Morning, everyone. I'm Brian Harbour. I cover restaurants and food distributors at Morgan Stanley. Thank you for joining us here at the conference. Just real quick, for important disclosures, please see morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. First today, we're going to talk Chefs' Warehouse. I'm happy to have Chris Pappas, founder, chairman, CEO, with us, and Jim Leddy as the CFO. Thank you, guys, for being here. We appreciate it.
Great to be here.
Thank you.
I usually like to start with this kind of bigger picture. I think you're unique at this conference just in your focus on the upper end of the dining market, certainly. Maybe kind of tell us what you're seeing from a demand perspective here and how you see that evolving with your customer base.
Yeah. I think we said on our last earnings call, really, we actually saw, surprisingly, some acceleration that our customer's customer was spending in a normal way and maybe even a little bit better than I had anticipated. I mean, we're always cautiously optimistic. This is our 40th year in business, servicing pretty much upscale casual to the French Laundry and the best chefs in the world, right, from Dubai to California to New York. We're covering almost every state now in the U.S. It's a business that I've seen the consistency. A few times, we saw dips in the financial crash and, obviously, 9/11 and COVID. Other than that, it's kind of fascinating to watch that our sector really has always pretty much performed. I always like to say to our team, there always seems that there's enough money to go out.
For lunch and for bar mitzvahs and christenings and weddings and all the celebratory type of spending, plus, of course, à la carte and just enjoying life. It just seems like something that there's always enough money for our customer's customers.
Yeah. To that point, you have seen many cycles in this business, right? How cyclical is that occasion in your experience? How do you weather that compared to some other segments of the market? What do you usually see over time there?
Yeah. I mean, our model, I mean, we have a certain amount of fixed overhead, right, our warehouse, our trucks. The sales team is over 1,000 strong, is mainly a commission-based job, right? The more they sell, the more they make. If business is a little soft, they make a little less, so that kind of flexes itself. Our operations teams are pretty sophisticated at this point, anticipating how much labor they're going to need to flex up and down a little bit. I think the model after 40 years, it's a pretty seasoned management team. We can manage a little bit less. Obviously, like right now, we're going into our really busy season. We have to make sure we have enough labor to meet the demand for our clients going into the busy season.
I think there's always a touch of Goldilocks and a little bit here, a little bit there. We've kind of mastered being able to service our segment.
By its nature, your customers are mostly not chains. They are independent restaurants. It is a bit hard to get data on those. Do you think they are more resilient today relative to some of the chains? I guess maybe also just comment on some of the non-restaurant segments that you serve.
Sure. Again, we go from upscale bakeries. When I say upscale bakery, it's not a chain. Not that they're making everything from scratch, which many of our customers still do. This is why we are building bigger and bigger freezers in our facilities because there's so much high-quality product that's labor-saving that we really specialize in being the leader in that department. I think that upscale casual is probably the biggest volume of our business. I mean, we do the cruise ships, right? We do airlines. We do food away from home, home replacement meal companies, again, all the way up to the hotel that we're in today and super fine dining. It does seem like it's the most resilient, I would say, of the food service sector besides maybe healthcare, which hospitals always need food and some education.
Much more resilient than what we're seeing in the chain business, lower tiers, fast casual. It always has been more resilient, and I think it just continues to keep that resiliency.
What's been kind of the key to driving market share in your business over time? You talked recently even some of these markets that are a little bit weaker right now. You're still seeing share gains. I mean, what's driven that with your model?
What do we think is driving our share gains?
What's kind of the secret to continually driving share gains?
I can't tell you all the secrets, but I think the 40 years-plus experience in servicing this segment. We went public in 2011, right? We were more regional at that point, and we thought what we do would work nationally and internationally. I'm glad we guessed correctly. It's been a fun ride. I think that it's a fragmented industry. I mean, there's the three big public companies, but underneath that, there's not a lot of us left of size. I think we're dominating the segment that we're in. A lot of the companies we bought early on were smaller specialty companies, and we continue to seek those out. It's very fragmented when you get to more subspecialties or categories like produce distributors and protein distributors, meat, seafood.
I think there is a lot left in the fragmentation for us to continue to acquire when the time is right. We haven't been as acquisitive the last year or two. Coming out of COVID, we were very acquisitive. We anticipated that we would continue to take market share from our smaller competitors. We also anticipated that we would continue to nibble away underneath the belly of the giants in the segment that we wanted to dominate. I think our focus has allowed us to really dominate the market that we want and to continue to build moats around our business the way we have been with our team cell, our hybrid cell that we're using salespeople and cross-training them to sell more categories. I think that's really driving our high organic growth that you continue to see quarter after quarter.
Has that changed significantly in the last five years out of COVID? I mean, part of it is that you have acquired so much. Maybe you are just much more of a one-stop shop than you were even 10 years ago. Is that fair?
That is fair. I think what's really driving the organic growth is the investments that we made and have been making for many years in the facilities to get more efficient and to be able to have better service, all our new trucks, and really the salesforce, the training, the experts. We really invested a lot into making sure that if we put out an army, it's got to be well-trained, and you don't want these people to leave. The biggest drain on capital is to train people that leave, and you're not getting the ROI. We made a conscious decision of we changed HR. We brought in a different thought process of who and where we're going to find these people. We're going to spend the money to highly train them.
We have to make sure we get the people that are going to stay 5, 10 years. Our best people have been with me for 30, 40 years. It is a job really that people do not want to give up, especially on the sales end. A lot of people are coming out of culinary, and they are working six, seven days a week. They are working nights. They are working holidays. Now they could still stay in food, and they have a career that they continuously make more money, get lots of benefits, and not have to be on your feet at 60-plus years old working the night shift in a resort.
Yeah. To that point, are you seeing sort of better retention lately with some of those changes you've made?
We are. I think it's starting to pay dividends.
Yeah. To the point you just made, I guess, how would you describe kind of competition, your slice of the market? The big three do compete in some areas, and I think they like this business generally. Of course, you have many, many local players, some of which you've acquired over time. How would you characterize that, or how has it changed recently?
There always seems to be competition. Sometimes we go into a smaller market, and we acquire, and we are the dominant force in that market for the customer base we want. There are always green shoots. There are always new entrepreneurs coming in and more specialty. They are picking a segment. They are specializing in X I always considered my uncompetitive nature. Anybody that has a truck is a competitor that can deliver food. We do go at it very seriously. The big guys are really good at certain things, right? It is a huge market, $300-plus billion food away from home. It is a huge market. I think everybody has their place in the market. They are always going to come after what they can to take from our business. I think we are always going to go after segments of where we think that we can dominate.
Even certain types of accounts that they're the dominant player, we'll still grab a piece. When I look at the puzzle, it's dominating where we should dominate, and it's participating in an overall much bigger market. I think that drives a lot of our success.
Earlier this year, you had laid out kind of a growth plan through 2028. You're running a bit ahead of that on top-line growth. A little bit of that is inflation, right? But you've still had good performance through the course of this year. What are kind of the key drivers? What would continue to run ahead of that? What are some of the key drivers to getting to that plan?
Yeah. I think the way to think about it is, and we talked about this at our investor day, it's continue to execute the business model that Chris just so eloquently described. To continue to grow the portfolio of unique distribution centers and operations that we have in very unique markets. Not all markets are the same. All of our markets and distribution centers are in different phases of maturity. We have a place like Florida where we started out like a small pastry company selling to the cruise lines and hotels. Now we're in a state-of-the-art facility that we invested in coming out of COVID. We're processing center of the plate fish and meat. We sell produce, and we sell all the specialty products. That's a market where we're a couple hundred million dollars, and we can be a billion dollars someday.
That's just an example. We have multiple phases of maturity. Chris mentioned leveraging the significant investments that we made coming out of COVID, both in infrastructure and in M&A. We're still in the process of integrating that M&A. Texas is a good example where we bought a company that's really not a Chefs' Warehouse but gave us all the routes. We're going to leverage that going forward. The last thing is really, if you take a look at the slide we put up at our investor day, it's a waterfall to 2028. We wanted to highlight all the different things that our teams are doing within all the different segments of the company behind that kind of macro perspective.
Everything our procurement and pricing team is doing around dynamic pricing and using AI, our digital team's growth, improving our customer's experience, and arming our sales reps with real-time data to better understand our customer's behavior, systems to make our operations more efficient. Those are all the things that kind of come together for a lot of base hits and doubles. It is not one home run that is going to help us to continue to achieve the 2028 goals or even exceed them.
Right. You just gave the example of Florida where you think you could still be three or four times the size there. I mean, remind us, what are the other markets where you think you could be kind of a multiple?
Continue to grow?
Yeah.
I mean, so it's almost a fun time budgets where our small markets come in, and they're going to grow 100%. I'm like, "Well, that's great, but you're growing from a very small base." I would say overall, all markets are growing kind of to expectation. It's where the people are, right? I mean, Southern California, Northern California, you hear all the numbers. Everybody's leaving. Not everybody's leaving. Those markets are growing exponentially for us and continue to grow. Jim mentioned Texas. We think Texas will be a top three market for us in five years. Florida has been very, very good to us. We made the bet there to invest, and it continues to even surprise me sometimes how fast it continues to grow. New England, we're going to put up a new facility, consolidate. We have multiple businesses there. It's a solid market.
I think it's pretty much everywhere. I mean, like you said, there are some pockets that it seemed that we have to extend the areas in the Midwest in certain areas. We're growing really well in Nashville and Detroit. Illinois does. It's a good market. It's growing, I would guess, 8-10%. We think that market has a long runway. It's not growing as fast as, say, New York or Florida or California. The Middle East has been a great market for us, and we've invested heavily into different facilities and more sales staff, and they continue to really execute. We're pretty happy with our investments.
Okay. Great. I do have an M&A question later, but I'll save that. Maybe just if we could talk about kind of the margin side a little bit. Obviously, EBITDA margin expansion is part of your multi-year plan as well. What are sort of the key drivers of that on the gross margin side? Then maybe also just talk about the SG&A and the OpEx side. What could help deliver on that improvement over time?
With gross margins, I know a lot of the street investors tend to focus on that. We focus on gross profit dollars per unit, per drop, per truck. Really, that's how we measure our operators. And with our business, because we sell all the categories, you take Texas, for example. We're growing a protein business that we were shipping in from Chicago. We built a facility. Now we're getting all those protein boxes on Hardie's and CW trucks, and we're combining those businesses. Their average gross profit dollars and revenue per case or per unit is growing really fast. Because protein is a very expensive box with a little lower gross profit margin, you might have flattish or lower margins, but you're making more money from a gross profit dollar perspective.
I think for us, it's really about when we go into a market, our goal is to get enough scale over time and bring in all the categories, enough critical mass where we can bring in full containers and remove some of the expensive truck lanes where you're shipping in from New York or from one of our other big distribution centers that's closer regionally. That allows us to be more competitive on the gross profit margin side. On the EBITDA margin side, it's really just more of doing what we've been doing. Chris mentioned leveraging all of the infrastructure investments. We're going to continue to make investments where we need capacity, but not at the level we were when we delayed everything coming out of COVID. We were spending 2% of revenue on CapEx.
Now we're focusing on more closer to 1%, but still put in enough capacity to continue to drive that fixed cost leverage.
Yeah. Just to add a little bit to what Jim said, I mean, it's a pretty exciting time for myself. I haven't built this from the ground up. You always wonder, is your core business, is your core strategy going to continue to work? The answer is yes, and it's actually accelerating. Going public in 2011, what we didn't realize was the amount of expectation from the street to grow exponentially and keep the EBITDA margins where they were when you had to build facilities, you had to hire a ton of people, you had to invest in technology. I think it kind of got lost that nothing had changed. When our EBITDA margin percentage had dropped as we were growing, some investor would sort of panic, like, "What's wrong?" I'm like, "There's nothing wrong.
We're just investing into so many new markets that it's an EBITDA drag, right? The core businesses are performing and accelerating. It's really about how does the EBITDA margin continue to expand as we get better and better in our new markets, as we start to get that level of enough box moving dollars moving through the warehouse and through the trucks, and we manage our expenses. Their EBITDA margins will start coming up. That will, quarter by quarter, we have been showing increases in our percentages of EBITDA to the bottom line. Unless we, God forbid, we get another COVID, that threw us for a little loop, we think we can continue at a moderate pace to continue to drive that EBITDA percentage margin up as we grow.
Yeah. Are we still in the midst of some of those newer facilities?
Are we still in the midst of those benefits for newer facilities or newer companies? Because, as you said, you're probably about a year and a half past some of the heavier acquisition periods. Are you starting to see some of the synergies come through? Are you starting to see some of the procurement benefits come through? We're still in the midst of that right now.
Yeah. We lapped the big kind of OpEx costs that were associated with the significant facility investments we made in 22 and 23 coming out of COVID. We lapped them in the second half of 24. That is when you really—and we talked about that. We knew we were going to lap it. That is where you have seen kind of—it is still early innings. You are seeing a little bit of an acceleration of the operating leverage as we lap those costs.
Okay. Where do you see inflation running typically? I guess the derivative question is this is mostly a pass-through business, obviously, with regards to the price of the underlying product, also tariffs. You probably have more goods that—this is changing by the day—but that might be subject to tariffs. How have you—you passed that through, obviously, but how have you helped some of your customers manage through all of that?
Yeah. Our model is we carry a very long tail, right? That's why you see our overall overhead higher than, say, the big three. It's purposely designed, understanding our customer base, that we're a solutions company. We have to have lots of different solutions. We service the best Chef's in the world. They're very creative, very demanding, and all want to differentiate themselves. From really the inner strategy and the culture of the company as a solution company, it's really played well in crazy times where you don't know what the hell the price is. Predictive. Trying to predict is, I guess, like being the weatherman, right? I mean, you got a 50/50 chance of being right. The tariffs have actually forced us to really dig deep and become even better at managing the business, managing the inventory, and coming up with solutions.
We've done pretty well with the craziness, and it's, I think, because we have so many options. If you really can't absorb the price point that, say, Italian olive oil went up, I think last year went up like 50-60%, we had a lot of different solutions. The same went through whether it was frozen croissants or canned tomatoes or beef. Beef is an issue. We do have other solutions. We do carry beef from Australia and other places, but it's predominantly American beef. That's been a real headwind for restaurateurs. We manage that by trying to get creative. We have processing centers, so we can eliminate a lot of labor. We can get really creative, giving them different solutions on their cuts and sizes and helping them meet their price point to where they think they have to be.
Not everybody could sell a $125 New York strip.
You were talking about the salespeople, Chris. This has been sort of topical with the big three, but talk about how your salespeople are compensated. Have you ever changed that through the years, or has it been consistent? Any issues with kind of hiring, or you're very happy with where your salesforce is right now?
We're never happy, but I would say that we're satiated at this point that we think we're compensating our team correctly, right? We want to create that incentive for them to always sell more. We're constantly tweaking it. With the amount of inflation that we have seen and the plethora of categories that we allow them to sell, I think it's a unique model. I'm not going to go into it completely, but it's a salesperson by nature and always trying to think, "How do I incentivize them? How do I maximize their desire to want to sell more?" It’s tough. Salespeople go out every day, and they're competing, and they have to juggle helping to collect the accounts receivable and watch their inventory. Everybody's after them. They're bringing in items. They're not selling. Some customers are hard to collect.
To keep them motivated, we're constantly tweaking it to overcome the tough part of the job. The good part of the job is they're getting to meet with the best chefs in the world. They eat really well, and they're in an atmosphere that they really enjoy. I think it's a great job for the right person.
Okay. This is the year I have to ask this question of everyone. How are you using AI, both in a customer-facing capacity and maybe also internally? Can you talk about your use cases for that?
Yeah.
Yeah. The two I would highlight would be in procurement and pricing. We're using AI to optimize pricing. We always had a traditional kind of attribution type of model, and now we're using more predictive type of AI products. They're a commodity now. You can get a third party to work with you in a pretty economical manner to build this stuff. The most impactful so far has been in our digital platform. We're using it to really better understand our customers' behavior to the point where if they're on our site and they're hovering and they're looking at something two days in a row and not buying it, we're communicating with them automatically. The model builds itself to understand their behavior. What are they sensitive to from a price standpoint? What are they not sensitive to? What's their elasticity?
That is where it is proving to be very valuable for us right now.
Any other kind of technology areas or specific areas of focus? Have you looked at any sort of automation solutions in your facilities or anything like that?
Yeah. I mean, it's a constant improvement that we challenge our operations team. I mean, eventually, I think it's going to go robotic at a certain point. Right now, the ROI is just not there. We study it daily, and it's very expensive. We have automation. We're using tons of different types of automation in our processes. Humans still go faster for what we do. We pick a lot of pieces, right? We break a lot of cases. We're very much just in time. We have great technology, but we still feel that it's really important to have the right people. Even when you're replacing with automation, now you need more engineering. You still have the cost that's going into labor. I think that from the sales side as well, like Jim was saying, a lot of the AI, it's really to make them better.
I think a lot of the sales team thought that we were trying to eventually replace them. It is really the opposite. The AI now, it is actually making them better. It is a quality of life improvement, right? Because they do not have to search so much. They do not have to work a lot of the late nights they were working. It is driving. It is really giving them the ability to actually do a lot more than they were before.
I'll just add that Chris mentioned the automation we're putting in our processing facilities. That's something where we look at the ROI. When we put that automation in our processing facilities, the payback's in a year and a year and a half. Those are no-brainers. We'll put that into the CapEx budget because we know that we can save four or five butchers as a result of that, and that's going to pay back really quickly.
Yeah. Okay. When I look at sort of your capital budget for the next, just generally for the next year, I mean, how much is new capacity? How much is technology? How much is other things? It seems like you're past some of the heavier investment in new capacity, but how much would you typically add in a year?
Our typical CapEx budget is somewhere between 60%-80% retrofitting facilities because we're still a high-growth company. We're growing organically, industry-leading, 8%, 9%. Our long-term growth algorithm is even a little bit less than that. I would say, given the cost of retrofitting a facility since COVID has gone up, we'll do a little bit less, but the ROI is still there. The other, call it 30%-20%, is mainly technology investment and then your typical maintenance CapEx.
Yeah. Okay. What is typically the right pace of M&A? I mean, what new markets do you want to add in the U.S., perhaps? I mean, what kind of meets the hurdle for, "Hey, we'd like to put a facility here"? Also maybe just you're in the Middle East, but what other international markets can be attractive?
Traditional distribution expansion, which we're not a traditional distributor. I always think we're more of a sales and marketing company that also distributes because of our relationships and who we distribute for, right? Thousands of, besides our larger manufacturers or farmers, it's tons of small artisan companies that we pretty much take—we're buying 80-90% of what they produce, right? We have that responsibility almost as a manufacturer. We are processing. The way we go to market, and I've kind of lost now—I am so lost in thought, I forgot your question.
Just what new markets would you want to be in? How would you think about adding new markets?
We're very opportunistic. Typical distribution, as you annex the next market next year, it's the easiest, right? We didn't have that luxury. We had to acquire where companies fit in to grow. Now we're at a really good stage where we're much more selective. We can continue to feed small fold-ins into the capacity that we've built, which is extremely—the return on that could be one or two years, right, depending on how successful we are. We're really good at executing it, right? We eliminate a lot of the cost. We're really keeping the sales. We continuously hunt for that. In the Middle East, we've really set them up for success to continue to grow organically. If something really good comes along, again, it's more of a fold-in that I see. We're constantly looking at certain international markets.
I think, again, we're opportunistic to see if something really, really makes sense. I would say that more of a focus right now is to continue executing on the organic level, to do fold-ins where we have capacity. The markets that we're really not in is the South at this point. We have so much to do in Texas, really, to grow that business, but we'd like to get into the Carolinas. We'd like to get into Georgia. Connect the dots, right, now to make us a complete national distributor. I think that's more of the focus. Every time I say that, the phone rings, and I'm like, "Well, this is really interesting." Yeah. I think we've learned going from a private company for so long and being public how to balance it.
I think we're just in a really good place where we don't have to do anything, and it's really nice to have. I think we've learned to be more patient now when something comes up. We probably walked away from 90% of what we looked at. We're saying it just doesn't fit in. We've learned our lesson too in our growth stages that what is too difficult, we're up for the challenge. Now I think we really know who we are and what really makes sense. If we're going to go after something, it's got to make a lot of sense.
Okay. Makes sense. Maybe Jim, just remind us your leverage range, and then if you're within that, is buyback sort of the use of additional cash?
Yeah. I mean, the way we look at it is it's flexible. If we have an M&A transaction that we think we're going to complete, we'll preserve some cash to fund as much of that with cash. We usually only have to borrow if it's a fairly decent-sized deal. It stands that we'll continue to moderately pay down some debt and buy back shares opportunistically, really depending on the market and where the share price is, things like that. It's a very flexible capital allocation model. I think we've gotten net debt leverage right where we want it towards the lower end of our defined range. We feel good about the balance sheet right now.
Okay. Maybe I'll finish with my lightning round questions. These are standard for everyone. Demand outlook just relative to recent trends. How do you expect demand over the next 12 months accelerate, remain stable, decelerate?
My crystal ball, I would take what we've been experiencing now for the next 20 years and be really happy.
Okay. I'll say stable. Margins over the next 12 months, margins to face more tailwinds, balance of tailwinds and headwinds, or more headwinds?
Are you talking EBITDA margins or gross profit margins?
Probably EBITDA margins.
EBITDA margins. I mean, we'll guide in January. But I think just going back to what we talked about earlier, we're still in the early innings of getting the operating leverage from all those investments. I think we feel pretty good about getting to the range that we set for 2028.
Okay. Just on capital, we know how you sort of prioritize capital allocation, but I guess CapEx intensity related to technology over the next 12 months, do you expect that to increase, stable, decrease?
I think it's increasing a little bit for everybody. I think especially with AI becoming more of a commodity, you're going to see companies, including us, applied in other areas over time. I would say increasing, but not materially.
Okay. How about a focus on portfolio optimization, whether that's acquisitions or it could just be footprint rationalization or anything like that? Increase, stable, decrease?
I think it's stable. I think, again, it's opportunistic. The market right now, there was a lot of roll-ups coming out of COVID or they started before COVID. I think some of the sponsors are kind of stuck. We are patient, and I think there could be some really good opportunities down the road.
Okay. Great. With that, right at time, we'll leave it there. Thank you very much.
Thank you.
Thank you.
Thank you, Brian. Thanks for having us.
Thank you.