Middleby Corp (MIDD) 2005 Q3 法說會逐字稿

Good afternoon. My name is Nicki (ph), and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Middleby Corporation Quarterly Earnings Call. [OPERATOR INSTRUCTIONS.]

Thank you. Mr. FitzGerald, you may begin your conference.

Good morning, and thank you for attending today's conference call. I'm Tim FitzGerald, CFO of the Middleby Corporation, and joining me today is Selim Bassoul, our Chairman and CEO. I have some initial comments about the company's third quarter results, and then we'll open up the conference call for questions and answers.

We were very pleased with the results of our third quarter, which historically along with our second quarter have been our two strongest quarters due to the seasonality of our business. Net sales in the third quarter increased 14.6% to 80.9 million as compared to 70.6 million in the third quarter of 2004. Sales from the Nu-Vu acquisition completed during the first quarter of 2005 amounted to 4.9 million, and accounted for 6.9% of the sales growth in the quarter. Sales at Nu-Vu accelerated during the quarter due to timing of store openings at a major restaurant chain customer, which were concentrated during the third quarter. Excluding the impact of the Nu-Vu acquisition, organic sales growth amounted to 7.7%. The organic sales growth in the quarter reflected another strong quarter for our international distribution business, which experienced growth with international chain customers in an-- emerging markets.

The company realized sales increases at all divisions during the quarter. Sales at our Blodgett division increased 7.1%, reflecting continued momentum of the Blodgett combi oven and the Blodgett steam line of products launched in the second quarter of 2004. Sales in our Southbend division increased 4.5%, with continued success of the heavy-duty range lineup. Middleby Marshall sales increased 3.4%, with increased sales of conveyor ovens utilizing our patented energy management systems. Net sales at Pitco increased 11.9% during the quarter, reflecting continued success of the Solstice fryer platform. At Middleby Worldwide, our international sales and distribution division, sales increased 22% from the prior year quarter with growth in all international regions, including an 18.8% increase in Latin America, a 22.4% increase in Asia, and a 22.6% increase in Europe and the Middle East.

Gross profit increased from 26.3 million to 32.5 million on higher sales volumes, and the gross margin rate improved from 37.4% to 40.1%. The improvement in gross margins from the prior year reflects an improved sales mix, with increased sales of higher margin new products and international sales. Although the cost of steel continues to remain higher than in the prior year, initiatives to offset the steel impact, including the first quarter price increase and efforts to switch to lower-cost grades of steel, benefited the gross margins. Additionally, as compared to the first half of the year, there was a decline in steel prices early during the third quarter. This decline, however, was curtailed by the hurricanes due to a surge in demand at our steel suppliers after the recent hurricanes.

We also experienced improvement in gross margins at our newly acquired Nu-Vu operation, which had detracted from our gross margin in the prior two quarters. The improvement was driven by a combination of operating improvement associated with our integration initiatives and an increase in business during the quarter with a major chain customer, which resulted in greater overhead absorption.

Selling expenses increased 1.1 million to 8.7 million, reflecting higher selling costs on the increase in sales volumes and increased marketing costs associated with an industry trade show that took place in the third quarter. General and administrative expenses increased 1.3 million to 7.5 million, reflecting an increase in incentive compensation and increased expenses associated with the acquired Nu-Vu business operations. Operating income increased 29.4% from 12.6 million to 16.3 million, reflecting the benefit of higher sales volumes and the improved gross margin rate.

Interest and deferred financing costs in the quarter were 1.6 million as compared to 700,000 in the same period last year. The increase in interest expense is due to higher debt balances resulting from the funding of the December 2004 stock repurchase transaction and funding of the 12 million Nu-Vu acquisition in January of 2005. The provision for income taxes increased by 3.1 million from the prior year, from 1.6 million to 4.8 million, and the effective tax rate for the period increased from 13.5 million to 33.1%. The prior year quarter included a favorable adjustment to tax reserves of approximately 3.2 million associated with tax exposures for a tax period which had been closed. The current year quarter included a similar adjustment of approximately 1 million.

Net income from the quarter was 9.6 million, or $1.19 per share as compared to 10.4 million, or $1.03 per share in the prior year quarter. The decrease in net earnings as a result of the large favorable tax adjustment which was recorded in the prior year period. The increase in earnings per share reflects the impact of the December stock repurchase transaction, which resulted in a reduction of the weighted average [inaudible] 8,110,000 as compared to 10,040,000 in the prior year quarter.

Now, turning to the balance sheet. Accounts receivable increased as a result of higher sales volumes, including the sales from the Nu-Vu acquisition. The large increase as compared to the prior year-end also reflects lower receivables at the year ended 2004 due to a production and billing shutdown during the last several days of 2004 around the holidays. The reduction in inventories reflects an effort to reduce inventory levels as we continue to standardize products and reduce SKUs. Tray (ph) payables increased from the prior year-end due to increased sales volumes and increased working capital associated with the Nu-Vu acquisition. The increase in goodwill and other intangible assets as compared to the prior year-end is also associated with the acquisition of Nu-Vu, and prepaid taxes decreased by 9.9 million in the first 9 months as overpayments from 2004 were utilized during the first 9 months of this year. Accrued expenses decreased due to the payment of severance obligations due to the former chairman, and total debt at the end of the quarter amounted to 104.1 million as compared to 123.7 million at the beginning of the year, and 121.3 million at the end of the second quarter. The 17.2 million in debt reduction in the third quarter reflects strong cash flows from operating activities.

Capital expenditures amounted to approximately 500,000 during the quarter and 1.1 million during the year, primarily associated with the replacement and upgrade of manufacturing equipment and display equipment used for marketing purposes. Depreciation amounted to 800,000 during the quarter, and 2.4 million during the entire year.

Nicki, that's all for our prepared commentary. Could you please now open the call to questions?

[OPERATOR INSTRUCTIONS.]

Richard Rossi of Morgan Joseph.

I have to apologize. I am out on the road today, and have not had a chance to look at and crunch the numbers in detail. But, in looking at the SG&A, it looks to me like you got very good leverage on your SG&A. You were able to-- obviously, the higher volumes. Was there anything else in those numbers that gave you that leverage other than just the normal impact of volume?

No, I think it’s just the normal impact of volume, Rich.

Okay. And also on the tax rate, I think you were running close to 39, 40% in the first half. Again, I didn’t have the moment to do the calculation of taking that $1 million adjustment. But, was there anything else? Is there a mix benefit on the tax side that got you down to this rate?

Well, no, it was primarily driven by a reversal of some tax reserves. So, we had some exposures that we had reserved for and, as that period had closed from a statutory standpoint, it just resulted in a benefit coming through the P&L.

Did you quantify that in some way, or what-- let’s put it this way. What rate should I be using in the fourth quarter?

Well, I think the impact in the third quarter was approximately $1 million.

Oh, okay, that was the million you were referring to?

Yeah. But-- yeah, so I think we’re still--.

--So, if I added the million back in and calculated the tax rate, then I can look at the 9-month rate and carry that into the fourth?

Yes, I think that’s fair. I think the one thing I’ll mention is we’re still evaluating these dividend received deductions out there, which we have not made a final determination on those, which were lost or repatriated some earnings from our foreign operations. And that could create a little bit of lumpiness in the fourth quarter as well but, at this point, we haven’t quantified the impact of that.

All right. And related to the hurricane, obviously there’s a lot of destruction down there. Eventually I presume you’ll be getting a flow of business related to facilities reopening. But, is it fair to assume that that’s-- it’s certainly a ways off, and is it possible that, in the interim in those states where franchise owners may have had multiple units, the units that are still operating out of the hurricane zone might cut back capital spending a little because they’re hurting from the units that are not operating?

Rich, I’m going to answer this question. When we’ve seen other hurricanes hit United States in the past, and they seem to occur mostly in the region where we are pretty strong, if you look at our presence in Florida, we have a very strong presence in Florida, and we seem to have had in the past three years hurricane hit Florida. But, the pattern we’ve seen from the past is, truly, that’s not the case because, in most instances in the long run, most of those operators are covered by some types of federal funds or insurances that comes back and provides them the capital to go on. In the short term, usually, we can just see some type of delayed orders sometimes of a [inaudible] ways of reopening the store, then rethinking, and that’s why we forecast maybe in the fourth quarter to have some type of slowdown of orders a little bit, but we always see the rebuilding taking place and, in many instances, you see them upgrading the stores with new technology equipment. They go back and say, “Well, give me the latest equipment with energy savings, and whatever needs to happen.” So, they upgrade the equipment. And if you think of where the hurricane seems to hit, they are in highly populated areas and now growing area, whether it was Gulf Coast or Florida, there is a huge market where those market continues to flourish even after a hurricane hits, with people moving into those markets in large numbers from colder states.

So, fourth quarter we get a bit of an impact, maybe carries over into the first or not? But certainly, as we move through ’06, you can see this positive swing as a net plus? I don’t want to talk about the hurricane as a net plus, but as a net plus to your business, upgrades, etc.?

Yes. Towards the second half of ’06 would be where usually it takes, by the time the paperwork’s done, by the time the insurance assesses an appraisal, so we’re looking into second half of ’06. it usually takes a lag of usually 9 to 12 months in a tragic incident like this for it to occur. But, I want to reemphasize, let’s reemphasize what we’re talking about. We’re not talking about a decline in total absolute sales. We’re talking that this will affect our sales growth. We’re still going to have the growth in the fourth quarter of ’05, but it’s going to be mitigated by the hurricane.

Interesting to see that your Latin American business was up very nicely, to be honest. I’m not certain I know how big a part of the total that is for you internationally. But, could you give us some sense of that, between Asia, Europe and Latin America, how it breaks down as a piece of the total international business?

Well, first of all, it’s-- okay, we’ll do that, and I think Tim will give you that breakdown. But, I’m going to give you a little bit reason why. First of all, all our international business is growing and, globally, we’re doing extremely well, and we’ll talk about that. But, I would like to specifically address Latin America. As we see the emergence of local chains in addition to the fact that U.S. chains continue to go into Latin America strongly and we see emerging businesses in Brazil now in addition to Mexico, in addition to Central America, we see Latin America continues to be a strong market for us. And, interesting enough, Latin America seems to be very in tune to what I call energy savings, so we see several of our ovens, which have energy savings, to be in demand in that region.

Rich, this is Tim. In terms of the breakdown, Mexico and Latin America, it counts-- in the quarter was approximately 2.3 million of our international distribution sales. And the international distribution sales were about 14.5 million. And then, Asia would be about 4 million. Europe is roughly 4.5 million, and the UK specifically broken out of Europe is about 3.7 million.

And then finally, a question I think somebody always asks, and I usually end up doing it, and that’s the pipeline. Been very strong, a key to your success over the last year-plus. I know you go over it every quarter, and I’m sure there’s a good pipeline in front of us again. Some sense of the number of launches coming up over the next four or five quarters?

Let me reshape (ph) what we say. Everything we state on every conference call we’ve delivered. We said we’re going to introduce 24 new products. In the past three years, we did. We said the impact of those 24 new products usually takes a lag of 8 to 12 months once they are seeded (ph). They have. They’ve come to be highly seeded. Today, in this year, almost a third of our sales are now generated by new products. So, I would say between 25% to 30% of our sales are generated by those new products introduced in the last three years.

Looking forward, we’re looking at 20 to 25 new products to be introduced in the next three years. What is unique about the next three years is the fact that, out of those 24 new products, we are expecting between 7 of them, 7 to 8 to be totally disruptive. What I mean by disruptive design or disruptive technology is that they’re going to most probably transform the market similar to the way a plasma TV has obsoleted the tube TV or the iPod obsoleted the Walkman. And what we’re looking at, that we’re going to have some disruptive technology in the next three years that will provide significant improved profit margins to us as company and huge margins and efficiencies to our customers.

So, I’m very excited because, in the past 24 new products, we did not introduce much disruptive technology in the past. They were more brand extension or energy-saving designs. Looking forward, we have some strategic market transformation technology being introduced.

In with those products, a couple of questions. One, will they be obsoleting products you have on the market, or are you going after products that-- or market segments that you’re not in or not strong in? And secondly, given the nature of a transformation of technology, is it fair to assume that the revenue impact might-- before it starts to build, might be a little lengthier than the normal delay that you’re seeing with the other product launches?

Yes. First of all, if we answer your last question, then I go back to-- you’re right, because they are innovative. It’s going to take time to make sure that we showcase the benefits. We showcase the technology, we train our end user to do it. But, in many instances, they’re going to be highly well accepted, and the reason they will be because they are intuitive, they are easy to use, and many of them will provide training on-site on the piece of equipment, and so that we feel that-- yes, to be a little bit lengthier. Maybe instead of the 9 to 12 months, that we might see 12 to 18 months introduction, maybe a little bit longer. But then, we’re also looking at those to be-- a lot of them are new markets for us. Maybe a couple of them will be cannibalizing some existing products, or they will expedite the replacement of existing product today. Somebody, let’s say, have had an oven for 5, 6, 7 years. With the introduction of a new oven, we’ll be talking about our WOW (ph) oven, which will be one of our disruptive designs coming out online in the first quarter of ’06 I think will have-- will shorten the replacement cycle and the life cycle of the past technology. But, many of the disruptive designs that we’re introducing will be totally affecting new markets that we are not in yet.

James Clement of Sidoti.

Couple of quick questions. First of all, Tim, are you guys operating under any kind of steel contract right, or are you in the open market?

We’re open right now.

Okay. Any thoughts on that in terms of maybe locking something up?

I think we’re-- start negotiating for a contract for next year.

Okay. And the other question is I think I remember back when SARS was an issue, and I think maybe that the first sort of well-publicized strain of bird flu, that you guys I believe had discussed a little bit of the Asian market disruption. First of all, is my memory accurate about that, because I’m not entirely sure? And then, second of all, what are you hearing from your customers in Asian in terms of the avian flu situation, and would any kind of disruption now be maybe less than perhaps what you saw before?

Well, your memory is correct. There was some delay in store openings at certain customers when that-- experience last time. I think what it means moving forward, I don’t know. I think the situation, people have learned from it the first time. I think it might have less of a disruptive impact. But, it’s really hard to predict the magnitude of those types of things. I know there’s a lot of talk about it right now. I mean, we haven’t seen any impact to our business at this point, but that’s something that we’re always concerned about.

Okay, very good. And one just follow-up question. In terms of the hurricane-related equipment orders that may have been temporarily shelved, is there any kind of sense what kind of revenue dollar value we should be thinking about in terms of the near-term?

I would say-- I’m going to answer that. I would say at this moment we have not assessed the total impact on it because, remember, it just hit. We’ve had two hurricanes hit. We had one that hit-- well, in fact you want to call them, there were three hurricanes that hit-- Katrina, which was late summer, you had Rita, and then you had Wilma, and they affected the markets, and we have not assessed exactly how much it will be. And usually we’ll figure that out once-- as soon as spring (ph) starts coming in. Now, it’s been in the past that our customers start sending us some insurance claim or helping them appraise some of their equipment, and that’s how the process starts and how we can figure out what has been the impact of the orders that has been delayed or lost.

Okay, but you would-- just to follow up-- but you would expect for most of that business to come back within-- call it 12 months or so, right?

Yes.

Tony Brenner with Roth Capital Partners.

Thank you. Tim, could you provide the actual tax adjustment number?

In the third quarter?

Right.

Yes, it was 1 million.

Exactly 1 million?

Well, maybe it’s like 950 some-odd thousand.

Okay, so it’s roughly 39.5% normalized tax rate, in other words?

That’s correct.

Okay. Also, in your comments and in your release you noted that higher fuel costs are beginning to have an impact. Are you passing those along in the form of a surcharge or some other way, or are you just absorbing that?

Yes. To this point we’ve just been absorbing it, so that’s something that we’re starting to monitor. Our shipping suppliers had been passing surcharges onto us, which have been increasing, so that’s something we’re starting to pay closer attention to right now.

Yes, because your restaurant customers are getting surcharges from all of their food distributors, and are paying it.

We also understand that many of our competitors have started putting surcharges. We have been most probably lagging in that area at this moment, and we are watching it now. It feels that fuel prices are going to remain high for at least ’06 if we look at the economic forecast, Tony, so we will be looking very seriously in the next month, month and a half, to look at what type of surcharges we’ll be passing on to our customers, to pass some of those costs along to the customers.

Okay. And lastly, could you address maybe the timing of some of your new product introductions over the next several months? Are there new items that are being launched now or launched in the third quarter, or will be in the fourth quarter?

Well, we have launched one product in the-- well, two products in the third quarter, and we launched them at the NAFEM show, which is the North American Food Equipment Manufacturer’s show, and those two products were the XL2, which is a Blodgett, a new generation of Blodgett convection oven, and a steamer from Southbend, which is a countertop gas steamer, which required no boiler, which was highly received, well received at the show. And the reason a gas steamer is better than electric steamer is the usage of energy. It’s a lot less costly to operate and much more efficient. And we will be one of the leading manufacturers to introduce a countertop gas steamer which requires no boiler, and that was also launched in the third quarter.

In the fourth quarter, we’re in the process of introducing a couple of products that will be introduced. Two new products will be introduced the fourth quarter and, for competitive reasons right now because they are highly customized to some customers, I will not tell you what they are because they are of competitive nature, and we’re working with the customers to launch them in the fourth quarter. So, they will be launched in the next week or two. So, we will have fulfilled our pledge of introducing seven new products in ’05, that will make seven total new products, totally innovative products that will be introduced-- will have been introduced in ’05.

In the first quarter of ’06, we’re introducing our first disruptive technology, which is our new generation of conveyer oven, which is our Wow oven. That will be highly disruptive technology because it will introduce an additional 30 to 35% of energy saving, so it will bring the energy saving with EMS2 to almost 60% in savings. It will also cut the speed-- well, faster-- the cooking. It will enhance the speed of the cooking of the pizza by over 25%, which should bring it below 6-- in the 5.5 to 6 minutes from the 7.5, 8 minutes cooking time today, which has been very well received by our customers. This will be our first disruptive design. It will have also other bells and whistles on it, including on-site quality control. It will have under-oven quality checks, where they can check the quality of the pizza and train on it right up front, so our first Wow oven will be coming out, our first disruptive design in the first quarter of ’06.

You’ve begun showing and selling that to customers. Has it been ordered by chains as of yet, or not till the first quarter?

The ovens have been tested now. There is almost over maybe 100 ovens out in the marketplace being tested. We’ve been testing that oven now for almost the past 6 to 7 months, and we believe that we’re going to be receiving orders in the second quarter of ’06.

You mentioned the Nu-Vu products as well. Could you talk about what some of those might be?

Yes. Well, let’s talk about Nu-Vu. First of all, you’ve seen the integration, what we’ve done with the integration. And such a good point, I would like to thank the team and congratulate my team at Nu-Vu for the great job. I think they took a company that had margin in the 20% and, as I promised, I said we’ll get close to what Middleby’s corporate margin will be, and right on track. I say that within 18 months we’ll be there, and that’s the power of the ability of Middleby to integrate acquisition whether it’s big like a Blodgett acquisition, which was-- in fact, when we-- both Blodgett’s just bigger than Middleby, and we did a great job integrating that. When both Nu-Vu-- it’s a lot smaller and it gets the same attention and the same integration on both level, on the big ones or the small ones. We’ve done a great job, and kudos to my team for having done a great integration.

But, let’s go back to the trends, because Nu-Vu-- the reason we bought Nu-Vu because we saw a trend. We believe that baking fresh bread on premise or fresh cookies on premise is a huge trend, and we are right. In fact, cooking breads within restaurants is one of the fastest-growing trends. And when it comes to baking bread, its quality and freshness truly matter. So, when restaurants are offering bread today, they want to make sure that it’s a good bread production where it gives them the fresh taste, a fresh smell. And Nu-Vu is working with many of our chains and restaurants in developing proofers and ovens beyond one famous chain that we have in trying to help them perform the art of good bread production within chains and restaurants. And we’re seeing significant demand for that company and for those products.

In addition, we have Blodgett that are also introduce a baking oven, which is different than one Nu-Vu’s done. Nu-Vu is more of a quick, high-speed proofer oven in a small footprint in a very efficient way for chains. Blodgett is introducing an oven, a bakery oven that is more display type of baking, which applies more to the Panera Bread type of exhibition display cooking of breads, which is a new market for us. So, we’re attacking that market from two brands that are very strong in oven production and oven design. So, we’re attacking a unique market we have not been in, which what I call the rotary bakery oven market, which is a growing market we have not been playing in, and we’re attacking the sandwich fast, small footprint baking of bread through the Nu-Vu.

Peter Lisnic of Robert W. Baird.

Tim, I was wondering if you could break down sales for us a little bit differently between maybe price and volume, and then talk about what your path (ph) for a steel kind of bid to the top line, and bottom line I guess.

Well, I think we believe that a price increase that we instituted in the first quarter gave us about a 2 to 3% pickup on the top line.

And is it safe to say that that’s all steel, or is just a portion of that, or probably look at that?

That’s just a general price increase that we passed to our customers. So, if you’re talking about our top line growth, that’s-- 2 to 3% of it’s driven by our price increases to the customers.

Okay. And then, the remainder is all volume?

Yes.

Okay. And then, if we could kind of maybe just take a step back and ignore the hurricanes for a minute and look at what ’06 might be like given what we’re hearing, at least out of industry periodicals and restaurants, and that is kind of the squeeze that’s going on at the consumer level, what your outlook might be for ’06 in terms of growth and capital spending by some of your key customers.

Peter, I’m going to answer that. This is Selim. I do not see any cutback from our customers so far. It seems that our restaurant business continues to be very strong. But, since we don’t give guidance, we’re not going to give guidance on this. So, we can tell you what the industry-- we expect the industry to continue growing between 3 to 4% at this moment, and we said we’re going to accelerate. We’ll be always ahead of what the industry growth will be, and we’re going to continue that. But, I’m going to give you a different way of looking at Middleby.

Okay.

I think if you look at Middleby and you followed what this management team has done, and the success of Middleby over the years is our ability to anticipate trends. And I’m going to most probably talk to you about trends. That’s basically what makes it-- instead of only talking about store openings and, well, replacement, there’s a lot of things that make our company successful. A year ago, last year the headlines were all about low and no-carb diets. If you remember, it was the South Beach Diet, the Atkins Diet, and many food service and restaurant menus quickly caught the trend. And in that, Middleby was on the forefront. We saw the trend. We anticipated it, and we worked with many of our customers to retrofit some of their kitchens very quickly to allow them to make money off that trend. Now, that trend is now curtailed. It’s gone out, and it’s no longer-- it’s almost on the decline. And let me tell you what Middleby is now doing. We are anticipating new trends. I talked about bread is back. Baking bread on premise is a big trend that’s going to continue being there. That’s trend number one, and we are on the forefront of that trend.

I’m going to give you another trend, which is interesting, what I call-- while still there is a huge focus by the consumer on health and nutrition, we Americans-- and not maybe only Americans-- around the world as consumers going to a restaurant, we still love to indulge. And what we’re seeing in trend number two is what I call a trend of the mini-desserts, when diners can have their cake and eat it, too, without the guilt, when it takes only two or three bites to eat the cake. So, miniature desserts are popping up on the menus everywhere, and we’re seeing a-- we are helping our customers use-- because they are smaller, they are more delicate to make, we’re seeing a significant amount of different type of convection ovens to be used, and we are on the forefront of that trend.

Trend number three, global dining. Emerging cuisine are finding their way to American restaurant menu, and they are shaping how operators are preparing and cooking foods. I’m talking about a general interest in ethnic and world cuisine, Asian, specifically Southeast Asia, Mediterranean, [inaudible] and Latin countries. We’re seeing a lot of those, and a lot of them are taking place in display type of cooking. With this, many of the chefs and the diners and the consumer are demanding authenticity, so we’re seeing a lot of grilling and steaming taking place in those restaurants. And many of those restaurants are acting similar to that, no boiler-steamer. We’re seeing a lot of demand for that. They are also, because of the display cooking of grilling dumplings or grilling skewers, chicken skewers and whatever, we’re seeing a huge demand on our chrome griddle plates, which is a unique technique of having a grilling with the chroming on top of it to make it easy-- to make it non-stick and easy to clean, and no transfer of flavor from basically grilling a beef skewer to chicken skewer to shrimp skewers.

In addition, those cuisine require lot of frying, so they are trying to get those special fryers which have unique filters to them. So, having seen those trends, we’re working very hard to develop those consumer trends and be ahead of them, and that’s what Middleby has been very successful in doing, not only anticipating the trend, but working with our customers, which are the restaurant and the chains, to make sure that we fulfill their equipment [inaudible] and the training.

Now, let’s talk about specific trends that have nothing to do with consumers trend. They are relevant to operators trends. Shortage of qualified labors continued to plague operators as our restaurants continue to grow. So, there is a great need for training, and that’s where we come in not only because those chains are only in the United States, they are global, and we’re making sure that training on our equipment becomes easy, and it’s consistent. The cost of energy also is starting to worry operators. When in year 2000-- just to remind you, in year 2000 Middleby spent a lot of resources on EMS1, Energy Management System 1. In year 2000, we started doing the energy saving device. None of our competitors have followed.

In the meantime, people told me and told my management team you’re on the wrong strategy. Look out in the parking lot. Look how many Hummers. Look on the highways. In fact, Hummer introduced their H2 that year. I remember. Navigator came on. Expedition introduced the Excursion, and everybody was introducing bigger and bigger SUV. And today, finally today, it took us almost 3 years, 3, 3.5 years, we started seeing our restaurant operators concerned about energy savings not only in the United States, all over the world. And we don’t see the price of energy and fuel isn’t likely to decrease any time soon, and we see that happening.

So, rising energy and labor costs means operator will demand energy-efficient equipment that’s easy to use and requires little training, and that’s another trend that Middleby has done. That’s why if you came to our shows-- and I urge any one of you to come to-- whether it’s an NRA show, which is held in May in Chicago, to look at how our booth looks. We show our equipment. We show our energy saving. We show our customers how they can operate our equipment in less training and in a very efficient way. And this is a type of thing that Middleby has done, and we continue to do. That’s why the 24 new products that we’re going to develop and engineer in the next 3 years are all based on those trends.

Okay. I appreciate the thoroughness of that answer, Selim. Thank you.

Andrew Kaplowitz with Lehman Brothers.

Selim, you alluded to this earlier. You said your goal for Nu-Vu over the 18-month period was to get the gross margins to the mid-30% range from the low 20% range when you bought it. You also said-- this is I guess on your last conference call-- you also said that you would get back to the 20% operating margin sometime in the next three years. Well obviously, you’re over 20% this quarter, and it looks to me like Nu-Vu is much closer to your targeted range than you first thought. So, I’m just wondering what that means for sort of 2006 and beyond. I mean, are there new goals that you’re sort of targeting, or is this sort of a one-time sort of seasonality? What should we be thinking?

Andy, this is Tim. I’ll step in, and then Selim will finish. But, you’ve got to remember that this is a seasonal business. So, when you look at the second and third quarters, those are the strongest quarters of the year. so, we definitely get the benefits of leverage on volume. And so, when you look at a third quarter relative to a first or fourth quarter, you would expect that the operating margins would be higher. So, when you look at a blended rate for operating income, I think at this point we’re still moving towards a sustainable 20% I guess if you look at four quarters as a whole. So, I just want to point that out.

I think Nu-Vu’s kind of a separate issue. We’re probably ahead of schedule on the integration there. I think we’ve done a good job of executing that in a short period of time, so we are, in fact, up to kind of the mid-30% sustainable margin rate we believe at this point with Nu-Vu.

Andy, to answer again your question long-term what I see, I think we’re going to continue pushing the margin. It’s what has been expected from us, and the [inaudible] does very well. However, there are extra (ph) things in short-term that can always-- we don’t think-- people look at how we perform, and it hasn’t been-- if you look back, the last 3 years haven’t been easy for Middleby, either. So, if you look at how we perform in the last 3 years, for some of you who have started investing in our company recently or got to know our company, it hasn’t been an easy ride. Really, it hasn’t been-- we can’t go and say, well, the sky was totally blue. I remember we got hit by recession. We had a huge acquisition to integrate right after September 11th. We had, as Jamie alluded in some of our key markets in China and UK, we had mad cow disease, we had SARS.

We then had the issue of seeding all those new products, which takes time. You have to seed it. You have to invest. We also in the process did the buyback of our joint shareholders, which consumed some of our term (ph) to do that. We got some debt on that. We got steel issues. So, I assume in the next three years I operate in an environment that I will always have some type of storm somewhere out there. So, we’ll always have to figure out maybe we’ll have some setback in one quarter or two quarters, but this management will always look at efficiency and look at a way of cost containing and anticipating those terms. As we go through our annual budget review, which is ongoing right now, part of what you expect as investor or analyst or shareholder to come back and say is Middleby, is Selim challenging his people to continue looking out of the box to make sure that, if there is a setback, how do we do that and how do we manage it. And we’ve managed I think in other situations that you expect from us.

As we continue integrating so beautifully acquisition, we need to continue looking at acquisitions. We need to continue reducing debt. We need to continue reducing our working capital. Margin alone is not-- we’re going to continue pushing margin as much as we can, and we’re committed to that goal, to be north of 40%. I said in the next three years, I’m continuing pushing for that. As a corporation, I would like to be on EBITDA north of 20. However, I would like to make sure also we manage our working capital. We want to manage also our acquisition process, and we’ve committed to acquisition as we go forward because we’re integrating them so well. We seem to be-- we understand our field. We understand cooking, and we feel that this is a field that we are very efficient at giving value to shareholder, whether it’s a big company like Blodgett or a small company as Nu-Vu.

Okay, thanks. Did you get impacted by the pre-buy that you had in the first quarter here in the third quarter? Because I guess you had told us that the organic growth would slow down a bit in 3Q now. I guess it did a little bit in the US, but it was still better than expectations. So, I’m wondering, it seemed to hold up pretty well. What are sort of the drivers behind that?

Well, I think we did carry-- although backlog’s not a good indicator for our business because it’s such a short lead-time. We did carry a lower than normal backlog coming into the third quarter because we did have a much lower order rate in the second quarter as a result of the pre-buy that we had in the first quarter. so, that impacted us when we moved in, but then we saw order rates return to more of a normalized level as we moved through the third quarter.

So, if I look back, going forward I think overall we should have seen our order rate starting to normalize by now. The problem, we got hit by the hurricane, slowed us down a little bit. And then, the other thing that I’m-- the impact on margin is back. We are now seeing at this moment as we’re negotiating steel, Katrina didn’t help us. Steel prices are going down, and now we understand that steel is starting to move back up slightly, which gives us a short-term setback until we figure out this whole impact of Katrina both on the top line as well as on the steel pricing, because we seem to read the newspaper, and suppliers say, well, there is-- with reconstruction taking place, there’s going to be a lot of steel being used and required. And supposedly they are using Katrina as another reason why they see a spike in steel prices. So, we should be in negotiation with our steel supplier again shortly. We should be able to figure out where we stand on that-- on those steel prices.

So, if you go back and say what we told you, we basically were right. We got a pre-buy. We were expected to get away from that by the fourth quarter, and now we got affected by those two events. And we’re going to manage them, and we’re going to manage them. they are short-term, and I continue looking long-term, which is three years down the road, which is a horizon that I would like to look at. I think the company will continue performing as well as it performed in the past.

Great. That sounds good, Selim. On steel, you had mentioned I think in 1Q that it was about a 35% headwind, and then it went down maybe to 25% in 2Q. What was it in 3Q, and can you tell us what you expect for 4Q in terms of a headwind year over year?

I think really in the first half of the year, our steel costs increased 35%, so I think that was consistent for both the first and the second quarter. And then, I think we got some-- we did get some relief here in the third quarter. We saw about a 10% reduction in the price of steel in the third quarter. And after that, I guess we’re not certain exactly where steel’s going to end up for us in the third quarter. We were on a trend where it was continuing to decline. That was our expectation initially in the fourth quarter, and then with Katrina that declined, obviously stopped, and steel prices moved up a little bit. But, I think they haven’t settled yet, so we’re not certain exactly where they’re going to end up in the fourth quarter.

Selim, this is pretty subtle, but you had mentioned just on this call 7 or 8 disruptive new products. And I remember you mentioning more like 4 the last time that we all met. Is there a change there, or is it just sort of more clarity on what’s going to be out there, or are you even being more aggressive with the disruptive technologies?

We are being more aggressive with disruptive technologies. It seems our engineers have done a great job coming up with disruptive technology, and looking for the next three years. You know, remember, some of those disruptive technology-- it’s one way to say, well, I’m going to have a concept is to take it to implementation. Until I see a prototype and it works and we can manufacture it, and does the results we are going to do, we usually do not consider this a new product. For us, a new product is based on a prototype being built and does exactly what we conceptually thought it will do. And so, what we need to do is we now on 7. We feel pretty strongly on 7 in the next 3 years, and they will carry a much higher profit margin than we’ve had in the past. So, it should help us carry our margin higher as those roll into the marketplace. Because not only they are all disruptive in terms of speed, energy, but they provide significant savings for our customers, investment to our customers. So, we’ll see the margins being in the 50% or higher on every one of those.

Wow, very nice. Just one more question on cash flow. Tim, did you give us the cash flow from operations number? If you did, I missed it. And then, when you look for the entire year, I think you had mentioned that the target was to pay down to about 100 million in debt by the end of the year. Can you do better than that now since you’re close to that now, or is that sort of the target still?

Our target was to be below $100 million in debt, so we’re on target for that. I haven’t reported a cash flow for the quarter yet, so we’re-- that will be in the 10-Q, which will come out later in this week. But yes, we believe that we’d be on pace for below 100 million.

Mark Grzymski of Needham & Company.

Selim, could you just-- you went in depth there about trends that you’re seeing, and I’m wondering if you could kind of correlate that with trends in the international market. You’re going to see obviously volume growth there, but are a lot of the trends that you’re talking about in the domestic market, are-- any of that going to spill over into the international markets?

Very much so. Speed of cooking internationally is the same way our US chains are looking at the same thing through internationally. I see a lot of regional chains taking place, and we’re benefiting from those regional chains who are copying and emulating the US chains, whether it’s Latin America or in Asia or in Europe, and we’re getting a significant emergence. I just came back from the Milan show, which happened in Milan, and it’s the biggest food service show in the world. It’s held every two years, and we had a booth there. And the difference between us and everybody else-- there were Europeans, there were Americans-- we were focusing on energy. We were focusing on speed. And you would be surprised how many people were lined up in our booth. We’re different. Our message is not how beautiful our equipment look. It was not that. It was about energy. And we’re seeing the same energy trend there, so we’re seeing about efficiency in terms of our frying capability.

I spent three days literally at the booth, at the show, and I was-- and I had dinners with customers from all over the world. They were visiting there. And we’re getting kudos for all the innovation we’ve put in our equipment. Originally, we’re doing it for our US chains. We had a huge contingent from the Middle East, but the Middle East has not been a huge chain-driven region. And many of our customers in the Middle East were all looking for that energy saving. They were looking for that easy of training, easy to wash their equipment, and we had a lot of success at the show. So, coming from that show, I feel that the trend that we have built for our chain business, which today accounts for 60% of our business, is spilling over to everybody internationally. And if the show is any indication and the excitement that you saw [inaudible] from our customers, and the fact that we’re differentiated from everybody else, we’re very differentiated from anybody else from the fact that we’re focusing on bottom-line value to our customers on design that provide features and benefits. And at that show, we did not introduce any disruptive technology. We didn’t even talk about it. It was all what you’ve been talking about, introduced in the past year or year and a half here in the United States. It’s been well received.

Great. So, is it fair to say that you’re almost driving your customer’s needs as opposed to the needs of their customers driving what you’re trying to achieve in the new product line?

I agree with that. I think that’s exactly-- I think that’s well put way of saying it.

And just finally here, going back to steel, how much steel-- how far in advance are you buying steel, Tim, currently?

We’re not buying steel in advance. I mean, we’re just-- based on the production need.

Okay. And you said you’re negotiating price. What kind of time period is that as far as--?

--Well, we were locked into typically-- we’ll probably move back to what we had done historically, which is moving to a contract that starts January 1. This year we had a contract that went from January 1 to mid-year. In prior years, we had had an annual contract, so I think-- I don’t know if we’re going to have an annual contract or a six-month contract, but that’s what we’re I guess evaluating right now.

Larry Callahan with Huntley Securities.

Yes, hi. I just had two questions. I wondered if, with this more aggressive new product introduction, if you could give us an idea of the R&D expense this year for the first nine months versus last year.

R&D expense is running roughly 2% of sales, and it’s relatively consistent with last year as a percentage of sales.

Oh, okay. And then, I was noticing TurboChef had some warranty issues. How do you intend to deal with any warranty issues on disruptive new products that you might come out with?

Easy, Larry. We want to test, test, test, and test. That’s one of the things we do. We do not seem to have been-- we’ve introduced 24 new products in the past three years, and we haven’t had-- of course they would not be disruptive. But in many ways, our disruptive technology is based on many of our already reliable technologies, and we feel that testing and testing and testing-- that’s one of the reasons we feel that our revenues don’t come very quickly. Our customers-- for example, today-- I could take orders today for our Wow oven, today, and we keep on telling our customers no, we want to test. I repeat, test, test, test and test to make sure it works in the environment, to make sure it does what it’s supposed to do.

Number two, we’re working with suppliers that have been with us for a long time, and we’ve been in this business a little bit longer. The depreciation between us and TurboChef is simple. TurboChef is focused on fully one platform. Remember, across the company we have a lot of platforms, and we seem to have tried over the years, and we’re a lot older than TurboChef in terms of existence. So, there’s a lot more, and our people have been with us a lot longer from the engineering standpoint. So, we’ve seen a lot more, our [inaudible] and our design have been tested over the years, and we feel a little bit different than what they have introduced. And my feeling is we’ll do the same thing. If we feel that we have issues, we’ll go back and put some reserve up front in those disruptive technologies, we need to do. But, I’m hoping that we don’t have to do that, and I hope that we’ll introduce-- we’ll be luckier-- let’s put it this way-- that our testing will be luckier in introducing disruptive design. That’s all I have to say about it.

James Clement of Sidoti.

Hey, Tim, just one quick question. Through the first nine months of this year, approximately what would-- stock compensation expense, what would that have been?

2.5 million.

And that’s pre- or post-tax?

That’s pre-tax.

Pre-tax. Thanks very much, Tim.

At this time, there are no further questions. Mr. FitzGerald, are there any closing remarks?

Okay. We’d just like to thank everybody for attending today’s call, and we look forward to speaking with everybody next quarter. thanks very much.

This concludes today’s Middleby Corporation Quarterly Earnings Call. You may now disconnect.