The Middleby Corporation (MIDD) Q2 2019 Earnings Report, Transcript and Summary

Welcome to The Middleby Corporation Second Quarter Conference Call. With us from management today are Chief Executive Officer, Jim Fitzgerald; Chief Financial Officer, Bryan Mittelman; and Chief Operating Officer, David Brewer. [Operator Instructions]. Now I'd like to turn the call over to Mr. Fitzgerald. Sir, you may begin.

Okay. Thank you, and joining -- thank you for joining us today on Middleby's second quarter earnings call. I have some initial comments about the performance and continuing initiatives at each of our three business segments, and then we'll turn the call to our CFO, Bryan Mittelman for some further commentary on the financial highlights. In Commercial Foodservice, we realized modest growth both domestically and internationally. In the domestic market, we realized growth in the general market as we continue to deepen our relationships with our channel partners. We're gaining momentum with our consolidated Middleby sales reps and are making investments in digital marketing, training and sales tools to support our combined efforts. Our pipeline of activities with the restaurant chains continues to develop in areas of beverage, delivery, rapid cook and ventless technologies. Although we have strong engagement and recent added product approvals, we have seen customer delays in timing of replacements and rollouts, which may extend certain anticipated 2019 business with some of these chain customers into 2020. Internationally, we realized growth in Asia and Latin America. However, as expected, we have continued challenges in the U.K., our largest market due to uncertainty related to Brexit and growing headwinds in China due to tariffs enacted on our products exported into that market. We continue to focus on expanding margins in the segment and are making progress and profitability across the numerous recent acquisitions, which are dilutive to profitability in comparison to our long-standing businesses in the segment and detracted from margins in comparison to the prior year second quarter. Most notably, we remain on track at Taylor as EBITDA margins have expanded to 25% from 19% one year ago. As part of our ongoing integration initiatives, we will be consolidating several manufacturing operations, which we expect to be complete by the end of 2019. We anticipate these consolidations will result in annualized savings in excess of $10 million for 2020. The impact of tariffs dilutive margins as we continue to see material cost increases during the quarter, particularly impacting our higher-margin aftermarket parts business. We have implemented recent pricing actions, which will take effect in the third quarter to mitigate these costs. We continue to invest in key strategic long-term growth initiatives related to technology, most notably related to our automation, controls and IoT initiatives. These incremental investments increased during the quarter and currently is at an approximate $15 million annualized operating cost run rate. With these investments, we have developed several automated solutions and are working closely with several customers on these opportunities. We expect to launch our new control platform across many of our high-technology products in 2020 with enhanced capabilities, ease of use and a common interface across Middleby product platform. We're also actively working to further expand our IoT platform and integrate the Middleby Connect and the recently acquired Powerhouse Dynamics SiteSage cloud-based platform. Our combined platform offers the most comprehensive solution for our customers to operate and monitor their restaurant operations and equipment, facilitating improvements in operations, food safety and profitability. We were excited to announce our recent acquisition of Ss Brewtech, a leader in professional grade equipment for small-scale craft brewing industry. This acquisition further adds to our growing beverage platform and allows us to capitalize on the growing popularity of on-site brewing in bars and restaurants and provides opportunities to expand into other developing beverage categories. At our Residential Business, sales continued to be impacted by market conditions both in the U.K., associated with Brexit and a slowing appliance market in the U.S. The appliance market in the U.S. has declined by 6% in the first half, impacted in part due to weather conditions affecting traffic at our dealer partners. At Viking, we continue to outperform the market with modest growth in the quarter as we continue to gain market share and realize the benefit of new product introductions and investments we have made in our sales and distribution organization. Traffic at our dealer partners remained challenging early in the third quarter and visibility to the remainder of the year remains difficult to forecast. However, we remain confident in our strategy to leverage and promote our portfolio premium brands. We continue to build upon our sales and products initiatives as we invest in our showrooms, product displays at our dealer partners and introduce differentiated new product across our brands. In the second half, we'll be completing the launch of our Viking built-in refrigeration line. We're also excited about the launch of our AGA-branded Mercury and a lease line of Euroceil ranges into the U.S. market in this upcoming third quarter. We continue to promote other recent product launches from earlier this year, including the new Virtuoso line of built-in cooking products from Viking and our new series of under counter refrigeration and ice machines from U-Line. We continue to take actions to expand the profitability of the segment toward our long-term goals and realize improved margins in the second quarter, resulting in part from the exit of our noncore Grange furniture business. During the second quarter, we also began efforts to consolidate manufacturing of our outdoor cooking brands into the Viking campus in Greenwood, Mississippi. We anticipate this initiative will be complete by the end of the year and savings from this effort is estimated to be $4 million annually and will expand EBITDA margins in our outdoor segment to the mid-20s. We also continue to further ongoing initiatives related to supply chain and operating efficiencies, which we expect will gain momentum as we mature our processes related to the manufacturing of the numerous new product launches. At our Food Processing Group, we realized modest sales growth in the quarter, however, incoming orders declined as large projects in the U.S. market continued to lag, particularly in our core hot dog and sausage segment. However, our level of coding activities and pipeline of potential projects is promising, and as a result we anticipate improving order intake in the second half of the year. Although we remain challenged with an unfavorable sales mix with lower sales of larger meat processing systems, we realized modest improvements in our EBITDA margins as profitability in the baking business continue to expand. Additionally, in the quarter, we completed the consolidation of manufacturing for our recently acquired Packaging Businesses, CVP and M-TEK, which will allow us not only to enhance the margins but accelerate new product innovation. We are focusing efforts to extend our reach into new and faster growth markets such as bacon, cured meats, pet foods and sous vide cooking applications. We've seen positive response to the new product innovations developed for these market segments, and we're excited to be opening a new Innovation Center later this year for our meat processing business in Chicago, showcase many of these new technologies and work collaboratively to develop solutions with our customers. I would also like to note that we're very pleased just this morning to announce Bob Nerbonne joining our Board of Directors. Bob is a tremendous addition to our Board and brings with him a deep and extensive industry experience. Bob has served in senior leadership positions at the Ali Group and Enodis with today is changing name to Welbilt. Bob also early in his career was the President of Pitco, Middleby's leading fryer company and most recently Bob served as an adviser and Board member to Cooper-Atkins and advised on that company's sale to Emerson. So I'm very excited to welcome Bob to the Middleby Board of Directors. So with those initial comments, I'd like to turn the call over to Bryan Mittelman for further commentary on financial highlights for the quarter.

Thanks, Tim. Looking at things by segment. Our Commercial Foodservice Segment sales for the quarter amounted to $530 million, which included an increase of $95 million related to acquisitions completed within the last 12 months, most notably Taylor but as well as the brands acquired from Standex on April 1. I would also like to remind you that Taylor will be a part of our organic sales base for all of Q3 and was actually for nine days in Q2 as well. Excluding the impact of acquisitions and foreign currency, sales for the quarter increased 2.3%, sales growth was 2.1% in the domestic market and 2.8% internationally. In terms of regional contributions, Latin America and Asia continued to be primary drivers while challenges in the U.K. persist. Major rollouts by U.S. restaurant chains continue to take longer to materialize, nonetheless chain spending continues to be the main driver of our growth. We're pleased that our brands in the beverage area, which is still relatively new collection of companies for us are making meaningful contributions. The gross margin in Commercial Foodservice was 37.8% as compared to 39.1% in the prior year quarter. Excluding the impact of acquisitions and foreign exchange, the gross margin rate would have been slightly down to 38.7%. EBITDA for Commercial Foodservice amounted to $130 million, representing 25.3% of sales or 25.8% when excluding the impacts of foreign exchange and acquisitions. We regularly discussed the expansion of profit margins as being a key focus of our efforts. Our goal remains to grow margins in acquisitions to levels consistent with the overall platform. As Tim discussed, our sizable investments in technology are a detractor to margin expansion currently. This factor along with other acquisitions over the past 12 months as well as those over the preceding year are the main causes of results not generating around the 30% level that we have discussed as our long-term goal. Recall, acquisitions such as QualServ, where we have sought to broaden our capabilities in areas such as fabrication and store design, this broadening of our portfolio brands, technologies and capabilities will drive top line growth and improve profitability over the long term, but our work continues in the near term. As Tim noted, Taylor did operate at above 25% for the quarter, given this brand is now part of our organic reporting base, we're likely not going to be commenting specifically on its margins going forward. Nevertheless, we're definitely focused on continuing to make improvements. Taylor was accretive to earnings by $0.07 for the quarter. The recently acquired brands, including AI, Bakers Pride, BKI and Ultrafryer as well as Powerhouse Dynamics are meaningful detractors to segment EBITDA performance. The acquisitions in Q2 were a $0.04 drag on our earnings. Moving onto the Residential segment, sales amounted to $150 million, excluding the impact of foreign exchange and the closure of a noncore business, we experienced the sales decline of 2.6%. Domestic sales decreased by 2.3%, international sales decreased by 3.1%. International sales were fairly equally impacted by weakness in our core business as well as the remaining noncore business. We have not seen improved market conditions in the face of Brexit. Domestically, as we discussed last quarter, the market slowdown we feared did materialize. Our dealers are indicating weakness in food traffic through their stores in spite of investments in displays. Viking did grow marginally, however we struggled with under counter refrigeration sales as we work through a change in third-party distributors and saw significant destocking by various dealers. Overall, we continue to invest in displays to showcase our new products and are pleased to be increasing market share as consumers positively react to our new offerings in the face of the market slowdown. Gross margin at the Residential Group improved to 38.8% as compared to 36% in the prior year period, which was impacted by the shutter business. While EBITDA improving -- EBITDA margins improved to 18.3% from 16.9% in the prior year. Again excluding the impact of FX rates and the remaining noncore business, EBITDA for the current period would have been 19.7%, an increase of 110 basis points over the prior year on a comparable basis. Onto the Food Processing segment, where sales amounted to $98 million, of which the acquisition contributed approximately $3 million. Excluding the impact of acquisition and foreign exchange rates, sales increased 3.4% for the quarter. Gross margin at food processing improved to 35.8% as compared to 35.5% in the prior year period, while EBITDA margins improved to 21% as compared to 19.4% in the prior year period when adjusting for FX and acquisitions. Margins were positively impacted by product mix as the protein portion of the business, which has higher margins experienced growth as well as improvements from cost control efforts across the segment. The absence of large customer orders will continue to be a headwind for the segment. We continue to be optimistic that we'll see ongoing improvement in both the top line and EBITDA margins as 2019 progresses, but meaningful increases remain a challenge given the absence of large customer orders. Before moving onto cash flows and debts, I did want to provide some further insights into manufacturing optimization activities that will be driving future GAAP restructuring costs as well as some related transition expenses. In the face of numerous market challenges and in order to drive improvements with the acquired businesses, we're undertaking manufacturing optimization actions in a couple of our segments. A few actions have commenced. Largely in Q3, we'll anticipate additional actions. Restructuring charges and the associated transition costs, which may not qualify as restructuring under U.S. GAAP in the second half of the year could be $5 million to $10 million. Savings are likely to be realized more fully beginning in 2020 and should annually exceed the amount of expense incurred. We believe these actions along with executing normal -- numerous programs impacting day-to-day operations and spending levels when coupled with pricing actions, new product innovations and emerging technology solutions provide the opportunity for improved performance after we exit the second half of 2019. Cash flow generation during the quarter amounted to $68 million from operations, this represents a decrease of $34 million over 2018, which was the strongest second quarter in recent years. Working capital changes were detracted to our performance although to a much lesser extent than in the first quarter. For the second quarter, noncash expenses added back in calculating operating cash flows included $24.2 million of depreciation and amortization expense and $300,000 of share-based compensation expense. This total of $24.5 million is higher by $4.5 million over the prior year period. Share-based compensation expense will be higher in the second half of the year as the new plan was not in place in the first half. We have recently been generally in a cycle of making grants over three year performance periods. A new plan was developed that combined some issuance of time-based awards with much greater performance-based awards. During the quarter, the company utilized $13.5 million to fund capital expenditures, primarily related to investments in manufacturing equipment and enhancing production capabilities. Net debt at the end of the quarter was approximately $1.9 billion, which was up around $100 million compared to the end of fiscal 2018. Our net debt-to-EBITDA leverage ratio based on bank covenant definitions at the end of the quarter was just under 3x. That concludes all my remarks. So with that, Justin, please open the line to questions.

[Operator Instructions]. Our first question is going to come from Jamie Clement from Buckingham Research.

So, quickly on Taylor, as it relates to the organic commercial foodservice calculation going forward, I think when you bought the business, it's top line growth have been pretty dramatically exceeding the broader market. What's kind of going on there? And is that something we should be factoring in kind of as we think about Q3 and Q4 estimates in terms of organic top line?

So when we bought the company, I wouldn't say it was exceeding the market. I would say it was kind of in line with market if you looked at it over a longer of time and the business is driven much like many of our other businesses by large chain customers. So I think we can be lumpy at times just kind of depending on how they are dealing with kind of a handful of customers kind of where we're at right now, and then we've focused pretty heavily on kind of the integration activities. Some of that goes to SKU rationalization, which is fairly common was for reshifting margins of -- focus on higher-margin products within the segment. So you would see probably some decline there as we've held out some SKUs, which you may see in the second half of the year, if you're thinking about year-over-year where Taylor is and really where we're thinking about driving growth long term is where we're developing new products, right. That's also kind of Middleby's DNA is really coming up with a new pipeline of higher margin and innovative products. So that's really kind of that phase we're starting to enter into with Taylor right now. We had a product come out earlier this year and actually just had it at the annual ratio, which we're pretty excited about called ZAMBOOZY and that's probably a good example of things to come, and those are things that we think will gain traction in the market to help us grow at higher-than-industry rates and expand margins, but realistically, we're counting on that more as we move out into 2020, not really in the back half of this year as we're really in development stages of the new products at Taylor right now.

Okay. So, Tim, just aggregating kind of the earnings release and the commentary in there and your commentary on the call. I mean is your expectation now to kind of see more of a second half of commercial foodservice kind of in line with the first half from a sales perspective and obviously you got some investments going on and certainly some longer-term margin opportunities, but I mean do you think kind of low- to mid-single digits in commercial foodservice is probably the right way to be thinking about it right now, with maybe more chain rollouts coming in the first half of 2020, is that what our takeaway should be?

Yes. I think that's fair, and Bryan and Dave may have some comments on it. I mean I think we feel that we're doing pretty well in the general market. I mean certainly, what we're doing in the channels, we feel good about -- the beta is really chain business. So I mean I think the challenge for us is, we had some pretty good chain business as we exited last year and had a couple of larger rollouts, one in particular, on the rapid cook side of our business. So we have probably a better pipeline right now than we did this time of last year, but timing is I kind of mentioned in the comments is really the trigger there. Some of the items that we thought we might have in late this year kind of pushing into 2020. So I think that's kind of as we move particularly late in the fourth quarter, we got some tougher comps because of that, that we're uncertain with the timing of how things are going to lay up with chains.

And our next question comes from Walter Liptak from Seaport Global.

I want to ask about the price increase that you guys put in I guess in June. How was that accepted by customers? Was there any prebuy? And do you think that your competitors -- were they in the same situation with the price cost is -- well below yesterday? I don't think you talked about price increase -- midyear price increase may be some of the other competitors are also raising prices, just some more color on the price increase?

Yes. So I'm not going to necessarily mention what any particular customer is doing. But I think certainly, everybody, not only in our industry but many industries are facing the increased costs related to tariffs. So we are continuing to be challenged by that and we're trying to stay ahead of it, and we've monitored it closely. We've gone through the year was a headwind to margins in the second quarter, which we anticipated. And as we kind of seen multiple waves of increases come in, we kind of sharpened the pencil on where that's hitting us and that's where we signaled to the market in June that we would be taking price increases. That was really kind of a preannouncement and then the actual price increases themselves are going into effect in the third quarter. So many of those have -- they've really been going to affect even over this last week, and we've got many brands and not everybody hits it exactly the same time line, but a lot of the price increases that we're having are in the late July, August time frame. So those will start to kind of bleed in late in the third quarter, and we'll see more of the impact in Q4.

And just if I can do a question on the new products, it sounds like across the board I guess especially in resi and commercial foodservice, there's more spending on technology and new products. And you gave that $15 million annual number, is that the increase for all segments? Or is that just the increase in Commercial Foodservice in the quarter, I guess divide by quarter is the question?

Yes. So that really relates to the Commercial Foodservice segment, that comment. So I mean we've had a lot of initiatives that we've been talking about and many have been on display at recent trade shows. So our control initiative certainly investments in our IoT platform both with Middleby Connect and the recent acquisition of Powerhouse. We're making investments there and integrating that into a consolidated platform, and we're engaging with customers on that as we speak as that is a platform that is prime time and install their customers today and we're continuing to invest in it. And then automation, which -- that really started with our acquisition of L2F which was not that long ago, and we've been investing in a number of different types of automating concepts that are, I guess, we kind of paraphrase out-of-the-box solutions that can then be customized specific to customers and we're having engagement in that, but certainly that's a long runway of coming with broad set of solutions that complements the large portfolio of equipment that we have in the portfolio. So that is a $15 million run rate cost that I mentioned in that commentary annually. So I mean we saw that -- basically a quarter of that in the second quarter. I mean that's an investment that we're going to continue to make and really that is one of the key areas for future growth. I mean you can see across a lot of our customer base, this is really where they're headed to optimize kitchen operations both from a labor and a data standpoint. So it's really a critical initiative, and we're very intentionally making investments there and our expectation is to try to offset that with initiatives around really integration of a lot of the acquisitions we drive the improvements there. So Dave maybe you want to...

Yes. No, that's a good summary. And obviously, in your opening comments, you talked about the technology and this specific incremental investment that we've been making in operations and food safety, but those are customers. The restaurant operators were being so smart about our investment in this and really gets to an ROI for them. So that money is being spent so smartly around labor management, return on investment, food safety, all the things like I've been probably in the last two months every C-suite in this restaurant industry. They are all resonating with how we're spending that money that you've outlined per quarter. And don't forget, food processing we're doing the same thing. We brought TurboChef in there, and we're seeing really amazing technology, you've been to some of our shows. And in residential, some of the stuff we're doing in the commercial food on controllers and cloud-based management systems that enable the use of our cooking, that's applicable right into the home. So the investment that Tim referenced both in his opening comments and to -- he answered your question, just spreads right through our customer and just an easy way to understand and it really comes back to that ROI on the things that the restaurant operator is concerned about.

Yes. And maybe just to kind of pick up because you asked about the multiple segments. I mean as I also mentioned that we are still in kind of new product launch cycle at residential rate. So I mean, I mentioned a number of products that are coming out in the second half and already some of that have hit the market in the first half, right so that is maybe not the type of spend that we're talking about with those technology investments on the commercial side, but still we're an investment stage there -- as we're spending more in R&D, engineering and frankly new product launches to see those markets into the -- with our channel partners. So making investments in really across the three platforms.

And our next question comes from Mig Dobre from Baird.

Just looking for maybe a little more clarification around Commercial Foodservice to start with. So if I understand it correctly, there is some -- you're counting on some QSR rollout in -- from your prepared remarks, there's been some delays here and you're expecting those delays to potentially extend maybe into 2020 is what I heard. And then on Taylor, is that coming through as part of your organic calculation? You're still running some SKU rationalization, which can impact sales. So I guess, I'm looking for a little more color here and specifically, how we should be thinking about organic growth compared to what you've done in the second quarter based on obviously the things that you know and you can't control recognizing that comparison don't really get much easier as the year progress? I'll just start there.

Yes. So I'll start and maybe Bryan can add on. Yes, I mean -- so I think it's kind of a mixed bag, right. So we are, as you mentioned, we've got Taylor, which potentially is a little bit of a headwind as we call out some SKUs there. As we kind of head into the third quarter, I mean we do have some chain activities that are positive, and we seem to be doing fairly well with the general markets. So we do anticipate to have, I would say, growth that is similar to what we've seen in the first half of the year. The comparisons get a little bit tougher as we get into the fourth quarter where we had some more active rollouts going at the end of last year and some of the chain activities that we might otherwise anticipate to offset and maybe even grow from there, simple. A lot of that have been pushed, so I think the bigger challenge for us is probably in the fourth quarter, and we'll have better visibility of that as we kind of get through third quarter and see how that chains lay out. So that could be kind of move up or down from kind of where we're at with run rate of kind of this low- to mid-single-digit growth that we've experienced in the first half of the year.

Okay. That's helpful. One other things that we turned out in our checks was that much of the growth that seems to be happening in the industry is driven by price rather than volume. So I'm wondering your perspective on that and of course, you're talking about an additional price increase as you're looking at the second half of the year based on a comment that you just provided, is there really any volume growth that's baked into our expectations?

Yes. So I mean, I think that's fair, right. I mean, I think if you look at the industry domestically, I mean, if you go international, there's still new stores, and I think the challenge we have there and that's also typically an area that we get higher growth internationally because we're focused on the emerging markets, but we've got some challenging markets right now. So that's where we're experiencing the low single digits. So that's not kind of a data to the upside until we kind of get through Brexit and maybe some of the near-term challenges with China. But domestically, I guess a large installed base of equipment. There is probably as many restaurant openings as there is closures. We're focused on fast casual segment, which continues to grow. There is some segment opportunities for us, which are really market share gains as we kind of -- as we focus in areas such as convenience stores and retail, which Middleby has not been as strong historically. And with some of the acquisitions that we made as well as some of the change in terms of how we structure our sales organization, we're targeting those areas where maybe there's market share opportunities. But if you kind of look at the market overall, it is a -- the replacement cycle is more critical and the replacement has become, hey, we're not just going to -- the equipments breaking down, and we're going to buy the more energy savings piece of equipment. It is really how do we reinvent the restaurant. And that's kind of then led to what is the restaurant need to look like and how we drive out labor, how do we have more flexible equipment and then you get into kind of these longer cycles that we're experiencing right now, where we can have a meaningful impact to our customers. But to move them through that decision process, which is more strategic to them takes longer, and that's where, I think kind of having chain rollouts, which may in the past have laid up quarter-over-quarter those cycles become a little bit more lumpy right now and that's kind of what we're experiencing, but we feel pretty confident about, hey, we've got a great portfolio of innovative solutions. That's kind of how we've geared our acquisitions and then you can hear obviously, how we're focused on technology. So I mean I think that's where we feel like we're getting strong engagement with our customers right now.

Yes. Let me just add to that. I think, Tim, obviously, they're trying to recreate in the North America where they're not building new stores. While they recreate those back-of-house efficiencies that they're confronting every day, one of the little bit of color, one of our newer divisions QualServ manufacturing in the last six months just -- they've been approved by four of the five largest chains in the world to supply around upgrading the look and the feel of the restaurant. And so not only are they looking at technology, but they're looking at changing the way they interact with the customer from appearance. And so existing chains need to upgrade their perspective -- from a customer perspective, well, how they look, freshness, all these SKUs that really drive same-store sales growth. And so QualServ has had huge advantages in the last -- just in the last six months, thanks to our connectivity with our bigger customers. But four out of the five biggest chains just approved them, now that's all going to happen next year, but we'll get some little bit -- teeny bit this year as we go start those rollouts.

Yes. I think that's a great example. And if you kind of -- I mean, it's a relatively recent acquisition still. I think more so than other acquisitions we're transforming what QualServ is as a business. I think -- in the past, I think as many of you know, they were involved more with distribution, we'd turn them into manufacturing company, right. So the margin expansion kind of going back to -- as you peel back the onion with the new margins is where we are with margins on acquisitions as we come online with some of those customer opportunities that Dave is talking about, which were exciting. That really kind of moves us into a manufacturing margin versus a distribution margin. So there is the element of timing with chain rollouts, there is -- how that's additive and it wraps around the other Middleby brands, and we can be more important as they kind of think about their story of the future and then that will be piece of how we -- growing the margins of that as an example at a relatively new acquisition, get closer to the Middleby expectation of margins in Commercial Foodservice.

And that's a transition and transformation that takes more time as opposed to where we did with Taylor, I would say, maybe have some low-hanging fruit and with the businesses recently acquired from Standex maybe we'll take a little bit longer than the ramp up that we experienced with Taylor but still relatively quickly and QualServ was more transformative and thus takes a little bit longer, but that's where our patient long-term outlook will hold as we drive towards 30% overall. So hopefully that gets after your question sufficiently.

No, no. It doesn't. That's a good segue for my last question, which is really on the margin. There are a lot of crosscurrents here and higher input costs and you got some savings, you're working on investments, pricing and obviously the volume as well. So as we're sort of looking at the back half here of 2019, I mean when I'm looking at the front half, your EBITDA margin in CFS has been remarkably consistent right around that 24.7%, 24.9% range. As you're looking at the back half with everything going on, how should we think about this margin sequentially versus what you've done in the front half? And then into 2020 based on the things that you already know such as restructuring and the things that you're going to be doing with recently acquired businesses, how should we be thinking about EBITDA margin?

Mig, this is Bryan. I'll take it and start with kind of sequentially. And I would broadly say and especially, we're focusing on commercial here, back half of the year to look relatively consistent with Q2. I'm not saying that's exactly the same number within 10 or 20 basis points, but we're kind of at that same level is probably fair to be thinking about again, given investments we're making and the timing to transform some of the acquired businesses, right. Those are, I would think, the biggest headwinds and biggest challenges we face. It's going to be a little bit hard for me to give you a really specific -- as you know, give you a specific number for next year. But especially around those recent acquisitions, our major transformation actions will be largely completed by the end of the year into Q1. And we do expect dramatic improvements there, probably more dramatic than we had seen in kind of the first stages of our last big acquisition. So we really do look forward to having really positive in big numbers, I would say, to talk about as that happens and as well, I know you didn't specifically focus your question on residential. But as Tim noted, we've also been going under some plant combination there and really all three segments, food processing as well. So what's the impacts there, probably not as significant in commercial, just given again, the size of the recent acquisition and what we're confident that we'll be able to deliver there in early '20.

Our next question comes from Joel Tiss from BMO.

I wonder if you can -- just a quick one on European restructuring around the Residential side. Can you just kind of characterize where we are? Is that largely gone? I know there has been plant closures, which are always tough and all that sort of stuff is kind of the structure of that business where you wanted to be? Or is there still more work that has to be pulled through as we go into second half and into 2020?

Yes. So I would say, it is still work in process. I mean there continues to be some more opportunities. I mean I think as mentioned, we've had several noncore businesses that came with AGA. We exited Grange, which was a headwind and that's additive to our margins and reduces frankly some losses at a business. We still have a couple of other businesses that I think are in that noncore segment and are a detractor from the margins. So there are activities that are going on right now as we improve the profitability of those businesses and kind of evaluate what we're going to do with those long term. So I mean I think those will be continued efforts as we go through this year and into next year.

Okay. And then I just wondered I know some of the pieces, you've talked about the biggest pieces, but there are some other end markets and I just wonder if you could run through or maybe, Bryan, real quick can give us a little color about what the pipeline? And how those markets are looking in areas like QSR and retail and fast casual and things like that like I think you covered the chains pretty well and certainly, the residential and the processing?

Are you asking -- say that question again because I'm not clear you're asking for what?

Just the color on what's happening sort of like the tone of the pipeline across the other end of markets with retail and QSR and some other areas that you didn't talk as much about? Just trying to get the depth of the end market?

Yes. Yes. So I would say, grocery, there is tremendous aggressive behavior in grocery as they try to take advantage of getting food, whether prepared or partially prepared to the end user. We're seeing a lot of activity and obviously, you all know about some of the rollouts we've had and successes we've had in the last couple of years. We entered that grocery market, and they're very positive. They have a lot of financial capabilities to go after the technology and the BKI acquisition was key and enabling us to even do more with the other brands to pull in TurboChef, to pull in Pitco, to pull in all the sort of technology into grocery. So it's a lot of fun. We're enjoying it, and it's a tremendous success story. There is fast casual. When you talk about fast casual, you talk about more regional chains. There is a lot of activity in smaller chains, thanks to just technology overall to enable supply chain. Strong regional brands, in our restaurant operations, fast casual, quick service are growing in that normal rate because through the use of technology in their own systems, a chain of 50, maybe a 100 restaurants has tremendous supply chain capability today versus 15 years ago. And so there's a lot of growth and aggressiveness around that. I can call out some regional chains that are just growing and doing great job and are easy to work with. I mean they're very friendly to work with, they're very single-source oriented. And so we got people on board through both our acquisitions. We've acquired people capital that allow us to get into those emerging chains locally. So grocery delivery, getting food to where the customer wants it across all those segments is a key activity, and we're the leaders in technology around the world on home delivery, delivery to off-premise consumption. And if you're at the last two shows, you saw the locker technology from Carter-Hoffmann that enable carry out and the Uber Eats and the people to engage in a fast casual operation or a quick service operation and allow them to get their menu to the consumer any place they want to get it to or if the consumer wants to come, pick it up in a secure safe way. I don't know if that's the color you were looking for, but that's what I gave you.

Our next question comes from Larry De Maria from William Blair.

I want to switch gears may be the appliance market, which have obviously had a tough first half. Can you maybe discuss the recent monthly trends, any opportunity for a change in the negative trends? And what's driving it? Is it high-end appliances that are going weaker into a remodeling? Or is the builders or just further color around the market for appliances and how it's shaping up in the second half, please?

Yes. I mean I think that's something that's been a little bit of a mystery to us. So I mean as we kind of track the appliance market and I mentioned that's 6% down. I mean that's an industry statistic on cooking appliances that comes out of an organization called AHAM, and we've outperformed that. So I mean I think that's kind of our benchmark on how we think we're gaining market share as well as really kind of our checks with our partners, how we're doing relative to how their business is doing overall in the categories. So I mean I think as we've gone through our Top 5, 10 customers, we've gapped the market. What we kind of hear from them is weather patterns have affected, and they hate to talk about weather. But I mean our -- one of our largest customers said that weather impacted 22 out of 26 weekends for them in the first half of this year and that was kind of anomaly if you kind of go back over a number of years. So kind of as we look at that, it feels like the appliance market should be doing better than down 6% based on where the economy and consumer spending unemployment is, but that's been what the first half is kind of has borne out, and we did see that carry into early third quarter because honestly, I think we anticipated that will start to revert if it's truly weather, but July is continued to carry down traffic. So that's what we've seen early in the third quarter. We're still hopeful that we'll see an improving back half of the year and certainly, we feel like we're pretty well positioned for this and all the investments that we've done over a really number of years with the new products and our sales organization is kind of mentioned we continue to put new products out there as we've got a continued pipeline. So we focused really heavily on launching those to market as quickly as possible to maybe offset some of the market softness where we know we've got some market share opportunities as we kind of come into refrigeration and maybe extend areas of cooking, which is kind of what the AGA ranges, which gets us into categories even beyond what Viking has. So but yes, so we're watching kind of closely the market. I think we're confident at some point here, it will turn back and then we'll revert to some better growth rates in residential domestically.

Okay. So I mean that's the moving parts in there and you have obviously shown growth in Viking and tougher comps I guess, but new products et cetera come from AGA. So should we think about low single digits organic in the second half? Or is it too early to kind of expect that kind of a change?

Yes. I mean I think what we we're -- I mean we were down, right, in Q2. I mean residential was the one segment that was down obviously. We continue to face the challenges in the U.K. and that carries through as kind of Brexit doesn't get resolved until October assuming that, that stays on that date, which hopefully, will this time and that overhang will go away and then we'll see what really the impact is. But I mean I think we're expecting that we're going to continue to face similar market, certainly in the U.K. as we go through the rest of the year. And then, I guess, the question is kind of what are we going to see in the U.S. market, but I think in the third quarter, we're anticipating is probably similar to the second quarter. So I would say probably expecting to be flat to down in third quarter and then hopefully, we'll see some rebound in the U.S. market that will kind of drive us back positive again.

That's great color. And then last question, Tim, processing obviously continues to be pretty lumpy. Is this a factor of there's simply just enough capacity in the industry and segments that you play in? Or is it something else and bigger that's going on to creating this lumpiness, maybe the portfolio, et cetera? So just talk about what's driving that? And if it is a capacity issue that there is too much simply in the protein capacity for what you guys sell, is that going to -- how long will that last for?

Yes. I mean we're heavy in the baking business obviously, and then we're heavy in meat. I think in particular, there is -- we call out is hot dog and sausage and I think that is a combination of capacity and kind of a cycle of when they come up to investments either to upgrade technology or expand. We feel like that based on the activities that we're seeing, we're kind of getting to the front-end of them. Some of our customers starting to invest in those core categories again. We kind of -- we're hopeful we would see some of that come through quicker than we have this year, where maybe we kind of get some better growth in our core businesses, which is our highest margin as well. So we're really still operating kind of, I would say, at more of a trough margin. We're expanding it from there because of operational efficiencies as we enhance -- reduce supply consolidations. We have some new products coming out, but we're really kind of looking forward to seeing some investment in those cold lines. And that's really domestically that I'm talking about because internationally, you do have new lines that are -- go up in other markets such as Russia and parts of Asia that are investing in lines in the meat side of the business and that's where we've gotten some of the growth. So I think it's taking longer to work kind of through this cycle we thought we would kind of see a better rebound this year. We think that, that we're kind of building towards that as we move into next year and that's kind of where I'm alluding to. We're hopeful that some of the things that we see in the pipeline start to turn into orders as we go through the second half and then that turns into revenues maybe later this year and into -- and certainly into 2020. As we are kind of looking at that platform, that's why we've also been really focused on developing new products. I think we had more new products come out in the food processing segment in the last 12 months than we had in the prior three or four years combined. So that's pretty exciting for us. So that does take time to seed that. Some of those products are going into adjacent segments that we have either not been in or may not been as heavily. I mentioned some of those, but baking the certainly one where we've got very unique solutions there, and we continued to enhance those. Cured meats and jerky I mean you see that in a lot of retail files and convenience stores, I mean that's an area of growth and that's an area that we focused on heavily. There's a number of products that are addressing that segment whether that's maturing room said that we launched at the beginning of this year with -- under our Miele brand or as Dave kind of mentioned, we came out with a -- under ALKAR with our new TurboChef oven which is a microwave-assisted conveyorized automated platform that really cuts across many different applications and we're pretty excited about that, but that's really in early stages. We just showed that at the recent IFFA show. So excited about that. And then pet foods is another area. Our equipment really plays well into that category. We've been working hard to really engage with customers in that segment and it has some unique solutions, but that's a market that Middleby's not played in any meaningful way. So that's where a lot of the effort this year is really been to expand into those segments, which offsets maybe some of the cycles that we have with the concentration that we have in sausage, hot dog, ham and in those cases are probably faster growth markets as well.

Our next question comes from Jeff Hammond from KeyBanc Capital Markets.

Just on free cash flow, looked a little bit light and you're still building some working capital there. Can you just give us a sense of how you think free cash flow shapes out for the year either in total or as a percentage of net income?

Yes. I mean we do anticipate seeing a rebound and it getting back to more historical trends and levels, obviously we talked some about inventory, and it's going to take us a little while, call it, to drive the corrections. We expect -- I would just say that we do expect Q3 and Q4 to be stronger as it has been in the past, and I don't -- I'm not going to really provide you, say a specific number, but again, I think we'll start to revert back to close to what has been the historical norms.

Okay. And then just food processing, I'm just trying to get the shape of the year. It looks like you have a pretty tough comp in 4Q. So just how should we think about growth for the year or decline in food processing? And how to think about that 4Q comp?

Yes. I mean -- so I think we were down slightly in Q1, we're up slightly in Q2. I mean I think as we're thinking about the back half of the year, we're thinking that we'll be -- have a similar look to the back half of the year plus or minus depending on how orders trend. We're hopeful that we will see some of this -- the items that are in our pipeline right now start to transition into actual POs that then help us out in the fourth quarter. So I think we're probably actually feeling a little bit better about Q4 than Q3 right now.

Okay. And then just last one, back to the commercial foodservice processing. Did I hear you right, Bryan, that we're thinking kind of in line with 2Q sequentially end of the back half?

Yes. I think that comment was really -- around what was the EBITDA margin amount and that's where I was getting after both, I'll call it, on a total or just organic basis, right, I'm not expecting great levels of expansion from what we had seen as the Q2 level.

And our next question comes from George Godfrey from CLK.

Just want to follow-up, Tim, on your comment, that, you just made there about converting into purchase orders and specifically some of the technology investments you made around Internet of Things, automation, the acquisition of Powerhouse Dynamics. Are some of those initiatives’ customer driven as much as you promoting a solution to your customers such that the sales cycle there might be a little bit quicker and realizing orders on those strategic initiatives could come quickly, just trying to get a sense of how quickly these investments monetize into revenue?

Okay. So two answers. I mean I think the broad answer is, look, these are long-term solutions, right. So I mean I think we're getting engagement now, and I think there's a different answer to automation than IoT, but really for this to be a meaningful business and where we expect it to be in a longer term, that is a multiyear cycle really. That's three to five years out is where we think that the brains of the kitchen will be as important as kind of the leading technologies that we have behind it. So in the near term, I mean, we bought Powerhouse. They already had customers. We had -- they had a large installed base -- the largest installed base via a cloud-based solution in the restaurant industry, right. So we bought the leader. You marry that with up some of the investments that we're making on a combined basis because Middleby had its own platform and the equipment base to connect to and then obviously, we've got conduit to the customers, which can really expand the opportunities more quickly in terms of the doors that we can walk through and coming together as we're investing in that right now. We can have a more meaningful solution to those customers and a proven ROI. So I mean I think there we're engaging. Certainly, it's going to take a number of years for that to ramp up, but that is a business that's in early stage but it is -- we've got revenues and those revenues are growing. Take automation, that is we are certainly engaging with customers, but that is kind of really -- it's really going to be in investment stage for a few years before we kind of flip to the other side of that. And Dave is going to add on to that.

Yes. I think that's where we've been so smart around our acquisition strategy, which was well planned out because we're buying these technologies with -- they're proven. A lab to path with their automation. In a very micro level had some proof of concepts in operating kitchens before we purchased them. Powerhouse Dynamics has existing customers with proven technology. So the market really is clamoring for this support around after-sale service and support, ensuring uptime of their equipment, reducing their labor, food safety, all the things that we can bring to the party. They really want it very badly but they want it proven. And so those acquisition strategies have been key in a sense that we have proof of concepts, incredible proof of concepts. Now we have to expand it and make that technology more user-friendly, but we inherently feel this acquisition strategy of technology that surrounds the store whether it's delivery, after-sale service and support, connecting that kitchen to every aspect of its operation is a -- are able to -- our ability to ramp it up over the next couple of years is better than anybody else out there.

And your last question for today comes from Jason Rodgers from Great Lakes Review.

Just wanted to get estimate if you have for the sales impact from the SKU rationalization that you'll be doing for Taylor and maybe company-wide through the second half?

I'm sorry, broke up on this. Jason, can you repeat that? I apologize.

Sure. You're doing some SKU rationalization for Taylor, just -- you mentioned it will be somewhat of a headwind to the commercial foodservice sales in the second half. Just didn't know if you could quantify that?

Yes. So I mean I'll take a shot at it and this is going to be a little bit more of an art than a science or something kind of depends on mix, but I would say that probably what we have targeted there in terms of revenues coming out, that's probably along the lines of 5% of what their revenues would be. It's substantially more in terms of the actual number of SKUs, if you look at it as a percentage, but it's probably affecting about 5% of the business. It can be slightly -- may be slightly more, but it's kind of that mid- to maybe approaching high single digits.

And good to see the margin improvement in residential kitchen and food processing in the quarter, would you expect that those trends to continue in the second half?

Yes. I mean, so we -- I actually -- Bryan, I mean maybe let you comment. I mean, certainly, the improvements that we had in the first quarter carry into the second half, Bryan kind of already talked about how the numbers overlap. I mean we're out of the Grange business. We are continuing to focus on operating efficiencies. I mean I think we believe that particularly at Viking we're -- with all the new product launches we had, which are very exciting. The flip side of that is we're not at optimal operating efficiency. So in terms of manufacturing, in terms of supply chain, we know that there's opportunities there that we're going after that in the second half of the year. The other thing that I mentioned is we're also consolidating our manufacturing operations. So the outdoor line is we know, we're shutting down a facility and that's in California and then moving that into our Greenwood, Mississippi campus really leveraging that footprint that we've got there at Viking. So we're excited about that. That's not going to benefit us in the second half. In fact, it's actually going to be a headwind because we're going to have the operating cost of the transition as we're moving equipment. We'll have probably employees in two places, there's training elements. So there's probably actually a couple million that we'll have as a headwind as we get to the savings that will occur in 2020. And so kind of maybe going back to that and I know, it's not the question, but I mean, if you kind of look at what we're doing from manufacturing standpoint I mean there is four plant consolidation initiatives that we've been attacking this year, one we've completed, several others that are in process. We anticipate that as we go into next year, that's probably something that's approaching $20 million in annualized savings relative to where we were at the beginning of this year, which we got a pretty good view on. But as we kind of go through the back half of this year, we actually have the operating cost as we go through those transitions for several of those facilities and that includes what we're doing in the residential side of the business.

Yes. I mean I think, Tim, really fully explained it, however, slight improvements could be seen, right, but the more dramatic improvements would need to come with a greater volume increases, right, just between the leverage and especially, if you think about Europe new product acceptance and so all of those things will drive it up more meaningful -- more meaningfully I'd say, over the medium term. Given our little bit of concern about very short-term growth rates, hard to say there will be a lot of margin expansion in the absence of significant improvements to the top line.

That's very helpful. And the next benefit that you got in residential or in food processing in the quarter, should that continue in the second half?

Well, it really was not a mix benefit, right. I mean I think we've seen some improvement on the baking side of the business, which likes the meat processing, really. We're looking forward to having improved mix as we see more orders in that other side of the business come in. So I mean we're getting improved margins, and it's really in the absent of having favorable mix.

Thank you. And that is all the questions we have for this morning. I would now like to turn the call back over to management for any closing remarks.

Okay. Yes. No, thank you, everybody, for attending today's call. We appreciate everybody being on the line this morning and look forward to speaking with you next quarter.

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