisition.

Net cash used in financing activities was $3.9 million for the thirteen weeks ended March 25, 2022, driven by $2.0 million of shares surrendered to pay tax withholding related to the vesting of equity incentive plan awards and $1.4 million of payments made on senior term loans and finance lease obligations..

Seasonality

Excluding our direct-to-consumer business, we generally do not experience any material seasonality. However, our sales and operating results may vary from quarter to quarter due to factors such as changes in our operating expenses, management’s ability to execute our operating and growth strategies, personnel changes, demand for our products, supply shortages, weather patterns and general economic conditions.

Our direct-to-consumer business is subject to seasonal fluctuations, with direct-to-consumer center-of-the-plate protein sales typically higher during the holiday season in our fourth quarter; accordingly, a disproportionate amount of operating cash flows from this portion of our business is generated by our direct-to-consumer business in the fourth quarter of our fiscal year. Despite a significant portion of these sales occurring in the fourth quarter, there are operating expenses, principally advertising and promotional expenses, throughout the year.

The Pandemic has had a material impact on our business and operations and those of our customers. Our net sales were most significantly impacted during the second quarter of fiscal 2020 when, in an effort to limit the spread of the virus, federal, state and local governments began implementing various restrictions that resulted in the closure of non-essential businesses in many of the markets we serve, which forced our customers in those markets to either transition their establishments to take-out service, delivery service or temporarily cease operations.

Inflation

Our profitability is dependent on, among other things, our ability to anticipate and react to changes in the costs of key operating resources, including food and other raw materials, labor, energy and other supplies and services. Substantial increases in costs and expenses could impact our operating results to the extent that such increases cannot be passed along to our customers. The impact of inflation and deflation on food, labor, energy and occupancy costs can significantly affect the profitability of our operations.

Off-Balance Sheet Arrangements

As of March 25, 2022, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

Critical Accounting Policies and Estimates

The preparation of the Company’s consolidated financial statements requires it to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The SEC has defined critical accounting policies as those that are both most important to the portrayal of the Company’s financial condition and results and require its most difficult, complex or subjective judgments or estimates. Based on this definition, we believe our critical accounting policies include the following: (i) determining our allowance for doubtful accounts, (ii) inventory valuation, with regard to determining inventory balance adjustments for excess and obsolete inventory, (iii) business combinations, (iv) valuing goodwill and intangible assets, (v) self-insurance reserves, (vi) accounting for income taxes and (vii) contingent earn-out liabilities. Our critical accounting policies and estimates are described in the Form 10-K filed with the SEC on February 22, 2022.

Interest Rate Risk

As of March 25, 2022, we had an aggregate $188.2 million of indebtedness outstanding under the Term Loan and ABL Facility that bore interest at variable rates. A 100 basis point increase in market interest rates would decrease our after tax earnings by approximately $1.4 million per annum, holding other variables constant.

Evaluation of Disclosure Controls and Procedures

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company’s “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of March 25, 2022.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended March 25, 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes to our risk factors as previously disclosed in Part I, Item 1A. included in our Annual Report on Form 10-K for the year ended December 24, 2021 filed with the SEC on February 22, 2022. In addition to the information contained herein, you should consider the risk factors disclosed in our Annual Report on Form 10-K.