The Middleby - Q1 2023
May 10, 2023
Transcript
Operator (participant)
Good day, and welcome to The Middleby Corporation First Quarter 2023 Conference Call. With us today from management are Tim FitzGerald, CEO, Bryan Mittelman, CFO, James Pool, Chief Technology and Operations Officer, and Mr. Steve Spittle, Chief Commercial Officer. Management will begin with opening comments, and then we will open the call for questions. Instructions to enter the queue will be given at that time. Now, I'd like to turn the call over to Mr. FitzGerald for his opening remarks. Please go ahead, sir.
Tim FitzGerald (CEO)
Good morning, and thank you for joining us today on our first 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 to begin the year, reporting a first quarter with strong performance both at our Commercial and Food Processing businesses. While our Residential business was expectedly impacted by challenging market conditions and destocking of inventories at our retail partners. In the quarter, we drove improved profitability, and we continued to make progress towards our longer-term margin targets through focus on profitability of our sales mix and with further improvements yet to come through efficiency gains and supply chain initiatives.
During the quarter, we were pleased to have also realized meaningful reduction in production lead times across most of our businesses as we benefit from improvements in our supply chain and through the investments made across our manufacturing operations. We're now in a significantly improved position to better serve our customers and take advantage of market opportunities. To start the year, we continue to have strong engagement with our channel partners and customers across all three of our food service businesses, with interest in our latest products and innovations offering benefits focused on energy, labor, speed, and sustainability. The investments made in our innovation centers demonstrating these latest solutions have proven to be a strategic asset for our businesses.
The traffic in these showrooms continues to increase as we invest heavily in training with our channel partners, as our world-class culinary teams engage hands-on with customers looking to evolve the kitchen and food service operations. We're excited to have recently opened our latest Middleby Innovation Kitchen in Spain, now providing a resource to our partners and customers throughout Europe. In the quarter, we also continued to make strategic and financial investments in our business, investing $25 billion in our manufacturing operations as we continue to retool our operations to support new product launches, increase capacity, and advance the automation within our operations. We repurchased $48 million of Middleby shares during the quarter. We were also excited to complete the acquisitions of Flavor Burst and Blue Sparq, adding to the innovation in our beverage portfolio and expanding our in-house controls development capabilities.
As we've progressed into 2023, economic conditions continue to present challenges and uncertainty, particularly as it relates to our Residential segment, but we remain excited about the direction and long-term goals and confidence in the investments and strategic initiatives underway that are enhancing the competitive positioning for each of our three foodservice businesses. Now I'll pass it over to James Pool to spotlight a few of our exciting recent product innovations, which are also highlighted in our investor slides. James.
James Pool (Chief Technology and Operations Officer)
Thanks, Tim. We have a few items to cover. I'll jump in today with the FryBot. If you've heard me speak on other calls, you know that I often talk about the digital, embedded, and collaborative automation that's driving innovation across Middleby. FryBot brings these together in a complete Middleby solution. It is the only automated fryer designed, manufactured, and integrated by a single company. From the collaborative robot to the dispenser, fryer, holding, and SpiceBot, the FryBot is 100% Middleby. The base FryBot, as shown, is capable of autonomously dispensing, frying, and seasoning two unique items at rates hitting 65 baskets per hour, depending on product. The FryBot was designed with ease of installation, meaning it can easily be rolled out to new, but most importantly, existing restaurants. The FryBot is currently in test with leading brands.
We look forward to continued FryBot installations in test locations in 2023, with FryBot hitting revenue-producing stores in 2024 and 2025. If you'd like to see and taste the FryBot in action, it'll be on full display at the NRA show in May in the Middleby automated burger and chicken bar, as well as in the NRA's Kitchen Innovation Pavilion. At the NAFEM Show this past February, the FryBot flawlessly delivered over 1,500 orders of fries and chicken in just over two days. Continuing with the NRA Show, the FryBot will be accompanied by Taffer's Tavern, a concept created by Jon Taffer that features an all-electric and all-ventless Middleby kitchen. The Middleby Cafe, a concept dispensing the highest quality espressos and drip coffees from the Middleby Coffee Solutions Group, the best baristas, and best roasters in the Chicago area. Open Kitchen, Middleby's inter-enterprise IoT platform.
Middleby's Electrified Innovation Alley, where we will showcase the latest electric products designed for the efficient electrified kitchen. Lastly, please look for the HydroRinse and the Plexor M2, additional KI Award winners in the Kitchen Innovations Pavilion at the NRA Show. HydroRinse automates the cleaning of MvS machines by washing, rinsing, and sanitizing the machines while the machines are still assembled. The Plexor M2 is the latest modular and rapid cook and accelerated cooking platform from TurboChef. I would like to close by talking a little bit about Blue Sparq, our latest acquisition. Blue Sparq adds to Middleby's common control strategy by helping our brands develop and launch controls faster than ever before, thus accelerating new product development across Commercial, Residential, and Food Processing groups. With their industry-recognized capabilities in the area of UX, UI design, and embedded firmware development.
Blue Sparq also brings fast PCB board manufacturing, while also being able to support volume production. We are excited to have Blue Sparq developing for Middleby. Thank you, and over to you, Bryan.
Bryan Mittelman (CFO)
Thank you, James. 2023 has started out strong for us. We posted another quarter with revenues over $1 billion, with exceptional growth in two of our segments. Our Adjusted EBITDA exceeded $210 million, resulting in an organic Adjusted EBITDA margin of over 21%. While our total revenue growth was rather modest given challenges in Residential, we were still able to grow our Adjusted EBITDA 6% over the prior year. Our margins expanded 100 basis points. 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 at $1.82. Adjusted EPS, which excludes amortization expense and non-operating pension income, as well as other items noted in the reconciliation at the back of our press release, was $2.19.
I will go through our segment results in a moment, first, I wanted to briefly note that we realigned some small operations internally, which in turn had a small impact on the composition of our segments. Nonetheless, I know some people will see differences in their models, so here are the details. We have moved approximately $4 million of quarterly revenue from the Commercial segment to Food Processing. We have restated prior periods in our press release, and the growth figures I will discuss here are based on a consistent basis. The impact will be approximately $4 million per quarter as well for the remainder of the year. Back to our segment results. Commercial Food service revenues were up over 11.5% organically over the prior year, with North America up 14% and international regions growing at 5%.
The Adjusted EBITDA margin was 26.5%, 230 basis points ahead of the prior year. In Residential, we saw an organic revenue decline of 32% versus 2022. The Adjusted EBITDA margin was 13%. Food Processing continues to perform extremely well. Total revenues exceeded $173 million, an increase of over 24% organically. Our Adjusted EBITDA margin was 24%, up over 500 basis points over the prior year. As I've noted before, our full line solutions continue to resonate with customers. Our operating cash flow generation of $92 million was a record for the first quarter. During the quarter, as Tim noted, we invested approximately $25 million in capital expenditures and had $10 million on acquisitions. We utilized $48 million for open market stock buybacks.
After giving effect to all this activity, our total leverage ratio moved down slightly to just under 3x. I remind folks that our covenant limit is 5.5x, we currently have over $2.3 billion of borrowing capacity. It was not an easy quarter, we still delivered strong results. While we have noted that supply chain has improved, I do want to add that it does remain a constraint in numerous areas, especially around legacy chips and controls. Customer inventory levels present a short-term headwind as well in Residential and to some extent in Commercial too. In terms of the near-term outlook, I will start with Residential. Demand in the marketplace obviously remains off from the peak levels seen a year ago. However, our revenues have been relatively consistent for the past three quarters.
When I discussed results last quarter, I noted that Residential revenues for this Q1 might be slightly below Q4. We ended up actually exceeding Q4 by a few million dollars. Thus, given the timing of some shipments and current demand levels, with softer-than-expected conditions in the U.K., I'd say Q2 will see revenues relatively flat to what we just posted for Q1, and margins should also be similar to Q1. Thinking about all of 2023 for this segment, it is hard to offer a very clear view given all the dynamics impacting us currently. Nonetheless, our current assessment, which is subject to a fair amount of risk, is still sequential improvements over Q2 in the back half of the year. This also means year-over-year growth for the second half of 2023. For Food Processing, we obviously posted a very strong quarter.
This business will continue to exhibit strength. I expect Q2 to look really similar to Q1. We should continue to grow and improve from there over the back half of the year. For Commercial, when comparing Q2 to Q1 sequentially, revenue should be up modestly with slightly better margins. Our engagement with customers remains incredibly positive, and they are continuing to invest. Chain activity is probably somewhat back-end loaded for the year. Consistent with what I had portrayed a quarter ago, each quarter through the year should improve sequentially. Just the improvements from Q1 to Q2 will be modest. Putting the three segments together, when looking at the total company potential Q2 performance, revenue and EBITDA levels are likely to show single-digit growth when comparing either back to Q1 of 2023 or Q2 of 2022.
Thinking about how 2023 will shape up overall, our view remains consistent with what I noted last quarter. We continue to expect full year-over-year growth, margin expansion in Commercial and Food Processing. Resi, after holding the line in Q2, should likely see year-over-year growth in the second half of 2023. reiterating that this means for full year 2023, we should see total company revenues up modestly and growth in EBITDA dollars and then. In true Middleby style, we look to continue to deliver solid results and have another record year. Thanks. With that, we will now open up to your questions.
Operator (participant)
We will now begin the question-and-answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question will come from John Joyner with BMO. Please go ahead.
John Joyner (Equity Research Analyst)
Good morning. Definitely a solid start. Bryan, I was just waiting for your for your stories there, but so you kind of let me down.
Bryan Mittelman (CFO)
Okay, you know, just, come to NRA, and, we'll let your taste buds work rather than, have to, hear me tell stories.
John Joyner (Equity Research Analyst)
Okay, excellent. I look forward to it. I guess for the Commercial business, I mean, are there any particular areas that you would call out? I mean, it's definitely a strong quarter, but any areas that you call out as being stronger than others or ones that maybe are performing better than kind of your internal expectations? Then, also kind of based on conversations that you, that you're having, right? I mean, would you say that CapEx intentions by your customers lately have actually taken a step higher?
Steve Spittle (Chief Commercial Officer)
Yeah. Good morning, John. It's Steve, maybe I'll take a first pass at it. I think what I would maybe call out, you know, over the last, you know, quarter or two, we've talked about on prior calls, you know, the progression of how different segments have more or less recovered, you know, since COVID. Obviously, we've spent a lot of time talking on the big, you know, QSR chains, which have done so well, you know, these last couple years. I think what I would call out are maybe some of the other areas that are, you know, just kind of getting back to recovery. I would call out, you know, probably more of the independent restaurants than some of the casual dining restaurants.
I think, you know, what I'm excited about there is, you know, a lot of those customers are served by our, you know, dealer partners in the U.S. I think we've spent a lot of time, you know, over the last two years, you know, getting closer to those dealer partners, giving them tools to help navigate, you know, the dynamic that we're all faced with. We spent a lot of time training a lot of those dealer customers at the MIK. I think you're starting to see that pay off. I think actually, if you go to the pie charts there in the deck, it's an interesting nuance that you see the independents and casual dining changes tick up as a part of the overall, you know, revenue mix.
I think it's a direct correlation to us talking about just being closer to the dealers, but also really just seeing those segments, you know, kind of start to pick up on the recovery, if that makes sense?
John Joyner (Equity Research Analyst)
Okay. Yeah. Thank you, Steve. That's helpful. Then just maybe just one more on the Food Processing business. Bryan Mittelman, I believe highlighted that you expect 2Q to be more or less flattish with 1Q. Similar to Commercial, I mean, the results there were probably even more impressive. When you think about the EBITDA margins for the year, right? I mean, starting at a higher level than probably most anticipated, do you expect margins there to progress? I mean, maybe you answered this already, I don't know. To progress sequentially higher as the year unfolds.
Bryan Mittelman (CFO)
You know, as you said, we're thinking about, you know, Food Processing here. Q1 certainly was a big step up from where we've been in the prior year, and to your point, you know, was strong and, you know, higher than we may have expected. That's why I think, you know, Q2 looks like Q1, and we can see, you know, some expansion in the back half of the year. Just given how strong we started, you know, I'd say that needs to temper, you know, expectations on how much they grow from here. You know, obviously, we have our target margin, you know, now, you know, well within, you know, sight.
Again, as we especially think about the back half of the year, I think we can, you know, move up, you know, a little bit from where we started the year.
John Joyner (Equity Research Analyst)
Okay. All right. Well done. Thank you.
Operator (participant)
The next question will come from Saree Boroditsky with Jefferies. Please go ahead.
Saree Boroditsky (SVP and Equity Analyst)
Hi, good morning. Congrats on the results. Within Residential, can you just strip out the performance you saw in grills versus the legacy business? How do you see channel inventory currently, and how should we think about the cadence of destocking through the remainder of the year? I believe you have much easier comps as we get to the second half.
Tim FitzGerald (CEO)
Yeah, this is Tim. I'll kick off, Bryan can maybe break it down a little bit. definitely is kinda, you know, I commented, the, you know, the inventory levels were higher, right? they continue to come down. There is still inventory in the channel. Sell-through is probably a little bit lighter to start the year, given, I'll say weather and other market dynamics. I think, you know, it still holds true that we'll be in a much better position from an inventory standpoint in the back half of the year as it relates to grills.
We are, you know, excited about a lot of the new product introductions that we've got coming out right now that, you know, digital, come out of JoeTap or Konnected Joe, that we've talked about in the past. James has highlighted as well as, you know, continued promotion and penetration of the Masterbuilt Gravity Series. I mean, I think we feel pretty good about the long-term momentum that we've got that we think will, you know, build as we go through the, you know, back half of the year. You know, certainly we'll still see some of the, you know, probably the destocking in the second quarter. You know, improvement as we go through the back half of the year.
Definitely, I mean, as you look at the overall Residential results, the, you know, the grills had an oversized, you know, impact on Residential, which was expected and certainly seen, you know, across that whole category, not only by us. You know, as we talked about, you know, in the last year, I mean, I'm sorry, last quarter, but last year in Q1 really was, you know, the peak of the performance for the, you know, the grills company. We talked about, you know, revenues, I think being in excess of $110 million, you know that and, you know, we're obviously down, you know, quite significantly, you know, from that.
You know, excluding grills, you know, Residential would probably been, you know, down, you know, more along, you know, the order of, you know, 20%. You know, we still are expecting as we think about, you know, the grill season, I would say, you know, Q2 is right, still part of, you know, this year's grill season, and so we will. Now, again, this is consistent with what we've talked about before, you know, see certainly challenges year-over-year if you were to look at, you know, grills alone. You're right, you know, the comps, you know, are certainly, you know, much easier in the back half of the year, right? Because in the back half of 2022, we're, you know, we're still part of this, you know, destocking phenomena we're dealing with.
That's why we do believe, you know, grilles will be better in the back half of 2023 than the back half of 2022. That really gets after our comments of as you think about Residential overall as well, second half of 2023 being better than second half of 2022.
Saree Boroditsky (SVP and Equity Analyst)
Appreciate the color. Just one more. Obviously, Commercial Food service had another strong quarter. How do you see underlying demand as you might be working down some backlog here? Are you seeing any headwinds from more challenging financing conditions, especially on the franchise side?
Steve Spittle (Chief Commercial Officer)
Saree, I would say demand, more or less across, you know, the customer segments. Again, talked a little bit about, you know, the dealer side, the independent side, you know, nice to see that coming back. Also the chains that we talked about, the QSRs continue to do well. I, I see the demand, you know, continue there both from a new store standpoint and also starting to see some gear replacement business come back, which we've talked about before. Yeah, from that standpoint, believe we're in a good position. I'm sorry, Saree, your second question.
Saree Boroditsky (SVP and Equity Analyst)
Yeah. Just are you seeing any headwinds from the challenging financing conditions?
Steve Spittle (Chief Commercial Officer)
Yeah. It's interesting that we have had a lot of discussions with the bigger QSRs really focused on what I'll call, you know, unit economics of making sure the ROI on, you know, the new stores for their franchisees is where it needs to be. It's critically important for, you know, I think for two or three reasons. If you look at the big QSRs that have aggressive growth plans, which many of them do, and many of them are in international markets, you know, how are you growing? You're growing with either existing franchisee groups taking on more locations, signing up for more locations, or you're going out and finding new franchisee groups to expand into, to new markets.
You know, the ROI of those new stores when you're trying to attract, you know, those franchisees is more important than ever. Obviously, as, you know, financing has become, you know, more expensive over the last, you know, year or two, again, you know, the equipment that is going into those locations, it's not necessarily about, hey, what is the upfront cost? It's always important, but actually, it's more about the ROI to open those stores and have a attractive package to the franchisees, if that makes sense. It's a very active conversation that we've had, I would say, the last six or eight months with the chain specific to, you know, this question and an issue.
Just it supports, you know, their plans for, you know, pretty aggressive growth, especially into most international markets over the next, you know, two, three, four years.
Saree Boroditsky (SVP and Equity Analyst)
Thanks. I appreciate the color. We'll see you at the NRA Show.
Steve Spittle (Chief Commercial Officer)
Yeah, we look forward to it.
Operator (participant)
The next question will come from Mircea Dobre with Baird. Please go ahead.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Thank you for taking the questions. Good morning. I wanted to go back to Residential for maybe some clarification. Well, what I heard just moments ago was that leaving grills to the side, the core, call it Viking/AGA business, was down maybe 20% in a quarter. Maybe can you confirm that? You know, as you talk about the business getting better overall, the segment getting better from a revenue standpoint overall, what sort of assumptions do you have embedded for Viking and AGA as the year progresses? Because presumably the comparisons are not nearly as easy there as they are on the growth side.
Tim FitzGerald (CEO)
Yeah. Mircea Dobre, you did hear me, you know, correctly on the Residential side. I'll say it kind of, you know, with and, you know, without, you know, grills. As we look, you know, at the rest of the year, you know, the outlook, I would say, you know, if I had to pick one word, and then I will expand on it, you know, is kind of, you know, flat from here. We feel like we've kind of, you know, are at a bottom. Q2 I said will be similar to Q1. Same, you know, same neighborhood, right? I was very specific in pointing out, you know, that we've been at a relatively consistent level for the past three quarters.
I think what we're not seeing yet is, you know, outside of, you know, grills, where there really, you know, are some unique circumstances with the destocking, you know, we're not really ticking up our expectations, you know, specifically yet, right? I don't have, you know, exact indicators that, okay, all of a sudden, you know, next quarter is gonna really change the trajectory.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
I appreciate that.
Tim FitzGerald (CEO)
I would say, I mean, I think uncertain is the, you know, the word unfortunately, you know, right now. I mean, we'd seen, you know, obviously the housing market being, you know, challenged all in the back half of, of last year. There was maybe a little bit of signs here at the, you know, at the beginning. The, the, the world, you know, continues to be, you know, a bit tough with rates going up. I think we also feel like we're kind of stabilized at a lower level. I think that, I think the question is when does it inflect up as opposed to, you know, it's gonna continue to, to come down.
I mean, I think if you look at a lot of the housing stats, you know, it was expected to maybe bottom out in the, you know, in the middle of the year and then start, you know, seeing things, you know, pick up. I mean, I think those are, you know, larger macroeconomic, you know, trends that we can kind of take a look at, and I think we would expect our, you know, business to follow. I mean, I think that we feel like, you know, we're stable here at the bottom, and then we'll kind of see how the, you know, the year goes. You know, now, you know, beyond that, you know, we continue to be investing in our business, right? Like, we have a lot of new products coming out.
I would say our electric, you know, products are doing fairly well. A lot of that includes a lot of the products that we've been launching over the last several years, such as the AGA products that have come into the U.S. Those are growing, you know, right now, you know, despite the market being done. You know, brands like La Cornue, you know, are doing very well. We've got other new products that are induction based as we kind of go through the back half of the year. Kind of, you know, along, you know, the comments also about the investments that we're, you know, making.
Go to, you know, market activities, we've had a lot of great, you know, traffic at our showrooms, bringing our dealer partners, our designers through that really have not seen the, you know, the portfolio that has to offer. I mean, a lot of that stuff has been, you know, exposed to a broader audience over the last year, and we see some traction of that, and we expect that to continue. We're excited about opening a new showroom in Chicago, which will really be kind of the. You know, I'll say the, you know, really state-of-the-art for us, kind of in the middle of the year, to really capture all, you know, the expanded product, you know, portfolio that has grown over the last year.
You know, we acquired Novy, you know, about a year ago, plus, you know, which has got some great technology, induction, you know, hobs, ventilation, et cetera. I think we're, you know, very excited about the product, you know, portfolio. Again, the market's gonna do what the market is gonna do, but I mean, I think, you know, we're, you know, I think there's a lot of great things going on as we go through the back half of the year and into 2024.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Let me maybe clarify what I was trying to get at. My impression was that Viking was still operating with longer lead times and a fair amount of backlog, through much of last year.
Tim FitzGerald (CEO)
Yeah.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
As you're running that backlog down, my question is, do you have to essentially reduce production or have a sequential headwind in the back half of 2023 relative to the current run rate?
Tim FitzGerald (CEO)
Bryan, I don't know if you wanna...
Bryan Mittelman (CFO)
Yeah. I mean, as Tim noted, you know, the backlogs, you know, have, you know, come down. Our lead times are, you know, much closer to what I'll call, you know, normal levels. There's some pockets there. Again, you know, given, I'll say, you know, the modest amount of backlog that remains as well as just the. You know, a baseline day-to-day, you know, demand from customers, I mean, is why we're kind of, you know, calling the year the way we are.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Understood. I would like to ask a question on the FryBot, and I guess a question in three parts. You're saying here that this is a modular design, but I'm sort of curious when you're trying to sell this product, are you seeing customers looking to essentially buy the entire set? Is it just maybe the robot arm and they're keeping the existing equipment? I guess that'll be question number one. The second thing is how big of an investment is this for a customer? Lastly, what is the payback in terms of what you guys have seen or calculated thus far?
James Pool (Chief Technology and Operations Officer)
Yeah, I think when we look at our customers and they see, you know, kind of the advancements with, you know, fryers today, the advancements that the FryBot brings, you know, the customer is typically gonna want to upgrade, you know, the frying solutions they have in their stores with kind of the latest, you know, frying to take advantage of automatic, you know, filtration, smart oil sensing and various other, you know, features that are built into the fryers to, you know, help you with, you know, profitability around, you know, oil management and oil quality.
We really do see the majority of customers buying kind of everything that you see on the page, from the rand dispenser, to the, to the fryers, to the robot, and to the holding and the SpiceBot. Now there could be some, you know, situations where we are integrating in with existing, fryers, but I would say that's not really what we expect to do, day to day. When, when I think of modularity, I'm really thinking that, you know, our FryBot doesn't require kind of customized engineering to go into the store to build a structure in the store to, you know, cordon off, you know, space in the store to put something, you know, behind a, behind a shield or, any sort of, you know, protective, you know, cover.
You know, our FryBot's kind of designed to work out in the middle of the restaurant with the employees in a collaborative fashion. It's modular in that it's gonna kind of roll up and interface with our products and roll away if you need to de-install it for any reason. I think when we look at kind of the ROI on it, and I think this will probably, you know, kind of get into the cost, really talking about the cost, but we really do see the ROI kind of being slightly over a year for the FryBot solution and the equipment, you know, package.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Understood. My final question is on your CapEx. Significant investment, maybe you can talk a little bit about what was unique about the quarter. Certainly, that's the biggest Q1 CapEx that I think I've ever seen. What sort of payback are you hoping to achieve here? Is there a segment that is getting maybe more investment than others? How do you think about free cash flow for the year? Thank you.
Bryan Mittelman (CFO)
Yeah, certainly this was our highest CapEx quarter. I mean, some of the just kind of the timing of payments and projects have come, you know, together. You know, I don't expect we will be at, you know, 4x, you know, Q1, you know, for the year. You know, Tim has noted and we've talked about, you know, we're actually making fairly sizable investments in Residential. Talked before, really, a lot of, you know, retooling of the AGA Rangemaster plants. You know, much like our customers, you know, we see challenges with, you know, labor availability and cost, and we've been adding, you know, fabrication equipment, you know, across the board.
You know, our Residential plants on a, if you think about, I'll call it, you know, revenue per plant, tend to be larger facilities, and thus tend to get, you know, larger, you know, larger investments. We really have been, you know, spreading it around. You know, the paybacks, you know, really do vary. I mean, you know, obviously, when we're making investments in buildings, you know, that's something we have, you know, a longer expectation on than when we're doing something, you know, more modest around, you know, welders or, or small, you know, small equipment. Usually, if I focus on fabrication equipment, it tends to be, you know, I'll say, you know, 2 -3 or 4 years in terms of payback for us.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Free cash flow?
Bryan Mittelman (CFO)
Yep, you know, free cash flow, I have, you know, I'll have to echo, you know, what I, you know, said at, you know, at year-end, where I think, you know, we start being, you know, much closer in terms of a margin plus or minus of our income for the year.
Mircea Dobre (Senior Research Analyst and Associate Director of Research)
Okay. Thank you.
James Pool (Chief Technology and Operations Officer)
Yeah. I mean, I think if you look at the last couple years, obviously supply chain has been a big challenge, and it's been hard to balance inventory. Probably I'll say.
Tim FitzGerald (CEO)
Sometimes difficult forecasting demand levels, et cetera. I mean, I think, you know, one of the benefits that we have as we go through this year is, you know, we do expect inventory to decline as opposed to kind of be in a cash use over the last several years. I mean, I think we've got a little bit of a tailwind from a cash flow perspective coming into the year, so it should be solid from that perspective.
Operator (participant)
The next question will come from.
Tim FitzGerald (CEO)
Go ahead, sir.
Operator (participant)
Go ahead, please. Yeah. The next question will come from Tami Zakaria with JPMorgan. Please go ahead.
Tami Zakaria (Executive Director)
Hi, good morning. Congrats on excellent results. I have a couple of quick questions. The first one is, I think you mentioned that lead times have normalized for most part of your business because of increased capacity and also supply chain getting better. Can you just remind us which segments you saw or had the most increased manufacturing capacity? And at what capacity are your facilities currently running on average right now?
Tim FitzGerald (CEO)
Yeah, that's kind of tough to answer given we got 115 brands, I'll be honest with you, because we run decentralized, right? It's gonna vary significantly across the platform. I think the way I think about it is, you know, our backlog is still at a fairly healthy level, but certainly it's, you know, it's come down from a lead time, you know. I would say about 90% of our factories now are at a normalized, you know, lead time. May not be every SKU, but by and large. There still is, you know, a percentage of our factories, about 10% that remain, you know, a bit challenged, and that's usually because of, you know, one of two reasons or maybe two of two reasons.
One, you know, we have very strong demand for those product categories. In some cases, those are, you know, more of our automated, you know, products or new, newer lines. The other area, and Bryan touched on it, is where we've got, you know, controls, and some of the electronic components continues to be, you know, a challenge, particularly as if it's legacy controls. I mean, we've done a lot to invest in our next generation control, and James talked about that in the past with Moby. You know, OneTouch, and we're excited about moving a lot of our new brands and products over to that, which we will continue to do through the year, which is also connected to our Open Kitchen platform.
We still have a lot of, you know, legacy controls, PCBs, and it's hard to move everything quickly. I think that's where, you know, we still see, you know, challenges at about 10%. The good news is about 90%, you're gonna get within a, you know, window that's kind of more normalized. I think that's an opportunity for us, you know, also as we go through the year, because I think there's been some business and also, you know, as we went through last year, which we were really not in a position to serve our customers.
I think as that kind of comes back in, there's some areas, you know, that we'll be able to accommodate and, you know, really take some orders where we had to walk away from, you know, last year. I kind of think of it as a 90/10 situation, if that's, if that's helpful. Lead times vary, you know, depending on the, you know, product category. What I'm saying is true for really those comments relate to Residential and Commercial, you know, predominantly.
Tami Zakaria (Executive Director)
Got it. That's very helpful. Seems like things are looking up. That's great to hear. My second question is on... I think if I heard you correctly, you're saying that the Commercial Food segment margin should be modestly higher quarter-over-quarter. When we were speaking last quarter, I think the expectation was like a 26%, 27%, 28%, 29% sort of margin cadence for the four quarters of this year. Is that sort of still the expectation? Or you think 2Q's should be somewhere between 26% and 27% and not really like the 27% range we talked about last time in the last quarter?
Tim FitzGerald (CEO)
Yeah, I mean, I think those numbers represent, I'll call it a general trend. You know, I'm not gonna comment to whether we're gonna specifically, you know, hit 27 or be above it next quarter. I think the I'd say the appropriate modeling is, you know, is as you just kind of noted, you know, somewhere between 26 and 27.
Tami Zakaria (Executive Director)
Got it. Got it.
Tim FitzGerald (CEO)
You know, the back half of the year, you know, we'll see improvements from there, right? I try and be very specific about not offering, you know, point guidance, but I'll call it, you know, general, you know, trend expectations, let's say.
Tami Zakaria (Executive Director)
Got it. That's fair.
Tim FitzGerald (CEO)
'Cause I think, you know, it's all our business is always a little bit difficult to forecast just because there's so many moving pieces, and mix has a lot to do with it. I think as we're working through the backlogs, there still is a little bit of legacy, I'll say, older backlog out there that we're kind of pushing through the, you know, the system as we go through the second quarter that is at, you know, I'll say, older pricing. That, that is still, you know, a little bit left to get, you know, out of the system, so to speak, as we kind of, you know, move to kind of more current pricing in the back half of the year.
Tami Zakaria (Executive Director)
Perfect. That's very helpful. Thank you.
Tim FitzGerald (CEO)
Thank you.
Operator (participant)
The next question will come from Tim Thein with Citi. Please go ahead.
Tim Thein (Lead Machinery Analyst)
Thanks. Good morning. Just to continue on that discussion, Tim. As we think about the kind of the margin for just for Commercial, the exit rate or second half looking into 2024. As we went back to the conversation in Dallas last fall, where we outlined price, cost, and mix being two drivers to longer term to get margins up. I would imagine is it fair to assume that those would start to become more meaningful tailwinds for you in the back half, and then that likely extends as we think about where we're exiting 2023? Is that a fair kind of synopsis?
Tim FitzGerald (CEO)
Yeah. I'll make a couple comments, then Bryan can clean it up. So, you know, again, you know, the mix of our portfolio as we focus on, you know, higher technology, categories, say, good product, happy brands, I mean, that's the underlying, you know, theme. That, you know, that's always that may be difficult to forecast on a quarter-to-quarter basis, but I think we continue to make progress towards the, you know, with the mix of the portfolio. That's something that, you know, I think is reflected right now, but, you know, continues to be, you know, something that I think we'll see improvement as we go, you know, through the, you know, make progress the year going into 2024.
As there's other factors, you know, we still from a supply chain standpoint, just make two comments. One, there are some commodity areas that we'll see improvement as we get to the latter part of the year. Like, we still have higher priced steel. Steel's come down, but we haven't seen the benefit of that yet because, you know, we do have a lot of that in our inventory, you know, is still. We'll get some of the supply chain -- a little bit of supply chain, you know, relief, as we go through the latter part of the year as well. Those are two things. I guess maybe the third is also production, you know, efficiencies.
You know, there's still a lot of thrash that we have in our operations right now. I think as lead times normalize, order rates kind of normalize, you know, with customers and how they're placing orders with us, with our lead times, as we can better utilize some of the investments that we've made in the factories. A lot of that stuff is, you know, on the floor operating, but I wouldn't say that, you know, we're getting all the benefit yet because we're working through, you know, thrash and touch and, you know, equipment still, you know, sometimes a couple times before it goes out the door and we really get into better cadence. I think that's kind of the color behind some of the comment I made about some of the manufacturing, you know, efficiency.
I think those are the things that we'll be working on as we go through the, you know, the latter part of the year that is part of the bridge to get us to higher margins. There's still some headwinds out there as well, 'cause I will tell you, supply chain, you know, as Bryan commented, is not done. I mean, it's not only that we got some components that's harder to get, but there's still increases, you know, out there that we're, you know, our teams are fighting, you know, hard to, you know, push back on or think about how do we, you know, be, you know... kind of gone through a, you know, period of, you know, fire drills, right? Like, let's make sure we can get product out the door.
Now as we kind of start thinking about that as a lever again, and I think that, you know, that's, you know, something over the next, you know, several years. I mean, I think we've been a, you know, a price taker to this point. I think, you know, we'll kind of, you know, this year be a little bit of an inflection, you know, for that as, you know, as well. I think we're still getting price increases as we go into 2024. I think, you know, the supply chain teams will, you know, be focused on driving efficiency there as well.
Tim Thein (Lead Machinery Analyst)
Okay. No, that all makes sense, Tim. Thank you. Maybe I think it was you or Steve, I forget, but there was a comment earlier about that the supply or the inventory levels posing a headwind for you. I, the Residential side makes perfect sense, but I was surprised, I think you referenced in the Commercial side as well. Can you maybe just touch on that? You know, we've been hearing to, just to your point, I mean, supply chain has been an issue and just for you guys to get products out the door. I was a little surprised to hear that comment, but maybe it's just more of a one-off. Any thoughts on that? Assuming I heard that right.
Steve Spittle (Chief Commercial Officer)
I believe Bryan actually touched on it briefly. You know, Tim, I'll just say I think there is some inventory in the channel in Commercial, both for the general market and for chains. Yeah, the chain side especially, and I would say you have gone through such an odd period of time the last year or two of, you know, how your customers have ordered with the longer lead times, placing orders, you know, go back a year ago, they're placing orders, you know, farther out than they ever have before. You know, our dealer partners or the KSOs and service chains, you know, their job was to get as much equipment in place to support, you know, new store openings and replacement. I think you're seeing a byproduct of that.
There was so much ordering that took place just to make sure everybody was in a good place to support new store openings and replacement. We're going back to, you know, quote-unquote, normalizing, you know, lead times, normalizing how our customers order from us, kind of back to how it was pre-COVID. I think, again, the inventory that's in the channel right now is a byproduct of just the longer lead times and ordering process. I do think that normalizes as this quarter unfolds and certainly the back half of the year unfolds and we get back to, again, more of a normalized, you know, cadence of ordering in the channel.
Tim FitzGerald (CEO)
Interesting. Okay. All right. Thank you, Steve.
Operator (participant)
The next question will come from Larry De Maria with William Blair. Please go ahead.
Larry De Maria (Equity Research Analyst)
Hi, thanks. Good morning. I know you've touched on a lot of this stuff, but I wanted to get some clarity on Resi second half, flat 2Q sequential, I guess. Then we expect sales up in the second half, shouldn't that imply we're back to mid-teens or better EBITDA margins in the second half in, specifically in Resi? You know, maybe you can discuss some of the restructuring you've done in there that maybe leads to even higher margins, you know, into what might be a clean year in 2024. Just some further color on second half and maybe run rate EBITDA margins in Resi.
Bryan Mittelman (CFO)
Yeah, no, we do expect margins to be increasing in the back half of the year, as well with the increases, you know, in revenue. You know, given the dynamics of the, you know, the grill business, you know, we do get, you know, nice, you know, leverage, incrementals as those, you know, revenues, you know, improve. In terms of, you know, the benefits of the manufacturing, you know, that really especially, you know, given current demand levels, really isn't something that has a meaningful impact this year.
It's certainly a meaningful, you know, driver, as we get into next year, as we hope to look forward to, better revenue levels, and again, is one of those drivers in bringing us back towards the target margin levels. You know, specifically to the stuff we've talked about for, you know, AGA in the U.K., this is a, you know, long-term project that, you know, really comes together over the remainder of this year. Thus my, you know, benefits start accruing much more so next year.
Larry De Maria (Equity Research Analyst)
Thanks for that. If we think about second half margins, EBITDA margins, I guess, you know, obviously grill's better, but you have some a little bit of benefit, and but maybe some mixed headwinds, not sure. Does that imply, you know, mid-teens or better EBITDA margins in the second half? Or is that the way to think about it, mid to upper teens?
Bryan Mittelman (CFO)
Yeah, I mean, you know, I talked, I think, some about some of this, you know, last quarter and back to the fall. I mean, I do feel like mid-teens is where we can get. It's just, you know, you need to take that with a little bit of, you know, caution. Again, I mean, I've tried to use the words risk, you know, uncertainty here as we look at the back half of the year. I mean, I think that's a fair assessment. Again, I just, everyone needs, I think everyone is aware of, you know, the risks and uncertainty surrounding that business. Again, I think that's probably a fair assumption.
Larry De Maria (Equity Research Analyst)
Okay, fair enough. My second question, I want to talk about Food Processing backlog and order trends. You know, how did orders progress through the quarter? Postpones, delays, or were still strong, maybe touch on some of the end markets. I know poultry might not be huge, but there's some headwinds in the market. Just give us some color to get comfortable on sort of the duration of the processing upturn.
Bryan Mittelman (CFO)
Sorry, I can't hear. I don't know the question.
Tim FitzGerald (CEO)
Food Processing orders and trajectory.
Bryan Mittelman (CFO)
Yeah, I mean, Food Processing, you know, has continued to do well for us. I mean, obviously last year was a really exceptional year in terms of, you know, order intake and driving up our backlog. I mean, things are still, you know, very good there. You know, again, last year was really, you know, exceptional. Maybe, you know, at the current is not, you know, at the same levels. Nonetheless, you know, orders continue to be, you know, strong. Our backlog is holding in, you know, well. You know, the areas where we've been strong, we continue to be strong. You know, we've seen a lot with bacon. We've seen a lot of acceptance and excitement around the TurboChef by Alkar.
We're making, you know, inroads into pet food and snacks. You know, it has been, you know, fairly, you know, good across the board, I would say, you know, for us.
Tim FitzGerald (CEO)
Yeah. Larry, I'm sorry, I can't. We're having a speaker problem. Yeah, I'd just say, you know, the backlog is holding pretty solid. I think as we look at the orders, you know, for Food Processing are always gonna lumpy from one quarter to the next, depending on what projects come in. I think we kind of look at what the pipeline of opportunities is out there. You know, as Bryan just alluded to, I mean, I think we feel pretty good about the pipeline and the areas that we've been targeting with full line solutions, which continue to resonate. Again, I just kind of remind everybody, we've invested a lot in automation.
If you look at a lot of the acquisitions over the last year, particularly with, you know, with ProxiHub, Vmac, more recently Escher, Colussi, you know, where the teams are really working together, you know, on some, you know, bigger projects to help customers, again, with our line, a lot of different applications that we were not in, if you kind of go back five years ago, as Bryan just alluded to, a number of them. I think, you know, we feel pretty good about the, you know, the momentum of the, you know, the business. Nothing's really changed from, you know, that perspective from what we, you know, by and large that we're seeing last year.
Larry De Maria (Equity Research Analyst)
Okay. Thank you, guys.
Operator (participant)
The next question will come from Brian McNamara with Canaccord Genuity. Please go ahead.
Madison Callinan (Equity Research Associate)
Good morning. This is Madison Callinan on for Brian. Thanks for taking our questions. Just to piggyback off a previous franchisee question, with the recent high-profile bank failures, we're just curious where your, like, restaurant customers and franchisees predominantly get their financing from, and any additional color you can give on how that affects your Commercial Food Service Equipment business. Thanks.
Tim FitzGerald (CEO)
You know, as we think about our Commercial customers, you know, there's a few things. They're obviously our largest customers. You know, I don't have a roster of where they, where they all bank, but, you know, they tend to be, you know, large entities. I haven't seen anything in the public domain, you know, I'd say, you know, align with our large customers about concerns about, you know, their, you know, their, you know, their financing. There's also obviously lots of really large, you know, franchisee organizations out there. You know, I would say that we haven't. You know, I understand where the question's coming from.
I can't say that we've explicitly seen any, you know, slowdown or change in our activity level, or, you know, negotiations with customers, you know, specific to what's happening, you know, with regional banks, you know, and the like. I think if you take it all the way down to our smallest, you know, customers, you know, kind of, you know, independent restaurants, you know, they're probably, you know, you know, raising cash, you know, to open things up, you know, given some of the, you know, the risk profiles with really small entities. Again, I'd say overall we don't feel like it has been, you know, yet, impacting us in a noticeable way.
Madison Callinan (Equity Research Associate)
Awesome. Thank you. Just as a follow-up, in terms of grills, can you give any color on material distribution gains you expect for your grill brands after the wholesale channel is cleared, whether they'll be deeper with current retail partners or new partners altogether? Thanks.
Tim FitzGerald (CEO)
Sorry, I don't know.
Bryan Mittelman (CFO)
Yeah. You know, with the grill companies, you know, we are seeing gains with our existing customers in terms of what I'll call, you know, the floor space, you know, allocated to us and really, you know, acceptance of our products for, you know, a variety of reasons, right? Charcoal gives a better, you know, cooking experience. We have, you know, awesome technology. We have different features for all these reasons. We are seeing gains with, I'll call it, our current, you know, base of customers.
We're also, you know, making headways in terms of, you know, bringing these, you know, these grill products to, I'll call it, like, you know, specialty retailers, where they may not have been carrying them before or were really able to because of everything Middleby offers, also have them, you know, bringing especially Kamado Joe, you know, into their showrooms, as well as, you know, leveraging what we're doing, you know, internationally. There are a couple of pockets I would say, you know, of new distribution, you know, in the U.S., as well.
Madison Callinan (Equity Research Associate)
Awesome. Thank you so much.
Bryan Mittelman (CFO)
Yep.
Operator (participant)
The next question will come from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.
Jeff Hammond (Managing Director and Equity Research Analyst)
Hey, good morning, everyone. Thanks for fitting me in. I just have one quick one, just on, you know, the cash flow should look better this year. I noticed you guys bought back stock and, which I guess was a little surprising given your penchant for deals and kind of the current rates and leverage. Just kinda update us on kinda how you're thinking about capital allocation as we move through the year.
Tim FitzGerald (CEO)
Yeah, I think it's probably unchanged for how it's been for a long time. I mean, certainly we're more conscious of the cost of capital and interest rates, et cetera. I think as we kinda think about, you know, deals, I mean, we're very strategic in our approach and how we build out the portfolio and things that we think will strengthen us, you know, for the long term and stand the test of time. We'll, you know, we'll be active, but we're also, you know, keenly aware of, you know, cost of capital's gone up as well as, you know, uncertainty and outlook in, you know, certain, you know, parts of the market. Just from a valuation standpoint.
You know, we do think, you know, valuation will kind of, you know, evolve here, and that'll be, you know, part of the, you know, our thought process as we look at deals. I mean, again, M&A is a, you know, as we always put the slide up there. We've been doing this for a long time and believe we're, you know, building upon three, you know, industry leading, you know, platforms. Obviously, you know, mentioned the two transactions, you know, start of the year we're, you know, excited about. You know, M&A will continue to be, you know, the forefront. You know, obviously we'll try to, you know, we will de-lever, you know, the process, you know, as well.
I mean, I think, you know, stock buyback, you know, we've always said we will do that opportunistically. You know, I mean, I think, you know, we felt that it was an opportunistic, you know, time. I think that that was, you know, something that felt, you know, was a good timing, you know, to buy back some shares. We started that in the fourth quarter of last year, so that was kind of a continuation of something that we put in place to finish the year and start the current.
Jeff Hammond (Managing Director and Equity Research Analyst)
Okay, thanks so much.
Operator (participant)
The final question we have time for today will come from Todd Brooks with The Benchmark Company. Please go ahead.
Todd Brooks (Senior Analyst and Managing Director)
Hey, thanks for squeezing me in. Congrats on the results in the quarter. I've got it's a three-parter, but it's all on the same topic. If we look at Commercial Foodservice, what's the mix of kind of new build versus replacement demand now versus what it would look like normally? I'm wondering, you talked about with maybe lead times normalizing, you may not get as much visibility into the new build programs with the restaurant partners. I'm just wondering about on as replacement seems to be picking up based on the comment you made, is your visibility there better than it's been historically? Finally, the margin spread between new versus replacement demand, if there is any. Thanks.
Tim FitzGerald (CEO)
Yeah, go ahead.
Steve Spittle (Chief Commercial Officer)
Todd, first question, you have a mix of new build versus replacement. You know, the pie charts that are in the deck I think are helpful. As you see today, you know, new build and replacement for 2022 were pretty much the same. Historically, if you go back to, again, pre-COVID levels, I believe there's probably a chart somewhere that, you know, replacement was historically half the demand that we'd normally see probably in the, you know, the period of, you know, 2017 to 2019, if you will, going into COVID. Obviously the new build demand, primarily from the bigger chains, really 2021, 2022, obviously is significantly higher than it was prior. That's why you see the mix being different.
I do think as you get into probably 2024, 2025, even though I do think you'll see new builds continue for a lot of the chains, I do think you'll probably see some replacement business uptick and actually be maybe not back to 50%, but probably be higher than the new build, you know, mix, if that makes sense. In terms of visibility into new locations, I've talked about on prior calls, one of the very nice byproducts of this disruptive period that we've lived through is, you know, being closer to our big chain customers. They've given us more visibility than ever into their development, you know, plans from timing, locations, et cetera, which has been extremely helpful. That has not changed.
I actually don't think it will change a whole lot as we go forward, just 'cause there's so many good benefits on both sides of the equation to giving us that visibility to make sure that we're always aligned with, you know, hitting a new store opening. Also, you know, your other question was making sure we understand the replacement demand. Again, we're in a good position to support that on that side of things. Visibility remains, I think, very open, very transparent, and I do expect that to continue as we go forward. From a margin perspective, you know, replacement versus new build, I would say, you know, new build, I would guess is probably higher margins, just 'cause if you think about new builds, they're putting in the newer technology products which historically do have higher margins.
It's not a hard and fast rule, but that'd be my answer that, you know, new store builds would historically probably have, you know, better margins than replacement business if you're replacing kind of a like for like product, if that makes sense. Hopefully, I answered all.
Todd Brooks (Senior Analyst and Managing Director)
Sure does. No, you did a great job. Thanks, Steve.
Steve Spittle (Chief Commercial Officer)
Thanks, Todd.
Operator (participant)
This concludes our question-and-answer session. I would like to turn the conference back over to management for any closing remarks.
Tim FitzGerald (CEO)
Thanks everybody for attending the call today, and we look forward to speaking to you next quarter. Thanks.
Operator (participant)
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.