MIDDLEBY Corp (MIDD) Q2 2023 Earnings Call Transcript

Thank you for joining the Middleby Second Quarter 2023 Conference Call. With us today from management are CEO, Tim FitzGerald; CFO, Bryan Mittelman; Chief Operating and Technology Officer, James Pool; and Chief Commercial Officer, Steve Spittle. We will open the call with management comments and then open the lines for questions. Directions on entering the queue will be given at that time. Now I'd like to turn the call over to Tim Fitzgerald. Please go ahead, sir.

Good morning, and thank you all for joining us today on our second quarter earnings call. As we begin, please note, there are slides to accompany the call on the investor page of our website. We are pleased to have posted solid results, reporting a record second quarter with strong performance at both our commercial and food processing businesses. And we continue to progress our residential business, while it is impacted by the challenging market conditions and destocking of inventory at our channel partners. We posted overall improved profitability during the quarter and continue to make progress towards our longer margin targets. Our profitability is benefiting from our focus on new product innovation to drive improved sales mix. We are realizing efficiency gains reflecting the impact from our manufacturing investments and we are focused on longer-term supply chain opportunities with ongoing product design and sourcing initiatives, providing for greater improvements over the next year. While market conditions have proven to be challenging, particularly in the residential segment, the inventory destocking, which has impacted the first half for our commercial and residential businesses, we believe will largely be normalized by the end of the third quarter. And we continue to have strong engagement with our customers across all three of our food service businesses. Our new product introductions have accelerated over the past several years as we target growing market trends and launched game-changing innovations, addressing customer challenges of labor, speed, energy, food waste and sustainability. In our Commercial Foodservice segment, we've expanded our electrified and ventless cooking solutions. Developed new and exciting ice and beverage offerings in a large addressable market. And established Middleby as the leader in controls, IoT and automation solutions, positioning ourselves to capture the future of the industry. In Residential, we have significantly broadened our portfolio of indoor and outdoor premium brands with industry-leading designs, a pipeline of innovation addressing the growing demand for energy-efficient electrified products and with initial launches of connected equipment with more to come. At Food Processing, we have executed on our strategy of becoming a leading provider of full line integrated and automated solutions for the protein and bakery markets while successfully expanding into new markets such as bacon, cured meats, alternative protein and pet food. Through our substantial go-to-market investments, we're creating greater awareness for our brands' product portfolio and the latest innovations with a growing pipeline of customer opportunities. The investments we have made in our innovation centers have proven to be a strategic asset for our businesses. The traffic at our commercial, residential and food processing showrooms continues to increase. We now have a total of 8 innovation centers. We have invested heavily in training with our channel partners and our world-class culinary teams are engaged daily with hands-on customer demonstrations. We are realizing the benefits from deepened relationships with our sales partners and have developed important new customer wins, demonstrating the value of these strategic investments. We're excited to have most recently opened our flagship residential show in Chicago, featuring the latest designs and innovations across our entire indoor and outdoor Middleby brand portfolio. Since our June opening, we have quickly booked the calendar with customers discovering all that Middleby Residential has to offer. We're confident these investments of today are translating into the early chapters of a long-term impact and growth trajectory for all our food service brands. In the quarter, we also completed several acquisitions with the additions of Blue Spark and Filtration Automation. Blue Spark expands our software development and in-house controls manufacturing capabilities, extending our lead in digital controls and IoT. An area we're confident will provide Middleby with a clear competitive advantage as automated digital solutions are implemented in the commercial kitchen. While filtration automation furthers our strategy of developing best-in-class full-line automated solutions, adding a patented oil filtration technology, providing our customers with operating cost savings and improved food quality with our now expanded frying solution. In early July, we also completed the acquisition of TERRY Water Solutions. The TERRY chemical-free biodegradable water filter solution provides for improved equipment performance, reduced maintenance and consistency in food quality, along with ice and beverage. The combination of the TERRY Water Solution with our portfolio of food, ice and beverage equipment provides for a better customer experience along with significant growth opportunity in a sizable and attractive aftersales market. And just last week, we announced our most recent acquisition of Trade-Wind, a manufacturer of residential ventilation complementing our portfolio of indoor and outdoor cooking brands with an expanded offering of unique designs and custom ventilation solutions. Our critical strategic investments in innovation, go-to-market capabilities and acquisitions continue to build upon our competitive positioning in the marketplace and further strengthen each of our three industry-leading food service businesses. Now I'll pass over the call to James to spotlight more on some of our most recent product launches that address the growing electrification trends and the demand for automation in the kitchen. These new product innovations are also highlighted in our investor slide deck.

Thank you, Tim. Today, I will discuss some exciting developments in our product lineup, focusing on sustainability and electrification in the residential space. La Cornue, Rangemaster, AGA, Novy, and Viking have recently launched or are launching a full suite of induction products for homes. These offerings provide our residential customers with the same benefits that our commercial customers rely on today: safety, speed, precision, performance, and sustainability. Additionally, CookTek, one of our commercial brands, is introducing a few unique products for residential use, such as the Drop In Induction Wok. Middleby is also proud to bring the most extensive lineup of induction range tops and ranges to the market with designs ranging from classic French to strong American commercial. And Novy is introducing an innovative undercounter product called the Invisible Hub, which allows users to cook directly on their countertops. As before, you can find these new products in our investor deck. I've also included a slide that compares the benefits of induction versus electric and gas cooktops, highlighting the near perfect efficiency that induction yields, along with a brief explanation on how induction works. Now let's revisit a highly successful product that continues to gain traction in the commercial space, the Taylor NextGen Grill. Why has been the griddle of choice for a few high-volume quick service restaurants for the past couple of years, the general market introduction of the NextGen Grill continues to generate strong interest and adoption among our customers, especially those who've had the chance to come experience the grill's capabilities first-hand at our Middleby Innovations Kitchens Automation pod at NAFEM and the NRA shows. The NextGen Grill brings embedded automation through active compression cooking, allowing for cooking for both sides simultaneously. With its continuously variable gap control, this innovative cooking method offers next-generation precision. The NextGen Grill can control its platinum gap or compression with an accuracy of 5,000s of an inch and a platen parallelism within 10,000s of an inch. This level of precision enables our customers to achieve consistent cooking back to front and side to side, dramatically improving consistency and reducing cook times by up to 80%. Furthermore, this automation significantly improves food quality by reducing instances of over or under cooking, thereby ensuring safer offerings and minimizing food waste, ultimately enhancing our customer profitability and consumer satisfaction. Before I conclude, I'd like to give you a glimpse of what's coming up. In the next quarter, we will focus on new products slated for launch in Q4 and Q1 in 2024 and expect exciting introductions such as the rapid cook oven from TurboChef, a groundbreaking frying innovation from Pitco, and a new residential platform from Viking consisting of cooking refrigeration, dishwashing, and built-in accessories. Thank you, and now I'll pass it over to Bryan.

Thank you, James. I'm excited to be reporting these record results from our Blodgett facilities. Before I get to discussing the past quarter and some record results, I'd like to look back a lot longer. During this past quarter, Blodgett celebrated its 175th year of making ovens right here in Vermont. This is certainly our oldest domestic company. I have not attempted to estimate how many pizzas and cookies have come out of their ovens, but I know they are responsible for my favorites. Also, when Tim began executing our M&A strategy at the beginning of this century, the process began here. As we look forward, logic innovations are helping to lead the way. So I want to thank the entire Blodgett family for helping build the foundation of Middleby and for leading the charge as we reach new heights. Speaking of new heights, Q2 was a record quarter, our highest revenues ever. They well exceeded $1 billion. In spite of continued challenging market conditions, our organic adjusted EBITDA margin was 22%, with nearly $229 million of adjusted EBITDA having been generated. On a last 12-month basis, we are at $885 million of adjusted EBITDA. While our total organic revenue was down slightly given the residential headwinds, we were still able to grow our adjusted EBITDA dollars 4% over the prior year. Our total company margins expanded 130 basis points and all the margin values I will discuss hereafter are on an organic basis, meaning excluding any acquisitions and foreign exchange impacts. GAAP earnings per share were $2.16. Adjusted EPS, which excludes amortization expense and non-operating pension income as well as other items noted in the reconciliation in the back of our press release, was $2.47. Commercial Foodservice revenues were up nearly 3% organically over the prior year. The adjusted EBITDA margin was 28%, over 250 basis points ahead of the prior year. We are very pleased with how margins have continued to evolve as we see benefits from an improved product mix from our capital investments, from our operational improvements as we integrate acquired businesses, as well as our constant focus on costs and driving pricing in response to inflationary pressures. In residential, we saw an organic revenue decline of 27% versus 2022. The adjusted EBITDA margin was nearly 14%. Food Processing continues to perform very well. Total record revenues were nearly $189 million, an increase of nearly 27% organically. Our adjusted EBITDA margin was almost 22% for the quarter, up 270 basis points over the prior year, and we are at just about 23% for the year. Our operating cash flow generation was $62 million for the quarter and a rather strong $154 million for the first half of the year, a $64 million year-over-year increase. During the quarter, we invested approximately $23 million in capital expenditures and $26 million on acquisitions. But looking at the past 12 months, our cash flows were approaching $400 million. Seasonally, second half cash flows are even stronger for us. Thus, we look forward to continued strength in cash flows in the back half of the year, driving higher cash conversion rates as we realize further working capital improvements. This then should result in for the full year having operating cash flows exceeding net income. As we closed Q2, our total leverage ratio moved down to 2.9 times. Our covenant limit is 5.5 times, so we currently have over $2.3 billion of borrowing capacity. While we are very pleased with how we performed in the first half, especially given notable headwinds. We anticipate that the second half of '23 can be better than the first half. Even more importantly, we remain bullish as we look out over the next few years and tirelessly work to increase shareholder value. But let me spend a little time on the very near-term outlook. Starting with residential. Demand in the marketplace obviously remains well off the peak values or the peak levels seen in the first half of last year. Challenging market conditions persist, and these extend beyond the US. The UK is a meaningful market for us, where inflation, interest rates, and the resulting consumer behavior are headwinds. Q2 should hopefully be the trough for residential. As we consider the recent positive momentum in order trends, we think the business can hit an inflection point coming out of Q3. Nonetheless, looking at Q3 sequentially, we see sales down modestly from Q2; seasonality and absorption impacts will challenge margins, but they should remain at least in double digits. To finish the year, we do believe the fourth quarter should be stronger than the third and should deliver year-over-year growth. For food processing, we obviously posted a very strong second quarter and revenues were higher than we had anticipated when we discussed this segment three months ago. Our backlog remains strong. We are seeing strength in many markets we serve, including cured meats and buns and breads. However, some areas are facing headwinds, especially in poultry and bacon, where the underlying food costs are high, but we expect this may improve in the short term. As we look at these factors, delivery schedules, seasonal impact on operations as well as product mix, Q3 performance will be down from Q2 and likely around Q1 levels. Nonetheless, Q3 will deliver year-over-year revenue growth and margin expansion. Q4 will be stronger than both Q3 and the prior year, so the second half of 2023 should be better than the first half. For commercial, when thinking about near-term performance, we believe it is important to note that Q2 revenue and profitability also exceeded our expectations based on our outlook from a quarter ago. Accordingly, I expect Q3 to be fairly consistent with Q2. Also, we expect the inventory destocking that we mentioned during the call last quarter to be behind us after Q3. Then Q4 should be even stronger than Q3. This too, results in a better second half of the year. Putting the three segments together then, when looking at the total company potential Q3 performance, revenue and earnings will be lower than Q2 due to the lumpiness in FPG and the anticipated bottoming out in residential. Before an anticipated stronger fourth quarter for all segments and the company in total. I reiterate that on a total company basis, we expect Q4 to be stronger than both Q2 and Q3. This would result in total company growth for fiscal '24 over '23, despite the challenges in residential markets. As I look across our entire organization, I see innovations being delivered and we are uniquely addressing customer needs. Our profitability and cash flows continue to drive our unmatched ability to innovate, to add new capabilities, to develop stronger sales and go-to-market processes, to improve our systems and modernize manufacturing to enhance and expand our service and to grow our reach globally. From Vermont to California, from the UK to China, our teams are fully committed to continue delivering strong results. We all come to work every day hungry and thirsty for greater success. We remain excited about our prospects for a long time to come. We have all the confidence in the world that we will continue to reach new heights. Thank you and we'll now take your questions.

We will now begin the question-and-answer session. The first question is from Saree Boroditsky of Jefferies. Please go ahead.

Thanks. Good morning. I wanted to see if you could quantify the impact of destocking on the quarter and then how you're thinking about it for the full year for both segments. And I think we could argue that in a flat demand environment, this destocking should really be a tailwind into next year. So if you could help us size that, I think it would be very helpful for people. Thanks.

Saree, it's Bryan. Given the Middleby way, I'm not going to offer you specific numbers to size that. I think it's important to consider overall what's happening in the market and the results we put out there, right? So Q3, I'm sorry, Q2 is really strong. And when I commented that we expect Q3 to be similar to Q2. And starting with commercial here, given what's happening in the market with our dealers and customers about their levels. But then Q4 does improve. And as we've noted, based on the trends and the customer needs, we do think it does present a tailwind beyond when we get past the third quarter. As you think about the residential markets, obviously, they're challenging these days in a variety of product categories and certainly our customers, the dealers, the retailers are being cautious in managing their balance sheets as well. Q3 is often a seasonally somewhat weaker quarter as well for a variety of our products within the residential segment. But that's where we think things do start to pick up in Q4 for us.

Maybe phrasing a question a different way. Could you go through what you're seeing from a sell-out perspective in commercial foodservice and in residential?

Yes, I think it will be challenging to quantify the impact as you'd prefer. The effect is more pronounced in the residential sector compared to commercial. We believe that our channel partners will face a headwind, but it should dissipate, and they may exercise caution when restocking as we move into next year, resulting in a more neutral situation. As you mentioned, we expect this to turn into a tailwind for us, especially in the latter half of next year. There are many brands and segments involved, but we have observed strong sell-through when engaging with our commercial partners. This gives us confidence because we are closely connected with them and understand their sales performance and business plans. There are two main components at play: the general market and the chain itself. In terms of the general market, we are aware of inventory levels with our channel partners and believe we're nearing the end of that phase, as I mentioned in my third-quarter comments. Regarding the chains, there is significant public information indicating strong plans for store openings, and they have maintained some inventory to ensure they can execute those plans. We feel optimistic about the end markets in commercial, and our position there is solid. In the residential sector, the biggest impact has been on our outdoor grill brand. We anticipate being in a much stronger position as we finish the year. We actually believe we have turned positive in outdoor sales as we enter the fourth quarter because we started witnessing significant growth at the end of last year. This provides some context. While I know it's not a specific quantification, we are confident that we will end the year well, which sets a favorable stage for 2024.

Appreciate the color. I'll leave it there. Thanks.

The next question is from Mig Dobre of Baird. Please go ahead.

Yes. Good morning. I'm going to stick with this topic that Saree brought up, destocking. Just to be clear here, is the destocking occurring in the general market with distributors and such? Or is it happening with some of the QSR customers? This kind of sounded like it's happening with both. But I'm not clear as to how much visibility you have in terms of where these inventories are and whether or not you can be firm in your assessment that, yes, by the end of Q3, this problem is really solved.

We don't have complete visibility since we can't see the inventory in the channel, but we are actively engaged with it. We receive many indications and shared numbers, especially from the larger areas. So, I believe we have quite a decent understanding of the situation. The issue has been present in both markets. In the general market, it generally doesn't involve our product. As you noted, many in the channel grabbed whatever they could during supply chain challenges. Much like our business, they are looking to normalize their inventory. As they work through their stock and possibly reduce some products that typically wouldn't be purchased under normal circumstances, they'll start placing orders with us again and move towards a more typical stock level. That’s what we've observed in the marketplace. With the changes, they seem to be holding a bit more inventory than in the past. However, we remain confident about their growth plans compared to what we believe is currently in the channel. We are quite optimistic that this will be resolved, largely by the end of the year and certainly by the end of the third quarter. We have one more quarter to navigate, and this situation should become much less of a challenge compared to Q2 and what we see at the beginning of Q3.

When you're talking about a headwind here, has this destocking resulted in a headwind to your shipments to your realized revenues in the quarter? Or is this a headwind to your bookings and orders?

I would say both. Yes, because we didn't touch on lead times. We've got many brands that are still adjusting to normalization. Looking across most of our portfolio, we're back to very normal or reasonable lead times, although there are still a few categories that are a bit behind. However, for about 80% of the portfolio, orders are starting to match sales on a normalized basis.

Right. And that's kind of what I was trying to get at because if I'm looking at the last reported backlog data that you've given us for commercial food service at the end of '22, that was, call it, $755 million pre-COVID when lead times were normalized. I mean backlog was less than $200 million. So I'm sort of curious as to how you think about this dynamic toward 2023, where backlog is going to be exiting '23 as these lead times have normalized. And related to this, does this backlog burn then become a headwind for production because you have to normalize your own production into 2024?

Yes. This is Bryan. I mean, obviously, our backlog continues to be, I'll call it, at an elevated level when you make those comparisons to pre-COVID times. I don't think I think you're getting after what's going to be the absorption impact from bringing down the backlog to what I would kind of say a normal level is. And we don't think that will have a meaningful negative impact on absorption. Certainly, we expect the new normal to be higher than it was pre-COVID times. Given inflation given our business is larger and how our relationships have changed with the customers, given the growth that they are still going through over the next coming years in terms of expansion, just leads to ordering patterns that are more ahead of their need a delivery date than it used to be, right? So we're a backlog for, again, focused on commercial here, used to be closer to a quarter of a quarter. We'll still see where the new normal is. I'm not sure that we've known exactly yet, but I'll say I'd expect it to potentially be closer to half of a quarter in the backlog. And again, given our current backlog levels, given some supply chain challenges, in a few narrow areas. I don't think we're ready to say we are completely in normal times, but that's a little bit of an indication of how I think things will play out over the next 12 to 24 months.

One final question, and I apologize for insisting on this, but I get this question a lot from investors. If I take what you just mentioned a moment ago, it sounds to me like by the end of 2023, clearly, backlog is going to come down relative to where it exited '22. Implicitly, what that means is that your shipments have exceeded your order intake for 2023. So is it fair for us to assume that demand just catches back up in 2024 and you won't have an impact on production? Or will you have to adjust production into 2024, again, if nothing else changes. Thank you. And I'll finish there.

Yes, I believe this is a result of normalization. As we approach the end of 2023, we will have a lower backlog compared to 2022. There were numerous orders that were advanced, leading to periods where our order rates significantly surpassed our shipments in recent years. Some of this has been balanced out by our production rates. As we progress through the latter half of the year, backlog, inventory in the channel, and order patterns will stabilize. We will likely see alignment between order patterns and shipments with demand. We are observing positive trends in the marketplace, particularly with our relationships in the dealer channel and with chains. We are also developing new business opportunities with new customers and products. The chains remain robust with their store opening plans. Overall, we think the various factors related to supply chain disruptions we've experienced over the past few years are moving toward a healthier and more normalized state as we head into 2024. A decrease in backlog shouldn't be viewed as a disadvantage for us; it remains a healthy backlog compared to pre-COVID levels.

Appreciate the color. Thank you.

The next question is from Jeff Hammond of KeyBanc. Please go ahead.

Hey, guys. Good morning.

Good morning.

Just want to, I guess, cutting through the destock noise? I'm just trying to get a better sense of underlying business momentum. The QSRs have kind of been blowing and going on new store growth. And talk about rollouts, just maybe update us on what you're seeing in real business momentum. And then again, I think concerns over tightening lending standards, what you're seeing on the smaller independent side around that?

Good morning, Jeff, it's Steve. So maybe I'll give you a couple of areas of what we're seeing just the underlying demand market. So you touched upon the large QSRs, which we've hit before. As Tim said earlier, we've been very close to them. And again, they've been very transparent around their new store opening pipeline, obviously, the back half of this year and even into the first half of next year. So they've really recommitted to those plans and we continue to see that really be a strong point of demand for us. We're also seeing the change certainly still trying to solve for all the challenges that we've talked about over the last couple of years, whether it's labor or service, etc. And I think that is driving adoption of new technologies, which I do think will lead to some rollouts as we get into the back half of this year and into next year, especially. Tim also talked about just the general dealer side of the business, which has been, I think, an area of focus more so than ever the last year. A big part of that has been we have more dealer training and dealer events coming through the innovation kitchen in Dallas, which I think has been a huge success for us. So allow us to get closer to the dealer market, which, again, I think does continue to do well for us, which I guess would lead into the last comment you asked about the smaller independent restaurants, which really do fall probably more in that dealer side of the business. I would say, by and large, Jeff, we have not seen a lot of issues from a lending standpoint, causing issues in equipment demand. So we have not really run into that. And then I would just say maybe the last thing I've touched upon before, but I think it's an important one to note. We talked about change. We talked about the dealer business, the consultant side of our business, as well, I think is always a very good indicator of both short and long-term demand, whether it's around schools or institutions. And I think that is a segment, especially the last several months, that we can track projects specifically that I think give us some pretty good visibility into demand in those specific areas, especially for 2024.

Okay. Real helpful, Steve. Just on the resi, it seems like maybe the snapback or the bottoming process is taking a little bit longer. I'm just wondering if that's destocking being deeper? Or is it something in the order rates? I think you mentioned the UK, I know on the grills side trigger was kind of out to clearing victory on destock and their stock is bouncing. Just maybe frame what's different versus maybe previous expectations?

The residential market has faced more difficulties this year. Interest rates have continued to rise, making the housing market challenging. While we anticipated some struggles, the headwinds have proven to be more significant, particularly regarding interest rates in the first half of the year. The UK market, which is a significant part of our residential business, has experienced even greater challenges compared to the US. This has been evident alongside destocking, which has impacted our grill business more than our other businesses that typically operate on a make-to-order basis. However, we believe that conditions are beginning to stabilize. Uncertainty and disruption have slowed the residential sector, but we have recently noticed some improving order trends, especially in our core cooking categories, as well as in our electric products which align with market trends. We've made substantial investments in this area and are integrating technology from our commercial line into residential products. Despite the challenges, we see signs of growth potential and healthier inventories, suggesting we may be nearing a turnaround. While Q3 is likely to remain difficult, we have a clearer outlook for Q4.

Okay. Thanks, guys.

The next question is from Tami Zakaria of JPMorgan. Please go ahead.

Hi. Good morning, Tim and Bryan. I hope you're doing well. So my first question is for the Food Processing segment margin, I think it was lower sequentially on the higher revenues anything unexpected happened there? How should we think about margins for food processing for the next two quarters?

Yes, this is Bryan. The second quarter margins are just impacted by the nature of the mix and the projects that we delivered. I do think the second half of the year will be at least in line. And then as we get into the fourth quarter, trending better than we did in the first half of the year. So I think if you look at the first half of the year as a proxy for Q3, that makes more sense. And then Q4 always is stronger than the third quarter.

Got it. That's very helpful. And then I'm not sure I missed it, but where does your backlog stand for the commercial food and food processing segment today?

Yes. That isn't a specific number that we were regularly disclosing.

Okay. Fair enough. Thank you so much.

You bet.

The next question is from Larry De Maria from William Blair. Please go ahead.

Thanks. Good morning, everybody. I wanted to follow up on processing. I know you don't want to give an absolute backlog number, but can you maybe talk to year-over-year sequential processing order specifically? Obviously, there's some weakness in the market. Others are calling out. You mentioned some of it. So curious about the order levels and what kind of coverage do you think you have over the next few quarters? And since you, I think, called out that you think that the weakness is temporary. So I just wanted to get some confidence that that's going to look better into 2024 or not?

Yes, the backlog remains strong and is still close to the peak in percentage terms. I believe we have good coverage in many areas for the rest of this year and into next year. However, the business has some mixed aspects. We receive some orders for products that will be delivered in one to three months, while other projects may remain in the backlog for 12 to 24 months. Last year and the beginning of this year saw very robust orders, but the interest rate environment has moderated things. I want to emphasize that we haven't gone from good to bad; rather, we've transitioned from great to still very good. Nevertheless, there are certain areas that are more challenging, particularly concerning underlying factors like food costs and their impact on customer margins, resulting in some segments being weaker than others. Overall, the backlog is at very high and strong levels. We mentioned that the lumpiness of the business indicates Q3 might not be as strong as Q2, but Q4 is expected to be stronger. Fundamentally, I don’t believe the health of the business has changed.

Thank, Bryan. And then I guess maybe a second question on processing would be are there larger potentially actionable M&A deals in processing out there? I know you're trying to get that up to $1 billion business. But is there a potential for larger M&A there? Or is it more likely to continue to pursue some of these smaller ones that you've done and have grown nicely.

Yes. We’re not going to comment specifically, but we have a long history of working on mergers and acquisitions. There are significant opportunities for us to grow the platform, both through acquisitions and organically. I believe there is still a lot of potential ahead.

If I could add one more question for clarification. In commercial, we are noticing increasing concerns about destocking next year. In the second half, are you producing less than retail, particularly in the third quarter? I'm trying to understand how you plan to manage the destocking while addressing the significant backlog. Are we indeed underproducing compared to retail? I'll leave it at that. Thank you.

Can you clarify what you mean by retail? I mean, do you mean by dealer inventory?

No. I mean the dealer inventory and then their sell-through into the retail, the dealers selling into the end user. And are you going to underproduce versus the retail? Or we potentially, if we don't, then potentially pushing the inventory issue out further, right?

Yes. So I think the answer to that is yes, we are. I mean, I would say in both the first half as well as kind of what we're talking about here in Q3 is that the sell-through, if you want to call it that, whether that's dealers selling to end users or maybe some of the supply chain that's in the channel that goes to the chains, we are underproducing and our revenues would be less than what we can believe is being sold to the end market, and hence, some of the destocking in the channel.

The next question is from Walter Liptak of Seaport. Please go ahead.

Thank you, good morning, everyone. I wanted to inquire about the residential business, specifically regarding your comments on the outdoor destocking and seasonality. It seems like you believe that some of the destocking has concluded. If that’s correct, could you explain the seasonality? If orders have increased slightly, how does the third quarter look? Additionally, how does the seasonality affect the fourth quarter?

The sell-through has not been strong, but the impact of destocking on our revenue has been more significant. Both factors are challenges we face. However, inventory levels are continuing to decrease. Typically, we see an initial inventory load in the fourth quarter, leading into the busy grilling season in the spring. This year, inventory levels have been slightly off for everyone, and we need to reach a normal level. We expect this normalization to occur by the end of the year, followed by some inventory load-in for the next year's grilling season. Retailers are likely to be more cautious with their inventory purchases next year, possibly not returning to previous levels. When we consider our comparatives, last year's fourth quarter saw significant destocking for grills instead of a load-in. Thus, while we may not fully resolve inventory issues due to varying brands, retailers, and SKUs, most of it should be managed, leading us into a more conservative stocking season. This will set the stage for a more favorable growth environment in 2024 with healthier orders and sales if the season normalizes. We've also launched some excellent new products that have been well received, like the Konnected Joe, which has sold well and is hard to keep in stock. We are excited about the gravity connected series on Masterbuilt, and we see ourselves as innovators in the charcoal category, which we believe will grow in the coming years. We have a strong product lineup and will continue to launch new items as we move into next year. We are also expanding our digital marketing capabilities and believe we are well-positioned for a more normalized grilling market ahead. We're optimistic about our future prospects.

Okay. That's great. Okay. Thanks very much. That helps. And then Brian, during your presentation, you called out the risk of Europe pretty clearly. But I wonder if you could just help us size how of Europe, like how much is the UK versus the rest of Europe.

Yes. The UK is a strong majority of it. I don't have the breakdown right at my fingertips for the past quarter, but I'm sure it's in excess of half of the Europe's revenue for residential.

Okay. Great. All right. Thank you.

And the next question is from Todd Brooks of The Benchmark Company. Please go ahead.

Hey, good morning, everyone. Thanks for taking the questions. First is on commercial. I'm just wondering and you've talked in the past about how the cycle now is very driven by the new unit builds that and we're talking more from the chain customer scale player standpoint. We're new build driven now, but eventually we shift to an upgrade replacement cycle. Just wondering if you have any thoughts on or from discussions with the customer with these larger chain customer is largely being in a much better staffed position from a labor standpoint and with commodity costs rapidly easing. Is some of the urgency for either specific pieces of equipment that would attack labor or food waste or more broadly, the upgrade appetite? Does it get slowed in the environment that we're in? Or do you think that the appetite is still as strong when you get to the upgrade remodel phase for the existing fleet?

Yes. Good morning, Todd, it's Steve. So I don't think there has been any slowdown in customers' need to upgrade to solve for challenges, specifically call out labor. I think I may give you a nuance. When we think about labor challenges in restaurants, there's a number of areas to think about. One, it is finding great employees, which has gotten, I would say, a little bit better over the last six months for restaurants. The cost of those employees, which continues to be elevated. I think the third thing I would call out, where we're actually seeing the adoption of some of these new technologies is actually the ease of doing the job. And the training that comes around with it, James hit the Taylor double-side grill. I think is a great example of this because working a grill, traditionally, it's probably one of the least fun jobs in the back of a kitchen, right? It's nuance. There's a little bit more of an art to it. another piece of equipment. So it's a high level of training. And obviously, you want to make sure you're cooking your chicken, your stake, whatever it may be coming off the grill appropriately and that's also a very hot and greasy position. So when you can move to something like the Taylor Grill where you're putting the product down, pushing a button, and walking away, you're eliminating the training and that becomes one of the easiest jobs in the kitchen. So I'm giving you that as a nuance of even though parts of labor may be getting better, there are still major challenges that every restaurant faces in terms of labor and training. So and I think to answer maybe your second question, we still do see the new store builds, I think, continuing on a strong pace back half of this year into next year. And I do think you still have that pent-up demand that we've talked about, both in replacement and upgrade that I do think you start to see more of that kick in, certainly, the first half and well into next year.

That's great. Thanks, Steve. I believe Steve addressed it well, but I want to add that despite significant improvements in staffing, turnover remains a major concern, which relates to Steve's point. When new employees come in, they're often untrained, and this has always been a significant challenge, even more so today. Many restaurant customers don't think this issue will disappear. Therefore, there's a clear need for smarter, more user-friendly automated equipment. Additionally, tied to this is the challenge of speed of service, which has returned strongly. As we consider delivery and drive-through options with increased throughput in smaller spaces, this is a critical concern for many customers. I believe we have developed numerous solutions to address this problem, which is why they continue to seek out automation. That's great. Thanks to you both. And then just a final question. As you're looking forward at your commodity basket, what's the picture look like for A) availability through the supply chain, but B) are you seeing any early signs of relief that you'd want to point us towards that could be margin enhancing as we go through the back half of the year? Thanks.

Hi. It's James. I think by and large, we still see pockets of issues in the supply chain, and they typically are around electrical items, some motors here and there, but also just kind of around the legacy controls where we've got kind of 10, 20-year-old silicon on the board. Those tend to be the items that slow us down. The general availability of steel, copper, things like that, have been fairly strong. We don't see that as a headwind anymore. It's just kind of these nagging legacy components or specialty products that are kind of highly customized motors can tend to be a challenge. So that's kind of our guidance on how we see supply chain affecting us in kind of 24 pockets here and there, but generally good availability.

And any outlook on kind of cost for the core metals, things that have become more readily available as we are headed into '24.

I think we continue to see them at the levels they are or going down slightly.

The next question is from Brian McNamara of Cannacord Genuity. Please go ahead.

Hey, good morning. Thanks for taking the question. I just want to circle back on Grills. I know, Brian, I think you had mentioned, I guess, selling a little bit below kind of what you were expecting yourself through. I'm just curious, do you think that's just primarily driven by simply brand awareness, like the checks that we perform, you talked to some of your retail partners and grills and half of the associates don't even know of the brands or know that they're in the store. I'm curious, to me, that sounds like an opportunity, but I'd love to hear your thoughts on that. Thanks.

That was, this is Bryan now, but as Tim was talking about the sell-through before. I think on the Grills, overall, I mean, certainly, we are a smaller brand than some of the other ones that are out there. We think that gives us tons of growth opportunity. I mean, we do look at stats around impressions and Internet traffic to our sites, and we are seeing a really great trajectory of our brands. As Tim noted, the Konnected Kamado is selling through really, really well. But I think you get after that part of the reason we're in this space is that there is still growth opportunities out there. There's still positive trends around charcoal and all the benefits that come through that. So I mean, again, this gets after why we are bullish for things for a long period of time to come, separate from how to managing inventory levels over a relatively short period of time.

Yes, I believe the situation reflects a period of slower growth. Many major retailers have indicated this in their calls, and it seems to be true across various product categories, not just grilling products. As a relatively new brand, we are working on increasing our visibility, and we see potential for greater interest in innovations within the charcoal category. We may be new to some stores, and we are not present in every location yet. This presents a growth opportunity as we enter more retailers. While we may not be represented throughout the entire system currently, we anticipate that our presence will expand as inventories stabilize, allowing retailers to showcase our products more prominently in the future.

Thanks a lot guys. Best of luck.

Thank you.

That is our last question for today. Now I'd like to turn the call back to management for closing remarks.

I'd just like to, once again, thank everybody for joining us on today's call and we look forward to speaking to you after the end of the third quarter.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.