The Middleby Corporation (MIDD) Q2 2018 Earnings Report, Transcript and Summary

Thank you for joining the Middleby Second Quarter Conference. With us from management today are the Chairman and CEO, Selim; Chief Financial Officer, Tim FitzGerald; and Chief Operating Officer, David Brewer. We will start today's call with remarks from management and then open the line for questions. [Operator Instructions]. I'd like to now turn the conference to Mr. FitzGerald.

Good morning, and thank you, everybody, for attending today's conference call. I'll make a few remarks on the financials and then pass it over to Selim here. Net sales in the 2018 second quarter of $668.1 million increased $88.8 million or 15.3% from $579.3 million in the second quarter of 2017. The second quarter sales include the impact of acquisition activity not fully reflected in the prior year comparative results, which accounted for $84.1 million or 14.5% of the sales growth in the quarter while the impact of foreign exchange in the quarter added $6.7 million or 1.2%. The adoption of ASC 606 increased net sales by approximately $0.4 million primarily related to previously recognized revenue on long-term equipment sales contracts at the Food Processing Equipment Group. Excluding the impact of foreign exchange, acquisitions and the adoption of ASC 606, sales decreased 0.4% for the quarter. This included an organic sales increase of 4.3% at the Commercial Foodservice Equipment Group. Our net sales increased 2.1% at the Residential Kitchen Equipment Group and a sales decline of 21.9% at the Food Processing Equipment Group. The sales at the Commercial Foodservice Group for the quarter amounted to $414.1 million. Excluding the impact of acquisitions, net sales at the Commercial Foodservice Group increased $16.6 million or 5%. This included $2.1 million of favorable impact on exchange rates. The organic sales growth reflects improving sales with major restaurant chain customers, including the benefit of rollouts with major chain and retail customers, which began in the second quarter. The sales at the residential group amounted to $160.4 million. Excluding the impact of foreign exchange, net sales increased 2.1% at the residential kitchen group. We continue to see strong order rates at Viking. And sales increased here over 20% for the quarter in comparison to prior year period. We also realized positive mid-single-digit growth at our other domestic residential brands, including Marvel, U-Line and Lynx. This growth domestically was offset by lower sales at AGA, which continued to be impacted by market conditions in the U.K., driven by uncertainty related to Brexit. Additionally, non-core AGA businesses have continued to impact the segment negatively as we continue to complete restructuring initiatives related to these businesses. And these businesses adversely impacted sales growth by approximately 2% for the quarter. The sales at the Food Processing Group amounted to $93.6 million. Excluding the impact of acquisition, sales decreased 20.8%. Excluding the impact of foreign exchange, acquisitions and the adoption of ASC 606, sales decreased by 21.9%. The sales decline in the quarter reflects a strong prior year comparison and quarter-over-quarter fluctuations, driven by the timing of larger projects. We did realize improving order rates as we went through the first half of the year. And this should translate to top line growth for the second half of the year. As it relates to the gross profit, the second quarter, our gross profit was $250.8 million, which was an increase from $234.6 million in the prior year quarter. The gross margin rate declined from 50 -- from 40.5% as compared to 37.5% in the prior year period, which reflects the impact of recent acquisitions which diluted the margin rate, which excluding the impact of acquisitions would have been 39.2%. Gross margin during the quarter at Commercial Foodservice Group was 39.1% as compared to 41.2% in the prior year quarter, primarily related -- the decline primarily related to acquired businesses with lower margins. Excluding the impact of acquisitions, gross margin rate at the Commercial Foodservice Group increased to 41.8%, slightly higher than the prior year. We anticipate with the recent acquisitions, we will realize synergies within the group and expect the margin expansion to continue over the next year as opportunities within those businesses are fully realized. Gross margin at the residential group was 36% as compared to 39.8% in the prior year period. Gross margin at the residential group were impacted by several factors, including lower sales volume at AGA and sales investments which continued to be made at the Viking brand, including increased displays as we introduced products for display at our dealer partners. Additionally, we continue to complete our transition of domestic distribution activities for our brands through our company-owned Middleby Residential distribution business, which was largely completed in the quarter. The gross margin at the Food Processing Group was 35.5% as compared to 41.6% in the prior year quarter. This primarily reflects lower sales within the group in addition to an unfavorable mix impact as sales declines were weighted to some of our most profitable business units. As it relates to selling, distribution and general and administrative expenses. During the quarter, those increased to $135 million from $121.6 million in the prior year quarter. The second quarter of 2018 includes $16.7 million of incremental expenses related to acquisitions completed within the past 12 months. This included $2.6 million associated with noncash amortization expense. The increase also included the unfavorable impact of foreign exchange rates in the amount of $1.5 million. These increases were offset by reduced cost related to cost reduction initiatives that we implemented over the last 12 months period. Provision for income taxes in the second quarter amounted to $26.6 million at a 24% effective rate in comparison to $38.6 million at a 33.2% effective rate in the prior year quarter. The tax rate in the second quarter was favorably impacted by the reduction in the federal tax rate from 35% to 21% due to the enactment of the Tax Cuts and Jobs Act of 2017. Earnings per share amounted to $1.51 for the quarter as compared to $1.35 in the prior year. EPS for the quarter included $0.06 related to restructuring activities, largely related to the AGA businesses. EPS also included $0.06 related to higher professional fees due in part to the Taylor acquisition. Cash flows generated by operating activities amounted to $102 million for the quarter as compared to $39 million in the prior year quarter. And for the first half, operating cash flow increased to $146.6 million as compared to $86 million in the prior year first half. Noncash expenses added back and calculated in operating cash flows amounted to $20 million for the quarter, which included $8.5 million of depreciation expense and $9.8 million of intangible amortization in addition to $1.7 million of share-based compensation. The company utilized $7.6 million in the quarter and $24.2 million in the first half to fund capital expenditures primarily related to investments in manufacturing equipment and enhanced production capabilities, including real estate investments to purchase certain manufacturing facilities that have been previously leased. Net debt, defined as debt less cash, at the end of the second quarter amounted to $1,974,000,000 as compared to $939 million at the end of fiscal 2017, which reflects the funding of the Taylor acquisition. And the company's net debt-to-EBITDA leverage ratio at the end of the quarter on a pro forma basis was approximately 3.2x. Now during the quarter, we were obviously very pleased to announce the acquisition of Taylor, which closed in the last week of the quarter. Taylor added $11.7 million to revenues in the quarter and $0.02 to EPS. We are working closely with the Taylor management team on integration plans and growth opportunities. As it relates upcoming quarters, we anticipate that Q3 will be somewhat impacted by operational transition and related costs as we separate that business from United Technologies. And this includes the transfer of manufacturing operations in China to a Middleby facility. We anticipate revenues in the second half will range from approximately $140 million to $150 million, weighted more heavily in Q4. And we anticipate that the historical EBITDA margins of 20% will be slightly impacted in the third quarter as we complete the transitional initiatives. And then the EBITDA margins are expected to improve in Q4 as the integration benefits are realized, which we expect should bring us to a 25% EBITDA margin run rate by the end of the year. Noncash depreciation and deal amortization, which is estimated to be approximately $31 million annually. In the third quarter, we also anticipate noncash fair market value purchase accounting adjustments to be recorded in the amount of approximately $4 million. Accordingly, we expect Taylor will be dilutive to EPS in Q3 by approximately $0.10 per share and neutral to Q4. And then as we move into 2019, we anticipate that Taylor will be accretive to earnings beginning in the first quarter. I'm going to turn the call over to Selim.

Good morning, everyone. I want to thank everybody, and I appreciate the patience they've had over the last 5 quarters as we made significant changes to our business. I am also a shareholder of the company as is Tim and David Brewer. And we understand balancing the short term and the long term. However, we made a variety of structural changes to Middleby that we believe have strengthened the areas that are the hallmarks of the company. It is not surprising and it's not a little blimp that when we made those structural changes, we knew that there will be a short-term disruption that will have a negative impact. However, we prepared the company for the long term. As you've been with me for a long time, without being arrogant or cocky, we have always tried to balance the short term with the long term. And we've been rewarded for this handsomely. However, during those changes that have been structurally the deepest we've ever done in the company, we've gone back to basically strengthening our innovation pipeline, our customer relationship, the most broad offering of products in the industry and world-class talent by upgrading our people, our sales force and our suppliers. We also enhanced our customer experience as we traveled around the country and internationally to hear from our dealer partners and our chain customers and our residential customers and architects and designers how to make our business easier to do business with as we got bigger and more complex. The last time I felt this way was in 2009. I have to tell you in 2009, when our stock was dropping and when a recession was taking hold right after the Lehman Brothers crash, we made investment in national accounts, in changing dealer relationships and significant acquisitions, including the acquisition of TurboChef at the time. I remember plugging in millions of dollars of investment in cash to do all those initiatives while our competitors and the rest of the world was holding cash and letting people go. While there has been some short-term costs in making these meaningful changes, we are confident that these are the right decisions for customers, for our Middleby employees and ultimately for long-term shareholder value creation. In essence, I can joke and say maybe we prepared, while it has been painful the last five quarters, for Middleby 2.0. Interesting enough, as I look to this quarter, and this is just the beginning of reaping the benefits and the fruits of what has been the changes that we've done, I am going to go back and go into each one of the segments and talk about our commercial business first and highlight the 3 specific results of our actions. First, ease of doing business, which is a big benefit to our customers and make us more efficient. As we've acquired more and more companies in foodservice, we became complex. We had almost 160-rep companies calling on our dealers, on our chain customers. And we would have 20 to 30 sales reps calling on the same customer with different brands of Middleby. So the sales force and rep consolidation has taken our reps from 156 to 37. Our reps no longer carry competing products and customers no longer have to speak to 10, 20 or 30 reps for all our products in commercial foodservice. So let me give you the feedback. I've heard from many dealers, our partners and many of our customer chains of how easier it has been today to do business with our new rep organization. Now I can admit to you that they suffered through the change, it was turbulent. They had to basically wait until our new reps were trained on all our products. We had to make sure that they have to learn new people, new phones, new numbers. But they stayed the course. And today, it's reflected in our positive growth, both at the dealer level and our chain level. Number two. So in addition to ease of doing business, number two is strategic repositioning of our company. We acquired QualServ manufacturing, a company that basically does fabrication and millwork. When we acquired the company over a year ago, it created a lot of noise within our distribution partners. Our competitors fanned the flames saying we've become a dealer competitor. Today, a year later, I have to tell you that all that noise has died down. In fact, our dealer partners and one of the largest dealer organization in the country has embraced and now is using QualServ in their projects. Why? How did it happen? We never intended to become a dealer. We used QualServ manufacturing, their ability and expertise in fabrication millwork to help us and help us partner in their projects to offer our customers help at the front of the house as well as the back of the house. This does not negate our dealer participation. We are helping our dealers and our chain customers solve their business problems at a different level. Now we're interacting with more senior employees and CEOs at the customer level and have become a key partner to help them achieve their objective through the QualServ manufacturing acquisition. And that's where the dealers took a year to come through. And proof in the pudding a year later, we basically honored what we always committed to, that we are a partner to the dealer community and a parter to our chain to bring an additional, added value in the equation. Number three. In addition to ease of doing business, strategic repositioning, we have become the best solution for the chains. The Taylor acquisition allowed us now to enter a key area of the market. Now we not only are in the position of offering the hot side, but we became a big player in beverage. This is critical to the chain. And that's where the margin and the growth are happening. We can now offer the chain all the key products they need to complete, a complete package in the kitchen and in the front of the house when they offer beverages. In essence, the last 5 quarters between the restructuring our sales force, the acquisition of QualServ, the acquisition of Taylor makes us well positioned for Middleby 2.0. These changes effectively allow us to help our customers in a way we could not have several years ago. We can help them in all aspects of their business in a way that gives them an incredibly high return on investment and makes Middleby a key partner to drive down cost and accelerate their growth. Over the long term, we expect to see organic growth in commercial accelerate to levels of 6% to 8% organic growth, which is back to where we used to be. Now I'm going to move to residential. Residential has been a long way coming for all of us. We got -- we bought a company that has quality issues, service issues, that has a lack of innovation. And we fixed it almost three years ago until we faced a recall of 60,000 ranges that set us back, set us back tremendously for another two years. So where do I see residential strategy? We view this as a much bigger market than commercial, which has had very little innovation in that segment. We have spent considerable time on our residential brands. And we bought several additional companies as we moved forward. We starting with Viking. Now we have the best barbecue and outdoor grill company in the world, Lynx. We have the best under-counter refrigeration company between U-Line and Marvel. We have the best European brand of ranges, AGA and Rangemaster. And we have the most luxurious brand of ranges in the world, La Cornue. We have spent considerable time on every one of those brands. And now we believe that the quality and the innovation in each one of those brands are consistent with that of Middleby brand in commercial. And we are industry-leading. We see an opportunity to continue innovating and enhancing our brands, which can generate higher margins than in commercial. So in that thing, let me give you some ideas. We took TurboChef technology, speed cooking, into Viking. We took our Volcano burners both into our Viking operations, into our Rangemaster. And now we're taking it to La Cornue. Those are patented burners that we've used for a long time in commercial, that are non-plug burners that have been so efficient and deliver an amazing blue flame, irrespective of type of gas and the velocity of oxygen. It basically self-balances itself. We have used BlueZone technology in our refrigeration. We have now [indiscernible] in our ovens. So our residential business is today on its very strong legs. We have turned the corner. In food processing, we see bakery, our meat processing, specifically in bacon, chicken and protein, our pet food introduction two years ago as meaningful opportunities. I can tell you today that we have one of the strongest pipeline of orders and back orders now going into the second half of the year and to 2019. I'm going to [indiscernible] to give you a little bit of color on the Taylor acquisition. The Taylor acquisition is a company that we've been trying to buy for many, many years, a gem of a company with an amazing management team. This is not a distressed company. It's a company that had amazing customer loyalty. It's a global brand. It adds a significant brand awareness to the portfolio of Middleby. It's a large acquisition. It allows us to penetrate customers that we've never had. And we've seen that happening even in the first months, where we've seen an integration of customers that have never been knowledgeable of Middleby are now coming to Middleby. And people who have been knowledgeable of Middleby are coming to Taylor. We see significant client wins that will be mentioned in the coming quarters. So what's happening today is we're starting to win customers that we've never had. Our innovation is allowing to win this. So I want to come back and talk about our pricing strategy. In Middleby, we've never changed our pricing to gain market share. I'm not saying it doesn't happen here and here by some of our zealous salespeople. But it has not been a consistent strategy that was dictated by corporate. And we monitor our pricing significantly. The reduction in EBITDA that you've seen has nothing to do with our pricing model. We continue to be the leading in pricing, both in the residential and in commercial and in food processing. And we offset our pricing superiority by our innovation. People are willing to pay for our innovation and the fact that we provide a return on invested capital for them. Our payback has always been something we tout and we measure and we're very proud of. Going back to another situation, which is our free cash flow. Our free cash flow generation continues to be amazing at this company. This is something that we continue to leverage, measure and monitor. And at this moment, we continue even in this quarter to generate significant free cash flow, which brings me to some headwinds, steel and tariffs. On the steel situation, we have been able -- this is not the first time that we've encountered steel price increases. In general, we've been able to offset them with our price increases. And our customers understand that situation. The same happened this year. Steel has not impacted us that much this year as well as tariffs. It's unclear what the tariffs will do for us. It will most probably affect everyone in our industry in the U.S. I would say that the negative impact of the price increase might be offset by the cheaper inflow of Chinese products that have inundated our market today. We have been impacted slightly by the Chinese imports on some of our legacy products or some of our commodity products that have not been as innovative. So somehow, somewhere, we look at tariffs one way or another to be neutral for us. So if tariffs are imposed, we'll most probably incur some additional costing from our supplier from China. And we're going to have to most probably resort back to the U.S. suppliers. However, it will stem some of the inflows of Chinese imports that have -- that I call them copycats. Let me finish with addressing the complexity of the organization that many of you think we would become too big to win. In fact, as proven in this quarter and prove in the next quarters to come, the complexity of our organization remains something that we've kept an eye on. And that's why the last 5 quarters, we made structural changes. We've gone back and simplified the way we do business. We've gone back and, in fact, simplified our management organization at all levels. We have also been able to effectively allocate resources and manage our customer experience in a way that allows us today to win again. So to give you some color on this, this year in 2018, I'm proud to report that we have at least 10 new customers that have come our way that are new customers, large chain customers that have come to us and we've won them over some competitor. And I'm going to let Dave get into more details on specifically how we did that and what we've done. But when you talk to those new customers that have not been a Middleby customer today, they don't know customers -- Middleby before and Middleby today. But they will tell you that ease of doing business from the first initial contact, whether it's our national account or our new rep organization or customer service and dealing with a complete project, whether it's TurboChef, CookTek, Pitco, Blodgett, Southbend, Jade, Wunder-Bar, Concordia, have been easy to do business compared to their existing customers -- existing suppliers they've used before. This ends my prepared comments. And I will turn it over to questions and answers.

[Operator Instructions]. Our first question comes from Joel Tiss from BMO.

So I just wondered as long as I have you guys here for a second, can you talk, Selim, a little bit? It seems like the restaurants have been spending a lot of money on the front of the house. You can order on your phone or on your computer, whatever. But it's not connected to the equipment in the back of the house. And that seems to be the next level that everyone's looking for to really accelerate this shrinking the employees, improving the food quality, all the things that you guys are moving toward. Can you just give us a sense of how far away a solution like that is? Or is that a misperception that maybe there's other things that are happening and that's not exactly right?

So let me give you a macro [indiscernible]. The trends in our customer base have started to improve. So in general, trends favorable to the equipment supply side of the house or the kitchen side is starting to improve. I would say [indiscernible] that the last -- I would say the last two years, customers, especially the large chains have been involved in better texting, better ordering online. They were concerned about the Blue Apron -- [indiscernible] gone, by the way, just to let you know. And everybody, if you go to customers, they were all concerned about, "Okay, is Blue Apron going to eat my lunch? Is it the grocery store? Is it the convenient store? What's going to happen?" So they were totally distracted by trying to -- the C-suite of the restaurant chains were distracted by all those elements. And they built a business to compete, whether it's delivery and take out. And now starting in 2018, we started seeing trends toward back of the house, where they are looking back at equipment and menu changes. And when it comes to menu changes, Middleby, it's the heart of what we do. We win on menu changes. If you look at almost every restaurant that had a menu change, Middleby is at the heart of it. They have to use an innovation of Middleby. It's faster, it's quicker, it's more reliable, it lasts longer, it's easier to integrate. However, I'm going to turn it to Dave to talk about it because I think, Joel, Dave has been more involved with it as he heads the national accounts. Dave?

Yes, I think that's a great question. Probably in the last 90 days, I had work sessions with no less than 20 of the top global chains with the top 3 people -- or 1 of the top three people. And I didn't -- I'm not talking about meetings, I'm talking about going in stores, walking into restaurants. And what you're talking about, the connectivity of the customer and order entry, is pressing through the POS system and then into the back of the house. So it's kind of -- you're talking about kind of an SAP system for the back of the house. And I'll tell you right now, Middleby leads as an organization the industry. I think we have -- I can show examples over 1,000 stores. Now relative to the industry, that's teeny, tiny. Relative to our competition, we are far in the lead of connectivity around back of the house to kitchen equipment manufacturing from a foodservice perspective to the POS. So the process is great for Middleby and great for our industry because as the front of the house takes on the capability of taking in more orders, that presses the manufacturing process in the kitchen to need technology and automation and innovation for speed of service, food quality and labor reduction. And that just -- I mean, that falls into right to our bull's-eye of capability as a corporation. It's actually a lot of fun. The last 90 days has been great, specifically strategically around the point you're making.

Okay. And then just a follow-up, can we just peak under the covers a little bit at food processing? And it seemed like early in the year, you had a lot of stuff percolating, especially in the bakery area. And can you just give us a sense of do you have your full product lines across the areas you're targeting? And what are the customers saying? And maybe what does the pipeline look as we go '19, '20, '21, like out a couple of years?

I will say on food processing, I will tell you, at one point -- well, it's a lumpy business. Let's start with the lumpy business, cyclical business that generates phenomenal returns for us. So when we hit the numbers, it's very good. And I think part of the EBITDA drop has been because the volume in our food processing was pretty low and the product mix hurt us. So specifically, when people want to figure out from an analyst standpoint, is it -- are we discounting to get the business? I will tell you that on food processing, we've seen some discounting among our competitors. And we worried about it because we decided not to discount. But what happened is [indiscernible] we see customers coming back to us. And that's how the backlog came through. And I think Middleby has had a formula over the 20-plus years of being here that if you take care of your customers -- and we're not perfect, we've made mistakes and we've fixed mistakes and we've taken care of them at our own cost. And that's where the No Quibble Warranty comes in, in every sense of the way. We've had it, it's printed, we've done it. We've done it on residential, we've done it on commercial, we've done it on food processing. So the question goes back is the fact that we have stuck to our principle of if you discount at the beginning, there is not enough money at the end and margin to take care of the customer in the long run. You start cutting back on your service level. You cut back on the way you innovate. You cut back on the parts you buy because now you're buying cheaper parts to make up for your margin. As long as I've been CEO and our team together, we've basically walked away from that. And sometimes, it's tempting to [indiscernible] and discount to get that big order. And we've basically been reluctant to do that. And sometimes, when you go in the marketplace and you talk to people and to customers, they say -- or the competitor, they say, "Well, we're winning and Middleby is losing." It could be because we walked away from an order that has margin implication for us because we will not be able to service the customer in the long run. Our equipment on every one of our segments, whether it's food processing, commercial or residential last over 20 years, I tell our customers if they want to buy a cheap product, they will have to deal with cheap service after the sale. For us, we're going to be there with them for a long time. We take care of them. And that's why over 20 years at Middleby, a leading company, we've had repeat and repeat customer. And that's why we've won 10 new customers in commercial this year, 10 new customers. And I feel very strongly about food processing coming back. It will come back. It's a bit lumpy. So I want to tell you our investor base, our analysts that this is a lumpy business. We like it the way it is. It generates a lot of -- it's been with us now since 2000 -- Tim, when did we buy it, 2005, 2006?

Yes, 2006 is when we sold the ALKAR...

So 1two years later, we still are enamored of our food processing platform.

Our next question comes from Tim Wojs from Baird.

So just a couple of things I wanted to kind of ask about. I guess, first, on the commercial business, Tim, I just wanted to kind of clarify a little bit around the margin comment. I think some of the acquisitions, particularly QualServ, will start to anniversary here in the third quarter. So were you saying kind of reported gross margins would kind of be higher on a year-over-year basis as we go forward? Or is it just to underline that you continue to kind of improve and you still have that kind of acquisition mix headwind to think about?

Yes. I mean, the underlying margins actually improved. I think both gross margin and EBITDA went up. So it's the acquisitions that drove it down. QualServ, as you mentioned, is a piece of it. We're going to have Taylor rolling on, right, which is a larger piece. So that's going to dilute both the gross margin and the EBITDA. But I think fundamentally kind of boats all are rising. So the base margins of our long-term business, those are expanding as we're starting to see some top line growth again. And then obviously, with the new acquisitions that we've completed over the last year or two years, those margins are improving steadily. They're still maybe lower than the overall. So they're diluting, but they're coming up as we realize benefits in integration activity. So Taylor, we'll now layer in and we'll see the benefits of that as margins rise over the next year. But we'll also pull back. And that's kind of been the story here at Middleby, where the margins kind of -- they stay around the same level. But as the new ones come in, they're always -- we improve them pretty quickly.

Okay. And then just around some of the steel and tariff costs, it sounds like you think those are manageable. Do you feel like you have enough price kind of in the market to be able to offset that? Or do you think you'll have to, over the next 12 months, kind of push through some more price to offset those headwinds?

Yes. So the answer is it's a headwind, right? So we have the tariffs coming on steel in the first half. We implemented a price increase generally at most of our brands. That's kind of going into effect in the August time period. So steel was actually a little bit of a headwind. And that was a little bit of the margin detraction that we had across all of our segments in Q2. We'll start to overcome the steel piece in Q3 with the price increase that we had. And we would've covered that. But now we've got kind of the second round of tariffs coming in, in a lot of component parts. So that is going to be a headwind. We're still kind of getting our arms around that. But that's probably a $10 million to $20 million type number annually. So realistically, probably it won't have as much of an impact in Q3, but some. And then accelerating into Q4, there's still a lot of moving pieces and we're still trying to get a handle on it. I think we will be able to offset that with price increases. But that's going to be a lag, too. So realistically, it's going to drag in the back half of this year and then it will be 2019 where we can kind of get in front of it again.

Okay, great. And then just -- I know it varies by customer and by project. But when you think of kind of the chain rollout relative to maybe growth and maybe, call it, on a day-to-day business, but are the margins with some of the menu change rollouts better than kind of your core margins, just given the products you're rolling out? Or does it really vary across the backlog?

It's comparable. I mean, I think again as we have -- I wouldn't necessarily call it chain versus non-chain. But I would say is we've got new technologies that are coming up that are -- Selim talked about adding value to the customer. We're heavily focused on ROI. So generally, our portfolio is moving to higher technology over time and that's been a long-term trend. So that does have a margin benefit. So it's not customer-specific, it's really more product initiatives.

Okay, it sounds good. And then just last question for me. Just as we think about growth in kind of the back half of the year in commercial food, I think it was 4% kind of ex M&A and ex FX in the second quarter. The comp has been a little tougher. So relative to the -- I think, Selim, you commented that growth should improve in the second half. Should it improve relative to that 4%? [indiscernible] comparison, just any sort of color there would be helpful. Good luck on the second half.

Yes, thanks, Tim. So I think overall, if you look at first half versus second half, we certainly expect improvement. Obviously, Q2 is a step-up from Q1. I think it's -- the chain timing is kind of always very impactful to us in how growth lays out quarter-over-quarter. So we saw some of the improvement there as we talked about. In Q2, I think we see kind of a steady second half. It probably steps up more in Q4 relative to Q3, which I think we're kind of thinking of as kind of a steady continuation of what we saw in Q2.

Our next question comes from Jamie Clement from Buckingham Research.

So Selim, I was thinking back actually over the last 4 or 5 quarters when you talk about the growing backlog and all the testing that's been going on by some big chain customers, both preexisting and new customers, a lot of the discussion on the earnings conference calls had been around automation and labor costs and obviously still energy costs and water costs and all those kinds of things. This call, the topic of menu changes and food quality has come up a little bit more. So my question is has that been going on all along? Or has the new interest that you guys have been receiving from chains, has it focused a little bit more on the menu changes and on the food quality? And follow-up question there is can you give us some insight on how that stands with maybe some fast casual and casual dining customers, who in my opinion might need some menu changes?

So let me start first. This is a fantastic question because for me, this is the heart of what makes our commercial food -- our commercial foodservice division successful. And we'll continue to do what I call Middleby 2.0 that will grow very well in the next five years, starting in the second half of this year and will move on. Jamie, we've always been at the heart of what I call essentials, which are labor -- we've tackled labor and automation before anybody else tackled it. And I will tell you that when we tackled it in 2000, it was not a big issue. People say, "Well, I still can get labor." And then we kept on investing in automation more than anybody else. We invested, we bought companies in that, like Nieco that helped us even take the automation to the next level. We've gone into automation early on. We've gone into energy. If you remember, we were the first to talk about energy even then. And then we started talking about speed. Speed of -- I used to call it seconds and inches. So when we go to our customer, when I sat with CEOs of foodservice chain operations, I talk about seconds and inches. We're going to shave off seconds off your food preparation and inches off your kitchen. And seconds and inches end up being minutes and feet. But the question has been what happened to menu changes? It's an interesting revelation when I had several of my customers say to me, and that's happened this year, they said, "Selim, when we think of menu changes and we think about every division that has come into our existence and we introduce a new menu, you do that better than anybody else." And I think I would like to turn it to Dave because I think Dave can give a lot more color to this.

Yes, I think your point about fast casual is right on. We're obviously very connected to that segment. We're focused on them. We've been focusing on fast casual, which is in between that full service and QSR and you're struggling on the menu mix and new products. And I think the thing that we do and the reason that we're winning specifically around fast casual -- and you're exactly right, they need menu changes. But when we come in and allow them to add a menu item, an LTO or a permanent line item change, we not only allow them to do that. But we also maintain the quality of the food on their existing menus and we lower their labor. So I think it's the strategy of and. So we allow them to add a menu, change their menu and we lower their energy cost and we lower their labor cost. And when you put a couple ands on that statement, we are the obvious solution because they need that customer experience. They're looking for additional menu items, limited time offers. But they also need labor reduction. They also need food quality improvements and temperature of food delivered to the table. So we can give them those 2 or 3 ands that nobody else can.

Okay, I appreciate. Selim, if I could ask one more, very big quarter at Viking. Can you refresh us a little bit on the timing of kind of the recent refrigeration rollout at Viking, whether refrigeration is also selling better in addition to the ranges? Because obviously you had the big range recall. But I think Viking's reputation in refrigeration over the last couple of years had gotten a little bit spotty.

So I'm going to give you a complete flavor on Viking. I think you know and you've been involved with that because you went to visit many of our dealers. And you were most probably at the forefront as one of our analysts who cares about us. And you went out and started -- you remember at the beginning, we had quality service. And I have many of your messages that would say, "Selim, is Viking for you? Is it something that Middleby should get in?" And today, when I look back, it took several years of hard work. And I give credit -- again, I gave credit before to our team, I will give it again. I think our team, our salespeople in the field, our direct salespeople, our -- Scott Grugel, who's running our selling organization, Kevin Brown, Pat Hynes, Sue Bailey, I can keep on going, Jane Moss, Andy Doberstein, I can go on and on in our residential platform of all those people who've committed and became Middleby-like in terms of quality and service, ease of doing business, innovation. So what happened? Why I kept on telling you we will turn the corner? And some people started not believing because they said, "Well, it's taking too long." So yesterday, I had a chance to remind one of our board members that when we started in foodservice, and I remember right after September 11, we bought Blodgett, Pitco and MagiKitch'n. And that was an acquisition from Maytag, Maytag commercial. At that time, people did not believe that we've never made an acquisition. We borrowed heavily. We overpaid for almost what people assumed it was -- I don't know how much multiples at that time. And it was right after September 11. The markets were still jittery. People were not traveling. People were panicking. And we started changing those companies. They had been starved for innovation, starved for customer service. They were overloaded with overhead. They were basically not connecting to the customers. And in fact, I will share with you a story on we had just acquired Blodgett, Pitco, paid a lot of money. And in fact, the borrowing, if you remember, was high because we had to use a mezzanine borrowing at that time. And one of our largest customers at the time, Darden, fired Blodgett 2 weeks after buying the company -- after Middleby bought the company because they had nothing but issues. And that was their largest customer. Not only we buy the company, but also the #1 customer. It took us five years before we started winning again when we turned to foodservice. Viking took five years. It took a lot of time because they had the recall. The recall was probably the biggest hurt that we've done. It affected the brand. From issues we bought, this was not made under Middleby -- I want you to remember, the recall was not Middleby-induced, it was legacy that we inherited from the previous ownership. So what happened is we kept on innovating. We kept on going back to the field and we kept on stopping product because of fit and finish. If you go back and talk to our people in Greenwood, Mississippi, how many times I stopped new product that went out and I say I did not like the fit and finish, I did not like the way it was assembled, I did not like the way it looked -- similar to what I've done at commercial. If you go and ask, tell people I am anal about quality. And you know what, people talk about that. But this is the way how you win. This is the way how -- when you buy a Lexus or a BMW or a Mercedes, those people are anal about what they do. I want to be anal about what we did here. And the fact today, if you go and ask -- you go to P.C. Richard & Son in New Jersey, you look at what we've done. You look at our product, where it is today versus when we inherited or even two years after us buying it, we got the fit and finish. Now let's talk about refrigeration. Refrigeration was our Achilles' heel. And what happened today is we are -- refrigeration is the biggest driver of our growth. It's maybe not -- I will take it back, maybe not the biggest driver of our growth, but it's definitely a significant driver of our growth. We have not yet introduced -- we just redesigned the 5 series, which is going out right now. The 7 series just got launched. We have not yet launched the [indiscernible]. So we see refrigeration as our biggest opportunities to win.

And our final question comes from Larry De Maria from William Blair.

Selim, thanks for the color on the Viking there. Just curious, the 24% increase is -- do we view that as sustainable for the rest of the year, I guess? Obviously, you're getting tough comps after that, but -- And then is that sold through to the end user? Or is that go into the channel? And by channel, I guess, it's your inventory at this point, right, because it's company-owned. So just curious if that's sold through or if that's an inventory build.

Okay. Tim, do you want to [indiscernible] the inventory build?

Yes. So Larry, I mean, yes, we own distribution, but I mean, that is sold through. So I mean, those are sales that are going through our dealer partners to the end users. In residential, our dealers really don't carry stock. So those are pretty much orders that are flowing through. In terms of the order rate, we think that we're kind of in a period of sustainable double-digit growth. Obviously, 24% is a high number. I don't think we're projecting what that's going to be. But we feel that we've got a consistent step-up now at Viking for a period of time.

Okay. And then secondly, obviously, Selim, you noted that you knew short-term disruptions would occur and that would have a negative impact. And obviously, we also have some optimism in the near term on some of the previous calls. So just to clarify, do we think the short-term disruptions are over now, and moving into next year, we can get 6% to 8% organic growth? And secondly, as it relates to that, can you just maybe just give net pricing by segment for the quarter? Because you gave a lot of color on pricing, but just to hear the net pricing would be helpful. I'll leave it there.

Let me take a shot at that one. So yes, so over the hump, it's never done. So are we going to continue to refine and stay focused on the end user at the restaurant level or food processing at the customer level and the manufacturing plants or in the home at the residential or commercial at the restaurant level, then we're constantly going to fine-tune our ability to take care of the end user. But clearly, the reset of those organizations on how do we get our product and how do we take care of our customer, we're over the hump. Work is never done. But I think the results of the work that we did last year and the beginning of this year are being seen.

Let me add. So I'm going to break -- there's residential and there's commercial. we've obviously made changes in both. So just on the residential piece, as we've talked about, we're bringing all the brands through our company-owned distribution that we've built over the last three years. So you've got Marvel, U-Line, Lynx, which we pulled into our distribution, and La Cornue. So we are largely through those changes and there's still a little bit of lifting to do it going into Q3. But that was a disruption that we saw in the first quarter, a little bit in the second quarter. Certainly, we've got a little bit of work to do in Q3. But we start to really get more of the benefits of that as we go into the back half of the year. On the commercial side, I mean, I think you've heard that we're starting to see that initial benefits of all the changes made with the rep organization. Obviously, QualServ was a big disruption, which we do think that's largely in the rearview mirror. The reps though, I mean, we still have a fair bit of work to do. We're getting a lot of positive comments. Selim mentioned them. The strategic reasons why we did it, we know it's starting to pay off anecdotally from -- we're seeing specific wins. But there is still some disruption there as well. We've got -- we have some training to do. We've got some pockets where we got to basically fill gaps to make sure that we're covering all the brands. So I mean, it's still mixed right now. I think the takeaway is going into 2019, the strategy is working. We've got some bumps as we go through this year. But we feel very positive about this strategic move. On the net pricing, we have a number, we haven't really reported that before honestly. Our organization is big enough and complicated enough that it's hard to come up with an accurate number. That being said, we had steel as a headwind, right, in Q2 that had started to come through and we had none of the price increases, right? So net-net, that's a negative across all 3 segments. And the margin, probably most significantly felt in the residential because our volumes were up at Viking so much. So as we were buying steel later in the quarter, we probably got hit most in the residential segment. So we probably get to be net neutral in Q3, given price increases will start going into effect kind of absent the next round of tariffs coming through, which that will be again more felt in Q4.

So let me add to that a little bit more, Larry. I think Viking has turned the corner. I think whether it's going to be 25% or whatever it will be, definitely double digit moving into the second half of the year. Because that's what I would say, is very confident about that. I think it's now unstoppable. As you've just seen, we've had the fact to see somewhat of a little bit of preview in July. And it's been very, very strong. I would say that part of it is residential. So let me go to residential. I want to do the same thing I've done in Viking to take it back to AGA. So I guess I'll be spending a lot of time in Europe to take the AGA Rangemaster, which is almost as big as Viking, and make sure that we are instilling the same innovation, product knowledge and take them outside the U.K. So my challenge is most probably the next year, 1.five years will be focusing on AGA Rangemaster. It never happens overnight because you have -- even if you produce an innovation, you have to have it certified by UL and CE and all of what we need to do. But my comment is to take it to the Viking level and start seeing the same results we're seeing at Viking at AGA Rangemaster. And that's where I'm definitely I know what to do now. We've done it. It's a second act for me, so I'm taking there and getting done. So I'm ready to move to my closing comments. I would like to remind everybody that what makes Middleby unique is the fact that we are a leading hot side foodservice equipment supplier that has basically taken that expertise into the hot side of residential. We've taken that expertise into the bakery and baking food processing. We have the high operating margin, high return on invested capital and strong cash flow generation. Number two, we have a leading market share and a broad customer base. We're #1 and #2 position in nearly every product category we compete in. Number three, our pricing power is enhanced through our innovation and our brand recognition. Number four, menu-driven changes are fueling our growth in foodservice. And we own the fast casual segment in the sense that when it comes to menu changes, we are the leading supplier to that segment. In residential, we have become the leading or a leading player in luxury brands from outdoor to indoor to under-counter refrigeration to rangers to global. Then I would like to talk that our innovation is focused on ROI for the customer. Our new products on customer productivity, automation, menu flexibility and energy efficiencies are highly measured by our customers and they deliver exactly what we promise to do. In addition, I'm proud to say that we have the highest pipeline of new products that we've ever had in the past three years. So if you look at where we've come the last three years, we have the most innovative products going through at every level of the platform, whether it's residential, whether it's food processing or it's commercial. Our international presence and global service network, 35% of our sales in 2017 came from overseas. We have a strong penetration in several of the emerging markets. And we continue to be not represented in market share in those underserved markets. We have a lot of room to grow, whether it's in China or India or the Middle East, Latin America. Our international service network is bar none. We have invested heavily even in 2017 in our service organization, specifically in emerging markets. Our acquisition is a key supplement to organic growth. We have had a superb track record of integrating acquisitions and driving for profitability. TurboChef at the big level is a big example of it. You turn on and go to our beverage business, whether it's Wunder-Bar or Jade on a smaller level or [indiscernible] you've seen what we've done in profitability. Taylor will definitely be the next one that we integrate. As I look at the trends in our customer base, the trends are favorable. They are going back to reinvesting in their the kitchen equipment, in their menu planning, in delivery. So our investment in sales, distribution and marketing and our new product will lift sales in the second half and in 2019 across every one of our platforms. Our investing in our brand, including hiring new sales reps to basically going over our entire line of commercial foodservice products, where we've changed almost 80% of our product, to our showrooms in our residential platform to our streamlining our distribution and going direct in our residential distribution, our huge investment in displays in our dealer partner showrooms are paying off and started to pay off in the second quarter and will accelerate in 2018 in the second half and in 2019. So I'm very excited that our order trends continue to improve in each one of our segments as the quarter unfolded. This finishes my prepared comments, and thank you.

Okay. Thank you, everybody, for attending today's conference call. We look forward to speaking with you the next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This conclude the program. You may all disconnect, and everybody have a great day.