The Chefs’ Warehouse Overstates Gross and Operating Margins

Filing reveals SEC letter that prompted specialty foods company to reclassify expenses.

February 22, 2021

The Chefs’ Warehouse (CHEF), a distributor of specialty food products in the United States and Canada, restated its prior year’s results from operations at the request of the SEC. In its 2020 10-K, The Chefs’ Warehouse disclosed the letter it received from the SEC:

“On September 1, 2020, the Company received a comment letter from the staff of the SEC’s Division of Corporation Finance (“SEC”) with respect to the Company’s annual report on Form 10-K for the year ended December 27, 2019, requesting information regarding the Company’s presentation of food processing costs and separate presentation of selling, general and administrative expenses from other operating expenses.”

Food Processing Costs
The Chefs’ Warehouse classified food processing costs as operating expenses but stripped out depreciation expenses. In its latest annual report, The Chefs’ Warehouse revealed it now classifies food processing costs as cost of sales and included depreciation:

“Upon further consideration and discussions with the SEC, the Company concluded that food processing costs are more fairly presented as cost of sales and such costs should include depreciation expense associated with equipment and facilities used in food processing activities.”

Selling, General and Administrative Expenses
The Chefs’ Warehouse now breaks out SG&A expenses from its total operating expenses, which the company suggests it was not doing prior to receiving correspondence from the SEC. The company also disclosed:

“Furthermore, management has reclassified gain/loss from asset disposal, which was previously presented as a non-operating expense, to other operating expenses.”

The Chefs’ Warehouse says reclassifying food processing costs was immaterial to the company’s financial results. Our analysis reveals the adjustment is 1.2% of 2019 sales.

Though net income remained unchanged for the years restated, it’s clear that The Chefs Warehouse was overstating gross and operating margins under its prior accounting treatment.

In restated financial results for 2019 and 2018, the reclassifications had the following impact:

1) Chefs' gross profit was overstated by $19.7 million in 2019, and $18.1 million in 2018
2) Chefs' operating profit was overstated by $101,000 in 2019 and $169,000 in 2018

The slap on the hand from the SEC is illuminating, especially in light of some of the other judgements the company makes in its annual report. For example, despite repeatedly discussing how the global pandemic negatively impacted the company, The Chefs’ Warehouse determined that as of March 27, 2020, none of its long lived or intangible assets had been impaired due to the pandemic.

However, investors that continue reading will learn The Chefs’ Warehouse did impair some of its long lived assets following the pandemic-triggered impairment test in March. Just a few paragraphs after disclosing no impairment in the first quarter of 2020, The Chefs' Warehouse reveals more than $40 million in impairment:

“During the fourth quarter of fiscal 2020, the Company recorded a $24,200 impairment charge, $17,545 net of tax, to write-down the value of its Del Monte and Bassian Farms trademarks.”

It’s not until the footnotes that the company provides a summary of both the triggered and annual impairment tests side-by-side— without forcing investors to look in different sections. Though The Chefs’ Warehouse has certainly abided by the letter of the law— it didn’t actually impair long lived assets until 6-9 months after determining no impairment— the company certainly leaves it up to investors to debate whether its judgment and disclosures abide by the spirit of the law.

Related: SYY, USFD, PFGC

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