Note 1—Operations and Basis of Presentation

Description of Business and Basis of Presentation

The financial statements include the condensed consolidated accounts of The Chefs’ Warehouse, Inc. (the “Company”) and its direct and indirect wholly owned subsidiaries. The Company’s quarterly periods end on the thirteenth Friday of each quarter. Every six to seven years, the Company will add a fourteenth week to its fourth quarter to more closely align its year end to the calendar year. The Company operates in two operating segments, Protein and Specialty, which are combined into one reportable segment, food product distribution. The Company’s customer base consists primarily of menu-driven independent restaurants, fine dining establishments, country clubs, hotels, caterers, patisseries, bakeries, chocolatiers, cruise lines, casinos, culinary schools, specialty food stores and, in the case of the Company’s Allen Brothers 1893, LLC, (“Allen Brothers”) subsidiary, individual customers.

Consolidation

The condensed consolidated financial statements include all the accounts of the Company, and its direct and indirect wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Unaudited Interim Financial Statements

The accompanying unaudited condensed consolidated financial statements and the related interim information contained within the notes to such condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the applicable rules of the Securities and Exchange Commission (“SEC”) for interim information and quarterly reports on Form 10-Q. Accordingly, they do not include all the information and disclosures required by GAAP for complete financial statements. These unaudited condensed consolidated financial statements and related notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the fiscal year ended December 26, 2014 filed as part of the Company’s Annual Report on Form 10-K, as filed with the SEC on March 11, 2015.

The unaudited condensed consolidated financial statements appearing in this Form 10-Q have been prepared on the same basis as the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K, as filed with the SEC on March 11, 2015, and in the opinion of management include all normal recurring adjustments that are necessary for the fair statement of the Company’s interim period results. The year-end condensed consolidated balance sheet data was derived from the audited financial statements but does not include all disclosures required by GAAP. Due to seasonal fluctuations and other factors, the results of operations for the thirteen and twenty-six weeks ended June 26, 2015 are not necessarily indicative of the results to be expected for the full year.

The preparation of financial statements in conformity with GAAP requires management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from management’s estimates.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance to clarify the principles for recognizing revenue. This guidance includes the required steps to achieve the core principle that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. On July 9, 2015, the FASB voted to defer the effective date by one year to December 15, 2017 for interim and annual reporting periods beginning after that date. Early adoption of ASU 2014-09 is permitted but not before the original effective date (annual periods beginning after December 15, 2016). We expect to adopt this guidance when effective and are still evaluating the impact this standard will have on our financial statements.

In April 2015, the FASB issued guidance to simplify the presentation of debt issuance costs. This guidance provides that debt issuance costs related to a recognized liability be presented in the balance sheet as a direct reduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance is effective for fiscal years and interim periods beginning after December 15, 2015 and is required to be applied on a retrospective basis. Early adoption is permitted for financial statements that have not been previously issued. We expect to adopt this guidance when effective and adoption is not expected to have a material impact on our financial statements.

In July 2015, the FASB issued guidance to simplify the subsequent measurement of inventory. This guidance provides that inventory should be measured at lower of cost or net realizable value. This guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within fiscal years beginning after December 15, 2017 and is required to be applied on a prospective basis. Early adoption is permitted at the beginning of an interim or annual reporting period. We expect to adopt this guidance when effective and are evaluating the impact this standard will have on our financial statements.

Note 2—Earnings Per Share

The following table sets forth the computation of basic and diluted net income per share:

Reconciliation of net income per common share:

The weighted average shares outstanding for the twenty-six weeks ended June 26, 2015 did not include the impact of 45,106 Restricted Share Awards (RSAs) or 1,237,374 shares from the convertible subordinated notes issued in connection with our acquisition of Del Monte Capital Meat Co. and certain related entities (“Del Monte”) as they were deemed to be anti-dilutive.

Note 3—Fair Value Measurements; Fair Value of Financial Instruments

We account for certain assets and liabilities at fair value. We categorize each of our fair value measurements in one of the following three levels based on the lowest level input that is significant to the fair value measurement in its entirety:

Level 1—Inputs to the valuation methodology are unadjusted quoted prices in active markets for identical assets.

Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities include the following:

If the asset has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset.

Level 3—Inputs to the valuation methodology are unobservable (i.e., supported by little or no market activity) and significant to the fair value measure. 

Assets and Liabilities Measured at Fair Value

As of June 26, 2015, the Company’s only assets or liabilities measured at fair value were the contingent earn-out liabilities related to our acquisitions of Del Monte, Euro Gourmet, Inc. (“Euro Gourmet”) and Allen Brothers. These liabilities were estimated using Level 3 inputs and had fair values of $8,042, $243 and $4,273 at June 26, 2015, respectively. These liabilities are reflected in accrued and other liabilities on the balance sheet. The fair value of contingent earn-out liabilities was determined based on a probability-based approach which includes projected results, percentage probability of occurrence and discount rate to present value the payments. A significant change in projected results, discount rate, or probabilities of occurrence could result in a significantly higher or lower fair value measurement. As of December 26, 2014, the contingent earn-out liabilities for the Euro Gourmet and Allen Brothers acquisitions were $243 and $5,696, respectively, and were reflected in accrued and other liabilities on the balance sheet. The increases in the contingent earn-out liabilities resulted in increases in operating expenses of $207 and $248 for the thirteen and twenty-six weeks ended June 26, 2015, respectively.

The following table presents the changes in Level 3 contingent consideration liability:

During the twenty-six weeks ended June 26, 2015, we paid $1,500 to the prior owners of Allen Brothers as Allen Brothers achieved the revenue component of the contingent earn-out agreement we entered into with the former owners of Allen Brothers.

Fair Value of Financial Instruments

The carrying amounts reported in the Company’s condensed consolidated balance sheets for accounts receivable and accounts payable approximate fair value due to the immediate to short-term maturity of these financial instruments. The fair value of the revolving credit facilities and term loans approximated their book values as of June 26, 2015 and December 26, 2014, as these instruments had variable interest rates that reflected current market rates. The carrying amount of the Company’s senior secured notes, convertible subordinated notes, capital leases and software financing arrangements at June 26, 2015 and December 26, 2014 approximate fair value as the interest rate obtained by the Company approximates the prevailing interest rates for similar instruments.

Note 4—Acquisitions

The Company accounts for acquisitions in accordance with ASC 805 “Business Combinations”. Assets acquired and liabilities assumed are recorded in the accompanying consolidated balance sheet at their estimated fair values as of the acquisition date. Results of operations are included in the Company’s financial statements from the date of acquisition. For the acquisition noted below, the Company used the income approach to determine the fair value of the customer relationships, the relief from royalty method to determine the fair value of trademarks and the comparison of economic income using the with/without approach to determine the fair value of non-compete agreements. The Company used Level 3 inputs to determine the fair value of all these intangible assets.

On April 6, 2015, the Company completed its acquisition of Del Monte. The aggregate purchase price paid by the Company at closing was approximately $185,332, including the impact of an initial net working capital adjustment which is subject to a post-closing working capital adjustment true up. Approximately $123,893 was paid in cash through cash-on-hand, the proceeds from the issuance of additional senior secured notes and additional borrowings under the revolving portion of the Amended and Restated Credit Agreement. The remaining approximately $61,439 consisted of (i) approximately 1.1 million shares of the Company’s common stock totaling approximately $24,689 and (ii) $36,750 in aggregate principal amounts of convertible subordinated notes with a six-year maturity bearing interest at 2.5% with a conversion price of $29.70 per share issued to certain of the Del Monte entities. The Company will also pay additional contingent consideration, if earned, in the form of an earn-out amount which totals approximately $24,500 to certain of the Del Monte entities; the payment of the earn-out liability is subject to certain conditions, including the successful achievement of Adjusted EBITDA targets for the Del Monte entities and improvements in certain operating metrics for the Company’s existing protein business and the business of any protein companies subsequently acquired by the Company over the six years following the closing of the Del Monte acquisition. At April 6, 2015, the Company estimated the fair value of this contingent consideration to be $7,871. This contingent liability is adjusted to fair value on a quarterly basis and is estimated to be $8,042 at June 26, 2015. The Company expensed $1,313 of professional fees and $3,000 of transaction bonuses in operating expenses related to the Del Monte acquisition during the twenty-six weeks ended June 26, 2015. The Company is in the process of finalizing a valuation of the tangible and intangible assets of Del Monte as of the acquisition date. These assets will be valued at fair value using Level 3 inputs. Other intangible assets are expected to be amortized over 15-20 years. Goodwill for the Del Monte acquisition will be amortized over 15 years for tax purposes. For the thirteen and twenty-six weeks ended June 26, 2015, the Company reflected net revenues and income before taxes of $56,128 and $3,404 respectively for Del Monte in its condensed consolidated statement of operations.

The table below details the assets and liabilities acquired as part of the Del Monte acquisition, which was effective as of April 6, 2015, and the allocation of the purchase price paid in connection with this acquisition.

The table below presents pro forma consolidated income statement information as if Del Monte had been included in the Company’s consolidated results for the entire periods reflected. The pro forma results were prepared from financial information obtained from the sellers of the business, as well as information obtained during the due diligence process associated with the acquisition. The pro forma information has been prepared using the purchase method of accounting, giving effect to the Del Monte acquisition as if the acquisition had been completed on December 28, 2013. The pro forma information is not necessarily indicative of the Company’s results of operations had the Del Monte acquisition been completed on the above date, nor is it necessarily indicative of the Company’s future results. The pro forma information does not reflect any cost savings from operating efficiencies or synergies that could result from the Del Monte acquisition, any incremental costs for Del Monte transitioning to become a public company, and also does not reflect additional revenue opportunities following the acquisition. The pro forma information reflects amortization and depreciation of the Del Monte acquisition at their respective fair values based on available information and to give effect to the financing for the acquisition and related transactions.

Note 5—Inventory

Inventory consists of finished product. Our different entities record inventory using a mixture of first-in, first-out and average cost, which we believe approximates first-in, first-out. Inventory is reflected net of reserves for shrinkage and obsolescence totaling $1,156 and $1,130 at June 26, 2015 and December 26, 2014, respectively.

Note 6—Equipment and Leasehold Improvements

As of the dates indicated, plant, equipment and leasehold improvements consisted of the following:

Construction-in-process at June 26, 2015 related primarily to the build out of the Company’s new distribution facility in Las Vegas, NV (which in July 2015, the Company sold and leased-back through a long-term lease, see Note 11 - Subsequent Events), and the implementation of its Enterprise Resource Planning (“ERP”) system. Construction-in process at December 26, 2014 related primarily to the build out of the Company’s new distribution facilities in Bronx, NY and Las Vegas, NV, and the implementation of its ERP system.

At June 26, 2015 and December 26, 2014, the Company had $509 of equipment and vehicles financed by capital leases. The Company recorded depreciation on equipment under capital leases of $24 and $52 on these assets during the thirteen weeks ended June 26, 2015 and June 27, 2014, respectively, and $48 and $104 on these assets during the twenty-six weeks ended June 26, 2015 and June 27, 2014, respectively.

Depreciation expense on equipment and leasehold improvements was $1,419 and $611 for the thirteen weeks ended June 26, 2015 and June 27, 2014, respectively, and $2,025 and $1,270 for the twenty-six weeks ended June 26, 2015 and June 27, 2014, respectively.

Gross capitalized software costs were $8,208 at June 26, 2015 and $7,781 at December 26, 2014. Capitalized software is recorded net of accumulated amortization of $2,944 and $2,423 at June 26, 2015 and December 26, 2014, respectively. Depreciation expense on software was $264 and $87 for the thirteen weeks ended June 26, 2015 and June 27, 2014, respectively, and $521 and $173 for the twenty-six weeks ended June 26, 2015 and June 27, 2014, respectively.

During the thirteen weeks ended June 26, 2015 and June 27, 2014, the Company incurred interest expense of $3,574 and $2,109, respectively. The Company capitalized interest expense of $252 and $122, respectively, during the same periods. During the twenty-six weeks ended June 26, 2015 and June 27, 2014, the Company incurred interest expense of $5,411 and $4,167, respectively. The Company capitalized interest expense of $739 and $243, respectively, during the same periods. Capitalized interest related to the build outs of the new distribution facilities in Bronx, NY and Las Vegas, NV.

Note 7—Goodwill and Other Intangible Assets

The changes in the carrying amount of goodwill are presented as follows:

The goodwill increase in the twenty-six weeks ended June 26, 2014 related to the Del Monte acquisition.

Other intangible assets consist of customer relationships, which are amortized over a period ranging from four to twenty years, trademarks, which are amortized over a period ranging from one to forty years, and non-compete agreements, which are amortized over a period of two to six years. Other intangible assets consisted of the following at June 26, 2015 and December 26, 2014:

Other amortizable assets as June 26, 2015 represent a preliminary estimate of the overall intangible assets acquired with the Del Monte acquisition. We are in the process of performing a valuation of these intangible assets and will allocate them to the appropriate category when complete.

Amortization expense for other intangibles was $3,244 and $1,469 for the thirteen weeks ended June 26, 2015 and June 27, 2014, respectively, and $4,589 and $2,937 for the twenty-six weeks ended June 26, 2015 and June 27, 2014, respectively.

Estimated amortization expense for other intangibles for the 52 weeks ending December 25, 2015 and each of the next four fiscal years and thereafter is as follows:

Note 8—Debt Obligations

Debt obligations as of June 26, 2015 and December 26, 2014 consisted of the following:

On January 11, 2015, the Company entered into an amendment to the Amended and Restated Credit Agreement, as previously amended, among the Company and certain of its subsidiaries and JP Morgan Chase Bank (the “Amended and Restated Credit Agreement”) that became effective upon consummation of the Del Monte acquisition (as described in Note 4 above) to, among other things, (i) replace the definition of Leverage Ratio with definitions of Total Leverage Ratio and Senior Secured Leverage Ratio (each as defined in the Amended and Restated Credit Agreement) and establish limits on the amount of leverage and senior secured leverage that the loan parties may incur, which limits decrease through September 30, 2016, (ii) modify the applicable rate for borrowings under the Amended and Restated Credit Agreement to provide for an increased interest rate when the loan parties’ Total Leverage Ratio is equal to, or greater than, 4.25 to 1.00, (iii) permit the acquisition of Del Monte and the related issuance of the Company’s common stock and up to $38,250 of subordinated debt pursuant thereto, and payment of the earn-out consideration in connection with the acquisition of Del Monte so long as the loan parties are not in default under the Amended and Restated Credit Agreement, and (iv) create an expansion option whereby Borrowers may increase the borrowings available under the Amended and Restated Credit Agreement in increments of at least $10,000, such that the aggregate increases do not exceed $60,000. The Company entered into a corresponding amendment to the Note Purchase and Guarantee Agreement for our senior secured notes that the Company and certain of its subsidiaries had previously entered into with Prudential Insurance Company of America and certain of its affiliates (collectively, the “Prudential Entities”) (the “Note Purchase and Guarantee Agreement”) that also became effective upon consummation of the Del Monte acquisition to effect similar changes to the Note Purchase and Guarantee Agreement, with the exception of providing for the possibility of increased borrowings.

Upon effectiveness of the January 2015 amendment described above, which occurred when the Company consummated its acquisition of Del Monte, borrowings under the Amended and Restated Credit Agreement bear interest at the Company’s option of either (i) the alternate base rate (representing the greatest of (1) Chase’s prime rate, (2) the federal funds effective rate for overnight borrowings plus 1/2 of 1.00% and (3) the adjusted LIBO rate for one month plus 2.50%) plus in each case an applicable margin of from 1.75% to 2.50%, based on the Total Leverage Ratio (as defined in the Amended and Restated Credit Agreement), or (ii) in the case of Eurodollar Borrowings (as defined in the Amended and Restated Credit Agreement), the adjusted LIBO rate plus an applicable margin of from 2.75% to 3.50%, based on the Total Leverage Ratio.

As of June 26, 2015, the Company was in compliance with all debt covenants and the Company had reserved $4,845 of the revolving credit facility portion of the Amended and Restated Credit Agreement for the issuance of letters of credit. As of June 26, 2015, funds totaling $22,225 were available for borrowing under the revolving credit facility portion of the Amended and Restated Credit Agreement.

On April 6, 2015, the Company issued $25,000 principal amount of 5.80% Series B Guaranteed Senior Secured Notes due October 17, 2020. The notes, which rank pari passu with the Company’s and its various subsidiaries’ obligations under the Amended and Restated Credit Agreement, were issued to the Prudential Entities pursuant to a Supplemental Note Purchase and Guarantee Agreement and Amendment Agreement dated as of April 6, 2015 among the Company, certain of its subsidiaries and the Prudential Entities, supplementing and amending that certain Note Purchase and Guarantee Agreement dated as of April 17, 2013 (as amended by the subsequent amendments thereto). The interest rate on these notes can be increased to 6.15% depending on the calculated leverage ratio of the Company. In connection with the issuance of these notes, the Company entered into an amendment to its Amended and Restated Credit Agreement to permit the issuance of the notes.

On April 6, 2015, the Company issued $36,750 principal amount of convertible subordinated notes with a six-year maturity bearing interest at 2.5% and a conversion price of $29.70 per share (the “Convertible Subordinated Notes”) to certain of the Del Monte entities. The holders of the Convertible Subordinated Notes may, in certain instances beginning one year after issuance, redeem the Convertible Subordinated Notes for cash or shares of the Company’s common stock. Moreover, the Company may pay the outstanding principal amount due and owing under the Convertible Subordinated Notes at maturity in either cash or shares of the Company’s common stock. The Convertible Subordinated Notes, which are subordinate to the Company’s and its subsidiaries’ senior debt, are convertible into shares of the Company’s common stock by the holders at any time at a conversion price of $29.70.

Obligations under the Amended and Restated Credit Agreement and the Note Purchase and Guarantee Agreement are obligations of, or guaranteed by, the Company and all of its subsidiaries other than Dairyland HP, LLC.

Note 9—Stockholders’ Equity

On April 6, 2015, the Company issued 1,113,636 shares of common stock as a portion of the consideration for the Del Monte acquisition. These shares were valued at $22.17 per share.

During the twenty-six weeks ended June 26, 2015, the Company granted 202,801 restricted stock awards (“RSAs”) to its employees at a weighted average grant date fair value of $21.59 each. Of these awards, 46,035 were performance-based grants. The Company recognized no expense on the performance-based grants during the twenty-six weeks ended June 26, 2015 as it is not on track to achieve the performance targets. The remaining awards were time-based grants which will vest over a period of zero to four years. During the thirteen and twenty-six weeks ended June 26, 2015, the Company recognized expense totaling $1,765 and $1,775, respectively, on these time-based RSAs.

During the thirteen and twenty-six weeks ended June 26, 2015, the Company recognized $331 and $645, respectively, of expense for RSAs issued in prior years.

At June 26, 2015, the Company had 435,435 of unvested RSAs outstanding. At June 26, 2015, the total unrecognized compensation cost for these unvested RSAs was $7,202, and the weighted-average remaining useful life was approximately 14 months. Of this total, $3,437 related to RSAs with time-based vesting provisions and $3,765 related to RSAs with performance-based vesting provisions. At June 26, 2015, the weighted-average remaining useful lives were approximately 18 months for time-based vesting RSAs and 11 months for the performance-based vesting RSAs. No compensation expense related to the Company’s RSAs has been capitalized.

As of June 26, 2015, there were 897,645 shares available for grant under the Company’s 2011 Omnibus Equity Incentive Plan.