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Welbilt, Inc. (NYSE:WBT)
Q3 2020 Earnings Call
Nov 3, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Samantha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Welbilt, Inc. 2020 Q3 Earnings Call.

[Operator Instructions]

Rich Sheffer, you may begin your conference.

Rich Sheffer -- Vice President Investor Relations, Risk Management and Treasurer

Good morning, and welcome to Welbilt's 2020 third quarter earnings call and webcast.

Joining me on the call today is Bill Johnson, our President and Chief Executive Officer, and Marty Agard, our Chief Financial Officer.

Before we begin our discussion, please refer to our safe harbor statement on Slide 2 of the presentation slides and in our earnings release, both of which can be found in the Investor Relations section of our website, www.welbilt.com.

Any statements in this call regarding our business that are not historical facts are forward-looking statements, and our future results could differ materially from any expressed or implied projections or forward-looking statements made today. Our actual results may be affected by many important factors, including risks and uncertainties, identified in our press release and in our SEC filings. We do not undertake any obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or other circumstances.

Today's presentation and discussion will include both GAAP and non-GAAP measures. Please refer to our earnings release for our non-GAAP reconciliations and other important information regarding the use of non-GAAP financial measures.

Now I'd like to turn the call over to Bill.

William C. Johnson -- President and Chief Executive Officer

Thanks, Rich, and good morning.

Before we get into our third quarter results, I want to share some details on the current market environment. Looking at the MillerPulse weekly same-store sales graph on Slide 3, you can see the recovery in the restaurant market since the historic drop that began the second week of March. It's notable that QSR same-store sales are now above prior year levels. Most QSRs had more than 50% of their sales come through their drive-through windows prior to the crisis and now are also embracing delivery. As a result, they have been more resilient than casual dining restaurants, who precrisis, saw the majority of their sales tied to dine-in traffic.

Same-store sales at casual dining restaurants began the quarter down 30% compared to the prior year, improved to being down 20% by the end of the quarter. We're not expecting to see much improvement in the near term due to the recent rise in COVID-19 cases, causing some reopenings to be rolled back in portions of the US and EMEA. The colder weather that is now impacting northern regions will also impede additional improvement. Until new COVID-19 case counts begin to fall again and diners regain confidence in eating meals indoors at restaurants, it will be difficult to see additional recovery in same-store sales for casual dining restaurants.

The National Restaurant Association estimates that 100,000 restaurants or 15% of the pre-COVID population have closed. We also reported that restaurant employment remains 2.3 million below pre-COVID levels, the majority of this is in those operations that rely on indoor dining or service. QSRs have also reduced headcount as they have been closing their indoor dining rooms and shifting to a takeout and delivery-only model. Given the current state of the market, it is possible that operators will defer new equipment purchases temporarily while they recover financially from the crisis and get clarity on the new demand environment. In this case, we would expect to see an increase in KitchenCare aftermarket sales, with operators spending more time on repairing existing equipment rather than replacing it.

For our foodservice equipment, our income-producing assets for operators and the cost to repairs, lost sales while the equipment is down and the food safety concerns that hang over the industry will likely keep extended equipment lives in check. We've had several QSRs publicly comment recently that they will begin to focus on new builds over the next several quarters as their same-store sales have recovered, and they see a share growth opportunity due to the continued weakness in casual dining. Given our strong position with most of these change, we expect to benefit as this market segment starts to expand again.

Looking at other end markets, the education market is seasonally strong during the summer months as they do the majority of their planned remodels and upgrades when school is not in session. As expected, we did see this market seasonally slow in late August as project work was completed in time for the anticipated return of students. Healthcare remains stable and is likely to stay that way for the foreseeable future, although there is the potential for some remodel and upgrade projects at long-term care facilities once the pandemic ends.

We have seen C-stores in government and correctional segments continue to spend on expanded sanitation. We have also seen a strong focus on beverage offerings in the C-store market, especially for our Fresh Blend smoothie machine, as well as the growing interest in our Crem coffee machines. We have many units in tests with a number of major C-store chains and are optimistic that this will drive new revenue opportunities for us in 2021 and beyond.

Moving on now to Slide 4 of our presentation to review our financial results. Our net sales declined 27.3% in third quarter, with organic net sales decreasing 28%. Year-over-year, monthly sales decreases improved each month during the quarter, and the 27.3% decline was almost half compared to that of the second quarter. Despite the continued high level of sales decreases, we delivered an adjusted operating EBITDA margin of 15.3%. This was down 470 basis points from last year's third quarter, but was a 570 basis point sequential improvement from this year's second quarter. This operating performance was made possible by the progress we've made on the transformation program over the last year and by the cost containment actions we took in March. We delivered $32.1 million of free cash flow in the quarter and improved our total global liquidity.

On Slide 5, sales in the Americas decreased 28.8% in the quarter from the prior year. We had $16 million of non-repeating large chain rollout sales in our prior year comparison, with only $3 million in new rollout volume in this quarter, which accounted for the majority of the sales decrease attributed to QSRs in the quarter. Notable within this quarter's rollouts was the first shipment of Merrychef high-speed ovens to a new global customer. These first shipments occurred late in the quarter, and we expect sales to this customer to gradually ramp up as they replace all of their existing ovens over the next several years.

In the general market, the sales decreases were a little less in the third quarter due to the healthcare, C-store and education end markets performing better than some other end markets. We did see demand for Manitowoc ice machines improved, which also supported general market sales. The level of KitchenCare aftermarket sales decreases eased later in the quarter as the distribution consolidation and inventory destocking related to the merger of the two largest master parts distributor neared completion.

Looking at EMEA on Slide 6. Sales decreased 21.6% with organic net sales down 25.8%. Large chain sales were weak, with sales due to our large carbonated soft drink customers remaining very low. Large chain sales were also impacted by strong QSR sales last year. We had a smaller decline in the general market due to a couple of small rollouts, one for Crem with a European governmental entity, another for Merrychef with a UK grocery store chain. We also saw better sales in the UK during the quarter as they reopened for dining out which was supported by the government through their Eat Out to Help Out program that subsidized 50% of the cost of the meal, up to GBP10 for individuals who dined out. Program was successful as there were 64 million meals eaten at a discount in the first three weeks, but unfortunately, the program has ended. Even more unfortunately, many areas of the UK and Europe are seeing spikes in COVID cases are reimposing localized restrictions.

On Slide 7, sales in APAC decreased 26.9% with organic net sales down 27.3%. Sales in China and Australia, the first areas to be impacted by COVID last winter, increased year-over-year with China benefiting from a large project. Excluding that project, China sales would have decreased slightly. Other areas of APAC, Southeast Asia, the Philippines, Japan and India, to name a few, were impacted later and remained weak during the quarter.

Moving to Slide 8. We're continuing to make really good progress on our transformation program. Our procurement team has implemented many new agreements with current and new suppliers and is continuing to review the majority of the remaining RFQ responses, most of which are now going through the product qualification and testing processes. We're starting to see the savings from our procurement activities begin to ramp up, but some of the early benefits are currently capitalized into inventory, while our P&L is reflecting some inventory obsolescence and transitional costs as we shift suppliers. We've also been developing our own site-led Value Analysis Value Engineering, or VAVE initiatives for the RFQ process didn't provide the right solution for our businesses. These VAVE initiatives have identified additional savings opportunities to supplement the RFQ process and is a great example of how we are transforming the culture of our company into one that embraces continuous improvement. We remain confident that we will complete our procurement activities close to our original time line but may lag in actual dollar savings until the business returns to pre-COVID levels.

We have continued to make progress with the five North American manufacturing plants that are currently part of the transformation program and have seen productivity gains emerge in not only these sites, but in most of our sites globally as we are deploying our lessons learned broadly to accelerate improvement. Some of these productivity gains have been substantial despite dealing with lower volumes and partial production shifts that hurt cost absorption and lead to higher transitional costs. These productivity gains have led to leaner operations and a smaller workforce with headcount reductions that began in Q4 of 2019 and continued in each quarter of 2020. We anticipate some additional productivity related headcount reductions continuing through 2021.

We've taken delivery in this fall some new fabrication equipment. However, the pace of capital spending for additional fabrication equipment has been slower than originally anticipated due to the impacts of COVID. The slowdown in capital investment, combined with temporary plant shutdowns and furloughs that we were enacted in the second quarter and continued to a lesser extent in the third quarter, will slow the pace of recognizing manufacturing savings by a few quarters. We did complete the transfer of all coffee machine manufacturing from our Crem Shanghai plant to one of our existing manufacturing plants in China during the third quarter. We are now in the process of shutting down the Shanghai plant and should be fully exited by the end of the year.

We did see a step-up in transformation program savings in the third quarter, with in-period savings increasing to approximately $4 million, which is a $16 million run rate. We remain fully committed to delivering the 500 basis points of margin improvement from the transformation program, and expect to complete all the planned execution actions that will drive the savings by the end of 2021. However, the timing of realizing the full $75 million of cost savings in dollar terms, along with the all-in EBITDA margin target of 23%, may be delayed due to the pause experience related to the pandemic creating uncertainty when sales and manufacturing volumes return to pre-COVID levels.

Before I turn the call over to Marty, I want to share some recent developments from some of our other strategic initiatives. On Slide 9, I'm pleased to announce that we launched our newest version of KitchenConnect and launched our new common controller into our first product lines. KitchenConnect is our open cloud-based digital platform that brings the benefits of connectivity to commercial foodservice operators and helps them in five key areas, facilitates new menu downloads and updates that provides visibility into the service needs of the equipment, assists with asset management and tracking, helps them measure what they produce and how they are utilizing their kitchen equipment, and finally, attracts quality management metrics such as oil filtration and fryers for cleaning cycles and combi ovens.

KitchenConnect 3.0 provides enhancements on all of these key features in a stable, secure digital environment. Because it is an open cloud-based solution, we can share data with other kitchen management platforms and connect competitors' equipment to Welbilt's KitchenConnect. Our new common controller connects to KitchenConnect 3.0 and is now being integrated into new products across all of our brands. We'll also be retrofitting existing products with the new controllers, and we'll offer kits to operators who want to retrofit to their equipment with new controller to take advantage of our integrated digital platform. Operators increasingly demanding digital capabilities when choosing what equipment they will use in their kitchen. Welbilt's integrated approach of having a leading cloud-based data management system with the only controller that uses the same operating logic across all its brands puts Welbilt at the bleeding edge for digital platforms in our industry.

Moving to Slide 10, we launched our newest Convotherm combi oven product line, the maxx, in the Asian and European markets two weeks ago. The maxx is for those customers who need a combi oven that is larger than our minis, has more features and performance, but don't need all the premium features and performance of our flagship C4 combi ovens. The maxx is born digital with our new common controller and connects to KitchenConnect 3.0, while being priced to be competitive with other mid-tier combi ovens in the market. We had several hundred people attend our live launch event in China and many more joined virtually for our launch events in Europe.

The last item I want to cover is an update on our ghost kitchen efforts. On Slide 11, you can see one of our standard ghost kitchen designs that was developed by our FitKitchen team to help operators, these kitchens adopt an efficient modular layout that is digitally enabled by KitchenConnect. Demand for ghost kitchen is expected to grow rapidly with an estimated 1,000 ghost kitchen openings over the next four years, and the Americas are representing approximately $100 million of equipment. We estimate that we have some equipment in the majority of ghost kitchens in operation today and have installed 25 Welbilt ghost kitchens so far this year, where the majority of the equipment and the kitchen is Welbilt equipment. This is yet another example of where our leadership and digital capabilities will help us grow in an emerging market segment.

With that, I'll turn the call over to Marty.

Martin D. Agard -- Executive Vice President and Chief Financial Officer

Thanks, Bill, and good morning, everyone.

I'm going to start with Slide 12 and the discussion of our adjusted operating EBITDA margin results. As you might expect, the drop in volume had impacts throughout our system and these margin drivers. Volume, which we measure at the gross profit level and is netted against the impact of net pricing, drove a decline of 310 basis points in the third quarter. This reflects the 27% decline in sales versus prior year, partially mitigated by positive net pricing as our January price increases have continued to hold up. Material costs, including tariffs, was 150 basis point headwind this quarter compared to the prior year.

While we have had some savings come through from our transformation program's procurement activities, we had two timing-related adjustments that impacted this driver. First, last year's comparison included favorable material costs linked to a large rollout volume buys in Q2 last year that went through inventory and benefited the P&L in Q3 last year. And conversely, this year, the transformation driven per piece cost reductions themselves are partially capitalized and spread across Q3 and Q4. The other issue to mention is that we increased our reserve for excess and obsolete inventory this quarter tied to the transfer of some production from China to North America and also tied to inventory of older controllers that are being replaced by our new common controller. Lastly, we still had a negative impact year-over-year for tariffs that have been imposed within the last 12 months.

Other manufacturing expenses, mainly labor, overhead and warranty were a 340 basis point impact to margin this quarter. We continue to effectively flex our production expenses to volume declines we experienced again this quarter. As a reminder, we implemented a reduction enforced at the end of March that addressed both lower volume and anticipated productivity gains. We took an additional but smaller action in early Q3 as we made further progress on improving productivity in our plants and gained more visibility on upcoming demand. This helped us reduce direct labor in excess of the demand declines and thereby continue to build on the productivity improvements we've achieved through the year despite the lower volume. But there is a degree of fixed cost we could not impact proportionate to volume, causing the margin deleveraging. We are continuing to execute the transformation program related labor strategies across our plants in Q4 and several more equipment upgrades planned over the next few quarters and remain encouraged by the progress we see.

We're also critically reviewing our other plant costs and creatively revisiting our structural costs by, for example, exiting warehouses and consolidating buildings within a given campus. We expect to continue taking additional restructuring actions over the next few quarters as each plant progresses in its individual transformation program. SG&A on an adjusted basis was down from prior year quarter by $9 million, equating to a 310 basis point contributor to margin in the quarter. Like our actions within the manufacturing footprint on SG&A, we also took early and aggressive action to contain spending as the pandemic's impact emerged in March. Many of those actions remain enforced and enabled us to show real favorability in most of the SG&A categories in the quarter as employee-related expenses, marketing expenses, travel and professional fees were all favorable. As a reminder, if you're reading the face of the income statement, SG&A includes the transformation program investments that are excluded from our adjusted operating EBITDA. You can track the specifics to the non-GAAP reconciliation schedules.

Moving to Slide 13. Free cash flow was a positive $32 million in the quarter. With the sequential growth in sales and production volumes, we did see growth in both accounts receivable and accounts payable during the quarter. Both are still well-managed and specific to accounts receivable, we have seen only a negligible impact on collectibility from the industry contraction. Net inventory decreased by $16 million in the quarter as we made progress on moving our inventory levels into better alignment with our sales levels. This decrease is inclusive of our investment in the initial stocking of our new common controller as we ramp up production of our born digital products and pursue our digital strategy execution.

Also impacting free cash flow is our investment program in both traditional capital spending and the transformation program. For the quarter, we spent $5 million in capital, down slightly through 2019, and year-to-date, we are at $16 million, in line with 2019, $17 million through three quarters. But we will ramp this up a bit in both Q4 and 2021 related to equipment upgrades, facility investments, new product innovation and IT initiatives. The transformation program investment is reflected in both SG&A and restructuring. For the spend reported in SG&A, after the $6.7 million in Q3, we have spent $56 million since inception in May 2019. And combined with transformation-related restructuring charges of $9 million since inception, we have already incurred $65 million of the original $75 million to $85 million range of investments planned, and these costs will certainly ramp down in coming quarters as the program continues into 2021.

One last reminder on our free cash flow is that it is traditionally a seasonal use of cash in the first quarter as we pay customer rebates and annual incentive compensation, build inventory and experience seasonally lower volumes. We then generate seasonally stronger cash flow in the remaining three quarters. As shown on this chart, we have remained free cash flow positive since the beginning of the pandemic. While we're not providing a free cash flow forecast today nor are expecting it to achieve the levels of the last four years, absent an abrupt market disruption, we should remain cash flow positive in the fourth quarter.

Moving on to liquidity, which we define as cash and short-term investments plus availability on our revolver. We ended the third quarter with $333 million of total liquidity, which is well ahead of where we were at the end of the last two quarters. Cash and cash equivalents plus restricted cash decreased by $17 million during the quarter, while our overall debt balance decreased by $52 million, providing the $35 million improvement in liquidity this quarter. We were in compliance with the liquidity, EBITDA and capital expenditure covenants in our amended credit agreement with significant headroom.

Finally, on Slide 14, I'd like to share a few updated thoughts on 2020. First, we withdrew our 2020 guidance in March and will not reinstate it until conditions have sufficiently stabilized. Given rising COVID case counts, installing or even reversing of the reopening process, we cannot offer any guidance on the fourth quarter. The color I can offer is that October's declines from last year was slightly better than Q3's overall and we're hopeful the quarter will also show slight improvement in the decline versus last year. We caveat this with the realization that the ongoing COVID-19 pandemic could make the pace of the gradual recovery uneven, especially during the winter months.

The last thought to share in 2020 is that we are focused on the execution of our key strategic initiatives, believe we have the financial resources to do that and we'll, of course, closely watch market dynamics and adjust as required. As Bill stated, we remain confident the transformation program actions are working. On a transactional level, we can clearly see the savings are materializing, and we are confident those benefits will accelerate. I will point out the direct pass-through to our P&L and our own margin progression will not be a linear path due to volume effects, inventory impacts and other time lags. But we remain convinced we're doing the work now that will make us a stronger and more profitable company in the quarters ahead when both our transformation actions are mature and the market has recovered. We have not lost sight of our 500 basis point improvement goal nor our path to it.

That concludes my comments. Operator, we'll now open the call for questions.

Questions and Answers:

Operator

[Operator Instructions]

Your first question comes from the line of Mig Dobre with Baird.

Mircea Dobre -- Baird -- Analyst

Thank you very much. Good morning, everyone. A couple of questions for me, a shorter-term and a longer-term one. I guess I'll start with a shorter-term one. I appreciate the commentary in terms of trends through the quarter. But I'm wondering if maybe you can put a -- sort of give us a little more context in terms of how you're seeing October play out, how you're kind of thinking about revenue sequentially in the fourth quarter. I know that the channel itself, your distributors do kind of have some stocking dynamics that normally happen at year-end. And I guess I'm wondering if this year is consistent with normal seasonality or we should be thinking something different.

William C. Johnson -- President and Chief Executive Officer

Yeah. So regarding October, if we look at what's come in, we improved each month through the third quarter, July, August and September. And October was an improvement over that. I would say in the low 20s in terms of the sales for October. When we start looking at November and December, it gets a little more dicey to kind of -- to see where the improvement is going to continue on through the quarter. There's a lot of closures happening in Europe right now and around the world, and we're just monitoring that, beg to be completely honest on kind of a day-to-day basis. And we look at it every day and try to see what's going on. But October was better than September.

And maybe a little more color on like -- the KitchenCare side of things was an improvement over the third quarter as well and the third quarter was an improvement over the second quarter. So the aftermarket side of things is getting a little bit better. In terms of the seasonality, we haven't seen distributors kind of come to us with kind of year-end buys that normally you would see. And I think a lot of them are watching their own balance sheets and kind of seeing what the volume levels are going to do and throughout the quarter. So we'll just have to wait and see.

Mircea Dobre -- Baird -- Analyst

But Bill, did you see those kinds of buys last year? So meaning, do we have a difficult comp in that regard that we need to be aware of into year-end?

Martin D. Agard -- Executive Vice President and Chief Financial Officer

Mig, it's Marty. No, not really. There was a little bit of that going on last year, but I would say we should expect a similar kind of seasonal pattern. And if the year-over-year declines improve a little bit, that will sort of help mitigate the seasonal patterns. Normally, the fourth quarter is down from the third quarter by a couple of points, let's say. In '18 it was two points, in '19, it was 7 percentage point sequential decline. So somewhere, that would be the normal seasonal pattern, call it, low single digits sequentially. And then the question is just what this improvement pattern does. Bill was saying October was down in the low 20s as opposed to the third quarter that was down 27 [Phonetic]. That's the improvement we're talking about in October. So we just don't know where November, December going, depending on how quickly things really start to close up again.

Mircea Dobre -- Baird -- Analyst

Sure. No, I understand that. That's helpful. Thank you. Then sort of the longer-term question is this. We're -- we obviously know more about the industry now than we did at the beginning of the pandemic in terms of where things seem to be heading. And you provide a good detail as far as the structural transformation. But I'm curious if you'd be willing to expand a little more on what do you think you have to be -- you have to do that's incremental from what you've announced as far as either footprint or capacity? Because while the framework that you put forth on returning back to pre-COVID level volumes, margins are going to look the way you outlined them initially, I'm wondering if there's not an argument to be made that the volumes here are either going to take quite a long time to get back to pre-COVID, or who knows, structurally, they might not. So I'm curious to get an update on your thinking here and what else we could be expecting as we look toward next year? Thank you.

William C. Johnson -- President and Chief Executive Officer

Yeah, so as we continue to monitor the situation, I think your point is valid. We are looking at other structural types of actions that we can take. We announced the closure of the Shanghai Crem facility and moved that into another facility that we had in China. And there are other actions that we're contemplating and looking at. And depending on how quickly these volumes return, we may have to take other structural actions to take out costs.

Mircea Dobre -- Baird -- Analyst

Do you have some sort of a time line in mind for where -- when you're going to make this decision or be able to announce it more broadly?

William C. Johnson -- President and Chief Executive Officer

Yeah. We'll be announcing any of those types of actions in the first half of next year.

Mircea Dobre -- Baird -- Analyst

Okay, thank you. Good luck, guys.

Operator

Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Brad -- KeyBanc Capital Markets -- Analyst

Hey, good morning, guys. This is Brad [Phonetic] on for Jeff. So it's good to see some minor rollout activity in the quarter. And Bill, you mentioned a positive tone from some of the chains around return to potentially new unit development. I guess I'm wondering if that commentary or that kind of anecdotal feedback is beginning to show up in your quoting pipeline and maybe your order book, or is it are we still kind of early on in the stages of planning.

William C. Johnson -- President and Chief Executive Officer

It varies by customer, but we saw -- I think we called out about $3 million worth of activity in the third quarter. We'll see a little bit more of that in the fourth quarter. It's not the big rollouts that are kind of happening. It's kind of the $1 million to $2 million kind of rollouts small -- on the smaller side. But the funnel is building. I think a lot of them are just waiting to see what happens with this COVID, is there going to be more lockdowns, how does the industry recover. But the QSRs, because their volumes are up, are starting to look at more of the rollouts and more additions and -- to their back of the house.

Brad -- KeyBanc Capital Markets -- Analyst

Okay. And then maybe taking a step back, I'm just kind of looking at -- you mentioned the NRA poll, which said 100,000 restaurants are closing, and that's mid-September. So it stands to reason that number probably gets a little bit higher as winter comes. I'm wondering, going back to a conversation from earlier this year on the used equipment market, has your view changed there at all given just how significant this capacity reset is, or did the same kind of fundamental barriers still hold in that, it doesn't have the infrastructure and there's specifics around the equipment that make that a challenge? And then I guess along the same lines, I'm just kind of wondering about the mechanisms of kind of alluding a restaurant and replacing a restaurant. Like will you typically see an operator come in and completely refurbish the kitchen, or is there some kind of blend between using the equipment that's already there? Appreciate it.

William C. Johnson -- President and Chief Executive Officer

Yeah, so on the used equipment side, our position hasn't changed at all there. We continue not to see any meaningful used equipment flooding into the market for all the reasons we've stated in the past, which is mainly, there is -- it's a regional business. It's a very hard distribution network, too complicated to get the used equipment to where it needs to be. There's food safety concerns with used equipment, the warranty lapses, all those kinds of things. And so we just don't see it, in -- and we don't expect it to materialize.

We see all the -- with regard to your second question, we see all kinds of different ways people do this. Some people come in and take over a restaurant and they take over the kitchen and they do small modifications and some people come in and depends on their concept, right, they may want an open kitchen design and they'll remodel the whole kitchen and put all new equipment in. So I think there's all different variants of that, that occur in the market. It's going to be interesting to see as these hundreds of thousands of closures take place, how quickly they -- the reopenings or new restaurants emerge. I do think at some point, out there, several years, there will be a buildup of restaurants. It's a very popular form of business that people -- a lot of people like to get into. And I think we will see more restaurant new builds, but I think it's a couple of years out.

Brad -- KeyBanc Capital Markets -- Analyst

Okay. I appreciate the time. I'll pass it on.

Operator

Your next question comes from the line of David MacGregor with Longbow Research.

David MacGregor -- Longbow Research -- Analyst

Yes. Hi, good morning, everyone.

William C. Johnson -- President and Chief Executive Officer

Hi David.

David MacGregor -- Longbow Research -- Analyst

Bill, in a tough environment, you guys seem to be making very good progress on the things you can control and the transformation projects. So I guess, congratulations on the progress there. You made the observation that people are repairing or turning to repair as opposed to replacement. And clearly, sales are running below kind of replacement rates or historical replacement rates right now, which is putting stress on that situation. What's your sense in terms of how much deferral room people have? I mean how far are people likely to go on the repair side before being forced to revert back for all the reasons you just talked about in answering your question about used gear back to the purchase of the new product?

William C. Johnson -- President and Chief Executive Officer

Yeah. I think there's a -- they can delay it for a reasonable -- maybe a year or two, but I don't think they can delay it much past that. These are income-producing assets. And if these things start breaking down more than they're operating, they have to replace them. It's just it's -- they just can't afford for it to constantly have service technicians in there. So I think maybe a year or two on the QSR side, maybe a little longer on the casual side because they're not operating as heavy, but the QSRs are -- they're operating those things, seven days a week for the most part, 20 hours a day.

Martin D. Agard -- Executive Vice President and Chief Financial Officer

Yeah. And David, I'd also remind you that the functional gap between new equipment and old equipment is going to increase markedly as we get the digital program going, and this is going to drive the demand. Not -- people are going to go out and carte blanche, overhaul all of their equipment. But there's going to be a night and day generational change here in a year.

William C. Johnson -- President and Chief Executive Officer

And that's one of the reasons why we made our common controller retrofitable to the equipment, right? So that we knew that there would be a drive for digital. But people would have -- be reticent to change out the entire piece of equipment. But hopefully, they will -- we can get the control -- a new controller and to get them born -- get them digital that way.

David MacGregor -- Longbow Research -- Analyst

Yeah. Is there much of an order book developing around this common controller? What kind of -- I realize you just rolled it out, but...

William C. Johnson -- President and Chief Executive Officer

Well, it's -- the common controller is going to be the new standard, right? So it doesn't matter what, if you order it, you're going to get it. That's why we say you're born digital.

David MacGregor -- Longbow Research -- Analyst

Okay. And then I guess on a related point. With people turning more to repair, one would expect that the KitchenCare business begins to reflect that. And you talk about things were improving there. But is the improvement you're seeing in KitchenCare related more to deferred replacement and the repairs we've been discussing, or is it more related to some of the channel inventory dynamics we've been talking about over the last few quarters? Can you just help parse that out for me?

William C. Johnson -- President and Chief Executive Officer

Yeah. The channel dynamics or the heritage and parts down coming together, there was a lot of inventory overhang there, right? So there was a -- but we had very clear visibility into that, and we knew exactly what that dollar number was that had to be burned off. So that was in the range of $20 million, something like that, $15 million, $20 million that had to be burned off of duplicate inventory in the channel. And so there was that dynamic going on. But we -- as these restaurants reopened, we certainly saw the service KitchenCare business get better. And -- but we also see it slowing when these closures happen. So it's -- those are the two dynamics that are going on.

David MacGregor -- Longbow Research -- Analyst

Yeah. Last question for me. Just you talked about some of the manufacturing curtailments in the quarter just as you were trying to balance out demand with production. I realize you've got a limited forward line of sight around this, but what can you say about the likelihood of more of these curtailments in the fourth quarter and into early next year? Do you feel like those are, for the most part, behind you at this point?

William C. Johnson -- President and Chief Executive Officer

We took out a substantial number of people between -- starting in March, and some of that was volume-related and some of it's productivity related. And we've been able to really operate these plants pretty efficiently by shutting down for a week or two weeks and then building a backlog up and then we can operate more efficiently that way without having a shutdown day on Monday, every week or something. We've tried to make it so that it's more manageable by shutting down for a week at a time, if needed. I think probably that's still going to be the case. And some of that's driven by some of the government subsidies that are out there that require us to be shut down for a period of time in order to qualify for the government assistance. So that drives a little bit of decision-making as well. And so I think with the rate of shutdowns that are occurring right now, I think you'll see us probably sporadically, not at the level we were in the second quarter, but a week here, a week there, depending on the plant. Some plants are full out right now, their volumes are really quite good. So they obviously won't be shutting down.

David MacGregor -- Longbow Research -- Analyst

Okay, thanks very much. Keep punching.

William C. Johnson -- President and Chief Executive Officer

Yeah, sure.

Martin D. Agard -- Executive Vice President and Chief Financial Officer

Thanks, David.

Operator

Your next question comes from the line of Todd Brooks with CL King & Associates.

Todd Brooks -- CL King & Associates -- Analyst

Hey, good morning, guys. Thanks for taking the questions. First question, you were just talking about some color on new unit development coming with some of the QSR customers. When they're talking to you about new unit development, can you speak to how new units are going to change as well, greater focus on off-premises, dual drive-throughs? And is the equipment content in some of these new formats lesser, greater, about the same, when you look at these opportunities that are starting to get into the pipeline?

William C. Johnson -- President and Chief Executive Officer

Yeah, so I think they're all looking at different formats and trying to assess it, and that varies by QSR. And I do think, for the most part, the ones that I can think of off the top of my head, they are -- the new store development, they're actively looking at their programs. But the kitchen piece of it, whether it's a ghost kitchen or a delivery-only location, depends on the format, and that will be the choice of the QSR. But the kitchens look pretty similar to whether it's a dine-in or not. But what they're all wanting is digital, right? And they're all wanting us to have the capabilities that come with being connected to our KitchenConnect 3.0 and being digital so that they can lower their cost and improve their processes. That's the common driver between all the formats.

Todd Brooks -- CL King & Associates -- Analyst

That's helpful. And if you look at this kind of universe of customers, how many are currently KitchenConnect customers that you're just bringing up to the new version versus the environment has gotten some customers over the hurdle to actually dive in and get involved with KitchenConnect?

William C. Johnson -- President and Chief Executive Officer

I don't have that number off the top of my head. There's -- we're adding new customers all the time. Every week, there's a new set of customers. The inquiries are coming in, we're having to actually staff up and add people and more resources into the area, and we'll continue to do that as we get more and more people on KitchenConnect. But it's coming. It's going to be the new norm for most people. And we think we're positioned really well to take advantage of this new macro trend.

Todd Brooks -- CL King & Associates -- Analyst

Okay. Great. And then the second question is just on the free cash flow side of the house. You talked about inventory, I guess it was about $6 million year-over-year. But there's maybe some obsolete controller inventory there. You're building common controller inventories. Just what are the -- what's the outlook for being able to get some capital out of the inventory balances over the next couple of quarters? And then any free cash flow generated? Should we just understand that it's earmarked toward debt reduction in the near term? Thanks.

William C. Johnson -- President and Chief Executive Officer

Yeah, so we are continuing to work on inventory, and then we should see it come down on a bit over the -- at least in the fourth quarter and probably a little bit more in the first, although that starts a seasonal build pattern as well. So if the industry is coming back a bit, maybe the first quarter will be a little bit more neutral, maybe less build than seasonally we typically have in the first quarter. But certainly, in the fourth, we're still bringing it down. This is just a natural function of you put on the brakes to your production system we did in the second quarter, and then it backs up through your supply chain and the purchase orders you've issued and stuff, you start to slow those down and figure out what the level of production to plan for is and you eventually kind of -- on a lag basis, you eventually get your inventory compressed. Meanwhile, we were -- as we consolidate plants, like we were mentioning around the Crem Shanghai facility, you build some transitional inventory while production is sort of disrupted like that. And then we have this common controller. We take a base load of that so we can start to put it into the units that we're building. So a few things like that will run their course as well and what we should see inventory continue to come down.

And longer term, I think we have terms, improvements around inventory longer term, but I don't think it's substantial. We don't -- we're not way out of line there. We do have a long, complicated supply chain with all these global plants. So we'll make some improvements. But after we get through this sort of compression, it will be more continuous improvement, I guess. And yes, the free cash generation, generally, I commented on a little bit of a ramp-up in capex from last year, this year and on into next year from kind of that run rate to ramping up a little bit. We've got still some equipment upgrades and some of the IT things to do. Some of these facility consolidations actually require some capital. So there'll be a little bit of elevated capex but the rest will go to debt paydown there. We still want to get back on the deleveraging program that we talked about a year ago.

Todd Brooks -- CL King & Associates -- Analyst

Great, thank you.

Operator

Your next question comes from the line of Walter Liptak with Seaport.

Walter Liptak -- Seaport Global -- Analyst

Hi. Thanks. Good morning, guys.

William C. Johnson -- President and Chief Executive Officer

Hey Walt.

Walter Liptak -- Seaport Global -- Analyst

Hey. I want to ask just a couple of things about -- you mentioned the pricing was still holding up. I wonder if you could just talk about the pricing dynamics. And you kind of alluded to the fact that there might not be that distributor build in the fourth quarter. Have you been seeing some of the large distributors come to you at all on pricing in the fourth quarter?

William C. Johnson -- President and Chief Executive Officer

Yeah, so on the pricing, I think we've been fortunate and pleasantly surprised that our pricing that we went out with in January has held up pretty well. We haven't seen a ton of deep discounting out there. And I think probably a lot of that is because there's not a lot of large project work can be had right now. So a lot of what's going on is replacement type of activity. I think the dealers and distributors are still watching and seeing what's going on. Marty made some comments about the seasonality from Mig's question. But last year, we didn't see a large buy either and right now, I would say that we're just watching to see what they want to do. But I would think that they're watching their inventory levels just as closely as we are.

Walter Liptak -- Seaport Global -- Analyst

Okay. Great. And then you mentioned on the retrofit for the controller. I wonder if there's -- if you have an idea of what the size of that opportunity? Are you seeing some of the bigger customers talked to you about getting those in? You talked positively about using digital technology, I would think the controller is part of that.

William C. Johnson -- President and Chief Executive Officer

Yeah. It's a little early. Give us another quarter or two to kind of see what the retrofit capabilities are. We've just launched the retrofitting capabilities so we'll need a couple of quarters to kind of give you a little more color on that. But certainly, everybody is talking about it, it's what everybody wants. They all want the digital capabilities. So I think it's a good opportunity for us to have new equipment that's more in digital, but also retrofit the existing equipment that's out there that we can -- that they can take advantage of all the KitchenConnect 3.0 stuff.

Walter Liptak -- Seaport Global -- Analyst

Okay. Great. And then the last one for me is, you guys called out a warranty issue. And I wonder if you just refresh us on that was regarding, is there any fourth quarter impact from that?

Martin D. Agard -- Executive Vice President and Chief Financial Officer

No, Walt. That was just me describing what's in other manufacturing costs in that EBITDA bridge. We've got labor overhead, warranty is in there. There was really nothing special about warranty this particular time. We haven't had warranty issues for -- since the end of '18, I guess it's been [Phonetic] since [Phonetic] early last year.

Walter Liptak -- Seaport Global -- Analyst

Okay, great. Okay, thank you.

Operator

[Operator Instructions]

You do have a follow-up question from the line of Mig Dobre with Baird.

Mircea Dobre -- Baird -- Analyst

Hey, thanks for taking a follow-up, guys. Bill, it's good to see that you guys continue to invest in new product and you've got some product intros. Can you give us a little more context around this? I'm kind of curious how your overall investment has changed with the pandemic. It sounds like it hasn't stopped, which is a good thing. But what does your pipeline look like in terms of new product introduction as you look into 2021?

William C. Johnson -- President and Chief Executive Officer

Yeah. It's actually pretty robust. We kept up the investment from a SG&A side on the engineering front. So all the activity around fryers, combi ovens, Fresh Blend, all the digital spend, the new 30-pound fryer coming out next year, so I would say that it's -- all of these key initiatives we continue to invest in. And then what we did was we took some of the engineering talent and in this downtime when the factories weren't running and allocated into the VAVE activity, the business transformation, so that we could continue to drive those costs. So I think we kept -- we decided to cut elsewhere in spending, and we were able to maintain a pretty healthy spend and overall development of our innovation pipeline.

Mircea Dobre -- Baird -- Analyst

Okay. And then lastly, I don't know if this is too early to know or not, but I'm curious if you're hearing from either customers or your salespeople in terms of any shift in competitive dynamics you're investing in new product. I suppose other competitors, maybe smaller competitors might not be in a position to do so. Are you getting a sense that there's any share shift from some of the larger players in the industry such as yourself?

William C. Johnson -- President and Chief Executive Officer

Yeah. I think digital is the key there, Mig. The little guys just aren't going to be able to keep up with the digital revolution. It's connecting to these systems like KitchenConnect 3.0 and stuff like that, it's just going to be very difficult for them to do that. So I think that's the key one that will result in share shift going forward.

Mircea Dobre -- Baird -- Analyst

Okay. Thank you.

Operator

There are no further questions at this time. I would now like to turn the call back over to Bill for any additional or closing remarks.

William C. Johnson -- President and Chief Executive Officer

Before we end today's call, I would like to thank our employees once again for stepping up to the challenges presented by the COVID-19 pandemic while continuing to stay focused on our strategic priorities. The entire management team really appreciates your efforts.

Next, I want to reiterate my continued belief that Welbilt will emerge from this crisis a stronger company that is structurally leaner and more efficient. We will focus on opportunities where we can use our competitive advantages on the innovation and digital leadership to help our customers succeed and grow. We will continue to win new business as opportunities arise by leveraging our culture of innovation and customer service. We will return to delivering profitable growth and delevering the balance sheet as this crisis abates.

This concludes today's 2020 third quarter earnings call. Thanks again for joining us this morning, and have a great day.

Operator

[Operator Closing Remarks]

Duration: 55 minutes

Call participants:

Rich Sheffer -- Vice President Investor Relations, Risk Management and Treasurer

William C. Johnson -- President and Chief Executive Officer

Martin D. Agard -- Executive Vice President and Chief Financial Officer

Mircea Dobre -- Baird -- Analyst

Brad -- KeyBanc Capital Markets -- Analyst

David MacGregor -- Longbow Research -- Analyst

Todd Brooks -- CL King & Associates -- Analyst

Walter Liptak -- Seaport Global -- Analyst

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