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Middleby Corporation (NASDAQ:MIDD)

Q1 2008 Earnings Call

May 8, 2008 11:00 am ET

Executives

Tim Fitzgerald - Chief Financial Officer

Selim A. Bassoul - Chairman of the Board, President, Chief Executive Officer

Analysts

Peter Lisnic - Robert W. Baird & Co.

Anton Brenner - Roth Capital Partners LLC

Amit Daryanani - RBC Capital Markets

Jamie Clement - Sidoti & Co.

Jason Rodgers – Great Lakes Review

Mark E. Grzymski - TimesSquare Capital Management, Inc.,

Operator

Good morning, my name is Tatiana and I will be your conference operator today. At this time I would like to welcome everyone to the Middleby Corporation First Quarter Conference Call. (Operator Instructions)

Tim Fitzgerald

Good morning and thank you for attending today’s conference call. I am Tim Fitzgerald, CFO of the Middleby Corporation and joining me today is Selim Bassoul, our Chairman and CEO. I have some initial comments about the company’s 2008 first quarter results and then we will open up the conference call for questions and answers.

We are pleased to report our 25th consecutive quarter over quarter record net earnings. The first quarter results included the impact from five acquisitions complete during the last 12 months, including Jade Range acquired on April 1, 2007, Carter Hoffman on June 30, 2007, MP Equipment on July 2, Wells Bloomfield on August 3, and Star Manufacturing on December 31, 2007.

The first quarter results did not reflect the impact of Giga Grandi Cucine and FriFri which were completed on April 22 and April 23, subsequent to the company’s first quarter.

Net sales in the first quarter increased 52% to $160.9 million as compared to $105.7 million in the first quarter of 2007. Sales from the acquisitions completed over the last 12 months amounted to $55.3 million in the quarter.

Excluding the impact of acquisitions, sales were flat for with the prior year first quarter and were comprised of a 2% growth in sales of commercial food service equipment group, while domestic sales were affected by a slowing economy, international sales for that group increased 16%. The rise in international sales reflects strong growth in emerging markets with US and international restaurant chains, growth in new products including a new Combi line from Houno in a positive effect of the weaker US dollar.

Sales in the food processing group were 16% lower and reflected delayed customer purchases during the quarter due to economic conditions and the timing of impact of large orders which can cause quarter-to-quarter variability for his business.

Gross profit increased from $41.1 million in the first quarter of 2007 to $58.9 million in 2008 on higher sales volumes and the gross margin rate decreased from 38.9% to 36.6%. The gross margin rate for the quarter includes a $1.5 million charge to adjust inventories at Star to share market value. The gross margin rate also reflects the dilutive impact of the acquisitions completed in the last 12 months, as gross margins at these companies continue to improve.

The newly acquired companies had an average gross margin of 33%, reflecting improvement from 29% in the fourth quarter of 2007 and 25% in the third quarter of 2007. Excluding the impact of these recent acquisitions gross margins would have been 40% during the quarter, despite the continuing challenges of rising fuel costs.

The recent acquisitions will continue to dilute margins in the first half of 2008; however we should see continued improvement in margins if those operations and integration initiatives implemented are fully realized.

Selling expenses increased $5.1 million to $16.2 million and general and administrative expenses increased $5.5 million to $16.6 million. Of the $10.6 million increase in selling general and administrative expenses approximately $9.7 million was attributable to the recently acquired companies.

Interest and deferred financing costs increased from $1.2 million in the first quarter of 2007 with $3.7 million in the first quarter of 2008 as a result of higher debt balances associated with the recent acquisitions and other non-operating expenses of $400,000 included $200,000 of unrealized foreign exchange losses and $200,000 of unrealized losses on interest rate swaps.

The provision for income taxes of $8.7 million was reported at a 40% effective rate, as compared to a $6.9 million provision at 39%. The increased tax rate reflects an increase in tax reserves of approximately $275,000 recorded in accordance with accounting standard 10-48 primarily for increased end tax exposures. These increased reserve requirements are due in part to growth of the company through acquisitions.

Net earnings for the 2008 first quarter increased 23% to $13.1 million from $10.7 million in the prior year and diluted earnings per share increased 20% to $0.77 per share from $0.64 per share in the prior year quarter.

Turning to the balance sheet and first quarter cash flows, the net change in the balance sheet from year-end reflects the impact of the 2008 acquisition of Star. The Star acquisition added $11 million to accounts receivable, $11 million to inventory, $7.9 million to property plant and equipment, $6.5 million of accounts payable and $10.7 million of accrued expenses. Additionally, we recorded $1.1 million of goodwill and $73.8 million of other intangible assets associated with this acquisition.

Other changes in the balance sheet accounts primarily reflect normal variations driven by seasonal work and capital requirements.

Cash flows provided by operating activities amounted to $12.6 million during the quarter, as compared to $4.4 million of cash utilized in the prior year first quarter. Non-cash expenses added back in calculating operating cash flows included depreciation and amortization of $3.5 million for the quarter and non-cash share based compensation costs of $2.3 million.

Operating cash flows for the year were utilized to fund the acquisition of Star for $188.4 million. The company also had capital expenditures amounting to approximately $2.1 million during the first quarter which included $1.2 million associated with the purchase of the manufacturing facility for our recently acquired Carter Hoffman division and $900,00 for the replacement and upgrade of manufacturing equipment.

Total debt at the end of the 2008 first quarter amounted to $272.7 million. This compares to $96.2 million at the end of 2007 prior to the Star acquisition. This net increase reflects the first quarter funding of the Star acquisition net of $12.6 million and cash generated from operations which were utilize to reduce borrowings.

As it relates to the acquisitions, we were pleased to announce the acquisitions of Giga on April 22 and FriFri on April 23. Giga is a leading European manufacturer of ranges, ovens, and steam cooking equipment located in Italy. FriFri is a leading brand of fryers based in Switzerland. The combinations of these leading brands with our Houno combi-oven line provides us with a complete line of cooking equipment for the European market. The combination of these companies provides for certain manufacturing and sales in marketing synergies amongst the group. Additionally, we believe the combination of this complete line of European cooking along with our portfolio of US brands will allow us to further penetrate the international markets.

Giga and FriFri have combined annual revenues of approximately $35 million and EBITDA margins approaching 5%. As with prior acquisitions, we believe we can improve these margins during the remainder of the year and expect to be at a run rate in excess of 10% by the end of 2008 and in excess of 15% in 2009.

We are pleased to report continuing progress at our Star acquisition which was completed during he first quarter. As we have previously announced, Star at the time of acquisition, had approximately $100 million of revenues and was generating approximately $20 million in EBITDA. As with other acquisitions, we anticipate that there will be some initial reduction in sales as we rationalize lower margin or unprofitable SKUs, which could result in the reduction in sales in the short term.

We have started to realize improvement in the EBITDA margins resulting from completed integration initiatives and are on track to improve the EBITDA margins to 25% or better at this operation by the second half of this year. We are also pleased with the continued progress made at the four other acquisitions completed during fiscal 2007 and we remain on track with our profitability objectives at these companies.

As I previously mentioned, these companies reported gross margins in excess of 30% in the quarter, up from 20% at the time of acquisition. Additionally, operating margins have more than doubled, approaching 15% for the first quarter, and we anticipate continued improvement in 2008 and if these companies will improve to operating margins in excess of 15% as we move into the second half of 2008.

………..

Question-and-Answer Session

Operator

(Operator Instructions)Your first question comes from Peter Lisnic from Robert W. Baird & Co.

Peter Lisnic - Robert W. Baird & Co.

To start off on the top line, the comments that you have on orders or sales being hurt potentially. Is that just in the food processing business that you’re seeing that?

Tim Fitzgerald

I think we have seen a general slowing on the commercial side as well. The fruit processing, which is more of a capital equipment purchase of some of the products, you tend to see some deferral right now, but some of it is just driven frankly by quarter-to-quarter variability too. We have larger orders in that business and the timing of one of those can spike up or down in orders.

If you remember in the fourth quarter the sales growth in that business was up double digits, so I think you see some variability there, but I would also say both businesses are slower right now due to the economic conditions.

Peter Lisnic - Robert W. Baird & Co.

Okay and how do we get comfort that deferrals aren’t necessarily just, but they actually are deferrals instead of people just never ordering in this environment, Are you still hearing your customers talking about new equipment, there is just the uncertainty in the first quarter that is causing them to buy equipment in the second, third and fourth quarter?

Tim Fitzgerald

I think that’s our general feel. As it relates to the food processing business, there are a number of projects that, you see specific quotations out there and I don’t think it’s a situation where projects are being cancelled, you just see them being delayed of taking longer for finance departments to make a decision on those.

Peter Lisnic - Robert W. Baird & Co.

Do you have, can you give us maybe color commentary on what April looked like in terms of either orders for the commercial food service business and food processing and/or if you have like a backlog number?

Tim Fitzgerald

Well we don’t, we have always indicated the backlog we don’t think is meaningful overall to Middleby because our backlog tends to be three weeks out, and we don’t want to get in the habit of reporting what our quarterly order rate is, we haven’t done that in the past.

Peter Lisnic - Robert W. Baird & Co.

I understand that, but I’m just trying to get a sense as to what gives you the comfort that these deferrals will actually be realized in terms of revenue in the second quarter and the back half of this year, because I’m not sure the macro environment is getting a whole lot better.

Tim Fitzgerald

I agree with that. I’m not saying that orders that we saw deferred in the first quarter all come to revenue in the second quarter, I mean I think we do believe that in ‘08 we will be a generally slower environment than what we saw in ’07.

Peter Lisnic - Robert W. Baird & Co.

Okay and if I could ask it this way, in terms of the organic growth number that you saw, first quarter is kind of flat. Is that a reasonable expectation for the rest of this year, based upon what you’re seeing in terms of orders right now or how do we think about that?

Tim Fitzgerald

I don’t think we are going to predict, I mean what we have always indicated in the past is that we will update to the rate of growth in the industry, so when the industry is slower, we will be slower, but out paced it when it’s stronger, we’ll be stronger. I think that’s consistent.

We are in uncertain times right now. I think the first quarter was slower and we’ll kind of wait and see how the second half of the year unfolds.

Operator

Your next question comes from Tommy Brenner of Roth Capital Partners LLC.

Tommy Brenner - Roth Capital Partners LLC

A couple of things, number one in the commercial food service side are there particular parts of the business that are especially weaker than others? I know at your analyst meeting it was pointed out that Pitco sales in particular were weak as some customers were anticipating purchasing a new rocket fryer which is not yet available and I wonder if there are distortions along those lines in these numbers.

Selim Bassoul

Tommy I think we compete at the same time. There are a lot of elements that are converging to slow off the ordering process a little bit, that have been stable in the past. One, we are introducing a bunch of new product lines. As I said in my previous conference call, we are testing a lot of new innovation with many of our customers. A lot of people who want to look at a fryer are waiting for the rocket fryer.

The other situation which is a macro situation of nothing to [inaudible] was literally is the fact that a lot of people are looking at this economy stimulus package and I assume that has something to do with it. What do they say, I want to be able to take advantage of that excellent depreciation, which I understand takes off starting May 15. This could have an affect on what happened in the ordering process, between the first of the year until May 15. People say, well why would I buy a piece of cookware today when I can buy it after May 15, if I am a franchisee, and get accelerated depreciation.

Number three, I think we have an incident with every chain. I don’t think that the business, the US trusts in sale have never declined. If you look and you have been covering this business for a long time. You have the technology, which I’m looking at right now, and we go back to 25 years, rustin [ph] sales have never declined.

I think what is at issue right now, we are seeing with our customers, is that operational costs and the margins, the commodity prices are way up, cheese is way up. Many commodity prices are way up. Utility costs are way up. I think that as those people are reconsidering the ways to make more money, to go back to the margin that they have been experiencing a year ago or three years ago, we see a lot of increase, specifically for our energy saving equipment.

I think there are a lot of things moving right now. It is not a matter of, I don’t think people are going off and starting up their stoves at home. I don’t think that, I think I will debate with everyone on the conference call that people have not gone back and said wow, wait a minute, I’m going to start cooking at home. I don’t think that trend is switching. I think that what is happening is our customers are under significant margin pressure and that is affecting the whole industry. It’s not only Middleby’s issue and now Middleby is better positioned than anybody else to come and offer a solution to reduce the costs for some more customers.

Finally, I think we see our energy saving devices that are opposite we’re saying we’re seeing a lot of increase in also.

Tommy Brenner - Roth Capital Partners LLC

It sounds like the two acquisitions that were recently made, Giga and frifri are going to have a neutral impact or close to it on the bottom line in 2008. Is that about right?

Tim Fitzgerald

Yes I would say it would not be meaningful.

Tommy Brenner - Roth Capital Partners LLC

You have expressed guidance for the tradition; I guess that earnings per share will be up at between 20% and 25%. Given the lack of any organic growth in the first quarter, the nickel charge for in Star and a number of other extraneous negative items loosely thrown in there, should one be pretty comfortable that you are at least on track if not ahead of that guidance at this point?

Selim Bassoul

I think we never gave guidance. What I said is that over the next five years we are going to average 20% to 25%. I said longer term we are going to continue doing what you [inaudible]. At this moment, I feel very strongly that we will not give guidance. I don’t want to get into the guidance game.

I think that environment is very tough out there; I think our customers are trying to find ways to make more money on the sales. We are trying to help them. I think that we are going to manage through contingency planning.

We are working with our suppliers. We do not understand the impact of steel again. There is some feeling that fuel is going up again in the third and fourth quarter, so I think we are taking all of that. This is an environment that is very unique for the economy. We are not the only company facing that. I think it is not only the industry that is facing it but I think across the board, I don’t know what is going to happen if oil goes to $200.00, I didn’t know a barrel of oil is going to be $200.00. I don’t know what I think. If you can, any of you can, call me back afterwards and tell me what it means to Middleby and then say, I will welcome those comments.

This is a new venture for all of us. We don’t understand what it means and we need to figure out where we go from here. At this moment this management has had a lot of other headwinds and we have managed them very well. We still have a headwind and we are going to have to manage it. We’re going to have to come back and strategize and say what these new winds are meaning for us.

I think at this moment we are not going to make any prediction one way or another, but I will continue saying, long term we will be in a better position than anybody else and I finalize with a conclusion once all the questions are asked, with what I will summarize what I see the next three years to look like. Not the next quarter, not this year, but the next three years, what it’s going to look like for Middleby.

Operator

Your next question comes from Amit Daryanani from RBC Capital Markets

Amit Daryanani - RBC Capital Markets

Not to be a dead horse, but this program for shouts and deferrals, can you just talk about when you saw this happen in the quarter? Was it fairly linear and it’s been about 40 days since Q1 close, have you seen some of these push outs translate into revenues for Q2 so far?

Tim Fitzgerald

I think the order rate has been volatile. When you have a period like this there is a lot of uncertainties at the customer level. There were a lot of things that were going on in the financial markets as to capital that affects certain of our customers and because of that I think we’ve seen some inconsistency in the order rate, which is typical when we’re in periods like this.

Amit Daryanani - RBC Capital Markets

Have you seen that come back, maybe you’re talking about March, May 15 about when you can take advantage of accelerated depreciation, but I would imagine people need to place orders to you right around now to at least get the product in the next few weeks, right? So, are you seeing those orders come back in Q2 so far?

Selim Bassoul

The moment we summarize that it is a good day it is a bad day. One day we’ve had a good day, one day we’ve had a bad day. As this moment we have not been able to forecast domestically. I’m talking on the market being very, very uncertain. Our feeling is we are sitting back and saying what do we do?

The other thing that is happening is there is a lot of trend in the industry right now by some of our customers to ask for a significant reduction in price. The other thing we have been very cautious about is the fact that while the temptation is there to stimulate sales, which some of our competitors have done, I am very worried that today, whatever I commit to today, looking at fuel prices in the second half of the year, we are very concerned about stimulating orders through discounting.

So we have been very disciplined not to give equipment at a discount to stimulate the top line and then be hurt with a double whammy not only we give more discounts to reduce to our margin, but then by the time we ship that and replace the steel we already have in inventory, we are going to face a lot higher steel costs. So, we have been very disciplined.

What you expect us all who have followed that company for the last 8 years. We have been very disciplined to have a lot of headwinds, we’ve had not a long time ago a discussion where Middleby came very strong, better than any other competitors that we’ve had and we believe that we’re going to continue becoming very strong moving forward

Let me summarize to your questions. Others are uncertain at this moment. Going forward we do not know what is going to happen day in day out. I think that customers are looking for discounts. Customers are looking for energy saving devices, which we can offer. And at the end we are looking at creating a process during that time that makes that company much stronger to the bottom line, so that we can continue growing to 20% +, 30% growth that we are committed to.

Amit Daryanani - RBC Capital Markets

On the rocket fryer, could you just update us as to where you all are with regards to those launches? Are these products getting tested with the customers today, are you still doing some internal tests and when do you expect those programs to be sold to customers?

Selim Bassoul

The program is being tested right now with one customer and it is being treated internally. The rocket fryer is having significant interest. It was recently shown a major, major franchise convention at the 2SR the response, I’m sorry this is not the right trial, I take it back, this is not the right trial. We showed another fryer that was very well received. It is also some type of energy saving fryer that was well received at the 2SR.

The rocket fryer will be shown at the national restaurant show launch which is next week and we are expecting sales in the fourth quarter, which we always committed in ’08. The first quarter of ’08 we will be launching the sale of the rocket fryer, which you always say that’s going to happen and we are going to be showing that food launch. We have shown it in the past and there is a tent a few customers know, we are going to be showing it openly to everybody at the national restaurant show in Chicago next week.

Amit Daryanani - RBC Capital Markets

What percent of total sales came from international segments, the markets? Did you give that out?

Tim Fitzgerald

I didn’t give it out; it’s roughly 20%.

Amit Daryanani - RBC Capital Markets

Just in terms of the industry headwind from the Star acquisition, as you mark-to-market for the inventory, is there any more that needs to be done or is the $1.5 million kind of headwind done with now?

Tim Fitzgerald

I’m anticipating that that’s the end of it.

Operator

Your next question comes from Jamie Clement with Sidoti & Co.

Jamie Clement with Sidoti & Co

I think a lot of the questions have been about end markets and sales and all that kind of thing. What I would sort of like to focus on is just productivity and manufacturing and that sort of thing.

You all acquired a fair number of businesses last year. You have Star that you brought on in January and two recent ones.

I think that the concerns for a manufacturing company are that if sales soften you get kind of a reverse operating leverage system in your plants and it sounds to me like, you know you’ve got a lot of productivity initiatives in gear and I just want to make sure that I’m hearing correctly that, you understand that the sales environment is going to be volatile, but you still expect to gain significant productivity as the year goes on.

Selim Bassoul

That’s correct. I think that we are working on a lot of productivity gains and we have a lot of processes in place that are working in our favor and we are very excited about that. By all means the year is not a lousy year. I have to tell you I look at it and I say, everybody’s expectation has to be reset.

Let’s make it clear, we delivered a phenomenal first quarter, okay. It was a very good first quarter; I want to say that very, very strongly. If you look at this, it is truly vintage Middleby. When everybody is, including companies like GE having hard times, which is well run by management and all that, you look at a company like us, Middleby, where on flat organic sales which we still delivered a 20%, and in particular one charge away would be more than 20%, 28% per share goal.

I have to say that you have to give credit to my management team. I don’t want to leave this conference call having people say what’s going on. You have been around me, unless the new investors come on we can go back and see we have had a lot of headwinds and we have managed. But I don’t want to be cornered into guidance. I think I am finding out more and more that people want guidance and I don’t want to deal with guidance.

I think definitely this management team and the board have made it too long to give guidance. I think you should trust that we have productivity improvements; you should trust what happened in the first quarter was a very strong indication of a strong management team that delivered and at this moment everybody is trying to pin me on the top line. I think the top line is difficult, okay. We know that, I’m not telling you anything new. If you are surprised by this then you must have been sitting somewhere in Burma or maybe in Dolledge.

To spend [inaudible] in the United States is difficult and my feeling is we have to manage it and this is not the only headwinds we’ve had. This company has had headwinds last year of strike, we’ve had steel and steel, we’ve had SARS, we’ve had issues such as introducing a wall oven which was energy saving and we’ve had customers say we’re not going to order because they think that the wall oven comps, we’ve seen those before and we’ve managed with them.

This is a different type of headwind. Totally different and we’re going to manage through it and you have to sit with me and say okay, the expectation needs to be reset. I could not come into a quarter like this quarter came at all and people say, wow he did not deliver, the management team didn’t deliver. Then something has to come in. Something has to change.

I think the productivity gains will continue very strongly. I think we’re going to continue doing that. I think we are testing a lot of products on our customers. I think the energy saving is going to be very good for us. Finally the payback on more equipment is going to be less than two years, so we are feeling very strongly about it.

We are working with our customers on one hand I don’t want to turn my customer off. Some customers are struggling. The business model is somewhat struggling right now with the margin being affected. I’ve gone out to my customers and said, “You know what, Middleby is unlike anybody else. We’re going to help you. If you need the equipment to be cultivated or repaired, we can help you to whether that storm”.

I’m not pushing our customers to replace equipment today. I want to be able to be in line with them and in partnership with them, to sell them the right equipment. I don’t want to just sell for selling, because I am here for the state of the long term. If you go and audit our customers and you look at the level of service and the trust that has been established between us and our customers, it’s very strong.

I don’t want to push our people to buy something they don’t need. So in many cases we are telling our customers “don’t buy this piece of equipment yet, wait until the rocket trial because the savings will be huge. Wait a little while; you don’t need to buy a wall oven. We launched the mini wall; get the mini wall because that’s a lot of production. You don’t have the volume for the wall oven, but the mini wall is good for you”.

I think we are working in partnership with our customers the same way we work in partnership with our investors. We have been very transparent and we’ve been very, very committed to delivering the results and I don’t think this year will be different, but the expectation needs to be reset.

It’s tough what happened the first quarter, to everybody not to the analysts only, but to that individual investor who is expecting okay, what’s going to happen? I think that we cannot reset expectation to say well it’s going to now deliver 10% yearly per share, but it cannot be 25%. Somewhere between around 20%, 18% to 20% is a good resetting.

Jamie Clement with Sidoti & Co

Okay, fair enough and if I could just ask on more manufacturing related follow up. On the fourth quarter call you gave a little bit of an update about the Elgin plant, because obviously you had the work stoppage and then you were taking some actions in the latter part of 2007 that you wanted to take. That’s obviously an important plant. Have you taken the actions there that you want to take? How is that progressing?

Selim Bassoul

Yes, we have. I think we’ve seen improvement in Middleby very, very strongly. We have, by the second quarter of this year we’ll have significant margin improvement which is superb. I think I credit our management team have moved the marshals, have done a fabulous job and we’re going to see significant productivity gains from that position as we go into second and third quarter, kind of a lost UN strike.

Jamie Clement with Sidoti & Co

I’m well aware, I’m well aware.

Operator

Your next question comes from Jason Rodgers of Great Lakes Review.

Jason Rodgers – Great Lakes Review

You gave out what the growth was in the commercial food service side internationally. I was wondering if you could give out what the number was domestically.

Tim Fitzgerald

It was flat domestically.

Jason Rodgers – Great Lakes Review

It was up 2% internally, up 16% internationally, so you’re saying domestic was flat?

Tim Fitzgerald

Yes.

Jason Rodgers – Great Lakes Review

On the international side it was about 20% of sales. Do you have the number for the corporate growth internationally?

Tim Fitzgerald

I’m sorry I don’t understand the question. What is the growth internationally?

Jason Rodgers – Great Lakes Review

Yes, I think you gave it for the food service, 16%. I was just interested in the company as a total what international…

Tim Fitzgerald

Oh breaking out the food process side as well, I don’t have that right now.

Jason Rodgers – Great Lakes Review

Okay and for steel costs being up, I think on the last call you might have mentioned what the basis point impact on the gross margin was. I’m wondering if you had that for this quarter?

Tim Fitzgerald

It’s been running 1.5% to 2%.

Jason Rodgers – Great Lakes Review

Looking at the acquisitions side of things, do you have the number of what acquisitions contributed to earnings per share in the quarter?

Tim Fitzgerald

It was over half of the earnings per share growth in the quarter.

Jason Rodgers – Great Lakes Review

Around $55 million in sales from acquisitions in the quarter, I wondered if you have an estimate or a range for what acquisition may contribute to the top line in the current quarter?

Tim Fitzgerald

No, that’s not something that we, we’ve given the size generally with all the acquisitions so we’re not going to specifically go quarter-by-quarter.

Jason Rodgers – Great Lakes Review

Then finally looking at, I was just wondering what your appetite was for acquisitions currently or what funds you may have available for acquisitions in the environment now?

Tim Fitzgerald

We have continually said that acquisition is a key part of our growth strategy here and we continue to believe that we’re very well positioned strategically and financially with our balance sheet and we are continuing to evaluate opportunities.

Operator

Your have a follow up question from Peter Lisnic - Robert W. Baird & Co.

Peter Lisnic - Robert W. Baird & Co.

Can you give us a sense for the order of volatility? Is that at the big chains, is it at mom and pops is it across the board, just kind of where are you seeing that, more specifically?

Selim Bassoul

Peter, I think at this moment the volatility is across the board. I think that there is not one segment that is doing better than others. I think that at this moment we see our volatility being across the board. We’ve seen it at all the chain levels and we’ve seen it on the institutional side. The volatility continues to be across commercial food service across the board. It’s not related to one segment.

As I mentioned, it’s not sales have declined it’s just because a lot of those people have margins issues and they are trying to figure out new menu changes replacing old equipment, trying to figure out ways of cutting their costs and we can be part of the solution, but the biggest part is food costs.

To be honest with you, food costs have been way up and if you have been out, if you go out into a supermarket and buy milk, even milk has gone up, everyday products are up significantly. Corn is way up and many of our products, many of our customers use corn significantly, or cornstarch or whatever, all of those are way up. Wheat, you know what wheat is, wheat is going through the roof and they have issues and we’re trying to work with them and as they continue finding ways to substitute ingredients without affecting quality and that’s where we’re working with our customers, the numbers.

Middleby is not about the best labs around the world in terms of cooking equipment and we’ve seen a huge drive of customers coming through our lab to figure out ways to change their menu. Some of our equipment is key to making menu changes, to continue delivering quality using the free ingredients or what so ever, so a lot of change in the industry. I think this is good for the industry. I think our restaurant businesses come from customers who will get stronger through this.

Some contacts will be flushed out, there is no doubt within the next 12 to 18 months many, what I call, badly run, badly managed concepts will be flushed out. However, the stronger ones will get stronger and we are well positioned with companies like Kim, very, very strong, doing extremely well. Cheesecake Factory is doing extremely well, blessing transfers; a lot of quick serve companies are doing well, Papa Johns.

It is a crazy example. Papa Johns is launching, along with other pizza chains, launching the text message ordering. A great innovation to get closer to the customer where people can order pizza by text messaging instead of calling the restaurant, figuring out where it is, they could be on their way back and text message. Papa Johns made it so easy. Domino’s is doing the same thing. I think this is fantastic and great for us. It could create a lot of demand for our customers.

We are truly partnering with the crème de la crème of chain restaurants. Most people are not buying, they are doing what you are doing, changing their prophecy’s to increase their margins, to service their customer better and to improve the quality. I think that is should look a year from now. You will remember that conference call and you will remember how well those restaurant concepts will be doing. They are all investing in smart ways of getting closer tot heir customers, only increasing their upward check or increasing their margins.

Peter Lisnic - Robert W. Baird & Co.

If I can go back to, Tim your comment on steel priced $150 to $250 bids in the first quarter is that after price and was that a gross margin comment?

Tim Fitzgerald

Yes, that was gross margin comment. I’m comparing it relative to a year ago obviously.

Peter Lisnic - Robert W. Baird & Co.

Then the inventory write up charge was only $1.5 million, I though last quarter you said it was going to be $3, million. Just to reconfirm, you’re basically done with that $1.5 million, you’re not going to recognize it anymore in the second quarter or beyond correct?

Tim Fitzgerald

Yes, that is my expectation.

Peter Lisnic - Robert W. Baird & Co.

Do you guys mind commenting on, you’ve got this order volatility and you also have some pretty significant competitive changes in the landscape with two or three big competitors kind of battling it out and somewhat consolidating the space. Does that change the competitive environment for you relative to those competitors? What do you see the competitive landscape doing because of a couple of these announcements that we’ve seen on the wires over the past couple of weeks?

Selim Bassoul

One of them is very recent, it happened this morning; so like you we don’t know what it means for us, we haven’t assessed it. Competitive with this conference call, we haven’t been able to digest it. I actually was talking about putting a bit…

Tim Fitzgerald

Yes, we’re not going to comment on it.

Selim Bassoul

We don’t know what it means in a competitive way. For me, let me go back to tell you what, the landscape in oils is being bought by one or another and we don’t understand what it means. We are focused on what we do. We have competed against oils in one way or another, we have competed against accidentally one way or another, and we have competed against a lot of companies.

We manage our business, our space exceedingly well. Our margins continue to be extremely strong. I think that we have been leaders on the hot side of delivering patented products addressing trends ahead of every competitor, whether it’s on energy saving and that’s documented.

For those new investors or those who haven’t been with us, this company talked energy saving in the year 2000, it is out, it’s public, we’ve been investing in energy before anybody else and we have energy saving in cooking equipment or appliances better than anybody else.

We have now been addressing the trans fat, free oil now for the last 2.5 years as a trial, in the sulfite trial. We have been addressing a speed in terms of addressing speed in conveyor ovens and automation 20 years ago. We understand automation better than anybody else. We have done some great things. We are now talking about the hydrovexion, which addresses energy, cleaning, ability to cook products better than any of the other ovens in the marketplace. We have disrupted the marketplace with technologies that change the way it is.

I have said many times, we may not be as good at apples, but we look like apples. So, in our business we have the substance. We have created many iForms, many iPods, and we will continue.

Just to remind everyone, I think everybody is focused on trying to get me to guide you and I have tried to walk away a little bit from that and show you and remind you the number of new products that we have coming up in 2008. I am going to re-read them to you. We have the Hi-H oven, we have the high direction convection oven from Blodgett, we have the rocket trial, we have the ventrix hood from Wells, we have divisional cooking turn the ovens from Houno, which are phenomenal on the oven, we have unique ethnic products from Jade, some other products, barbeque sate station, we are pitting Mongolian Grill, we have a conveyor fryer from Alkar we have a good exclusion from Alkar, forming equipment from MP and intelligent water capper from MP.

Let me tell you what you are addressing: we are addressing safety in the food processing business. If you look at the biggest concern of food processors right now is safety and that means safety by introducing good exclusion, by introducing in our RapidPak business flash pasteurization.

We are addressing in terms of the US we are addressing convenience and innovation with Star; with mini-WAN; with Hi-H we are addressing ethnic and exotic inspirations. There is a huge growing interest in food from far away; Spanish, Caribbean flavors are on the rise and it is truly unbelievable how many combinations of things. If you have been to restaurants as I’m sure many of you have, you look at garlic jalapeno, tequila lime, pinch of garlic, sesame pineapple, sauces and marinades and we’re working with many of our customers, especially on the Jade side to introduce products specifically that talk about that.

We are looking at as the coffee and beverage wars among chains continue to make news, interesting that the increased incidence of snacking is going way hand in hand and that’s where our Toastmaster, our Star, our Hoffman and our Wells business is continuing to have a major impact in 2008 and 2009.

I look at our fast casual and I’m leading here where we are a dominant player in fast casual. The overall growth rate of that segment continues to do very well and we continue to be very active in that sector. On that, we are feeling very, very strongly about the dynamics of where we’re taking our innovation and what does that mean for the company’s landscape? It means that we continue focusing on food safety, on energy and on basically addressing trans fat oils.

We’re feeling very good. I don’t think any of our competitors have come close to us on any of those three items; energy savings I take to be the leading of that, we talked about energy, but nobody has addressed it the way we measured it. We quantify it and we give you the feedback, whether it’s in our ovens, whether it’s in our fryers, or whether now introducing it into some of our holding cabinets, so Carter Hoffman.

Operator

Your last question comes from Mark Grzymski TimesSquare Capital.

Mark Grzymski - TimesSquare Capital Management

On the international business I guess you said about 20% there is that a true number or is it hard to quantify since some of your domestic customers are of course buying for international or, I just want to clarify that.

Tim Fitzgerald

That number I gave is an approximate number. I don’t have the exact number. It’s not in front of me, but I expect it’s pretty close to 20% and it will be in the 10-Q and that number will be an accurate number.

Mark Grzymski - TimesSquare Capital Management

Then just to follow up on Pete’s question there regarding the landscape. I know you can’t comment on the ITW men talk, but I’m just curious have, given where these evaluations are coming out, I’m just curious have you ever been kind of in discussions over the last year with either of these…

Tim Fitzgerald

We’re not going to comment on that at all.

Selim Bassoul

I have comments to make. First of all let me bring back into interesting dynamics in general. If you look at the others lifespan of food service cook it is eight years. We have a large installed base of over 850,000 established in the US and replacements represent approximately 1/3 of the market; so we are going to continue seeing replacement occur even though it is delayed from one quarter to another it will continue showing that trend.

Let’s talk about Middleby and I want to give you the right take away for the next three years. We are the leading value added manufacturer customer for food service and that group, but we have number one and number two market share in each product. Our products are now pre-shipped to our customers and they will represent a small portion of their budget and provide high ROI.

Our pay back on most of our products today, especially the new platform that we introduced since 2006, 2007 and the new product introduced in 2008 have a payback, most of them, of less than two years. We have a unique global operating platform that provides significant barriers to entry. We have been in emerging markets more than anybody else and we continue to grow those emerging markets for us.

The US growth in sales has never declined, over a 25-year period and we don’t expect that to decline. We have a bigger surprise revenue base with exposure to high growth end markets. We focus on continued operation improvement and margin expansion. We have a successful track record of creating significant values through acquisition and our long term annual. EPS growth target of 20% is consistent with the sort of good performance.

Most important for all of you on this conference call and everybody investing in Middleby, there has been a very stable and proven senior management team of significant years of industry experience and we will continue looking at opportunities to grow our margins and grow our EPS in the next three years. Thank you.

Tim Fitzgerald

Thank you everybody for attending today’s conference call. We look forward to speaking with you next quarter.

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Source: Middleby Corp Q1 2008 Earnings Call Transcript
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