Middleby Corp. Conference Call Notes
Board: Middleby Corp.
Middleby surprised to the upside again in Q1 and the shares got a nice bounce. The P/E continues to hover between 22.5 and 23, toward the high end of the historical range but perhaps appropriate given the growth, momentum and improving economic conditions in Middleby's sector of the economy.
Middleby has become a global player in food service equipment and food processing equipment. Of its $327.5 million in first-quarter sales, 26 percent came from outside the U.S. That figure would have been higher -- last year, it was 31 percent -- without the Viking acquisition because Viking does not (yet) have much international presence. The breakdown is roughly 50 percent in Europe, where sales are down due to economic conditions but seem to be leveling off 15-20 percent below previous levels, and 25 percent each in Asia and Latin America, where growth remains robust. CEO Selim Bassoul said, for example, that Starbucks plans to open hundreds of stories in India, and Middleby will supply the breakfast cooking equipment.
In addition to a top line bump of $58.7 million that came from adding Viking's results, the company largely completed a $30 million order from Chili’s to renovate all its U.S. stores with the automated kitchen of the future. Selim disclosed that seven other casual dining chains are now talking with Middleby about that product, in part because of the impressive results in the marketplace Chili's has already seen. He predicted the company will ultimately get orders from “several of those.” In fact, as the call went on, he basically said they already have one in hand for another major rollout in 2014.
The Viking story is short-term pain for long-term gain. Selim predicted sales will drop to about $50 million in Q2 as Middleby discontinues low-margin, low-volume product lines and before it begins to roll out new products in the latter half of the year. On the other hand, CFO Tim FitzGerald said Middleby now expects to bring Viking's operating margins up to Middleby standards (from 10 to 20 percent) in two years rather than three. It increased to 12 in Q1.
Middleby’s portfolio of technological innovation continues to grow. After emphasizing energy savings, speed cooking and ventless cooking in recent years, it is now adding a focus on water saving and getting a good response. Later this year, Selim said Middleby will be rolling out its waterless steamer with one chain and its waterless induction steam table with an Asian chain.
Restaurant operators across the Middleby customer base are upbeat about their business for the remainder of 2013 after a tough first quarter impacted by weather and the adjustment of consumers to smaller paychecks due to the increase in the social security payroll tax from 4.2 to 6.2 percent on the first of the year.
Selim also sounded a cautionary note about the second quarter, saying there will be a top line “lag” between the end of the Chili’s rollout and the various growth engines likely to kick in later this year, including new products from Viking, the waterless product rollouts and potential new deals for the automated kitchen of the future.
Here's a little color from the call. A couple of notes: Selim's syntax may seem strange if you're not familiar with his speech. English is not his first language. There is a conference call transcript available from Seeking Alpha, but I transcribed the quotes here myself from the call because SA's automated transcripts sometimes have trouble identifying words correctly through Selim's accent.
Financial details from Tim:
The increase in net sales was 43.1 percent year over year, mostly because of the addition of Viking sales, but also incremental contributions from three other acquisitions over the past year -- Nieco, Stewart Systems and Baker Thermal Solutions. All told, those contributed $74 million to the top line, or 32.3 percent of the 43.1 percent total increase.
That still leaves 10.8 percent organic growth, which breaks down to 8.6 percent organic growth in the commercial food service group and 18.4 percent in the smaller food processing group. Tim said the organic growth in commercial food service was “driven by increased sales to restaurant chains looking to upgrade equipment and adopt new technologies to improve efficiency of store operations.”
Growth exceeded 20 percent in Asia, Latin America and the Middle East. The rate of decline in Europe slowed from 15-20 percent over the past year to 5 percent in Q1. The Europe decline took 1 percent off the commercial food service organic growth rate. The continuing rapid growth of the food processing segment reflects "demand by food processing customers looking to modernize existing production operations and new customers developing operations in international markets.”
Growth in food processing was explosive in the second half of 2012, so FitzGerald said year-over-year growth rates should begin to moderate in the second half of 2013.
In Q2 and Q3, sales at Viking "will be impacted by integration initiatives, including the disposition of non-core revenue streams, the discontinuance of low-volume and low-margin SKUs as we simplify the business operations, and temporary disruption in distribution channels as we restructure and improve efficiencies in our sales and distribution processes. This will result in lower second quarter sales that we estimate will be closer to $50 million, with the second half of the year reflecting the initial benefits of the ongoing sales and product initiatives.”
Gross profit increased to $121.3 million from $87.5 million. Gross margins were 37 percent, down from 38.2 percent in the prior-year quarter. If you back out Viking, which had a first-quarter gross margin of 28.5 percent, gross margins would have been 38.9 percent. Viking will continue to dilute overall gross margins by 1-2 percent for the rest of the year. “However, we anticipate the Viking gross margin will improve in the second half reflecting the benefit of purchasing savings, SKU simplification actions, gains in production efficiencies and other ongoing initiatives benefiting the gross margin rate.”
General and administrative expenses were up $17.3 million to $42.9 million, more than $12 million of it related to non-recurring expenses and intangible amortization in connection with the Viking purchase and restructuring. There may be some of this in Q2 "as we complete our integration activities related to Viking."
Effective tax rate was 32.8 percent due to the mix of jurisdictions and
various credits and incentives. They expect it to be closer to 35 percent for the rest of the year.
Debt is up to $638.4 million after the Viking purchase, most of it financed under a five-year, $1 billion credit facility established last year. The interest rate is LIBOR plus 1.75 percent.
Fitz: “As it relates to the Viking acquisition, we are very pleased with the progress made during the first quarter to reduce product and operating costs, enhance focus on product quality and customer service and realize synergistic opportunities with our commercial food service business.
"The Viking acquisition including first quarter non-recurring charges diluted earnings by approximately 30 cents per share and we anticipate will continue to dilute earnings in the second quarter. However, we continue to expect this acquisition will be accretive to earnings in the second half as we realize the benefit of profitability improvements."
Q: Why do you now anticipate you can bring Viking's margins up to Middleby's margins in two years rather than three?
Selim: "One is cost reductions. As we benchmark against not only Middleby’s way of doing business but Viking’s competitors, we seem to be a lot heavier loaded in terms of both overhead and people. So we’ve started embarking on some cost enhancements. We also have started looking at our distribution channel costs, which were much higher than our competitors.
"No. 2, as we continue to look at pricing and innovation, we see significant margin in our new products as we have shown some of those new features, some of them coming from Middleby, some of them organically developed at Viking. We see significant interest by our dealers and distributors and willingness to pay for those features that are coming through . . . No. 3, there have been some purchasing savings. As we leverage the Middleby organization with Viking, they benefit from the savings we generate from our size and our scale."
Q: Organic growth in commercial food service is quite strong. What's going on there?
Selim: "Our customers came up from a very difficult first quarter. They were impacted by a very brutal winter and some economic pressure from the consumers. I think as we start seeing the second quarter come on, we started seeing consumer confidence getting healthier based on the results of the April survey. And it seems the impact of the payroll tax appears to be waning. So from a macroeconomic factor, I think our customers are starting to see less pressure on them. The weather is behind us, and I think the consumer confidence is getting better.
So from that perspective, we are very optimistic that our operators and our customers are going to have a better second, third and fourth quarter.
"Now, in terms of Middleby specifically, we are basically finishing up a major rollout with Chili’s. Most of it, you’ve seen the impact of it in the first quarter, so we’re going to have a lag until we get to fill up that order because it was a large order for Middleby. So on the food service side, you’re going to see a lag in the second quarter because we’re almost done with Chili’s. We’re doing the final few stores . . . So there’s going to be a lag in terms of top line.
"We have a lot of new product innovation, we have a lot of testing of products. In the third and fourth quarter, we have several rollouts that will start compensating for the lag between the first and the third quarters that will occur in the second quarter."
Q: What's the relative strength among restaurants in your commercial food service segment?
Selim: "It’s a great question. This is very critical to where I see the food service business going. First, I can tell that across all segments, I’m talking casual dining, fast casual, pizza, quick-serve, they are all voicing great optimism across all segments about the second half of 2013.
"I have personally called and spoken to many of our customers. I have spent the last six months basically either visiting or talking to our customers and they’re all reporting significant optimism in the second half of 2013 and they are starting to report that business has begun to improve very strongly in April.
"One interesting indicator, for the first time in 22 months, casual dining restaurants outperformed quick-serve in March. While casual dining has been really hit hard, for the first time in 22 months the average performance of casual dining outperformed the fast-food industry in March for the first time."
Q: Why is that? The economy or improvements in casual dining menus, etc?
Selim: "The word I am hearing from most casual dining operators is 'tactical value.' They have never talked about tactical value. Before, those people were saying, 'OK, I have a burger, it doesn’t matter if people are going to wait, I have a good burger, I have a decent burger, it doesn’t matter if people are going to wait 22 minutes to get the burger.'
"Today, they are finally getting the concept, and this is what happened with our relations with Chili’s, finally those casual dining chains are focusing on improving menu quality, speed of cooking and value.
"We have right now over seven chains, casual dining chains, looking at a similar process as Chili’s, so I’m going to give you a Chili’s rundown of what happened after they implemented the kitchen of the future and changed their menu and (inaudible) their cooking and retrained their people.
"Chili’s guest satisfaction scores are up in the first quarter of 2013 by over 10 percent across the whole chain . . . Their operating income margin and EPS increased and the Chili’s traffic exceeded the average casual dining industry traffic by more than 2 percent in the most recent quarter.
"As you look at their improvement, you have menu improvement, kitchen equipment innovation, investment in technology, and you look at what happened. So finally those operators are trying to do the same. So today I have seven chains testing a similar process, casual dining chains, and ultimately we will land several of those because they want the same things.
"So finally the light went on, they said, 'OK, we can’t compete. We are compressed between fast casual and quick serve and we’re losing the customers. So this is what’s happening.
"Let me summarize everything that’s happening. Very difficult start of the year for our customers because of weather, because of timing pressure on payroll tax. Today, April, it’s all changed. They show optimism across all the segments for the rest of the year, and you’re starting to see April come through a lot better, including our April.
Q: When will you have more presence in Latin and South America?
Selim: "We are the dominant player in Latin America. I think what was missing was Brazil. I think with us opening up a (sales and distribution office) in Brazil . . . we see Brazil to become a major player for us."
Q: Intermediate term, enormous opportunity for restaurant chains in Argentina, Brazil, Colombia, Mexico.
Fitz: "And we are building a broad base of customers there in Latin America. Not only the U.S. chains are going there, but the local chains, so we’ve got a pretty broad list of customers there."
Q: Acquisition pipeline? Will the pace trail off after the big Viking purchase?
Fitz: "The pipeline remains strong and consistent with the last couple of years. We’ve obviously done a number of acquisitions the last two or three years and really we see that pipeline is very consistent from quarter to quarter. The timing is just really a function of the opportunities, but we feel good about the pipeline in all the segments we’re in (and) we’re developing a pipeline on the residential side as well."
Q: Why not more leverage in SG&A? Should we begin to see that a little bit lower as a percentage of sales vs. a year ago?
A: Fitz: "The incremental SG&A was largely driven by the acquisitions and I kind of laid out the additive impact of that. We did see actually some leverage in the selling expense, excluding the impact of Viking as well as G&A if you kind of back out the acquisition impact."
Q: Europe, any signs of recovery?
Selim: "Europe continues to be very difficult. I think it will continue to be a very difficult year this year. It’s not getting worse than what it was a year ago, so if you’re wrapping around year to year numbers, it’s going to remain the same. Remember, last year we saw a drop in Europe by 15-20 percent. I think now that is a new level of where Europe is going to be. We’re not going to see a worsening situation from where we’ve been, but we’re not seeing a little bit of uptick. So I think Europe will continue to be most probably difficult through the fourth quarter.
"I am starting to see something interesting happening in Europe that I’ve not seen, specifically in places like UK, Germany and Sandinavian countries, where they are starting to look for what I call tactical value, trying to figure out, 'How do we upgrade the menu, how do we do restaurant remodel and how do we create value to our customers?' It took some time to do what we’ve done here (in the U.S.), but I think we’re starting to see a lot of menu changes, we’re starting to see them say, 'Hey, help me reduce my labor costs.'
"When we look at convenience stores and supermarkets, where we’re very strong with those customers in the UK, in the fourth quarter we’re going to start to see from Middleby some rollout in the UK and Germany with those two type of customers, convenience stores and supermarkets."
Q: New products in second half of year, any game-changers, or mostly incremental improvements?
Selim: "In 2012 we introduced 12 new products. In 2013 we’re introducing 13 new products. So let’s discuss those products. I’m not going to go through 25 products, but I’m going to talk to the major ones.
"We continue to see kitchen of the future innovation as we continue improving it, adapting it from what we’ve learned from the rollout with Chili’s. We will most probably have another big impact in the kitchen of the future in 2014.
"Then you look at the waterless steamer, which is a very disruptive product, steaming without water, basically. That product is going to roll out starting in the third and fourth quarter. We got acceptance from a major chain, so we’ll see this technology rollout in the third and fourth quarter and it’s a multi-million dollar initiative.
"Then I look at our induction cooking. We are in the process of rolling out our induction steam table with a large Asian chain. It’s rolling out as we speak.
"We are also seeing innovation in terms of toasters and waffle bakers and all of those coming through. The breakfast restaurants, I’m talking about Tim Horton’s, Starbucks, Dunkin’ Donuts, and I can keep on, a long list, we’re seeing significant investment in cooking equipment at those places and that’s ongoing."
"So let me summarize where we are . . . We have a lot of offerings in breakfast and we’re seeing that equipment being bought from us as we speak. Induction cooking, we’re seeing that continues to grow. Waterless steamer, third and fourth quarter we’ll see a multi-million dollar rollout with one large chain has been signed and the orders have been received, so we’ll fulfill that order. And the kitchen of the future, I think we’ll see other large customers coming in starting in the first quarter of 2014. That’s a timeline of where innovation is taking place."
Q: Any shares repurchased or foreign currency impact?
Fitz: Total of $1 million of share repurchases. Impact of currency was minimal.
Q: Break down revenue between Europe and emerging economies?
Selim: "If we look at emerging economies' impact, we were roughly around 5 percent of sales. I say by 2014 it will be around 10 percent of our sales. We’re growing our emerging markets significantly and we see this happening pretty fast.
"So let’s give you a little bit of flavor, more than just a snapshot of one quarter . . . Starbucks is planning to open hundreds of stores in India and we are the major supplier of cooking equipment with Starbucks. So we see that becoming very, very strong for us.
"We continue to remain very close with several chains in China and we have a little bit of an impact of Avian flu that occurred in China in March and impacted a little bit April, but other than that, we see YUM and other chains in Asia growing pretty fast and we remain a strong supplier to those chains.
"I want to re-emphasize what I said about Europe. Our penetration of convenience stores and supermarkets, that’s starting to have impact. We’re testing some very strong technologies in UK and Germany with several of those chains and we’ll see some growth in Europe in the fourth quarter.
Fitz: "Our total international sales were about 26 percent in the quarter (compared to 31 last year; down because of Viking, which has fewer international sales at present). That 26 percent breaks down with about 12-13 percent being Europe and then Asia and Latin America being 6-7 percent each."
Q: Organic growth picking up. Will it keep up?
Selim: "I would say in 2014, yes, we should see acceleration when you see the fact that we’re going to replace the Chili’s order with another customer. So in 2014 we’ll have a replacement of the Chili’s rollout with another customer that will replace Chili’s.
"Looking at the food processing business, we’re working with several customers right now to remodel some bakery factories and some food processing factories. So I would look at organic to accelerate in 2014."
Selim's closing statement:
After a very difficult start to the 2013 year due to the particularly brutal winter and economic pressure on consumers, we have seen same store sales and traffic trends beginning to rebound as we enter the second quarter. As I’ve spoken to and visited many of our customers, they all voice optimism across all segments about the second half of 2013 and reported that business had begun to improve in April.
For the first time in 22 months, casual dining restaurants outperformed quick serve in march, a great sign for our kitchen of the future implementation. According to the National Restaurant Association survey, the U.S. consumer looks healthier based on the results of their April survey, and the impact of the payroll tax appear to be waning.
We are today testing many of our innovations with many chains, focusing on improving many qualities, speed of cooking and tactical value.
As we move into the second half of the year, we’ll see restaurants grow their sales, compared to the first quarter, when the weather affected many parts of the U.S.
Our second quarter sales will be affected in China by the impact of the Avian flu on our customers like YUM and others operating in China. I think that will be behind us very quickly.
So we continue to see a shift toward healthier food options in emerging markets, a focus on labor saving and store sales growth trends that will continue through menu changes. We expect 2013 to be the third straight year of sales growth for restaurants in terms of food service sales and same store sales. So as we look at 2009, and we’ve recovered, this will be three straight years (of growth) for the restaurant industry.
We see breakfast places to continue to invest heavily into cooking equipment and we continue to see the emphasis on energy and water saving across all our customer base to continue. The proof is we just signed up our first customer on our waterless steamer and we signed up our first customer on our waterless steam table.
So as we continue looking at Viking and the Viking integration, we continue to change the channel of distribution there. We continue to consolidate our costs and reduce overhead. And we continue investing in new product innovation.
We see the housing market to continue to recover and we don’t see a stop to this. The inventory of housing supply has shrunk and housing prices continue to rise across all metropolitan areas. We see also our dealers to continue depleting their inventories and we start seeing in the third and fourth quarter, specifically in the fourth quarter, significant rebound in our order rate in Viking.
I would like to invite people to the National Restaurant Show in Chicago on May 18-21. We’ll be exhibiting there and we invite everybody to attend. And we are hosting an investor day on June 18 in Dallas, Texas at our TurboChef division and we’ll be exhibiting and showing most of our new products and some new Viking innovations. You are all invited to this.