Welbilt, Inc.

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 Well-Built, Inc. 2020 Q3 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. Rich Sheffer, you may begin your conference.

Good morning, and welcome to WellBuild'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 two of the presentation slides and in our earnings release, both of which can be found in the investor relations section of our website, www.wellbuilt.com. Any statements in this call regarding our business that are not historical facts are Our forward-looking statements and our future results could differ materially from any express 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.

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 miller pulse weekly same store sales graph on slide three 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 pre-crisis saw the majority of their sales tied to dine-in traffic. Main-store sales at casual dining restaurants began the quarter down 30% compared to the prior year and proved 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 U.S. and the NBA. 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. They 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. USRs 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 kitchen care after market sales as operators spend more time on repairing existing equipment rather than replacing it. However, food service equipment are income-producing assets for operators, and the cost of 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 shared growth opportunity due to the continued weakness in casual dining. Given our strong position with most of these changes, 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 plans, remodels, and upgrades from 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 and 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 crème coffee machines. We have many units and 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 four of our presentation to review our financial results. Our net sales declined 27.3% in the 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 five, 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 Mary Chef 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 improve, which also supported general market sales. The level of kitchen care aftermarket sales decreases ease later in the quarter as the distribution consolidation and inventory destocking related to the merger of the two largest master parts distributors neared completion. Looking at EMEA on slide six, sales decreased 21.6% with organic net sales down 25.8%. Large chain sales were weak with sales 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 Creme with a European governmental entity, another for Mary Chef 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 a meal up to 10 pounds for individuals who dined out. The 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 seven, sales in APEC 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's sales would have decreased slightly. Other areas of APEC, Southeast Asia, the Philippines, Japan, and India, to name a few, were impacted later and remained weak during the quarter. Moving to slide eight, 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, but the RFQ process didn't provide the right solution for our businesses. These VAVE initiatives have identified additional savings opportunities, 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 timeline, 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 at not only these sites but in most of our sites globally as we are deploying our lessons learned broadly to accelerate improvements. 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 in 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 and installed 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. Slowdown in capital investment combined with temporary plant shutdowns and furloughs that we enacted in the second quarter and continue 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 Creme 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 accepted by the end of the year. We did see a step-up in transformation program savings in the third quarter, with end-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 Kitchen Connect, We launched our new common controller into our first product lines. Kitchen Connect is our open cloud-based digital platform that brings the benefits of connectivity to commercial food service operators and helps them in five key areas. Facilitates new menu downloads and updates. It 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, it tracks quality management metrics such as oil filtration in fryers or cleaning cycles in combi ovens. Kitchen Connect 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 Wellbill's Kitchen Connect. Our new common controller connects to Kitchen Connect 3.0 and is now being integrated into new products across all of our brands. We will also be retrofitting existing products with the new controllers and will offer kits to operators who want to retrofit 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 kitchens. Wellvo'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 Wellvo at the leading edge for digital platforms in our industry. Moving to slide 10, we launched our newest Compotherm combi oven product line, The Max, in the Asian and European markets two weeks ago. The Max is for those customers who need a combi oven that is larger than our minis It has more features and performance, but don't need all the premium features and performance of our flagship C4 combi ovens. The Max is born digital with our new common controller and connects to Kitchen Connect 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 Fit Kitchen team to help operators of these kitchens adopt an efficient, modular layout that is digitally enabled by Kitchen Connect. Demand for ghost kitchens is expected to grow rapidly with an estimated 1,000 ghost kitchen openings over the next four years, and America is 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 well-built ghost kitchens so far this year, where the majority of the equipment in the kitchen is well-built equipment. This is yet another example 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.

Thanks, Bill, and good morning, everyone. I'm going to start with slide 12 in 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. 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 margin this quarter. We continued to effectively flex our production expenses to volume declines we experienced again this quarter. As a reminder, we implemented a reduction force 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, have 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 in force 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 through 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 collectability 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 from 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 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 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 and stalling 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 will, 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're 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 will now open the call for questions.

Ladies and gentlemen, as a reminder, if you would like to ask an audio question, please press star, then the number one on your telephone keypad. Again, that is star one to ask a question. Your first question comes from the line of Meg Doper with Baird.

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.

Yeah, so regarding October, if we look at what's come in, you know, we improved each month through the third quarter, July, August, and September, and October was an improvement over that. I would say, you know, in the low 20s in terms of the sales for October, you know, when we started looking at November and December, it gets a little more dicey to, to kind of, to see, you know, the improvements going to continue on through the quarter. And there's a lot of closures happening in, in Europe right now and around the world. And we're just monitoring that big, to be completely honest on kind of a day, day to day basis. And, you know, we look at it every, every day and, and try to, to, um, see what, see what's going on. But October was, was better than September. Um, And maybe a little more color on the kitchen care 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 throughout the quarter. So we'll just have to wait and see.

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?

Maybe it's Marty. No, not really. I mean, 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, You know, that will sort of help mitigate the seasonal patterns. Normally, the fourth quarter is down from the third quarter by, you know, a couple of points, let's say. At 18, it was two points. At 19, it was seven percentage points, sequential decline. So somewhere, you know, 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. That's the improvement we're talking about in October. So we just don't know where November, December are going, depending on how quickly things really, you know, start to close up again.

Sure. No, I understand that. That's helpful. Thank you. Then, you know, sort of the longer-term question is this, you know, 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 you think 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, you know, 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 towards next year. Thank you.

Yeah, so, you know, as we continue to monitor the situation, I think your point's valid. You know, we are looking at other structural types of actions that we can take. You know, 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.

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

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

Okay, thank you. Good luck, guys.

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

Hey, good morning, guys. This is Brad on for Jeff. Hey, Brad. So it's good to see some minor rollout activity in the quarter. And, you know, Bill, you mentioned a positive tone from some of the change around, you know, a return to potentially new unit developments. 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 we still kind of early on in the stages of planning?

It varies by customer, but, you know, we saw, you know, 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, it's not the big rollouts that are kind of happening. It's kind of the one to $2 million kind of rollouts and, you know, um, small, small on the smaller side, but the funnel is building. Um, I think, you know, a lot of them are just waiting to see what happens with this COVID. Um, you know, there are going to be more lockdowns. How does the industry recover? But the QSR is because their volumes are up, um, you know, are starting to look at more of the rollouts and more additions to their back of the house.

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

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, you know, mainly there is, you know, it's a regional business. it's a very hard distribution network to complicated to get the used equipment to where it needs to be. There's food safety concerns with used equipment, you know, the warranty lapses, all those kinds of things. And so we, we just don't see it. I mean, and we don't expect it to materialize. We see all the, with regard to your second question, we see all kinds of, you know, different ways people do this. You know, 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 it 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. You know, it's going to be interesting to see you know, as these hundreds of thousands of closures take place, how quickly the reopenings or new restaurants emerge. I do think, you know, at some point, you know, out there, you know, several years, there will be a, you know, a buildup of restaurants. You know, it's a very popular form of business that a lot of people like to get into. And I think, you know, we will see, you know, more restaurant new builds, but I think it's a couple years out.

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

Your next question comes from the line of David McGregor with Longabo Research.

Yes, good morning, everyone. Hey, David. Bill, you know, 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, you know, congratulations on the progress there. You made the observation that people are 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 the question about used gear back to the purchase of a new product?

Yeah, I mean, I think, you know, they can delay it for a reasonable, you know, maybe a year or two, but I don't think they can delay it much past that. You know, 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, you know, they just can't afford for it to constantly have service technicians in there. So, yeah. I think maybe a year or two on the QSR side, maybe a little longer on the casual side because they're not operating them as heavy. But the QSRs, they're operating those things seven days a week for the most part, 20 hours a day.

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. I mean, not that people are going to go out and cart bunch, you know, overhaul all of their equipment, but there's going to be a night and day generational change here, you know, in a year.

And that's one of the reasons why we made our common controller retrofittable to the equipment, right, so that we knew that there would be a drive for digital, but people would have you know be reticent to change out the entire piece of equipment but hopefully they'll you know we can get the the control a new controller and get them born you know get them digital that way yeah is there much of an order book developing around this common controller i mean what kind of well well it's the common controller is going to be the new standard right so it doesn't matter what the order is you're going to get it that's why we say you're born digital

Okay. And then I guess on a related point, you know, with people turning more to repair, one would expect that the kitchen care business begins to reflect that. And you talk about things were improving there, but is the improvement you're seeing in kitchen care 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?

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

Yeah.

Yeah.

Last question for me. 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 fourth quarter and into early next year? Do you feel like those are, for the most part, behind you at this point?

You know... we took out a substantial number of people, you know, between starting in March and, you know, some of that was volume related and some of us productivity related. And we've been able to really operate these plants pretty efficiently, you know, by shutting down for a week or two weeks and then, you know, building a backlog up and then we can operate more efficiently that way without having, you know, you know, a shutdown day on Monday every week or something. We've tried to, you know, 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, you know, and some of that's driven by some of the government subsidies that are out there that require us to be, you know, 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, you know, with the rate of shutdowns that are occurring right now, I think, you know, you'll see us probably, you know, 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 that, you know, they obviously won't be shutting down. Okay.

Thanks very much. Keep punching. Yeah. Yeah, sure. Thanks, Adam.

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

Hey, good morning, guys. Thanks for taking my 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?

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, you know, the ones that I can think of off the top of my head, they are – the new store development, they're, they're actively looking at their programs. Um, but the kitchen piece of it, or, you know, whether it's a ghost kitchen or a delivery only location, um, depends on the format and that'll be the choice of the QSR, but the kitchens look pretty similar, um, to, to, you know, whether it's a dine in or, or, or not, but what they're all wanting is digital, right. And they're all wanting us to, um, to have the capabilities that come with being connected to our Kitchen Connect 3.0 and being digital so that they can lower their costs and improve their processes. That's the common driver between all the formats.

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

You know, I don't have that number off the top of my head. You know, we're adding new customers all the time. Every week there's a new set of customers. The inquiries are, you know, 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 Kitchen Connect. But, It's coming. It's going to be the new norm for most people. And, you know, we think we're positioned really well to take advantage of this new macro trend.

Okay, great. And 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'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 flows generated, should we just understand that it's earmarked towards debt reduction in the near term? Thanks.

Yeah, so we are continuing to work on inventory, and we should see it come down a bit over 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 significantly. 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, you know, compressed. Meanwhile, as we consolidate plants, like we were mentioning around the Kremshang High 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 we should see inventory continue to come down consistently. And longer term, I think, you know, we have turns improvements around inventory longer term, but I don't think it's substantial. You know, 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'll be more continuous improvement, I guess. And, yes, the free cash generation generally, I comment 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, you know, require some capital. So there will be a little bit of elevated CapEx. But the rest will go to debt pay down. Yeah, we still want to get back on the deleveraging, you know, program that we talked about, you know, a year ago. Great. Thank you.

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

Hi. Thanks. Good morning, guys.

Hey, Walter.

Hey, I wanted 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 know, you kind of alluded to the fact that it 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?

Yeah, so on the pricing, you know, 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 just because there's not a lot of large project work to be had right now. So a lot of what's going on is replacement type activity. I think the dealers and distributors are you know, still watching and seeing what, what's going on. And, you know, Marty, you know, Marty made some comments, you know, about the seasonality from Meg's question, but you know, last year we didn't see, we didn't see a large buy either. And, you know, right now I would say that we're just watching to see what they want to do. But I would, I would think that they're watching their inventory levels just as closely as we are. So.

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

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

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 what that was regarding. Is there any fourth quarter impact from that?

No, that was just me describing what's in other manufacturing costs in that EBITDA bridge. You know, 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 since the end of 2018. I guess it was built early last year.

Okay, great. Okay, thank you.

Again, ladies and gentlemen, if you would like to ask an audio question, please press star, then the number one on your telephone keypad. You do have a follow-up question from the line of Meg Dobro with Baird.

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?

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

Okay. 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 shifts 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 are any share shifts from some of the larger players in the industry, such as yourself?

Yeah, I think digital is the key there, Meg. The little guys just aren't going to be able to keep up with the digital revolution. It's, you know, connecting to, you know, these systems like Kitchen Connect 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.

Okay, thank you.

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.

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 Wellbuilt 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 of innovation and digital leadership to help our customers succeed and grow. We will continue to win new businesses opportunities arise by leveraging our culture of innovation and customer service. we will return to delivering profitable growth and delivering 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.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect your lines.