The Middleby Corporation (MIDD) Earnings Call Transcript & Summary

Good day, and welcome to the Middleby Corporation First Quarter 2023 Conference Call. With us today from management are Tim FitzGerald, CEO; Bryan Mittelman, CFO; James Pool, Chief Technology and Operations Officer; and Mr. Steve Spittle, Chief Commercial Officer. Management will begin with opening comments, and then we will open the call for questions. Instructions to enter the queue will be given at that time. Now I'd like to turn the call over to Mr. FitzGerald for his opening remarks. Please go ahead, sir.

Good morning, and thank you for joining us today on our first quarter earnings call. As we begin, please note, there are slides to accompany the call on the investor page of our website. We are pleased to have posted solid results to begin the year, reporting a first quarter with strong performance both in our Commercial and Food Processing businesses. While our Residential business was expectedly impacted by challenging market conditions and destocking of inventories at our retail partners. In the quarter, we drove improved profitability, and we continue to make progress towards our longer-term margin targets to focus on profitability of our sales mix and with further improvements yet to come through efficiency gains and supply chain initiatives. During the quarter, we were pleased to have also realized meaningful reduction in production lead times across most of our businesses as we benefit from improvements in our supply chain and through the investments made across our manufacturing operations. We are now in a significantly improved position to better serve our customers and take advantage of market opportunities. At the start of the year, we continue to have strong engagement with our channel partners and customers across all 3 of our Food Service businesses with interest in our latest products and innovations offering benefits focused on energy, labor, speed and sustainability. The investments made in our innovation centers demonstrating these latest solutions have proven to be a strategic asset for our businesses. The traffic in these showrooms continues to increase as we invest heavily in training with our channel partners. As our world-class culinary team is engaging a hands-on with customers looking to evolve the kitchen and food service operations. We're excited to have recently opened our latest Middleby Innovation Kitchen in Spain, now providing a resource to our partners and customers throughout Europe. In the quarter, we also continue to make strategic and financial investments in our business, investing [ $25 million ] in our manufacturing operations as we continue to retool our operations to support the product launches, increased capacity and advance the automation within our operations. We repurchased $48 million of Middleby shares during the quarter, and we were also excited to complete the acquisitions of Flavor Burst and Blue Sparq, adding to the innovation in our beverage portfolio and expanding our in-house controls development capabilities. As we've progressed into 2023, economic conditions continue to present challenges and uncertainty, particularly as it relates to our Residential segment, but we remain excited about the direction and long-term goals and confidence in the investment strategic initiatives underway that are enhancing the competitive positioning for each of our 3 foodservice businesses. Now I'll pass it over to James to spotlight of our exciting recent product innovations, which were also highlighted in the investor slides. James?

Thanks, Tim. We have a few items to cover. So I'll jump in today with the Frybot. If you've heard us speak on other calls, you know that I'll be talking about the digital embedded and collaborative automation that's driving innovation across Middleby. Frybot bring these together in a complete Middleby solution. It is the only automated fryer, designed, manufactured and integrated by a single company from the collaborative robot to the dispenser fryer holding in [ spice ] spot, the Frybot is 100% Middleby. The base Frybot, as shown is capable of automatically dispensing, frying and seasoning 2 unique items at rates hitting 65 baskets per hour depending on products. The Frybot will is designed with ease of installation, meaning it could easily be rolled out to new but most importantly, existing restaurants. The Frybot is currently in test with leading brands. We look forward to continued Frybot installations in test locations in 2023 with Frybot hitting revenue-producing stores in 2024 and 2025. If you'd like to see the case the Frybot in action, it will be on full display at the NRA show in May in the Middleby automated burger and chicken bar as well in the NRA Kitchen Innovation pavilion. At the NAFEM show, this past February, the Frybot flawlessly delivered over 1,500 orders of fries and chicken in just over 2 days. Continuing with the NRA show, the Frybot will be accompanied by [indiscernible], a concept created by [ John Perruccio ] features an all-electric and all [indiscernible] Middleby kitchen. The Middleby [indiscernible] a concept of dispensing the highest quality espresso and [ direct ] coffees from the Middleby Coffee Group, the best [indiscernible] and best [indiscernible] in the Chicago area. OPEN KITCHEN, Middleby enterprise IoT platform, Middleby Electrified innovation alley, where we will show these latest electric products designed for the efficient electrified kitchen. And lastly, please look for the [ hydro rigs ] and the pressure into additional KI award winners in the Kitchen Innovation Awards pavilion in NRA show. [ Hydronics ] automates the cleaning the mode [ soften ] machines by washing, renting and sanitizing the machines while machines are still on site. The [indiscernible] into is the latest modular and rapid cook and accelerated cooking platform from [indiscernible]. I would like to close by talking a little bit about Blue Sparq, our latest acquisition. Blue Sparq met the Middleby's common control strategy by helping our brands develop and launch controls faster than ever before, thus accelerating new product development across Commercial, Residential and Food Processing groups with the industry-recognized capabilities in the area of UX, UI design, and embedded for [indiscernible] future development. Blue Sparq also brings fast PCB board manufacturing while also enable to support volume production. We are excited in Blue Sparq developing from Middleby. Thank you, and over to you, Bryan.

Thank you, James. 2023 has started out with strong performance. We posted another quarter with revenues of over $1 billion with exceptional growth in 2 of our segments. Our adjusted EBITDA exceeded $210 million resulting in an organic adjusted EBITDA margin of over 21%. While our total revenue growth was rather modest, given challenges in Residential, we were still able to grow our adjusted EBITDA 6% over the prior year. Our margins expanded 100 basis points. All the margin values I will discuss hereafter are on an organic basis, meaning excluding any acquisitions and foreign exchange impacts. GAAP earnings per share were $1.82. Adjusted EPS which excludes amortization expense and nonoperating pension income as well as other items noted in the reconciliation at the back of our press release was $2.19. I will go through our segment results in a moment. But first, I wanted to briefly note that we re-outline some small operations internally, which, in turn, had a small impact on the composition of our segments. Nonetheless, I know some people will see differences in their models. So here are the details. We have moved approximately $4 million of quarterly revenue from the Commercial segment to Food Processing. We have restated prior periods in our press release and the growth figures I will discuss here are based on a consistent basis. The impact will be approximately $4 million per quarter as well for the remainder of the year. But back to our [indiscernible] results. Commercial Food Service revenues were up over 11.5% organically over the prior year with [indiscernible] up 14% and international regions growing 5%. The adjusted EBITDA margin was 26.5%, 23 basis points ahead of the prior year. In Residential, we saw organic revenue decline of 32% versus 2022. The adjusted EBITDA margin was 13%. Food Processing continues to perform extremely well. Total revenues exceeded $173 million, an increase of over 24% organically. Our adjusted EBITDA margin was 24% and up over 500 basis points over the prior year. As I've noted before, our full-line solutions continue to resonate with customers. Our operating cash flow generation of $92 million was a record for the first quarter. During the quarter, as Tim noted, we invested approximately $25 million in capital expenditures and had $10 million of acquisitions. We utilized $48 million for open market stock buybacks. After giving effect to all this activity, our total leverage ratio moved down slightly to just under 3x. I'll remind folks that our covenant limit is 5.5x . So we currently have over $2.3 billion of borrowing capacity. It was not an easy quarter but we still delivered strong results. While we have noted that supply chain has improved, I do have to add that it does remain a constraint in numerous areas, especially around legacy chips and controls. Customer inventory levels represent a short-term headwind as well in Residential and, to some extent, in Commercial too. In terms of the near-term outlook, I will start with Residential. Demand in the marketplace obviously remains off from the peak last seen a year ago. However, our revenues have been relatively consistent for the past 3 quarters. When I discussed results last quarter, I noted that Residential revenues for this Q1 might be slightly below Q4. We ended up actually exceeding Q4 by a few million dollars. Thus, given the timing of some shipments and current demand levels, with softer than expected conditions in the U.K., I expect Q2, we'll see revenues relatively flat to what we just posted for Q1 and margin also similar to Q1. And thinking about all of 2023 for this segment, it is hard to offer a very clear view given all the dynamics impacting us currently. Nonetheless, our current assessment which is subject to a fair amount of risk is still to see sequential improvements over Q2 in the back half of the year. This also means year-over-year growth for the second half of '23. For Food Processing, we obviously posted a very strong first quarter. This business will continue to exhibit strength. I expect Q2 to look similar to Q1 and we should continue to grow and improve from there over the back end of the year. For Commercial, when comparing Q2 to Q1 sequentially, revenue would be up modestly with slightly better margins. Our engagements with customers remains incredibly positive, and they are continuing to invest. But chain activity is probably somewhat back-end loaded for the year. So consistent with what I poked quarter ago, each quarter of the year should improve sequentially, just the improvements from Q1 to Q2 will be modest. Putting the 3 segments together, when looking at the total company potential Q2 performance, revenue and EBITDA levels are likely to show single-digit growth when comparing either back to Q1 of '23 or Q2 of '22. Thinking about '23 will shape up overall, our view remains consistent with what I noted last quarter. We continue to expect full year-over-year growth in margin expansion in Commercial and Food Processing. Resi at [indiscernible] in Q2 to likely see year-over-year growth in the second half of '23. Reiterating, this means for full year '23, we could see total company revenues up modestly and growth in EBITDA dollars and [indiscernible]. In true Middleby style, we look to continue to deliver solid results and have another record year. Thanks. And with that, we will now open up to your questions.

[Operator Instructions] And our first question will come from John Joyner with BMO.

Definitely a solid start. Bryan, I was just waiting for your stories there, but kind of let me down.

I let your taste buds work rather than I have to hear me to tell stories.

Okay. Excellent. I look forward to it. So I guess for the Commercial business, I mean, are there any particular areas that you would call out? I mean it's definitely a strong quarter, but any areas that you call out has being stronger than others or ones that may be are performing better than kind of your internal expectations? And then -- and also kind of based on the conversations that you're having, right? I mean, I have -- would you say that CapEx intentions by your customers lately have actually taken a step higher?

Maybe I'll take a first pass at it. So I think what I would maybe call out over the last quarter or 2, we've talked about on prior calls, the progression of how different segments have more or less recovered since COVID. And obviously, we spent a lot of time talking on the big QSR chains, which have done so well these last couple of years, I think what I would call out or maybe some of the other areas that are just kind of getting back to recovery, I would call out probably more of the independent restaurants than some of the casual dining restaurants. I think what I'm excited about there is a lot of those customers were served by our dealer partners in the U.S. And I think we've spent a lot of time over the last 2 years, getting closer to those dealer partners, giving them tools to help navigate the dynamic that we're all faced with. We spent a lot of time training a lot of those dealer customers and the mix, and so I think you're starting to see that pay off. And I think actually, if you go to the pie charts there in the deck, it's an interesting nuance that you see the independence and casual dining changes tick up as a part of the overall revenue mix. I think it's a direct correlation to us something about just being closer to the dealers, but also really just seeing those segments kind of start to pick up on the recovery if that makes sense.

Okay. That's helpful. And then just maybe just one more on the Food Processing business. Bryan, I believe highlighted that the -- you expect 2Q to be more or less flattish with 1Q and similar to Commercial, I mean the results there were probably even more impressive. But when you think about the EBITDA margins for the year, right, I mean, starting at a higher level than probably most anticipated, do you expect margins there to progress? I mean maybe you answered this already, I don't know, but do you progress sequentially higher as the year unfolds?

As you said, we're thinking about Food Processing here. Q1 certainly was a big step up from where we've been in the prior year. And to your point, was strong and higher than we may have expected. So that's why I think Q2 looks like Q1 and we can see some expansion in the back half of the year, just given how strong we started, I'd say that needs to temper expectations on how much they grow from here. But obviously, we have our target margin now well within sight. And again, as we especially think about the back half of the year, I think we can move up a little bit from what we -- where we started the year.

The next question will come from Saree Boroditsky with Jefferies.

Congrats on the results. So within Residential, can you just strip out the performance you saw in grills versus the legacy business? How do you see channel inventory currently? And how should we think about the cadence of destocking through the remainder of the year? Because I believe you have much easier comps as we get to the second half?

Yes, this is Tim. I'll kick off and then Bryan can maybe break it out a little bit. I mean definitely is kind of I commented, the inventory levels are higher, right? So they continue to come down. There's still inventory in the channel. Sell-through is probably a little bit lighter at the start the year given, I'll say, whether there is other market dynamics. But I mean, I think it still holds true that we'll be in a much better position from an inventory standpoint in the back half of the year as it relates to growth. We are excited about a lot of the new product introductions that we've got coming out right now, the digital Kamado Joe or Konnected Joe that we talked about in the past, and James has highlighted as well as continued promotion and penetration of the Masterbuilt, Gravity Series. So I mean I think we feel pretty good about the long-term momentum that we've got that we think will build as we go through the back half of the year. But certainly, we'll still see some of the probably the destocking in the second quarter, but improvement as we go through the back half of the year. And definitely, I mean, as you look at the overall Residential results, the grills had an oversized impact on Residential, which was expected and certainly seen across that whole category not only by us.

As we talked about in the last year, I mean -- I'm sorry, last quarter, but last year in Q1 really was the peak of the performance for the Grills company. We talked about revenues, I think, being in excess of $110 million then. And we're obviously down quite significantly from that. Excluding Grills, Residential had probably been down more along the order of 20%. We still are expecting -- as we think about grill season, I would say Q2 is right still part of this year's growth season. And so we will -- again, this is consistent with what we've talked about before, see certainly challenges year-over-year, if you were to look at Grills alone. And then you're right, the comps are certainly much easier in the back half of the year, right, because in the back half of '22, we were still part of this destocking phenomena we're dealing with. And so that's why we do believe Grills will be better in the back half of '23 than the back half of '22, and that really gets after our comments of, as you think about Residential overall as well second half of '23 being better than second half of '22.

Appreciate the color. And then just one more. Obviously, Commercial Food Service had another strong quarter. How do you see underlying demand as you might be working down some backlog here? And are you seeing any headwinds from more challenging financing conditions, especially on the franchise side?

So Saree, I would say demand more or less across the customer segments, again, talked a little bit about the dealer side, the independent side, nice to see that coming back. But also the chains that we talked about, the QSRs continue to do well. And so I see the demand continue there both from a new store standpoint and also starting to see some new replacement business come back, which we've talked about before. So yes, from that standpoint, we believe we're in a good position. And I'm sorry, Saree, your second question.

Yes. Just are you seeing headwinds from the challenging financing conditions?

Yes. So it's interesting that we have had a lot of discussions with the bigger QSRs really focused on what I'll call it, unit economics of making sure the ROI on the new stores for their franchisees is where it needs to be. And it's critically important for, I think, for -- 2 or 3 reasons. If you look at the big QSRs that have aggressive growth plans, which many of them do, and many of them are in international markets, how are you growing? You're growing with either existing franchisee groups, taking on more locations, signing up more locations or you're going out and finding new franchisee groups to expand into new markets. And so the ROI of those new stores when you're trying to attract those franchisees is more important than ever. And obviously, as our financing has become more expensive over the last year or 2, again, the equipment that is going into those locations is not necessarily about, hey, what is the upfront cost. It's always important, but actually, it's more about the ROI to open those stores and have an attractive package to the franchisees if that makes sense. So it's a very active conversation that we've had, I would say, the last 6 or 8 months with the change specific to this question and issue. And just it supports the plans for pretty aggressive growth, especially in some of those international markets over the next 2, 3, 4 years.

The next question will come from Mig Dobre with Baird.

I wanted to go back to Residential for maybe some clarification. What I heard just moments ago was that leading growth to decide the core, call it Viking, AGA business was down maybe 20% in the quarter. So maybe can you confirm that? And as you talk about the business getting better overall the segment, getting better from a revenue standpoint overall. What sort of assumptions do you have embedded for Viking and AGA as the year progresses? Because presumably, the comparisons are not nearly as easy there as they are on the growth side?

Yes. So Mig, you did hear me correctly on the Residential side, I'll say it's kind of with and without Grills. As we look at the rest of the year, the outlook I would say -- if I had to pick one word and then I will stand on it, it's kind of flat from here. We feel like we've kind of are at a bottom. Q2, I said will be similar to Q1, same neighborhood, right? I was very specific in pointing out that we've been at a relatively consistent level for the past 3 quarters. I think what we're not seeing yet is outside of Grills where there really are some unique circumstances with the destocking, we're not really ticking up our expectations specifically yet, right? I don't have exact indicators that, okay, all of a sudden, your next quarter is going to really change the trajectory.

I would say, I mean, I think uncertain is the word unfortunately, right now. I mean, we've seen, obviously, the housing market being challenged all in the back half of last year. There was maybe a little bit of signs here at the beginning but the world continues to be a bit tough, interest rates went up. I think we also feel like we're kind of stabilized at a lower level. So I think that -- I think the question is when does it inflect up as opposed to is going to continue to come down. So I mean, I think if you look at a lot of the housing stats, is expected to maybe bottom out in the middle of the year and then start seeing things pick up. So I mean, I think those are broader macroeconomic trends, we can kind of take a look at it and I think we would expect our business to follow. But I mean, I think we feel like we're stable here at the bottom, and then we'll kind of see how the year goes. Now beyond that, we can continue to be investing in our business, right? Like we have a lot of new products coming out. I would say our electric products are doing fairly well. That includes a lot of the production we've been launching over the last several years, such as the AGA products that have come into the U.S. that are growing, right now, despite the market being done, brands like [ La Gardu ] are doing very well. We've got other new products that are coming out that are induction-based as we kind of go through the back half of the year and kind of along the big comments also about the investments that we're making, go to market activities. We've had a lot of great interacted at our showrooms bringing our dealer partners, our designers that really have not seen the portfolio that Middleby had to offer. So I mean a lot of that stuff has been exposed to a broad audience over the last year, and we see some traction in that, and we expect that to continue. We're excited about opening a new show in Chicago, which will really be kind of the -- I'll say, the really state-of-the-art for us kind of in the middle of the year. We capture the expanded product portfolio that has grown over the last year. We acquired Novy about a year ago plus, which has got some great technology induction, hobs, ventilation, et cetera. So we think we're very excited about the product portfolio. So again, the market is going to do what the market is going to do. But I mean, I think we're -- I think there's a lot of great things going on as we go through the back half of the year and into 2024.

Let me maybe clarify what I was trying to get at. The -- my impression was that Viking was still operating with longer lead times and a fair amount of backlog for much of last year. You're running that backlog down, my question is, do you have to essentially reduce production or have a sequential headwind in the back half of '23 relative to the current run rate.

So I don't know, Bryan if you want to.

As Tim noted, the backlogs have come down. Our lead times are much closer to what I'll call normal levels. There are some pockets there. But again, given, I'll say, the modest amount of backlog that remains as well as just the baseline day-to-day demand from customers, I mean, is why we're kind of calling the year the way we are.

Understood. And then I would like to ask a question on the Frybot and I guess a question in 3 parts. You're saying here that this is a modular design, but I'm sort of curious when you're trying to sell this product, are you seeing customers looking to essentially buy the entire set? Or is it just maybe the robot arm and they're keeping the existing equipment. I guess that will be question number one. The second thing is how big of an investment is this for a customer? And lastly, what is the payback in terms of what you guys have seen or calculated thus far?

Yes. I think when we look at our customers and they see kind of the advancements with fryers today, the advancements that the Frybot brings, the customer is typically going to want to upgrade the frying solutions they have in their stores with kind of the latest frying to take advantage of automatic filtration, smart oil sensing and various other features that are built into the fryers to help you with profitability around oil management and oil quality. So we really do see the majority of customers buying kind of everything that you see on the page from the RAM dispenser to the fryers, the robot and to the holding and the [ spike ] spot. Now there could be some situations where we are integrating in with existing fryers. But I would say that's not really what we expect to do day to day. When I think of modularity, I'm really thinking that our Frybot doesn't require kind of customized engineering to go into the store, build a structure in the store to come off space in the store to put something behind the shield or any sort of protective cover or Frybot kind of designed to work out in the middle of the restaurant with the employees in a collaborative fashion. So it's modular and that it's going to kind of roll up and interface with our products and roll away if you need to be installed for any reason. I think when we look at kind of the ROI on it, and I think this will probably kind of get into the cost and really talking about the cost but we really do see the ROI kind of being slightly over a year for the Frybot solution and the equipment package.

Understood. My final question is on your CapEx. Significant investment. Maybe you can talk a little bit about what was unique about the quarter. Certainly, that's the biggest Q1 CapEx that I think I've ever seen. And what sort of payback are you hoping to achieve here? Is there a segment that is getting maybe more investment than others? And how do you think about free cash flow for the year?

Yes. Certainly, this was our highest CapEx quarter. I mean some of the just kind of the timing of payments and projects have come together. I don't expect we will be at 4x Q1 for the year. Tim has noted, we've talked about -- we're actually making fairly sizable investments in Residential before really a lot of retooling of the AGA Rangemaster plants. And much like our customers, we see challenges with labor availability and cost, and we've been adding fabrication equipment across the board. But our Residential plants, if you think about, I'll call it, revenue per plant tend to be larger facilities and thus tend to get larger. Larger investments, but we really have been spreading it around. The paybacks really do vary. I mean, obviously, when we're making investments in buildings, that's something we have a longer expectation on than when we're doing something more modest around welders or small equipment. But usually, if I focus on fabrication equipment, it tends to be, I'll say, 2 to 3 or 4 years in terms of payback for us.

Free cash flow?

I have to echo what I said at year-end, where I think we start being much closer in terms of a margin plus or minus of our income for the year.

Yes. I mean I think if you look at the last couple of years, obviously, supply chain has been a big challenge. It's been hard to balance inventory and probably, I'll say, sometimes difficult forecasting demand levels, et cetera. So I mean I think one of the benefits that we have as we go through this year is we do expect inventory to decline as opposed to kind of being a cash use over the last several years. So I think we've got a little bit of a tailwind from a cash flow perspective coming into the year. So it should be solid from that perspective.

The next question will come from Tami Zakaria with JPMorgan.