Middleby Corp (MIDD) 2017 Q1 法說會逐字稿

Welcome to the Middleby Corporation First Quarter Conference Call. With us today from management is Selim Bassoul, Chairman and CEO; and Tim FitzGerald, CFO. We will begin the call with commentary from management, and then open the lines for your questions. Instructions on how to get in the queue will be given at that time. Now I'd like to turn the call over to Mr. FitzGerald.

Okay. Thank you, Andrew. Thank you, everybody, for attending today's conference call. I'm Tim FitzGerald, CFO of Middleby. I've got some initial prepared commentary, and then we will open the call for questions.

Net sales in the 2016 -- or '17 first quarter of $530.3 million increased 2.7% from $516.4 million in the first quarter of 2016. The first quarter sales include the impact of acquisition activity not reflected in the prior year comparative results, which accounted for $44.6 million or 8.6% of the sales growth in the quarter.

Sales in the quarter continued to be affected by foreign exchange variation in comparison to the prior year. This fluctuation resulted in lower reported international sales when converted to U.S. dollars in the quarter. And this impact amount -- impact amounted to $13.3 million or 2.6% in lesser reported sales growth and reflects the significant impact from the strengthening of the U.S. dollar versus the British pound, which impacted the reported sales at AGA and other business operations in the U.K. This impact is likely to continue for the upcoming second quarter, although would expect to be lessened in the second half if currencies remain stable at the current levels.

Excluding the impact of acquisition activity and foreign exchange, sales during the quarter decreased by 3.4% as compared to the prior year quarter. This reflects an organic sales decline of 2.6% at our Commercial Foodservice Group, a decrease of 0.9% at our Food Processing Group and a decrease of 5.9% at our Residential Kitchen Equipment segment.

Sales at the Commercial Foodservice Group for the quarter amounted to $312.2 million, and the lower sales in comparison to the prior year amounted to 2.6%. Although sales in the general market increased, this was more than offset by reduced purchases from major restaurant chain customers in comparison to the prior year. The prior year included the benefit of several chain versus the current year period did not include any significant chain rollout activity. We continue to have significant testing and approval activity across a number of our brands and with a number of our major existing chain account customers, which we are confident will translate to sales in future periods later in the year.

Sales internationally at the Commercial Foodservice Group were flat in comparison to the strong sales in the prior year. This reflects lower sales in Europe related to a prior year chain rollout, whereas we had sales growth both in Latin America and up -- and we were up double-digit in the Asian markets.

Sales of the Food Processing Group amounted to $77.3 million in the quarter. The organic sales decline of 0.9% in the quarter reflects a strong prior year comparison and normal quarter-over-quarter fluctuations driven by timing of larger projects at this segment. We see continued strong demand by our customers looking to develop operations in international markets to support growing market needs and are developing new growth opportunities in other segments. However, we expect revenues in the upcoming quarter will continue to be relatively constant with the first half of 2016 due to the timing of larger projects that we expect to occur in the latter part of the year.

Sales in the residential group amounted to $140.8 million in the quarter. Foreign exchange translation adversely impacted revenues at this segment by $8.5 million, primarily due to the strengthening of the dollar, as I mentioned before. Excluding this impact from foreign exchange, organic sales declined by 5.9% in the quarter. The organic sales decline reflects reduced sales at Viking of approximately 4%, while the AGA Group of Companies declined by approximately 7%. The revenues at AGA reflect the impact of product rationalization as we trim low-margin and unprofitable products from the product line and -- as well as efforts to reduce price discounting as we continue to focus on profit improvement at this business. Sales at Viking reflect the continuing impact of the Viking recall and legacy issues prior to Middleby's ownership. However, we are pleased with the positive response we are receiving on new products, product quality and a significant improvement in customer service and technical service, and we continue our efforts to convert this into positive sales momentum.

Our gross profit for the quarter increased to $209.5 million from $196.8 million in the prior year, and the gross margin rate was 39.5% as compared to 38.1% in the prior year. Gross profit margins during the quarter at the Commercial Foodservice Group were 41.3% as compared to 41.5% in the prior year quarter. And margins reflect lower sales volumes, mixed impact and increased steel prices, offset by favorable efficiency gains and the benefit of the material cost saving initiatives.

Gross margins at the Food Processing Group were 39.4% as compared to 40% in the prior year quarter. And the gross margin as compared to the prior year also reflects the impact of sales mix and steel pricing.

Gross margin at the Residential Kitchen Equipment segment increased to 36.9% from 31.1% in the prior year quarter. The gross margin rate reflects the impact of benefits from integration initiatives implemented at AGA and across the residential platform, as we further our efforts to leverage synergies across that entire business segment.

Selling and distribution expenses -- selling and general expenses in the quarter decreased from $109.8 million to $106.6 million in the current year quarter. The first quarter of 2017 included $8.4 million of additional selling costs related to businesses acquired during the past year. This increase was offset by $3 million of lesser reported expenses due to currency translation, $2.9 million in lower amortization expense and $1.5 million in lower stock compensation as well as $4.2 million in other net reduced costs associated with restructuring and integration initiatives.

Earnings per share of $1.24 for the quarter improved from $0.88 (sic) [$0.96] in the prior year quarter. And the first quarter reflected favorable tax benefits of $7.9 million associated with the adoption of new accounting standards related to tax deductions for stock compensation. Additionally, the company recorded restructuring expenses of $1.7 million during the quarter related to ongoing initiatives related to the integration of AGA. Excluding impact of these items on an adjusted basis, EPS increased approximately 17% to $1.12 per share.

Cash flows generated by operating activities remained strong in the first quarter, amounted to $46.8 million as compared to $14.5 million in the prior year quarter. The quarterly cash flows reflect increased earnings along with the absence of nonrecurring cash payments related to pension funding for AGA of approximately $12 million in the prior year in cash costs -- lower cash costs related to restructuring efforts. Noncash expenses added back in calculating operating cash flows amounted to $17.2 million for the quarter. For the quarter, this included $6.8 million of intangible amortization, $6.9 million of depreciation and $3.5 million of noncash stock-based compensation. And the company utilized $8.3 million in the quarter to fund capital expenditures primarily related to investments in manufacturing equipment and enhanced production capabilities.

And net debt at the end of the quarter amounted to $652 million as compared to $663.6 million at the end of the prior year. And the net debt-to-EBITDA leverage ratio was approximately 1.3x at the end of the quarter.

So Andrew, that's all for our initial comments. So if you could open up the call now to questions, that would be great.

(Operator Instructions) And our first question comes from the line of Tim Wojs with Baird.

I guess maybe just the first question I have is, maybe if you could talk a little bit about how the commercial business may be developed through the quarter relative to your expectations. And then just as you look into the back half of the year, could you give us a little bit of, I guess, flavor in terms of what you guys are seeing? What gives you the confidence that we'll be able to see, from a project perspective, some of the customers converting activity into orders in the second half of this year?

Well, I can answer that question because, as I spoke in my last conference call, we have huge visibility on testing since our business is mostly chains, and chains basically test and do a lot of rollouts. And our testing is -- continues to be very, very strong. So we are testing with many, many concepts. And we are seeing execution and rollouts happening in the second half of this year. So as I mentioned, we -- what happened in this quarter is a timing issue. That's it. We continue to see for our visibility is literally people coming -- restaurant chains and operators coming into our test kitchen, our labs, seeking solutions. And the amount of companies working with us right now to double up a new solution or a new menu item or to speed up a flexibility to address labor or address delivery or takeout is the highest we've ever seen. So from that perspective, I'm very confident that the second half and the next 3 years, as I've always said, our business is not dealing in quarter-to-quarter. It has always been longer than that, and we're very confident.

Okay. And then maybe just if you could comment a little bit on what the M&A pipeline may look like. I know you did a smaller deal in the industrial baking segment. Maybe what types of deals you're seeing in the pipeline, and then any sort of color on sizes or potential areas of focus?

Well, Tim, as always, we don't comment in any detail of what we're working on. But I mean, I would say, consistent with the course of many years, the pipeline is full. So I mean, I think, we're confident that we'll continue to add brands to the portfolio and continue to build on all 3 business segments. It's been a little bit slower recently, but I mean, it ebbs and flows over a period of time. And I don't think that's a reflection of the opportunities that are out there. So we did do the nice acquisition of Burford during the quarter, which is a smaller company, but strategically, it's a really great fit for our baking platform, really extends the line. And it's a big brand in baking, so I -- so we're very excited that -- to add that to the portfolio. So...

Okay. Okay, so it's really -- the timing really is -- it's more reflective of just timing, not necessarily the size of the pipeline, okay.

Maybe just to add a little more flavor to this. Because literally when I look at what's going on in the macro trends -- so let's address the macro trends right now. Full service and casual dining continues to lose share. So we know that. And that's an opportunity for us, because we're working with many casual dining chains to restructure their business, from delivery to take out to becoming more nimble in changing menu. So we have 2 casual dining chains right now working with us, and they are large, to basically work on automating, again, their kitchen. The fast casual posted a single-digit sales growth for the first time instead of its double -- usual double digits. And this was driven by greater competition and the inability to deliver the best value proposition associated with fast casual. I think we were the first and we're dominant player in supplying equipment to fast casual. And we look at the fast casual today, I think some of them have lost their value proposition, pricing, quality. They've become a little bit stagnant. And literally what I see now is there's a greater competition in that segment. And we're working also with several, many fast casual concepts to deliver a new kitchen layout that allows them now to become more competitive and go back to offering a better value proposition. Overall, the restaurant business, Tim, saw a lagging same-store sales, including delivery check averages and reduced basically food traffic. Now that's specific because grocery stores have become a challenging concept and making dining out less appealing. So from that perspective, our customers have to go back to the basic of delivering pricing and food the way pizza chains have basically reinvented themselves. And I've been meeting with many CEOs. I was at Scottsdale at the global -- at the leadership conference and I met many, many CEOs. I was one of the keynote speaker there. And one of the issue I spoke to many is, how do you reconfigure your business. And that's going to be boding well for Middleby. Because all those chains are baked and everything is wrapped, and many of them were not forward thinkers in trying to do what many of the pizza chain have done in delivering a value proposition. And if you look at most of our pizza chains today, they are doing extremely well. And I look at many of the coffee chains, they've also reinvented themselves. From that perspective, I am looking at Middleby. And we're very excited about all the testings and the restructuring we're doing with many of our restaurant concept and our customers.

Okay, great. That's really helpful color. And then maybe from a margin perspective, you cited steel as a little bit of a headwind in the quarter. Is there any way to maybe quantify that? And then how should we think of price costs through the year? Are you able to push through some pricing in some of the other businesses to offset the higher steel costs? And when would you expect that?

Yes. So I think, it's -- so the impact is probably about 0.5%, and we did take price increases going into the year. I think we are looking at taking certain midyear price increases, because we do still see steel going up in the second half for us. So I think we're largely able to offset with price increases, maybe not totally and then the kind of the rest of the offset comes from other initiatives with material cost savings and efficiency gains. So I think it's a headwind. It's a manageable one that we've had in the past. And over time, we are able to kind of jump ahead of it.

And our next question comes from the line of Larry De Maria with William Blair.

First, can you just specifically tell us what domestic versus organic growth was for commercial?

So Larry, I don't have that on top of my head. I would say international sales were flattish. So we were down a little bit on the domestic side. And maybe to kind of break -- give a little bit more color, if you look at the general market, we were -- we'd be up slightly. So it really is chains that's driving that down, which is our top 40 to 50 customers where, as Selim mentioned, we have visibility to what they're working on, but that becomes a timing issue. Internationally, which I think if you remember, we were up 20%-plus kind of consistently every quarter last year. We had some pretty strong comparisons. If you look at the first quarter of this year, we continued to be up pretty strong in Asia. Europe, we were down where we saw some softening. But we did have a major chain roll out there in the first quarter, so some of that's tied to that rollout. And then Latin America, it -- we were up, but we slowed quite a bit. And I would attribute a lot of that to Mexico, where we saw some disruption, I mean, absolutely after the election and the weakening of the peso, which I think disrupted some of our business early in the year with that market, which I think we'll probably start seeing recovering as we move through the year.

And that's good color. And then secondly, actually I think you called out timing in the first quarter of last year as well. So it shouldn't have been that big of an issue on an apples-to-apples basis. So my question is what gives us confidence that the organic declines are not share related, or maybe it's just mix, like you said with the fast casual being weaker. And if that's the case, do you have plans to maybe to be more aggressive in other segments of the commercial markets?

So Larry, I want to answer that. First of all, I keep on talking about the second half of the year. So most probably as our testing, and if you go back, I've been at this -- I've been doing this, me and Tim for over 20 years. So we are most probably the longest-standing executive in this industry doing that. So I've always said if you go back to 20 years of me talking on conference call or 15 years or 12 years or 5 years, our basically testing with our customer takes usually 18 to 24 months for it to take place. And so when I say I'm optimistic in the fourth quarter, meaning it will generate results in a year to 18 months later. So part of our business being so innovative where we get customers to come to us seeking solutions, they test because they are not changing a range to another range. That's not what they're doing. This is not a price play. They don't come to Middleby because they are looking for a discounting. They come to us because they are looking for an innovative solution. And innovative solution meaning it's disruptive in their kitchen. It's disruptive in the way the flow of their flavor going in. So when I look at why am I confident, because we are heavily, and me personally, aware of every chain spending time and energy with us, having several people and flying people away from their corporate offices, in our labs throughout many of our divisions spending time evaluating. And we have tests in place that have been put in place in several chains, more than 1 or 2 stores. So we're -- in some of them we are at 50 stores, in some of them we are at 10 stores, some of them we are at 3 stores. And I have seen the highest number of testing ever in my tenure at Middleby, has been the highest I've seen. So from that perspective, I'm very confident. People don't tend, especially today where every chain is lean, they would not be sending people to Middleby if they didn't see something that makes sense. Otherwise, they would have come in and tested for maybe a month and then they moved on and maybe move to our competitors or move somewhere else. But they are here conducting a solo testing in our lab and in the field. So that's number one . Number two, why am I confident? Because we have concept that today continues to be growing for us. And those concepts have been lately grocery and convenience store are becoming a strong driver for us. It's a smaller segment for us, but is growing pretty fast. I look at Mediterranean concepts, chicken, pizza, coffee chain and Asian concepts are driving strong growth not in the second half of this year as well as in the next year. And those concept continues to be some of the ones that we're testing with and doing extremely well for us. The next one where I'm seeing significant change flocking to us is about labor. So labor has become finally an issue that I've been talking about labor. We did Chili's almost 4 years ago. And Chili's was most forward-looking casual dining chain when they came and said, "I need to attack my labor issue because it's creating a climate of instability in our stores. Consistency, people aren't showing up. We have positions that are not filled in our kitchen, and it cost us a lot of money." And they saw that prior to the minimum wage issue and now basically broadcast on every media that minimum wage has to go up in the restaurant business. However, many of our other chains were very slow to follow suit. Today, it's not the case. We have more and more chains coming to us looking at how do we resolve labor issue. How do we offset the high cost of labor through automation? So automation, grocery store and convenience stores, Mediterranean concept, chicken concept, pizza store, coffee chains, Asian concept are all a big driver in the second half of this year.

And Larry, just one other added comment in terms of your question on the confidence. A lot of the activity that Selim is referring to, we're not -- it's not we're bidding and there's 3 parties that are competing for business. We're working really exclusively with these customers. So it's more of a matter of how and when, not a process where it might go to us or it might go to somebody else.

I appreciate that, and I'll pass on, but can you just let us know what full year tax rate we should use?

Okay. Larry, I think you asked the question on tax rate. I'd be honest, I didn't capture that, but just maybe I'll comment on the taxes. So in the first quarter, we did have the onetime -- well, it's not a onetime, but if it's an accounting change, so the company's got stock compensation. So in the past, those actual -- their cash benefits used to run directly through the equity part of the income statement. They now will go through the P&L. And that will benefit our effective tax rate kind of on a continuing basis. That being said, it's tied to discrete vesting of shares and when we get the actual cash benefit. So that's not a quarter-to-quarter benefit. So I think, we -- that benefit we realized in the first quarter, we would not realize a similar benefit in second, third or fourth quarter, but we likely would realize discrete benefits at certain points in time as there's vesting of shares of the company. So absent that, we would kind of revert to a normalized effective rate, which right now we forecast to be in the 33% range.

Our next question comes from the line of Jamie Clement with Macquarie.

Selim, if I can ask you a follow-up on the conversations that you've had with other CEOs of restaurant chains recently with respect to labor cost. One of the thing that I'm not sure investors or people like me totally understand is, how can a chain, if it doesn't want to go full-on Chili's Kitchen of the Future, can they effectively take out labor cost by just replacing or early replacing a couple of pieces of equipment? Or they really need to address the entire kitchen and have a bigger expense associated with it?

That's a good question. So basically, today, it is difficult to take labor out by just replacing a piece by another piece. The problem is it requires a complete transformation of the kitchen. So we have 2 types of customer -- well, there are 3 types of customers. There are customers that are still thinking that all they have to do is keep on becoming innovative on the front end, meaning, let me go invest in my app, in my electronic ordering, and I make it easier for people to order, online or texting or WhatsApp. And we figured that out. Those customers will most probably spend millions of dollars putting technology in the ordering process and then they don't see the same-store sales go up. And the proof is, Rizzoli, the pizza chain did that. They were the most innovative. In most probably 2005, 2006, 2007, they were the first to do mobile app. They did texting. You can order your pizza online. But then they realized that's not enough unless you have a great product. And when Domino's came out and Papa John's and Pizza Hut came out to say that we have started delivering a better product, a better value proposition, and then they find out that they needed to go do a $10 pizza and they need to figure out how to get a $10 pizza faster in a value proposition, it's required a complete change of what type of equipment they need to use. And that's why the WOW became a big one and then the WOW! 2 and all that. Next -- that's one type of customers. The second type of customers will be customers who are more interested in looking at expanding their menu items, so how do I increase my menu items. Now today -- in the past, you say, okay, let me add labor, let me add this type of equipment to the kitchen and add labor to it or extend my hours or extend to breakfast. Well, at one point, it's tough to keep on adding labor. First, you can't find it. Second, it's become very difficult to expand the kitchen, right? You don't have space. You need hoods, you need all of that. And the third type of customers, who have been very, very forward-thinkers, would come back and say, I need to become flexible in my -- I need to become like a factory, I want to come in and be able to have less people, be able to be open more hours, be able to offer more menu items, but with a lot less people, and maybe I want to be able to go ventless. So literally, you've seen what happened on one casual dining chain. So one of the casual dining chains, which we've tried to work with, and I had dealt with the COO of that chain many, many times, and I asked, "How come you're not reinvesting in the kitchen? Your kitchen is full of microwaves." And the answer was, "Oh, we're not a -- we're interested in the bar. Our business is a bar business. We make more money on drinks." Well, it doesn't preclude you from offering great food. So if Buffalo Wild Wings figured out how to do that, okay? Now the problem is, that chain -- that COO was fired early this year. That's my -- my feeling is finally now that chain has a new leadership, and they are working with us to figure out a way to get the kitchen and the food better, which, for years, they've used microwave, mostly microwave to rethermalize precooked food that they got from their supplier. And that chain kept on -- it's a large chain that kept on shrinking.

I appreciate it. Tim, just if I could ask you a follow-up. When you were discussing processing during the quarter, I think you kind of gave a little bit of some commentary on 2Q. You obviously -- I think you were around $83 million last year in processing in 2Q. I could be wrong about that. That's a huge number. were you implying that -- I think -- what was the number this quarter, around 77 or so? Were you saying we should be sequentially roughly flat? Or were you implying that we should be flat year-over-year in processing in 2Q?

Yes, I think I was referring to second quarter last year. So I mean, I think we're, as I mentioned and I think as everybody knows, that's a lumpy business and kind of individual quarters kind of drive the growth up or down. So I think what we're looking at is a lot of the bigger projects go later in the year. And I think sequentially -- or not sequentially but quarter-over-quarter, we'd probably be looking to be flattish. And I think as everybody -- well, as I'll point out, we were up double digit every quarter last year. So last year was a strong year for food processing all the way through. So we're looking at being, I think, flattish in the first half of the year against some pretty strong comparisons.

Yes. Absolutely. And it was that 2Q, was, I think, really the one that really kind of took off when you started seeing the backlog really come in. So that's why I wanted to ask the question.

And our next question comes from the line of James Picariello with KeyBanc Capital.

So for food processing, I mean, you made it clear that there's some -- you had some really nice backlog visibility in the second half. Just wondering, given the really strong margin ramp that you had last year, how should we be thinking about margins in the second half with these large projects coming through?

Well, we're -- we still have a number of initiatives to enhance margins really across the segment. So I think, in particular, we did a consolidation of our baking group, which should drive some manufacturing efficiencies. And we've really also focused on pricing in that segment. So I think that should give a little bit of tailwind. That being said, I would say mix is probably going to be the factor, depending on how the meat side of the business and baking splits out in the back half of the year because I do think we're seeing some strong growth in the baking side of the business, and that does have lower margins. So while we're bringing it up to the average, there's a little bit of a plus, minus there where baking margins are coming up. But they're -- but as compared to the meat side of the business, they're still -- they're lagging. So I would say that's kind of the dynamic that will play out in the second half of the year.

Okay. That's great color. And then just on the residential side, how are things turning? I mean, I think you guys provided some really nice context around AGA and the SKU reduction and less price discounting initiatives that are hitting the top line a bit. But for Viking, how should we be thinking about the rest of the year? Are dealers -- the anecdotes seem to be more positive, but is there any more visibility beyond that in terms of a recovery for Viking?

Yes, well, I'm going to say that literally, we continue to be affected by the recall. We've said that. And it's most probably a broken record now because you keep on -- we keep on addressing the recall. But it's such a hefty recall. It's 60,000 ranges that takes place now. Let's talk to what happens next. So let's dissect Viking. So the 7-series product line on the cooking side continues to be growing extremely fast. And this is a line that we've introduced into Middleby, which has all the Middleby technology. The burners, that are non-clog burners. The no-preheat ovens. Now we're introducing the 7-series refrigerator, which will be our brand-new refrigeration that delivered into Middleby this quarter. And we're missing that refrigerator. So we're still living off the refrigerator of -- that was designed under the old management. And it took us time to get there because we had to meet Energy. We needed to deal with them so that it's worldwide, globally accepted. So we took time to get our new line of refrigerators so it could accept the refrigerant that's used in Europe, the refrigerant that's used in the Middle East, in Asia and in the U.S. So we worked very hard to make this product line globally accepted, which was not the case in the former refrigerator. Today, I can't sell my 5 Series refrigerator without a transformer, if I want to sell it to Europe or to the Middle East. So now we're introducing the new 7-series refrigerator. So if I expect that to grow, that would be most probably doing exactly what the 7-series hot side did. We are also -- we were missing a, basically, a contemporary, or what I call an urban product line. So New York City, Chicago, Miami, L.A., high-rises, so we did not have this line. It's not only in looks, but it's sizes. So it fits in a different type of kitchen. And we're launching that later this year, a complete line called Virtuoso. So from that perspective, what we've been waiting for is to fill all the product line we needed. And we're starting to see. So we go back to 7-series ranges doing extremely well. Our French Door oven is doing well. And then now we're introducing 7-series refrigeration, and we're getting a Virtuoso launch at the end of this year. Now service and parts, we've basically talked about service and parts and we've gotten our service and parts basically in line. We've restructured our service organization throughout the U.S. And now it's shown and reflected in our warranty rates that has gone way down. The other thing that's very exciting, if you go online now, the online reviews on Viking has become extremely positive. So we are outpacing our competitors, including every high-end, every one, we've outpaced every high-end manufacturer of ranges and refrigerators in the high end of luxury appliance. And we're now beating them on online reviews by almost double the stars and the rating. So that was something that validates that we're on the right track. Now to answer your question, when do we start seeing results coming through? I think if you take away the fact of basically the recall on the 5 Series, which is still our largest product line, and you still look at all the products that were introduced by Middleby, the Middleby products introduced have been growing very fast. Our legacy products continue to be facing the recall, I call, the recall stigma. And now we'll most probably start, once we introduce 7-series refrigeration and obsolete the 5 Series and we start obsoleting all the legacy products, I think, clearly, we can start seeing a significant improvement in top line at Viking. Now the timing is most probably, I would say, again, like everything else, when you launch a product, by the time we put it in the dealer displays, I'm looking at most probably toward -- starting to see that happening at the -- toward the end of this year.

Just one thing, one other -- one last thing on residential. How would you assess the pricing competitiveness dynamic -- in the space right now?

I would say we are very competitive in the price point. We are right in line, I think, on certain pricing where we're very -- we have a very strong following, which is 7-series, is priced higher than everybody else. On the 7-series ranges, it's solid. So I think it's not a price-sensitive segment. Honestly, that's -- it is not price-sensitive. People buy with emotion. If you're going to buy a range that costs anywhere between $8,000 or $10,000, you're not going to be stopped because it's a couple thousand dollars more. Either you afford -- you're going to afford to put a high-end luxury kitchen or you would not. So you start with the appliance, then you end up with cabinets. Nobody is changing appliances without changing cabinets in general. Why? Because you're not putting all laminate cabinets and putting a range without inspecting. So literally, when you're looking at renovating your kitchen, you're not stopping at $1,000 item. You can afford to go for the best or you don't. So from a price sensitivity, there is none. Now going to Viking versus our competitors, we are usually either same price or priced higher.

Our next question comes from the line of Jason Rodgers with the Great Lakes Review.

Yes, I just wanted to follow up on the residential questions. Would you be able to say what percent of your Viking sales are legacy products versus the new ones you've introduced?

We have not divulged that number, but I can tell you it's still the majority until we introduce the Virtuoso. And on SKUs, let's talk SKUs. Upon sales, I'm not going to address that. Let's talk SKUs. Today, legacy product, today, remained a higher number than our -- the newly designed Middleby products because refrigeration has a large number of SKUs. So until we introduce the 7-series, which includes 7-series ranges, bottom-out and columns, once you introduce that and we introduce the Virtuoso, then by the end of this year, from an SKU standpoint, the newly designed product will outpace the legacy product from an SKU standpoint. So by 2018, the new product designed by Middleby, the 7-series ranges, French Door induction cooktops and 7-series refrigeration, Virtuoso, will outpace SKUs to the legacy product from a number of products in the catalog. If you go online on catalog or on the website, it will become much, much less. And at that point, somewhere in 2018, we can start phasing out some of our legacy products very quickly, but you couldn't do it today because I don't have sizes, I don't have refrigeration, I have -- I don't have a 7-series refrigerator. I am still selling a legacy 5-series refrigerator.

Jason, just one thing I'll add is even though there's legacy products out there, Middleby has gone back from a quality standpoint and made engineering design changes, which have basically put our quality standards even on the product that we would consider legacy products.

So let me clarify this. We have redesigned every product in terms of quality. So the difference between -- so let's add difference. The difference between the Middleby-designed product that came from scratch, which is 7-series induction, French Door, Virtuoso, they have Middleby technology in them. The legacy product, we did not put Middleby technology in them. They have great quality. They have the Middleby quality in them, but they do not have the non-clog burner, they do not have the 0 preheat, they do not have our chrome griddles, just to name a few. They don't have the Blodgett frame. So the question is, at one point, once I get the refrigeration to phase out the legacy products, even though we've spent a lot of money redesigning them in terms of quality and basically durability, and we've added a few features like soft chromes on some and we've added knobs, but we're phasing them out and will be 100% -- somewhere towards the latter part of 2018, we'll be 100% Middleby, that with every product you'll buy from Viking have Middleby technology in it.

Okay. That's helpful. Also, the gross margin performance was strong in the residential kitchen segment. Just wondering where to think about that as far as directionally. It's approaching the margin of the other segments, and I don't know if it can get there or what the target is for the gross margins.

Well, I would say it's still a work in process, right? I mean, the residential segment is still a

(technical difficulty)

relatively segment, AGA, which is the, by far, the biggest chunk of it we've only -- had done in the Middleby portfolio for about 1.5 years. So I mean, we've had substantial improvements. And I think we're -- we expect it to continue on that path. So I think our objective is to get that north of 40%. So I think we're well on our way to achieve that goal.

All right. And then just finally, on the food processing segment, understanding it's a lumpy business, but what's the risk that some of these projects could stretch out for a longer period similar to what you've experienced back in 2015? Or do you think the conditions are different that would preclude that?

Now Jason, there is a risk. This is a cyclical business. We lost that business, by the way, and we love that business. But it's a risk. It's part of the food processing business. It's not relative to Middleby, it's part of it. But I can tell you what is unique about that business is the fact that the launches are phenomenal on that business, the fact that, literally, it's a business where -- we love that business. So we continue investing in that business, continue acquiring companies in that business. And we just finished investing multimillion dollars in our bakery test center. So from our perspective, despite the cyclicality of the business, the margins continue to improve. So from that perspective, it had -- I would tell you, I think that today, even food service has cyclicality and when you think about it, the chains, when you look at the way we continue being closer to chains. Now you don't want cyclicality, go sell, go bid all day long in the general market. The reason that you've seen, maybe it's not as long as the cyclicality in food services, not as long as food processing when it happens, but literally, when you think about chain business, they are 18 to 24 months during testing and rolling. And people are stuck with us. We always say that. We're not a recurring revenue business where it's a razor and a blade. But the notion of that business is phenomenal. So when we look at -- I am willing to take cyclicality versus consistency and lower margins. And I'll give an example. People, I change my TV all day long, but the prices keep on dropping, I would hate that business. You want consistency? I can tell you that in my house, we keep on changing TVs every time. And they keep on going down in price, and that's the reason we change them because my children say, "Well, papa, like can we go buy a curved TV?" Yes, I go there, it's $200. It used to be $2,000 3 years ago. So our business is all about margin and solution-driven, but it takes time. This takes some time in resident, in food service and in...

That is all the time we have for questions today. So with that said, I would like to turn the call back over to management for closing remarks.

Well, thank you for everybody being with us. And I want to reinforce literally the macro trends so that even though some of them are repetitive, again, in the midst of the macro trends and what's going on in commercial food service in terms of some of our customers losing share and having less traffic, we're seeing major opportunities for Middleby because it's forcing our customers to reinvent, to shift and switch the way they do business. And in the middle of chaos, opportunities are happening for us. So in the middle of a fast casual slowing down, we're working with many of them to deliver a better value proposition in terms of quality and pricing. In terms of basically the restaurant business, seeing grocery stores and grocery prices take business away from them, we are working with several chains to figure out equipment that provides delivery and take-out for them to become more appealing and be able to combat the grocery store threat. If you look at basically labor and minimum wages increasing across the country and labor pool tightening, it specifically started happening in 2016 and 2017 in light of unemployment of 4.5%. Restaurant operators are faced with this challenge of finding ways to offset higher costs without driving customers away. And that's going to be tough because literally, they have to hold down menu prices, and the only way they have to do it is by reducing their labor, not only in the front of the house, but in back of the house. So looking at that, we're seeing innovation being -- driving our customers in the middle of the chaos. And it's creating opportunity for us. So automation is not just about robotics, it's about computerization. It's about a labor-reducing equipment solution. It's about speeding up the cooking. It's about reducing the foot space -- the space in the kitchen, the layout space. And it's becoming a major driver where many of them are testing new equipment with us. Ventus is growing fast as nontraditional outlets are growing. Grocery store and convenience store is becoming a strong driver for us. It's a new segment for us, it's an emerging segment for us, but we're doing well in that segment. Again, I talked about chicken, Mediterranean, pizza, coffee chain, Asian concept, bakery, will be driving strong growth in the second half of this year as well as the next 3 years. On the food processing side, I'm very excited about our bakery business. I'm excited our becoming a major player in pet food. I'm excited about our bacon. Bacon is a $4 billion market in the United States. It's growing at 10% a year, and we're becoming a dominant player on bacon -- in bacon. We are becoming a major player in [swavid], a major solution to reduce costs for restaurants. So our Armor Inox division has become the leader in swavid . Our third division is the leader in bacon. Our Cozzini is a leader in pet food. Our, basically, Stewart Systems and Baker and Auto-Bake has become a leader in bakery. And additional -- the acquisition we're making in food processing position us very well to continue expanding beyond protein, into pet foods and swavid and it's very exciting. On the international side, our legacy product today will be dwarfed by our new product that are Middleby-driven: 7-series refrigeration coming on; Virtuoso, which is our urban and contemporary line; our French Door ovens. And we'll continue expanding into outdoor with Lynx and under counter between U-Line and Marvell. And we continue looking at La Cornue, growing in the U.S. as well as AGA and Rangemaster doing extremely well in the U.K. Our service parts and our service organization have become best-in-class. It is reflected not only in our warranty rates, but reflected in our online reviews, live you can go online and you can see how better we're doing. So the question that was asked on that conference call, when would we have basically Viking become more -- growing faster? It will happen the day our Middleby product basically overcome and we basically eliminate our legacy product. And that's what will happen towards the end of this year, and we'll start seeing major impacts in 2018. And we're very excited about the residential business given the margin. So going back and looking at the whole, while the top line was not what we expected, however, it's just a matter of timing. In our press release, we talked about the fact that we have not lost customers. Our testing is the highest we've ever had. We also are proud to say that this quarter, we have basically started working with new customers, customer chains that are large and very innovative forward-thinkers that have not been Middleby customers in the past and now they have joined the ranks of leading customers to become potential customers in the future for us. And we're very excited about that. So from that perspective, it's not losing share, it's just a matter of timing and a matter of pushing our customers to create innovative solution that takes a lot more time to test because they are very disruptive and game-changing. Thank you for all of you to be with us on this conference call. And thank you very much. Have a good summer.

Ladies and gentlemen. Thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a wonderful day.