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Middleby (NASDAQ:MIDD)

Q3 2012 Earnings Call

November 07, 2012 9:30 am ET

Executives

Timothy J. FitzGerald - Chief Financial Officer, Principal Accounting Officer, Vice President, Chief Financial Officer of Middleby Marshall Inc and Vice President of Middleby Marshall Inc

Selim A. Bassoul - Chairman of the Board, Chief Executive Officer, President, Chairman of Middleby Marshall Inc, Chief Executive Officer of Middleby Marshall Inc and President of Middleby Marshall Inc

Analysts

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Anton Brenner - Roth Capital Partners, LLC, Research Division

James Clement - Sidoti & Company, LLC

Sid Panda - RBC Capital Markets, LLC, Research Division

Gary Farber - CL King & Associates, Inc., Research Division

Gregory W. Halter - LJR Great Lakes Review

Joel Gifford Tiss - BMO Capital Markets U.S.

Operator

Hello, and welcome to the Middleby Corporation Third Quarter Earnings Call. On the line with us today we have Mr. Selim Bassoul, Chairman and CEO; and Mr. Tim FitzGerald, CFO of the Middleby Corporation. [Operator Instructions]

Now to start off our conference, I would like to welcome and turn the call over to Mr. Tim FitzGerald.

Timothy J. FitzGerald

Okay. Good morning, and thank you for attending today's conference call. I'm Tim FitzGerald, CFO of the Middleby Corporation and joining me today is Selim Bassoul, our Chairman and CEO.

Net sales in the 2012 third quarter of $257.7 million increased 17.8% from $218.7 million in the third quarter of 2011. Third quarter sales reflect the impact of acquisitions completed during the past 12 months, including Auto-Bake, Danfotech, Maurer-Atmos, Drake, Armor Inox, Baker Thermal Solutions and Stewart Systems, and therefore, are not fully reflected in the prior year results. Sales growth from these acquisitions accounted for $39 million of the increase during the quarter.

Excluding the impact of these acquisitions, sales increased 9.8% over the prior year quarter. This reflects a 5% increase in sales at our Commercial Foodservice group, and a 40.2% increase in sales at our Food Processing group. Sales growth in the quarter was adversely impacted by foreign currency exchange rates, which impacted sales as reported in U.S. dollars by approximately 1.5%. In the Commercial Foodservice group, we continue to realize growth driven by increased sales to restaurant chains looking to upgrade equipment, adapt new technologies to improve the efficiency of store operations.

Sales in emerging markets also remained strong, with the growth of approximately 18% in Asia and Latin America, offset by reduced sales in Europe, which declined by approximately 15%, reflecting difficult economic conditions, which we anticipate will continue in the near term.

Sales at the Food Processing group realized significant growth in the quarter, reflecting sales on several large projects. Our sales growth will moderate in upcoming quarters as compared to the third quarter. Order rates continue to remain strong and we continue to see growing demand by Food Processing customers looking to modernize existing production operations and new customers developing operations in emerging markets.

Gross profit increased to $100.4 million from $87.3 million, and the gross margin rate was 39% as compared to 39.9% in the prior year quarter. The gross margin rate reflects a higher mix of sales from the Food Processing segment at a comparatively lower margin.

Sales at the Food Processing Equipment Group comprised approximately 23% of total sales in the quarter as compared to 13.5% in the prior year quarter. Within the individual segments, the Commercial Foodservice segment remained relatively consistent in gross margin as compared to the prior year at 40.5% during the quarter while the Food Processing segment recorded an increase of approximately 1.5% to 34.4%, reflecting improvement in operating efficiencies, offset in part by lower margin at the newly-acquired companies.

In the upcoming quarters, we anticipate the Food Processing business will continue to represent a comparatively higher portion of sales due to the recent acquisitions, which will impact the overall gross margin. However, we anticipate continued long-term improvement in the margins at the segment as we realize the benefit of business integration initiatives.

Selling and distribution expenses during the quarter increased $1.4 million to $26 million as compared to $24.6 million in the prior year quarter. Selling expenses in the quarter included approximately $2.5 million of additional expense from acquisitions not included in the prior year results.

Excluding the incremental expense of acquisitions, selling cost decreased approximately $1.1 million due to lower costs associated with timing of various trade show and marketing programs.

General and administrative expenses increased by $1.5 million to $27.1 million as compared to $25.6 million in the prior year quarter. General expenses include approximately $3.1 million of additional expense related to acquisitions not included in the prior year quarter, offset in part by lower stock compensation and leverage of general and administrative expenses over the greater combined company.

Other nonoperating expenses amounted to $2.8 million in the quarter and were higher than normal during the period. These expenses related primarily to foreign exchange losses. During the quarter, we realized losses on current period foreign exchange positions while offsetting gains on longer-term balance sheet positions were realized as an increase directly to equity through the currency translation account. As the scope of our international operations has increased, we anticipate the P&L impact of exchange exposures may be more significant than in prior years. However, we also anticipate they will be less than in the current period and gains and losses will naturally offset in the financial statements to a greater extent.

The provision for income taxes amounted to $11.9 million at a 28.6% effective rate as compared to the prior year provision of $11.8 million at a 33.5% effective rate. Current year tax provision reflects lower taxes on earnings in foreign jurisdictions, which have increased due to the foreign acquisitions completed in 2011. The tax provision also reflects nonrecurring favorable reserve adjustments associated with reduced state tax exposures, which favorably benefited the effective rate in the quarter.

Cash flows used or cash flows generated from operating activities amounted to $39.1 million in the quarter and for the first 9 months, cash flows from operations increased by $27.7 million to $93.4 million. And we continue to expect continuing strong cash flow for the remainder of the year as working capital is reduced from its midyear peak. Noncash expenses added back in calculating operating cash flows amounted to $9.3 million for the quarter and $27.8 million for the first 9 months. Noncash expenses for the quarter were comprised of $6.2 million of depreciation and amortization, $3.1 million of noncash share-based compensation.

In the first 9 months of 2012, the company utilized $38 million to fund acquisition activities and made $6 million of capital expenditures related to production equipment and facilities enhancements. And total debt at the end of the quarter amounted to $269.3 million and was reduced by $48 million from $317.3 million at the beginning of the year.

During the quarter, we were pleased to announce the recent acquisitions of Stewart Systems and Nieco. With these acquisitions, we continue to add to our portfolio of leading brands, both in the Food Processing Equipment Group and the commercial Foodservice group. Stewart is a leading manufacturer of automated baking systems. This acquisition, along with our other recent acquisitions of Auto-Bake and Baker Thermal Solutions positioned Middleby as a leading solution provider to the baking industry with a complement of comprehensive, unique technologies.

And Nieco is a leading manufacturer of automated broilers for the commercial foodservice industry. The Nieco conveyorized broiler is highly complementary to Middleby's platform of automated cooking solutions and allows us to continue to provide our customers with solutions to improve their operating efficiencies and lower their cost in their restaurant operations.

That's all for our prepared commentary. Lisa, could you please open the call to questions now?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Josh Chan with Robert W. Baird.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

I was wondering if you could talk about order rates within the Commercial Foodservice business, how that trended through the quarter and maybe into October?

Timothy J. FitzGerald

We continue to see kind of a consistent trend that we saw in the third quarter with growth in chains and the emerging markets. And Europe continues to be a struggle but generally, things remain positive there.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Is there any differences between the different months of the quarter or was growth pretty consistent across the quarter in the last 3 months?

Timothy J. FitzGerald

It's relatively consistent.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then on the comment that your chain accounts continue to grow, at what point do you think the comparison becomes more difficult? Because as you have these national accounts rollouts -- in order to grow, you would have to have incremental additional rollouts. So at what point do you believe that the comparison will become more difficult to lap?

Selim A. Bassoul

Josh, I would think that as we continue most probably in the second half of 2013, we have to most probably start looking at new tests that will have the most customer to come through. I think we are quite booked through the first half of 2013 and I think as we look at the second half of 2013 is where we tend to see most probably more challenging comparisons unless we close some of those test units. And I think so far, we have several test units that are very promising to our customers. But I think we don't have visibility in the second half of 2013 while we have very small visibility in the first half of 2013.

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

Okay. Great. And then last question, it's certainly encouraging the acquisitions are continuing. Can you talk a little bit about the pipeline, the number of potential targets out there as well as their sizes, if you could?

Joshua K. Chan - Robert W. Baird & Co. Incorporated, Research Division

I mean, Josh, we don't like to talk about any specifics related to things that we have on the pipeline, I mean, other than we can kind of reconfirm that the pipeline remains strong and the level of opportunities we're working on is as significant, if not more so than it's been in the past. So we feel pretty good about the opportunities there.

Operator

Our next question is from Tony Brenner with Roth Capital Partners.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Tim, you gave the change in Commercial Foodservice sales for Asia, Latin America and to Europe. I wonder if you could do the same for that business for U.S. and total international sales change.

Timothy J. FitzGerald

Yes. U.S., we were up high single digits. So it was in excess of 8% in the U.S. And then overall, international, it was down about 1% as Europe was a larger percentage of international in the quarter. So although we grew faster in the emerging markets, the weighting of it was that Europe brought down the international number by about 1%.

Anton Brenner - Roth Capital Partners, LLC, Research Division

Okay. And second, it sounds like Nieco, which is conveyor broilers fits pretty neatly into Middleby's kitchen retrofit initiative. And that's going to be part of that package for a number of change that you're working with on that program. And I wonder if you could just update on who might be in that pipeline that's already committed that will be in there through the first half of 2013.

Selim A. Bassoul

Tony, good morning. This is Selim. I'm going to address the Nieco acquisition first. The Nieco acquisition reminds me very much, on a much smaller scale, to TurboChef. When we bought TurboChef, it had literally what I call 3 major customers, and you look at acquisition from TurboChef and to Middleby, to where those 3 customers at that time represented around 80% of the business. Today those 3 customers represent 25% of the business. We feel that Nieco has almost the same characteristic of 3 customers most probably driving in that case 80% of the business. And I think in the Middleby, our hope is to take it and expand it beyond those limited QSR where they've done a fantastic job. The product of Nieco is highly, highly technologically advanced in terms of dealing with smoke, with meat fat and grease and with automation with fixed result. I think a couple of thing we can do with that product line is to take it internationally in emerging markets where it has a lot of appeal because it fits very nicely in smaller type of places where they don't have a huge kitchen where they have to put a griddle, a char broiler and they can do a lot with this unit. Another interesting thing that we can combine together, we have the patent technology in our broilers that has a self-cleaning unit that we'd like to most probably take and integrate with Nieco broilers. And I think between the 2 combination between CTX and Nieco, I think we have a lot of synergies to grow that business. On the aspect of what you have committed in terms of feasibility, we continue to see the rollout with Brinker continuing through the second half of the year. We continue seeing the rollout with Panda Express continuing to the first half of the year. I think between those 2, as well as we have smaller rollouts that are coming in the end of the third quarter, will continue through the first quarter of 2013.

Anton Brenner - Roth Capital Partners, LLC, Research Division

You said 4 new rollouts, is that right?

Selim A. Bassoul

No, no. I'm saying smaller, smaller rollouts that are coming from customers. They are not as big as the Panda and the Brinker rollouts. But in the third quarter, we had a strong rollout of smaller units on fast casual and QSR that basically will continue filling in that void into the first half. So when you add Brinker, you add Panda and you add those rollouts from smaller chains, I think we might have -- we will have a good first half in 2013.

Operator

Our next question is from Jamie Clement with Sidoti & Company.

James Clement - Sidoti & Company, LLC

Tim, I'm not sure if I heard it real well, but the magnitude of the expense below the operating line, what was that attributable to?

Timothy J. FitzGerald

Well, it's foreign exchange losses.

James Clement - Sidoti & Company, LLC

Okay. Got it. And nothing else in there just normal run-of-the-mill foreign exchange stuff?

Timothy J. FitzGerald

Well, yes, I mean, it's primarily foreign exchange. I mean, that's the bulk of it. It was larger than normal. As I kind of mentioned, during the quarter, I think you probably -- I wouldn't expect it to be as large going forward. If you look on the balance sheet and the details are -- we had gains in our CTA account, which runs directly through equity so we kind of had some mismatch of gains and losses in terms of what went through the P&L and balance sheet. So I think that will offset to a greater extent in the future periods, too, so, we expect to have lots of a P&L impact there. But we do have larger foreign operations now. So I mean, it probably will be larger than what we've seen in prior years, so.

James Clement - Sidoti & Company, LLC

And Selim, if I could just change gears a little bit. The processing business, I think there are some differences in terms of trends between the protein side and the baking side. Can you talk a little bit about what you're seeing in the marketplace now that the book of business is kind of rebuilding again, and ideas for new technologies over the next year or 2 or 3 -- where you all are going after those markets?

Selim A. Bassoul

Yes, very good question, Jamie. What we're seeing in terms of the trend in food processing is it continues to be emphasis on safety, on yield, on automation. I think we continue to see automation, especially in emerging markets, which is amazing where we are leaders in that system, including the J-Con from Alkar, and you look at Auto-Bake from the bakery. So one, across the bakery, whether it's bakery or meat or chicken protein, we see automation as a big, big aspect of the business and not only in the U.S. but in places like Thailand, in places like Saudi Arabia, in places like China. And we're seeing a significant amount of interest in our conveyorization where there's less handling by human beings. Safety is a big issue to a lot of those customers. Number two, the interesting part that has been a -- similar to what we've done in foodservice, I think when you came to realize what made Middleby unique, I will repeat in 2000, for some of you who have not been involved with us as far as 2000, I said the company, me and my management team unanimously say we're going to be the most energy-efficient company in terms of appliances to the restaurant business. And in time, first we were not even on anybody's radar screen. In fact, I always tell anecdote that when I launched energy-saving appliances and I went to see Papa John, I went to see Pizza Hut at that time, Domino's, David Brandon, the CEO of Domino's. Hummer had just introduced the most gas-using car ever, which is H2. So interesting enough, ACT and Toyota, which is a car manufacturer, and was talking about Prius, we were introducing energy-saving. Today, as you would say, the biggest trend that has propelled Middleby forward in foodservice is that we are literally known as energy-saving company. And we're talking about payback of 30% to 45% savings on our [indiscernible]. We have the most ENERGY STAR cooking equipment than any other platform in the industry. Now when we bought the Food Processing business, my interest has been to say what is -- how do we break the code in that business? And we have been focusing on yield. How do we increase the yield, whether it's in chicken, whether it's in sausages, in hotdog and in bakery? How do we get the yield to take place? And yield is a big issue in protein. In bakery, it's production. How do I get more cupcakes going through our system so that they can meet the demands of somebody like Starbucks, if you are a regional bakery like there's one here in Chicago that just got a contract from Starbucks. And one of the reason they got the contract is literally being able to get an equipment from us that allows them to get 3 things: one, be able to provide the production that Starbucks would need regionally; number two, they need to make sure that there is very little human interaction so there is no concept of ever, ever having any type of contamination or safety issues; and number three, making sure that they can deliver on time because Starbucks is not going to -- let's say, Starbucks is not going to store 3 days of goods. They want them to deliver twice a day or 3 times a day to each one of those stores. So what we focused on has been yield, safety with automation and speed. Very similar to what we've done in foodservice. So our success in Food Processing as we became a dominant player has been breaking the code, the same way we've done it in foodservice.

Operator

[Operator Instructions] The next question comes from Jamie Sullivan with RBC Capital Markets.

Sid Panda - RBC Capital Markets, LLC, Research Division

This is Sid Panda standing in for Jamie Sullivan. The first question I had was on the G&A expense that was sort of at the lowest level since like the fourth quarter of 2009. So is this a structural change? And should we be thinking about this expense at that level going forward and is this sustainable?

Timothy J. FitzGerald

Well, it's -- I would say it's not necessarily a structural change although we continue to make improvements as we're integrating some of the companies that we've acquired over the last several years. So I think it might be a little bit more favorable in the third quarter than some of the prior quarters. But I would say it's a relatively consistent number of what we would expect moving forward.

Sid Panda - RBC Capital Markets, LLC, Research Division

Okay. The second question was regarding the kitchen rollout. I think you did mention Brinker, Panda Express. I wonder once Brinker I suppose said in their calls that they would be expected to complete all the kitchen rollouts in the first quarter, first calendar quarter. So do you have something of a similar magnitude in the pipeline in terms of the number of stores and revenue opportunities, once this is complete?

Selim A. Bassoul

Yes. We've had other companies that have been interested in a very similar solution to their needs in terms of looking at what Brinker has done. Because literally, in addition to -- as you go back and listen to the Brinker conference call, the remodeling of their kitchen has been a huge success. If you look at their food scores and the quality of their concept as much as the labor-saving and the speed, it has been all commented on by the CEO on how well they've done with the kitchen remodel, of which we are a very important part of that. And we've seen we have several tests going on from other restaurant concept that are looking at the same thing. They might not be looking exactly at the same execution because they might have different menu items but they are looking at almost the same results in terms of trying to be able to provide better quality and more consistent food. So we're starting to see -- we are basically not trying to see, we are working in tests with several of those restaurant chains at this moment that we believe will come to fruition sometime in the latter part of 2013.

Sid Panda - RBC Capital Markets, LLC, Research Division

And I guess your success at Brinker was based around your WOW! Ovens, as you call this. So all the other discussions and tests that you're going on, is it based around the same product offering or are there more product offerings that could be coming into the picture?

Selim A. Bassoul

No, it's based on very similar product offering. That's high-tech. It's basically a combination of several pieces of equipments that we have put together. They are all highly patented. It's not only the equipment but it's a process that we've generated that has been very, very instrumental for making sure that from a training standpoint that makes sure from an implementation standpoint, it makes it easy. We did not throw in a piece of equipment just to say, okay, let's put 5 pieces of equipment all together into the kitchen. I think the process in addition, to the equipment -- so it was a combination of hardware and software that made it unique for Middleby to implement what we've implemented at Brinker.

Sid Panda - RBC Capital Markets, LLC, Research Division

And the final question I had was regarding the tax rate. For 2 successive quarters, your tax rate has been in the 29% range. Is that going to be the new normal in terms of tax rates for the final quarter in 2013 and beyond?

Timothy J. FitzGerald

Well, as I mentioned, I think there's some nonrecurring benefits in there related to some state tax exposures that have been closed out or settled. So I think we've guided more in the 33% to 35% range. The tax rate will be somewhat impacted by the mix of U.S. versus international earnings moving forward.

Operator

Our next question is from Gary Farber from CL King.

Gary Farber - CL King & Associates, Inc., Research Division

Just a couple of questions. One is in the past couple of years, you're very successful sort of having strategic initiatives. One was the international account program or your international buildout. I'm just wondering when you put aside your new product rollouts and excluding them when you look at it into next year, is there some sort of major significant strategic initiative you have? Is it still the international buildout or is it something else?

Selim A. Bassoul

I think you thought right. I think we have 3 initiatives that are now going into 2013. Our #1 initiative is literally continuing to look at all our product portfolio and we are very proud to say that when you look at what I consider outdated products, which means products that have no ENERGY STAR, they are not -- they don't have features that manifest in payback that's less than 2 years, today accounts for less than 15% of our overall portfolio compared to over 50% in 2009. So between 2009 and end of 2012, our outdated product, that means products that have not been refreshed with features and benefits with ENERGY STAR now represents 15%. So our initiative between now and in 2013 to target those 15% of our outdated product and get them refreshed. So by the time 2013 comes along, we should have over 95% of all our products to be totally updated with energy savings, with features and benefits that allows a payback of less than 2 years. The next initiative that we have, have been reflected in our quality. We have put into place a quality control process across all of our divisions. One of the major reason that we've done that is we continue to be one of the only companies offering a No Quibble Warranty similar to a Costco product. When Costco, you buy from Costco, you can return that product, we've had that forever. As you keep on adding features and benefits to our products, we have to make sure that the technology that's being implemented in our product is not at the expense of quality. So we put together a very unique quality control process and it has been reflected in our warranty rate that continues to drop. And the third initiative is our lead times. We continue to work on making sure that our delivery continues to go down this year, and we will complete -- we have a lead time standard that we have most probably decreased our lead time to our dealer and distributor. In most division, we have a few division still where we still have to implement and institute this lead delivery schedule. And that's going to be done in the first half of 2013.

Gary Farber - CL King & Associates, Inc., Research Division

Okay. Just a couple of other ones, if you don't mind. Just on the gross margins, it sounds like the mix should improve in the fourth quarter. Is that right, that the margins, gross margins should go up?

Timothy J. FitzGerald

No. I mean, I think we're expecting that the Food Processing is going to continue to be a greater percentage of the sales mix and that is at a lower margin base. So I think the overall margin is going to continue to be affected by greater Food Processing equipment sales as we focus on improving the margin on that segment.

Gary Farber - CL King & Associates, Inc., Research Division

So you would think it would stay in the same range as the third quarter then? Or less?

Timothy J. FitzGerald

Well, I mean, we're not guiding towards a specific margin but I think, similarly we'll probably see a -- we had a gap of about 1% in this quarter, and I would say that type of effect will continue through the remainder of the year.

Gary Farber - CL King & Associates, Inc., Research Division

Right. Okay. And then just lastly on this Commercial Foodservice business...

Timothy J. FitzGerald

Gary, I'll just mention one other thing, too. We just completed 2 other acquisitions. So I mean, those 2 most recent acquisitions will also have some impact in the fourth quarter as well.

Gary Farber - CL King & Associates, Inc., Research Division

Right. And then on the Commercial Foodservice business, just your organic growth rate. It sounded like October was, what, pretty consistent. That's sort of the organic level you think you'll be growing at in the near term?

Timothy J. FitzGerald

Yes. I mean, October was consistent. We felt good about the order rate in October and see that continuing in the fourth quarter. We feel pretty good about the trends right now.

Gary Farber - CL King & Associates, Inc., Research Division

Okay. And then just one last one on the acquisitions. Is there any change you're seeing in the rationale behind people wanting to put their businesses on the market at all or is it pretty consistent, the rationale behind the sellers, and have multiples changed much?

Timothy J. FitzGerald

No. I mean, I think the multiples have been fairly consistent over the last 12 to 24 months. They obviously, were much different during the downturn and coming out of it. The rationale for most companies selling is strategic in nature. Tax law on the edges has an impact of maybe trying to put something in one period versus the other. But really, the overall pipeline is really driven by the strategy behind wanting to sell.

Operator

Our next question is from Greg Halter from Great Lakes Review.

Gregory W. Halter - LJR Great Lakes Review

I didn't hear specifically a calling out of the business in Latin America, whether or not that was up or down in the quarter year-over-year?

Timothy J. FitzGerald

Both Latin America and Asia were up double digit year-over-year.

Gregory W. Halter - LJR Great Lakes Review

All right. And any representative examples of customers in the Food Processing area that are buying currently? I think you had mentioned some in the past like Nestlé and Sara Lee and so forth. Is that still the case or you attracted new folks as well?

Selim A. Bassoul

Greg, we've attracted -- yes, we've attracted quite a lot of new folks. As we continued to buy companies in bakery, so this is a new field for us. So we've attracted a complete new set of customers. We have also attracted customers that are pretty diverse in terms of customer base. I don't want to be specific in terms of who they are. Some of our customers maybe that they don't us want to release what they are doing to their competitors. So I'm going to have to be very discreet on that. But I have to tell you the interesting part is the normal customers we've had continues to be with us. The normal, large conglomerates of Food Processing worldwide continues to be very much in our company -- doing business with us, whether it's in meat, protein, chicken and bakery. But what is fascinating, we're seeing a significant increase of regional player in emerging markets. I mentioned Thailand early on in my discussion. I am looking at businesses in Latin America, Chile, where we've seen some completely new players coming through. Look at Mexico, where we've had some interesting, very good relationship there with large food processors. So in the U.S., we're seeing the major player, the usual suspects, the big players, the Nestlé, Sara Lee, come through. In North America, maple Leaf Foods, whatsoever. And then we've seen smaller players starting to come into niche play. I just mentioned, for example, this customer which just bought an Auto-Bake system from us to service -- to be able to go after Starbucks regionally. And we're seeing a lot of those type of players who are trying to go after niche customers. And we're seeing a lot of those coming through in the pipeline.

Timothy J. FitzGerald

I'll just also mention that while we're selling to a lot of the same customers, now that the portfolio has broadened we're having opportunities to introduce more brands into existing customers. So we believe we're getting greater penetration.

Gregory W. Halter - LJR Great Lakes Review

Okay. And any thought of not just being on the hot side but also on the cold side as well?

Selim A. Bassoul

I don't want to comment on that because I've been asked this question both from shareholders, analysts and customers, saying why don't you go to the cold side? So far, we have not -- I don't want to rule it out, I don't want to rule anything out, and then regret it and say never say never. But at this moment we have not, we've been sticking to what we have and what we've got and we're doing pretty well. So unless there is something compelling that we know about and get brought to our attention, we will not ignore it. We would be foolish to close our mindset to anything. But it has to be accretive, it has to make sense strategically. We're not a -- one of the things that makes Middleby unique, we're not going to buy a need-to company, we're not going to buy a commodity product. That's something that we're not going to be able to do. One of the major reason Middleby has been very, very successful is that we remain very, very disciplined to our core. And the core is not only the hot side. The core is literally how do we integrate an acquisition, how do I bring value to our customers? If there is any other companies that's going to bring the same value to my customers, they don't need me. They can go and bid it. I want to be able to bring solution whether it's in the cold side or the hot side that literally brings something to the customer where they'll go back and say I want to be able to use Middleby because I know that Middleby can guide me through that process. The way we've done, we've done it 20 years ago when we automated, or 25 years ago, when we automated the pizza business, we automated the pizza business. We automated the pizza business. We basically took the speed cooking today into many places with TurboChef. We created the energy saving platform that allows us today to save a lot of energy in terms of structure to our customers. We are the people who took Brinker, where we allow them now to automate their kitchen. You take our product that allowed SUBWAY to bake on-premise, bread. Where today, they are 37,000 stores and they bake bread on-premise. Without our oven, they cannot do it. So in many, many ways, we have been able to be instrumental in bringing added value to that customer at a payback that allows them to be competitive. And I think if there is something compelling out there that allows me to take refrigeration, let's say, and I can change that paradigm and take it to the customer and say, I'm bringing you some new idea. I'll be more than happy to look at it. So I don't want to close any refrigeration or any cold side. Otherwise, you would not want me to be a CEO, close-minded, if I don't look at those opportunities. However, they have to be changing, they have to be disruptive. Otherwise, there are many, many other companies that continues to sell commodity products and need-to products. That's not who we are.

Gregory W. Halter - LJR Great Lakes Review

Okay. And also noticed that your debt to total capitalization at 31% or about 28% excluding the cash is the lowest that I think it's been since 2001, which obviously is a good testament to your cash flow generating capabilities despite the acquisitions. Just wonder how you look at the capital allocation of Middleby going forward.

Timothy J. FitzGerald

Well, Gregory, I mean, we continue to be focused on acquisition and that's our primary use of capital. So leverage multiples or if you want to look at it as debt to capitalization has moved up and down over time and you're right, we're at a lower point right now. So I think we, as in the past, expect that we'll have periods that'll move up and move down. So we just happen to be in one of those lower points right now. That is a function of the capitalization going up and the cash flow continuing to be strong.

Gregory W. Halter - LJR Great Lakes Review

And any comment on the 2 segments' margins in the quarter versus last year?

Timothy J. FitzGerald

Well, I just -- I mean, as I mentioned earlier, the Commercial Foodservice continued to be strong. It was just over 40% and we expect that we'll continue to maintain strong margins there and with some of the new products, expect those to be -- continue to help us maintain or push margins on that side of the business. And then with Food Processing, there's a lot of new companies that we acquired just over the last 18 months, so we're in early stages. I mean, we did see some margin expansion in the third quarter here. But we're in the, again, early innings and we expect those to expand over time and kind of close the gap between the 2 segments over the next couple of years.

Gregory W. Halter - LJR Great Lakes Review

Okay. Great. Then one last one. Selim, any comment on recent successes with new products or things you may be looking at or working on bringing out?

Selim A. Bassoul

Yes. I'm very excited about many, many initiatives we have. I think I would look at 3. One, our ventless technology continues to be well, well accepted and adopted. I think we're making inroads there. This I'm talking about Foodservice then I'll talk a little bit of Food Processing. I look at number two, is of course, our what I call our kitchen revolution casual dining is extremely well accepted. I think we'll most probably have 2 other customers right after Brinker that will adopt that system in 2013 through 2014. And I'm very excited about that. So that has been a very big one for us. I think the new technology at TurboChef, the Encore technology, has been highly accepted also. It's been a fantastic platform for TurboChef. I look at that as looking -- and then induction. I think induction has been one of the most -- I have not spoken as much on it, literally, I kept on talking about all our core product but I have not focused the last 1 year, 1.5 years literally to tell you about how induction has become a big, big part of our business. Today, induction is a multimillion dollar platform for us and I think it continues to grow very, very well. All the innovation we've done there, which basically remaining water, in terms of steaming, in terms of buffet, in terms of school district, in terms of quick serve. I think the rollout we spent is literally a tribute to what induction at CookTek has done in terms of patented technology to eliminate steam tables the way they use a lot of water and a lot of cleaning and a lot of energy. So I'm very excited about those products as I move forward. I kept on talking about the traditional SPINFRESH. We talked about WOW! Ovens. I am very excited about what we've come up in new technology has come through. On the Food Processing side, I'm very excited about our bakery product, which are state-of-the-art technology. I'm very excited about the integration that we've done between Drake, Cozzini and Alkar. I'm very excited about our packaging technology and the RapidPak. And I think the biggest thing that we've done over the last 2 years has been to be able to take our automation, our conveyorized system and make some compact so that we can put some smaller factories around the world. It's been fantastic because one, not only we changed the layout and as well as the pricing, so while retaining our margins. And this has been a great, great accomplishment by our Food Processing engineers. So I'm very delighted to see how we've been able to go and take a system that used to cost, let's say, $4 million and now we can do it for less than $1 million, in a smaller footprint and still makes the margins and even higher margins and have a lot of customers excited about that product.

Operator

Our next question is from Joel Tiss with the Bank of Montréal.

Joel Gifford Tiss - BMO Capital Markets U.S.

Just, can you talk a little bit about the industry backdrop? How much pent-up demand is out there? And I think you have pretty much covered what your customers are really focused on. Just give us a little more color around some of that.

Selim A. Bassoul

I can give you a lot of color because I've been spending a lot of time with customers, visiting a lot of them. I've been looking at their releases the way you have. I look at the restaurant business as being extremely strong. I would say 2013 will remain very strong for our customers. Just to give you a little bit of same-store sales and growth increases in example. Starbucks reported 7% same store sales in the U.S., 30% growth in Asia. Chili's is around 3% same-store sale in the U.S. Chipotle is around 5%, with a 12% unit growth. Domino's, and I can add to it Pizza Hut and Papa John's, they are almost in the same realm -- around 3% to 4% same-store sales in the U.S., 5% same-store sale internationally. Domino's is expected to open, in 2013, 415 new stores. We talked to Papa John, I think they expect to do maybe 300. Yum! Brands, Pizza Hut, Taco Bell, KFC, showing 6% same-store sales in the U.S., 4% same-store sales internationally. Bloomin' Brands, which is Outback, Bonefish, Carrabba's, 4% same-store sales in the U.S. Those are just a sample of restaurants that have reported. And I have to tell you those are phenomenal numbers. When you look back at as far back as 2010, those were negative territories for many of those customers, maybe except Chipotle and Starbucks. But Domino's was not reporting 3% to 4% same-store sales. YUM! was not reporting 6%. Bloomin' Brands was nowhere close to 4%. They were flat or maybe at best 1%. So if you look at what's happening in our restaurant business and our customers, they are really finding the formula to attract people coming in. I have to continue saying that chains figured out a way, whether through advertising, through kitchen remodel, through new menu items, to literally bring in what I call new customers. And I think that this has come at the expense of 2 things: one, if you're a mom-and-pop and you're not able to leverage your capital to change your kitchen, you're out. If you're a badly managed company and I think through the last few years, I mentioned between 2009 and 2010, 125,000 restaurants closed in United States. A huge number, around 15%. So the bad operators are out. So from a Middleby standpoint, every one of those customers I mentioned we do business with. We're well -- very strongly into those chains. And I look at this, I can add Dunkin' Donuts, I can take -- I can add a lot of other customers where they have figured out a way to say, "Okay, I'm not going to grow because the market is going to grow. I'm not going to go out. I have to go and figure out a way to make sure that those people are going and spending the money here and not spending it eating at home." And I think they've done a great job. I am very, very impressed by what they've done. I can give you a great example. I was stunned when the pizza chain offered a $10 pizza. People say how could they do a $10 large pizza? And I have to tell to, it's been very successful for Domino's because they figured out a way to offer a $10 pizza and make money offering a $10 pizza by selling up, by offering other things. So I think our operators, if you look at the restaurant business, I think the next few years, it's a great business. It's a great investment for us as suppliers. It's a great investment to look at because it's good running in operations, leaders in management and restaurant business, must know how to run a business today. They're going to most spend the money, they're going to force their franchisees to be consistent, they're going to basically even if the franchisee can't afford it because they can't get bank loans, the smart ones are going out and saying I will fund, I will bank or fund this, the kitchen remodel. I think Papa John's did the same thing when they introduced WOW! 2. I think they are coming back, say, I don't care. If you can't afford it, I'm going to basically fund that kitchen remodel. I'm going to help you be successful. I think that's been a very, very good thing for us.

Joel Gifford Tiss - BMO Capital Markets U.S.

That's excellent. Can you just add on to that a little bit about the competitive landscape as well? Some of your competitors are highly levered and some other ones are part of bigger companies. And I think the string of acquisitions maybe indicates that some of the competitors are getting a little, like maybe they don't have enough in their arsenal to be able to compete against you so they're selling out. So can you just give us some -- what you're seeing on that?

Selim A. Bassoul

I would say, I think the competitors, I want to respect them because at the end, they work hard and they do a very good job. I think that some of them have great brands and they work very, very hard. I think the difference between our business model and our competitor is simple. We are totally focused on the hot side. In many ways, we are smaller, still a smaller entity so we can navigate a little bit better. We are not part of other things. I think that makes it -- we get up every morning knowing that if we do not sell to our restaurant business, we don't have any other thing that will offset it. So I can't -- some of our competitors are so large that, okay, foodservice is important, but is it critical to them? No. It sets a very big mindset. So if you are a company that's $20 billion or $25 billion and you have a foodservice division that's almost $2 billion or less, that's 10% of the business. Their CEO doesn't get up every morning and say, okay, how is foodservice doing? I get up every morning and say, how connected I am to my customers? If my customers don't like us, I'm not diversified enough to go back and say, well I can go and do other mixes. Number two, I think innovation has been a bigger part of our business versus bundling. So many of our competitors have more than just hot side. They have dishwashers, they have refrigerators, they have mixers. So they can offer a total solution, which is a big thing if you're looking for a price discount. In my case, I can't come to somebody and say, listen, you don't need to go somewhere else. I can only sell in cooking. So I have to be so good at what I do that they are willing to break up the package and tell my competitors, listen, I will buy the dishwasher from you but I'm going to buy the cooking from Middleby because they have such an innovative technology that I'm willing to pay extra for Middleby. The other situation we do is we have walked away from pricing discount. We do not do price discounting. We are most probably -- and if there are customers listening to this, I hate to say it, we are more expensive than our competitors in many of our platforms. And the reason is we provide payback. It's one thing to be more competitive but in the end, if we offer payback, we guarantee payback. That's why we've been working on all those outdated products to say to me it's important. Price becomes irrelevant if the cost of ownership is less than my competitor. And we can validate it, we can demonstrate it. In addition, I have a No Quibble warranty, I am very connected to my customer in terms of sitting with them and providing solution. The CEO of Brinker didn't come to us, saying I want a price discount. He said I want to take people out of my kitchen so I can reallocate it somewhere else. I want to get speed and consistency and he went to everybody. And we were the people who came up with a solution. And I think I come back and I say every day that our difference is we live and die by our focus and I have no luxury. I don't have any fallback position. If we upset our customer, if we turn around and not have the loyalty that you provide and the innovation, I can't sell something else. I can't go and sell automotive or construction equipment to them. And that's the biggest difference.

Joel Gifford Tiss - BMO Capital Markets U.S.

And I hate to take up so much time but in the past, you've talked about areas of opportunity like in beverages and you used to talk about steam tables before you got the induction business. Can you give us some highlights of what some of the areas of opportunity you think are out there for you?

Selim A. Bassoul

Yes. We are looking at 4 areas of opportunity for us that continues to be very, very strong. I look at, number one, the area of what I call steamer. The steamer is a big category that it will be as almost a nonplayer. And we wanted to disrupt that technology. So one thing we've done is we've come in with a waterless steamer that allows to basically steam with minimal water. So we are in tests now with one of the chains where they are spending 350 million gallons of water a year across their system. And with ours, that gets eliminated. And the product quality and the consistency is the same. So that's a highly patented technology that allows us now to target the steamer market aggressively. And that's a patented technology that we've been working on. And I have mentioned many, many times that I like the steamer business because steaming is in every almost -- in every -- in casual dining, in fast casual and something that's very large markets. And we disrupted it. Number two, our ventless technology where it's embryonic. We started the ventless technology in around 2006. Today, we see that to grow double-digit growth for us for the next 5 to 6 years as we continue investing in it. Number three, our fryer technology where -- between the low volume oil fryer and the SPINFRESH is getting some traction and we see that platform to be a multimillion dollar platform for me. Finally, our Hydrovection initiative, which is our combi oven initiative, which is very different than a traditional combi oven. I see this to be a fast-growing for us. I think that we have not been a major player in the combi oven business, and now we are a serious contender in that business. And then finally, of course, is the casual dining revolution, which was started with Chili's and Brinker, and they made us a better company, literally, over 2 years of working with them, we got to tweak everything we could tweak in terms of installation, in terms of implementation, in terms of training, in terms of adding menu items, in terms of consistency. So I have literally, I said 4 initiatives. I have 5 initiatives from a product innovation that looks very good for us. And we're very excited about that. And on the Food Processing, we continue seeing the following: I like to continue seeing 3 things that help us get there, one is to continue expanding our protein offering, that's number one. I see that as a very major thing for us. As we continue offering an integrated solution that comprises automation. So we can integrate back of our equipment. Because it used to be only in the oven. Now with Cozzini, we are basically sitting before the oven and I would like to continue seeing that. I'm very excited about taking our robotic technology and that we have Auto-Bake and start taking it into some of our other Food Processing technology. And those are the type of things that I'm looking at right now.

Operator

We have no further questions in queue.

Selim A. Bassoul

Well, I would like to finish to say that I look forward our -- to what we've done for the last few years, and as we look forward to a 2013, we are very excited about our domestic Commercial Foodservice business, as well as our emerging markets. I would say that Europe will continue to be challenging for us, as well as the foreign exchange that will most probably continue to be a challenge in the near future.

On the Food Processing, we'll continue to see sales growth to continue going up, and we continue seeing also the chain rollout that we talked about increasing. We also see sales internationally other than Europe. I think we'll continue being challenged in Europe in 2013 and maybe part of 2014. But other than that, emerging market, Latin America, China, India, Middle East, we see our business continues growing double digit growth.

So overall, as you look at our organic growth, we continue to see literally somewhere between 5% to 8%, 9% organic growth despite the European softness. In addition, as we look at our margins, our Food Processing margin will continue going up as we consolidate some of our operations. Our new products as they continue to be seeded today, they are around 25% of our business. As we continue putting new products that carries 5% to 10% higher margin will drive our gross margin higher.

We continue to see the chain rollout, which allows us to also provide higher margin for us, since most of those chains are going direct without prep [ph] interference. So from that perspective, we continue to see our margin getting better in the next 2 to 3 years. As we near 2016, we see incremental improvement every year in our margin. Our investment in national accounts. When the recession occurred in 2009, everybody cut back. Despite the fact that our sales organically went down significantly, we continue investing in our national account at the level of multimillion dollar investment in people, in travel, in training, in test kitchen. We expanded our people in emerging markets and we opened test kitchen around the world. We also instituted training or global training called Middleby Universities around the world. Our loyal customer strategy has been a huge success, where we have built a special relationship between our dealers and our customers using our equipment.

Our R&D program into innovation has been so well received by our chain customers where we are focused on application technology, where we customized that technology specifically suited to a specific problem. Chili's, Panda Express, Dunkin' Donuts and I can name many. We have refreshed our outdated product. It was in our portfolio. Now our outdated product accounts for around less than 15% of our overall portfolio compared to over 50% in 2009.

We are invested significantly in engineering and working with our suppliers and in features and benefits to make sure that those products generate value proposition to our customers whether it's in energy, in speed, in consistency and most importantly in payback.

Our integration of our acquisition has been making sure that it's accretive and making sure that the integration go smoothly so we can reach the margins that we expect from Middleby that we've incurred over the last 10 years.

On the Food Processing side, we see increasing margin to close the gap to foodservice. Our quality across our total portfolio has improved as reflected in our warranty rates. We have put in place a unique quality control process across all of our divisions. Since 2009, we have added features and benefits on our product but we have kept our eyes on quality. In 2013, we have still a few products and a few divisions that are going through this rigorous quality control initiative that will be completed somewhat by July of 2013.

Our lead times and our delivery have come down this year. We have had a few divisions still left that has to go through a certain lead time initiatives in order to be able to meet our standard of delivery and lead time, not only in the U.S. but across the world. And that will be completed also by July 2013.

I thank you for being with us today. That completes my remarks.

Operator

Thank you, ladies and gentlemen. This conference has concluded.

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Source: Middleby Management Discusses Q3 2012 Results - Earnings Call Transcript
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