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MIDD Q4 Conference Call Notes



March 01, 2013 – Comments (0) | RELATED TICKERS: MIDD

Board: Middleby Corporation

Author: ultimatespinach

Business at Middleby is good, as this quarter's results demonstrated, beating estimates on both top and bottom lines. The market's relatively restrained reaction -- the stock was up only 2 percent today -- is due mostly to the runup in the share price from about $125 to about $145 since the last earnings release. The market now seems to anticipate Middleby beating the street.

The biggest news out of Q4 was its expansion from two main platforms to three: commercial food service, still by far its largest business; food processing, which grew from 17 percent of sales in Q4 2011 to 27 percent in Q4 2012; and high-end residential, which it jumped into with its $380 million purchase of Greenwood, Mississippi's Viking Range Corp. at year-end. None of the 2012 results reflect the Viking purchase, which didn't close until Q1 2013.

Here's the earnings release for Q4 and full year 2012:

Selim and Tim offered some good color on the call. As an overview, Selim said Middleby received a $30 million order from Brinker International, owner of Chilis Grill and Maggiano's Little Italy chains, to overhaul something like 1,500 Chilis locations with Middleby's "kitchen of the future," which largely automates the kitchen with state-of-the-art equipment that reduces each location's energy and labor costs without impacting food quality. They have been executing that order for more than a year and expect to complete it by the third quarter of this year. The challenge looking ahead was to generate enough other business so as not to see a top line falloff when that order was completed. Selim sounded confident they will manage that.

They expect Viking to be a drag on earnings for the first half of 2013 and become accretive in the second half. Selim says Viking lost market share during the recession largely because it wasn't offering anything new. Middleby has already cut costs there, laying off about 180 workers -- 40 more than the 140 announced on Feb. 1, reducing the Viking workforce to something like 520 -- and will take a one-time charge for severance packages in the first quarter of 2013.

He intends to introduce "a slew" of new products from the Viking platform in the second half of 2013 and expects it to contribute significantly to the top line. But Viking's margins have historically been less than half of Middleby's and Selim said he expects it to take about three years to bring its operating margins up to roughly 20 percent, where Middleby's are. He expects continued small reductions in margins in the near term, both because of Viking and the increasing percentage of sales coming from food processing, also a lower-margin business.

Selim predicted positive industry trends in 2012 would continue in 2013. He said Middleby's booth at the bi-annual North American Association of Food Equipment Manufacturers (NAFEM) show was "packed" with representatives of casual dining restaurant chains who are looking to increase the speed and variety of their offerings in an effort to compete with the fast casual segment.

Here's some of the give and take. The transcript is homemade. Those familiar with Selim's unorthodox syntax will recognize some of the odder phraseology. I've made a few edits to keep it comprehensible.

In his introductory remarks, Tim said the commercial food service group saw 13 percent growth in Asia and Latin America, but declines in Europe due to economic conditions there. He said the European slowdown impacted overall growth in the food service segment by about 2 percent in Q4.

Tim on the food processing segment: "While we anticipate continuing sales growth as we enter 2013, this growth will likely moderate from the growth rates we saw in the second half of 2012, which included revenues related to several large customer projects."

Food processing increased its gross margin from 33.1 to 34.6 percent reflecting improvement in operating efficiencies offset in part by lower margins at the newly acquired companies. Gross margin at commercial food service segment was 41.3 percent, compared to 42 percent the prior year reflecting changes in the mix of product sales.

Tim: "We anticipate food processing will continue to represent a comparatively higher portion of sales due to recent acquisitions which will continue to be reflected in overall gross margin. However, we also expect to see continuing improvement in food processing margins.
Viking has lower gross margins and will probably dilute margins by 1 to 2 percent over next few quarters."

Q & A

Q: How was the NAFEM trade show?
A (Selim): We had more chain operators looking for solutions coming through the show. We also had independents coming in and we had a large influx of international visitors come to the show. The NAFEM show is the largest North American trade show for equipment. It’s held every other year. The last time it was held was two years ago and there was a huge difference in the consumer confidence between this NAFEM show and two years ago. It was a lot more upbeat.

For Middleby specifically, we really exhibited a strategic vision of our innovation. If you were one of the attendees at the show, you could see that our products and services were substantially different from others already in the marketplace. We stand apart in the way we connect with our customers by providing solutions to energy saving, labor reduction or speed to table. I think if you looked at that, you saw significant innovation in our booth.

Q: How do new rollouts in commercial food service equipment look? Steady? Lumpy?
A (Selim): We are working with several chains on rollouts of equipment. Some of them are more breakfast chains, some of them are casual dining segment. We see several of those rollouts taking place in the second half of this year. However, we have not finished yet the rollout with the casual dining chain that started almost a year ago, over a year ago. I think this will be completed sometime during the third quarter of this year. We see other chains coming in to fill in the gap, yes. It’s not going to be most probably one chain that will fill in the gap, but it will be several chains.
A (Tim): Expect Europe to continue to drag first half, then less so in back half when comparisons are to this year’s lower comps.

Q: Of 200 basis point reduction in gross margins, how much was mix and how much acquisitions?
A (Tim): In food processing we actually had an increase in the gross margin by about 1.5 percent. Food service was down slightly because of mix within that segment. So it’s largely the mix between the two segments, from 17 to 27 percent of net sales being food processing. Can't yet predict exactly the first quarter impact of Viking charges, but will highlight those.

Q: Waterless steamer and spin-first fryer in test applications for over a year. Meaningful contribution to sales this year?
A (Selim): These two products are being tested extensively. The waterless steamer is rolling out with a major customer chain this year so it should be on its way as a major rollout. We expect those two products to have meaningful impact to our sales growth in the next 24-36 months. As I’ve always told our shareholders and customers, it takes 18-24 months to seat a game-changing product in our industry. People need to test it, they need to train people, they need to validate the data. The spin-fresh fryer has been out now I think around 18 months. It has been well-received. We are still working with several chains who are testing it. The waterless steamer has been out for a little bit longer than 14 months and it is being rolled out in 2013 with a major chain.

We have a lot more innovation than just those two. I can talk about our kitchen of the future, which is being tested with several chains. We have our 30-second toaster, which is also being tested right now in five store locations of a breakfast chain. We have our induction waterless steam table that is being tested and rolling out this year with a major chain too. So I can talk about many, many products coming up, including out combi ovens. We have a brand new line of combi ovens out in the marketplace that just got launched, with water-saving features.

Q: What about the entrance into consumer market.
A (Selim): We are introducing a slew of new products for Viking and those will be introduced for both our domestic and international markets. They will be introduced within the next nine months and they are game-changers. Some of those are organic products that Viking is working on right now and we’ve had several of the dealers come in and visit Viking in the last two weeks and they had a chance to see a preview of those and the response was overwhelmingly positive. We are also going to integrate some innovation from our other divisions, including induction, including Turbochef speed cooking, including some Jade technology that they have been working on their own with residential. So in the next nine months there will be a slew of game-changing products coming out from Viking.

Q: What's likely to be the 2013 tax rate? Similar to 2012's 31 percent?
A (Tim): I think we’re probably looking in the 33-35 percent range. There still were some one-time benefits through the tax provision this year related to some state exposure reductions. With more of our recent acquisitions being domestic in nature, they carry a higher effective rate, so that will probably push it up a little bit from what we saw this year.

Q: Restaurant chains reporting recently have harped on labor costs, potential health care cost increases and so forth. Is that what you’re hearing?
A (Selim): I would tell you what customers are telling us. In the casual dining segment, they see a significant pressure on what I call the lunch menu and the ability to compete effectively against the fast casual chains. So it’s not specifically only about labor. They are looking at how do I build trade-ups and add-on items to build my average check and be able to provide a price-value proposition and impact the consumer perception. And we have many, many casual dining chains now coming to us and working with us on trying to find the following: How do I improve my food scores and consistency? How do I introduce trade-up and add-on menu items that allow me to increase my lunch (checks)? How do I reduce my costs to become more competitive with the fast-casual chains?

Part of it has been looking at automation. Automation is interesting. I want to address automation since we just did it with one of the largest casual dining chains in the world. They are making sure that the quality of food is better, they are making sure that the speed to table is faster, they are making sure that consistency across their 1200 stores, or 1500 stores, is consistent. Most important, many of them would like to reallocate labor, or reduce labor from the kitchen, or reallocate it to the bar or reallocate it out to the part of the house.

However, what makes Middleby cooking platform for the kitchen of the future, which is automation, unique, it still allows scratch cooking. So what has happened is we are not automating the kitchen at the expense of quality. We have combined the process that allows still scratch cooking with an automated process. That’s why it was very successful as we embarked on that kitchen of the future. So what we’re seeing right now is literally seeing the casual dining being one of our fastest growing segments today trying to reposition itself to compete effectively against the fast casual segment.

Q: Trends in commercial food service, do they accelerate organic growth? Sustain 5 percent range?
A (Selim): I think those trends most probably continue the same trend as 2012. As you see where we’ve been, we’ve had a fantastic run. We’ve had significant rollouts like the Chilis rollout. We’ve had also on the food processing significant increase in pent-up demand. What we’re seeing right now in 2013 would be most probably a similar pattern as 2012. It will continue filling up the gap of not falling off when you’re having a rollout such as the one that we’ve had with Chilis that will most probably end up in the third quarter of this year. We’ve done a great job replacing that rollout with other rollouts that will fill in the gap.

I think 2012 was a superb year; 2013 will continue being on the top line very similar, and I think we can continue expecting better improvement on the margins coming through the food processing platform. And now that we have Viking, Viking is most probably going to be our biggest nut to crack as we wrap our hands around that new platform.

I think as you look at the food processing and you look at food service, it will most probably continue being in a similar trend as we’ve seen before. The biggest wild card is going to be the residential platform as we continue introducing new products, as we continue looking at the cost structure and we continue looking at the gap, as Tim mentioned, of over 10 percent of EBITBA margin between the existing business and the residential platform of Viking.

Q: Viking growth rates? Synergies?
A (Selim): We’ve let almost 180 people go. That was substantial savings and it’s a one-time hit of severance because we were very generous with severance. We wanted to make sure that we take care of people as they exited. Those were great people, but we wanted to become more efficient, so we will most probably be hit with a package of severance costs in the first quarter of 2013, which will be a one-time (charge) And then we will get the benefit of the reduction in force as we move forward because it’s a permanent reduction.

Many of the dealers are waiting to see the new products unveiled. I think we’re going to most probably see somewhat of a reduction in top line while we introduce the new products. We want people to buy our new products. We don’t want them to get an experience of an older platform. So we’ve alerted our dealers, we’ve alerted our distributors, that a slew of new products are coming in.

So I would see we will have somewhat flatish to maybe slightly down sales volume in the first six to eight months until we launch the new products. And as I mentioned earlier, they are game-changers and we’ve had nothing but kudos from dealers who have been to our factory in Greenwood, Mississippi and had a chance to preview some of those game-changing products.

In terms of synergies, (will start seeing some this year). Viking is not an immediate turnaround. We never bought Viking to turn around within one year. We set a plan that within three years we hope to bridge the gap of the EBITDA of less than 10 to where Middleby is, around 20. We think we can achieve that within three years. So from a long-term perspective, by the end of the three years, we should be at a running rate at Viking where Middleby is in addition to a top-line growth that will be a lot faster in the next three years as we introduce the new products, as we take them internationally.

Just to remind you, Viking used to be a $400 million top line company prior to the recession. I think we can get to some of those numbers within three, three and a half years and at an EBITDA (margin) closer to 20 percent.

Q: As you saying total top line growth will decelerate in first half of 2013?
A (Tim): We were just talking about organic. Obviously, with Viking, the acquisition growth will be very strong on the top line, so it’s organic growth and it’s primarily related to food processing. We had 30 percent growth from food processing on the top line in the back half of the year, so the comment there is while we expect food processing will continue to grow solidly, 30 percent organically we don’t view as sustainable, so we think that’s going to moderate as we head in to the first part of next year.

Q: Commercial food service growth significantly outpacing your competitors who have recently reported. Do you still see single digit organic growth?
A (Selim): I think yes. That’s the way to look at the organic. We’ll continue outpacing our competitors. The biggest challenge we faced was we just came out with a huge rollout with Brinker. That rollout is ending this year. So our biggest challenge was how do you fill that so it’s not a one-time upswing and then you go back to normal? And what our team has done across the food service segment has been to fill in that basically $30 million order that came from Brinker over 18 months, so we’re able to fill in enough rollouts to basically continue at that same rate.

I am a little bit nervous about the weather impacting some of our casual dining customers as they face slowdowns as people stay at home with storms, where they cannot drive. That is the only wild card I see for our casual dining customers is the weather because we’ve had unusual weather hitting the United States both in New England and the Midwest in the first two months of this year.

Q: Typically Q1 pretty strong on commercial food service. Do you expect it to be more flat because of weather impact or is flat too dramatic?
A (Selim): No, I would say that’s too dramatic. (It's hard to say) sitting here in February, talking about a quarter that still has a full month’s impact to come through. I would say so far we haven’t been dramatically impacted, but you know what, we’re still in the middle of it.

Most of our orders are shipped within a week or two, so it’s not like we have a backlog. On the food service side, we’ve had two good months so far, so I don’t want to sound an alarm that the weather has impacted it, but I am worried like everybody else that our customers got impacted by critical weather deterrent. We still have one month to go. So far, if nothing happens, we should have a very solid first quarter but I am keeping my fingers crossed for March. So far, January and February have been good but we still have March to go.

(Tim): Trends basically consistent with last year. From quarter to quarter, it can be lumpy, but big picture trends are same – growth in emerging markets, chain customers adopting new technology. Europe is a challenge, but it will probably lessen in back half of year. Chilis rollout ending, but we have other chains coming on. So all together, things are very consistent with what we saw in 2012.

Q: Competition for Turbochef?
A (Selim): We welcome the competition. We don’t disregard them. I think that they bring visibility to the industry. They keep the industry alive. In the end, we think it allows us to promote speed cooking a lot faster. Fortunately, one of the things that Middleby has faced over the years is adoption of new technology is slow by our customers. It takes us 24 months to adopt a new technology. And we’ve been most probably at the forefront of this. We started on energy saving in 2000 and it took many of our competitors many years to catch up to us. We’re still leading the energy saving, we’re leading the labor saving, we’re leading the speed cooking, we’re leading ventless. So I welcome the fact that other competitors have jumped in to help (our customers) adopt the technology faster. We hope that everybody benefits, but I think given our size, our innovation and our connection with the customer, we will benefit more.

Q: Foreign exchange impact on top line?
A (Tim): Very minimal. There were currencies that were going different ways which netted out to not much of an impact in the fourth quarter.

Q: International highs and lows?
A (Tim): Europe as a whole slow; Italy, Spain, Greece, those would be challenging markets. Brazil is a market that we really have opened up this year. And then obviously China is a growing market for us. The largest market that we have in Asia and it continues to do well.

Q: Pizza oven replacement cycle?
A (Selim): Pizza chains are doing fabulously. If you look at Papa Johns, Pizza Hut, Domino's, they are doing fantastic. Their same store sales are up. They are all looking at ways to introduce more toppings, more side items. We’re seeing our pizza chain business growing very fast. The pizza chain still is a growth story overseas. Domino’s, Papa John’s, Pizza Hut and other local pizza chains are opening up stores all over the world -- Russia, India, Middle East, China, Latin America. So we see that the pizza chains continue to be very good. We’re also seeing most probably the last year or year and a half a huge migration from the old ovens that take 8 minutes or 8 1/2 minutes to cook a pizza, to going below 5 minutes, or even below 4. So we’re seeing a significant pent-up demand for our new ovens.

More important than labor savings is the fact that we have energy savings and speed of cooking and better bake. So as we introduce new ovens that have better bake, like WOW 2 will have a fantastic new belt on it and we’re seeing significant interest about the WOW 2 or the WOW 3 with the new belt. I think we’re seeing a huge pent-up demand on pizza chains, yes. And this is high margin for us because literally it is the only piece of equipment in that restaurant. If it fails, they have nothing. Not like casual dining – OK, my convection oven failed, I will use the oven underneath my range or I will stir fry or I will use the griddle or charbroiler. In a pizza chain, the conveyor oven, the Middleby-Marshall oven, is the only oven there. If they fail, they have no pizza to serve. There are roughly 100,000 Middleby-Marshall old ovens out in the marketplace and we’re seeing that coming in at a 5 percent a year replacement, which is lifting the Middleby-Marshall business strongly.

Q: Subway wants to go from 30,000 to 100,000 units by 2030. Helpful to you, no?
A (Selim): Our relationship with Subway has been fantastic, from baking the bread on premises and toasting their (sandwiches) on our Turbochef, it’s been a fantastic relationship. We just introduced a new platform for them with the Turbochef, a new Turbochef platform that reduces energy usage on the Turbochef and increases speed. We continue benefiting from the growth of Subway. We are also benefiting from other chains that have adopted Turbochef, whether it’s Starbucks or Dunkin’ Donuts. We’ve seen some significant growth within the Turbochef.

CookTek is also growing very fast in its induction platform. We have a rollout with a major pan-Asian chain, one of the largest in the world is rolling out a complete induction platform, ventless, waterless. We are also seeing CookTek being generated in many other places, including casual dining places where they are using induction to do scratch cooking.

Our kitchen of the future, which is a CTX, Carter-Hoffman, WOW combination is being tested by other casual dining chains. So we are very excited about those. I think our frying platform, whether it’s perfect fry or spin-fresh or LOV (low oil volume) fryer, is also gaining traction in many places. So we’re very excited about all the innovation, not only within Turbochef, but kitchen of the future, induction with CookTek, the frying platform, ventless. I think Wells Ventless is recording double digit (growth) in non-traditional outlets both in the United States and overseas.

At NAFEM, we were packed. We had every chain operator almost that was visiting the show that spent hours in our booth looking at all the innovation we had. So we are very excited about the future of our product execution from our engineering and our innovation standpoint.

(Tim): Capital spending, even with Viking, should not exceed 2 percent of revenue for 2013.

Selim’s closing comments:

I would like to summarize where we go from here. I think that there are three items that literally set us apart:

-- One, we continue doing a great job executing on product.

-- Two, the focus on customization to meet the needs of our operators is so critical, and it cannot be emulated by our competitors.

-- Three, our international footprint of sales, service and manufacturing, especially in emerging markets, is unique and tailored to both (inaudible) and local chains.

So as we look at the three platforms that we now have, let’s start with the residential platform. People are beginning to feel better about spending money on their homes as the housing market slowly recovers. So the rising home values have given homeowners additional confidence in spending on renovating their homes. No. 2, new construction is starting to increase as the housing inventory has shrunk and we see improved activity in new home construction. Today’s data showed new home sales hit a 4 1/2-year high. However, we are not only counting on the housing market to grow our residential platform. We believe that Viking lost market share during the recession as its core cooking platform remained the same without much innovation. The slew of new products to be introduced within the next nine months will reposition Viking for significant growth. Those new products are game-changing.

On the food processing platform, we see the following three trends: One, the food processing segment will continue to grow as companies are looking at food safety issues and better quality oversight. No. 2, the customers of the food processors such as restaurant chains and supermarkets are going to require food processors to make more investment in equipment and management to ensure quality and consumer safety. No. 3, there will be greater need for safeguards in emerging markets. This is a critical spot for our food processing business as the emerging markets will grow much faster in the next two to three years.

Finally, the food service platform. Some of you attended the NAFEM show. You could see a clear strategic vision of our innovation. Our products and services are substantially different from others already in the marketplace. We stand apart in the way we connect with our customers by providing solutions to energy savings or labor reduction or speed to table. Our biggest opportunity is the casual dining segment when it needs to introduce new menu items to compete effectively against the fast casual chains who already are a dominant player. The service times at the casual dining are far too slow to compete. We are currently working with several casual dining chains on ongoing remodels to improve food scores and consistency. We are working with them to build up their checks via trade-ups and add-on menu items. Food scores outside the U.S. will accelerate at all chains. The fastest growth will come in the next two years from casual dining as they expand in emerging markets. We will also continue to benefit from the international influence of pizza chains. The pizza chains, whether it’s Domino’s, Pizza Hut, Papa John’s, will continue to grow internationally – in Russia, in Indian, in Latin America and the Middle East.

The response of all our customers is to introduce menu items that tweak the price-value propositions and impact consumer perception. A great example of this has been Chilis, Buffalo Wild Wings and TGI Friday’s, where they continue tweaking menu items and remodeling their kitchens to get there. I think working with chains like Olive Garden and Red Lobster position us to look at innovation, whether it’s reducing water, reducing energy, improving speed of cooking in those kitchens, make us the supplier of choice. So most important, I look at the fact that within the next couple of years, labor costs will increase across all segments. They will increase in the food processing segment, they will increase in the restaurant segment.

Middleby is a leader in kitchen (optimization?) both in the restaurant segment and in the food processing segment, including companies like Alkar, MP Equipment, Drake, Middleby-Marshall, Autobake, Turbochef, CTX, Star, Nieco, Carter-Hoffman and Pitco. We are currently testing these technologies with several restaurant chains and food processors to help them improve their food quality and consistency, speed to table and labor savings.

The most important thing that we accomplished with the latest casual dining chain that we just implemented this kitchen of the future has been to allow them to automate their kitchen while not sacrificing food quality or scratch cooking. Our kitchen of the future is a testament of how we have successfully (installed) an automated process at one of the largest casual dining chains in the world. It has resulted in better food scores and labor savings.

For the past 20 years, Middleby has automated the pizza business, reducing cook times and labor costs across that segment. The acquisition of Nieco is another piece of technology that automates the broiler which is being used by several leading quick-serve restaurant chains and fast casual. The ability to improve food quality, speed up the cooking process and reduce or reallocate labor is critical to most operators across the whole business. This is a little bit the reason why Middleby stands apart from its competitors. 

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