Interconnectivity Solutions Outlook COVID-19 Edition – Interview with David Evans, CEO of Kauffman Engineering

Monomoy Interconnectivity Solutions Outlook: COVID-19 Edition

What were the first indications that COVID-19 was going to have an impact on Kauffman?
We don’t source any materials from Asia, so rather than catching wind from our suppliers, we first started hearing about COVID in the news in January. Soon thereafter, we began having sporadic issues with customers who were struggling to source parts from China, which caused them to slow down their operations. As the virus continued to spread to Europe and eventually locked down Italy, it became clear that COVID would become more than just an issue for a few customers and overseas suppliers; it would have a major impact on us as it moved into North America. The crisis became real for us on March 17^th when we received word that one of our customers on the west coast was shutting down operations due to the shelter-in-place order.

Once you realized that the virus was not going to be contained to Asia and was likely to spread to the U.S., how did the management team proceed?
At the beginning of March, customer demand was strong and we were having a great month. However, based on what we saw happening to our competitors in Asia and Europe, we knew that we were going to be impacted imminently. The week of March 9^th, we began to focus on two priorities: 1) maintaining operations while keeping our employees safe, and 2) implementing a strategy to protect our liquidity and remain profitable in the face of an unknown and negative impact to demand.
With respect to employee safety, we looked at the actions being taken by Asian and European companies, and we worked with the Monomoy operating team to understand best practices across Monomoy’s portfolio. Our first challenge was determining how to physically get as many people out of the office or plant as quickly as possible while maintaining operations. For production workers, we wanted to ensure that they could work safely in the plants, which required changes to our operating practices and mindset. For office workers, we needed to set up the infrastructure to allow for remote work, which included setting up intranet access, distributing laptops and creating telephone lists.
Next, we developed plans to protect margins and liquidity levels given a likely volume impact. Our strategy involved pulling all available levers quickly: ramping down plants, pausing the shipment of materials and constantly communicating with customers who were shutting down operations. We worked closely with the Monomoy operating team and leveraged the visibility they had from their other portfolio companies, so that we could be ready to take action as soon as revenue started to drop. When we did start to see a drop, which for us was the week of March 23, we were able to move quickly.

How have you seen COVID affect your supply chain?
Thankfully, COVID has only had a limited impact on our supply chain, as we do not source any materials overseas, and our suppliers have also been able to maintain their operations and deliver products in a timely fashion. In fact, we’ve been able to use this time to make proactive changes to our supply base and negotiate improvements in some cases.

What was the low point for sales over the last two months? What were sales last week? What does next months sales picture look like?
Our low point for sales was in May when sales were down 43% to prior year. As of last week, our sales levels had partially recovered but were still behind last year by 18% as industrial activity remains soft. While visibility remains limited, we expect month-over-month demand to be stable to slightly higher as we head into September.

How have you seen COVID affect your customers/end markets?
We have a diverse customer base across a variety of end markets, many of which were deemed essential and some of which were not, and the crisis has affected them differently.
Many of the markets we sell into are seasonal, such as HVAC, lawn and turf care, and marine. For these seasonal end markets, we typically produce in the winter and early spring months to cover their peak selling seasons of spring and summer. We are now seeing those selling seasons shifting out. In some instances, certain customers are starting to partially make up for lost demand in April and May.
In other industries, such as heavy truck, demand is much lower as industrial activity has dropped. Commercial equipment for the foodservice industry has dropped significantly as restaurants, cafeterias and other foodservice outlets remain closed or have been operating at lower volumes. On the other hand, some areas of medical equipment, such as ventilators, have seen increased demand.

What portion of your customer base was able to stay open at the beginning of the pandemic, and how did that evolve over time?
We’ve gone through several stages of shut downs at this point. At first, customers on the west coast shut down following California’s shelter-in-place order. Soon thereafter, as other states followed suit, more customers shut down. During March, there was some confusion about what industries and businesses were considered essential, so some companies shut down before issuing notices a few days later that they were essential and able to reopen. Despite being deemed essential, though, several of our customers that reopened soon found their demand to be lacking, which forced them to voluntarily shut down (again). At our low point, about half of our customers were operating and half were closed.
Starting in mid-May, as states began to reopen and demand started to return, various plants would shut down for a few days or a week at a time related to COVID outbreaks amongst their employees, as I imagine is the case for most operating facilities nationwide.

What challenges did you face with your large, North American footprint of facilities?
While having a broad footprint with proximity to our customers is generally a good thing, we did face several challenges in maneuvering through various, evolving COVID restrictions. The first was to implement our safety and hygiene measures across a diverse footprint where each facility was experiencing this crisis differently – some facilities were in areas with early outbreaks and moved quickly to combat the impacts of the virus, while others were impacted to a lesser degree and didn’t have as much context for how to react. We leveraged our daily calls among all of the plant managers to really help improve coordination and communication across the plant network and share best practices.
Second, we needed to ensure that all of our employees understood that they were considered essential workers and Kauffman was taking precautions to protect them at work. At the start of the shelter-in-place orders, there was a lot of confusion about which businesses could stay open in each state. For example, at some of our facilities, employees were concerned that they would not be allowed on the roads to come to work, so we printed letters for them to show officers in case they were stopped.
The third major challenge was keeping our Reynosa, Mexico plant open. At the beginning of April, the Mexican government ordered all non-essential businesses to close. We were confident we would be able to stay open since our plant assembles products for the medical equipment industry, the HVAC industry (which was supplying equipment to hospitals and mobile hospitals at the time) and other essential industries. However, the Mexican authorities decided to close our plant until we completed the administrative process of proving definitively that it was essential, which took about three weeks.

What is the operating status of your facilities? How much of the workforce have you brought back?
All of our plants have remained open throughout the pandemic except for the three-week shutdown of our Reynosa, Mexico facility, which we were able to correct. Additionally, we experienced relatively short breaks at a few of our facilities in order to conduct deep cleanings following any instances of employees testing positive for COVID.
We have now brought all employees back from the furloughs that were put in place during April and May. However, in light of the softness in demand that we’ve been experiencing throughout the pandemic and that we expect to continue to some degree in the near-term, we have also revisited our overall cost structure and have made adjustments to bring our margins more in-line with pre-COVID levels at a lower level of run-rate sales. Accordingly, we accelerated our long-term goal to consolidate and streamline our facility footprint and permanently closed three of our US facilities during the second quarter, reducing our global footprint from 22 facilities to 19.

What does the demand picture look like going forward and how are you modeling that? When do you think demand in your business will return to pre-COVID levels? How will the business operate differently going forward?
As of now, we are modeling a slow ramp up in demand into next year. Overall, demand is likely to differ widely based on end market. For some of our end markets, such as commercial equipment for foodservice, it is likely to take longer for demand to hit pre-COVID levels as that will require people to feel safe returning to their pre-crisis dining habits. Other end markets, such as warehouse operations that are benefitting from the increase in e-commerce, are already running at or above pre-COVID levels. In the meantime, our North American footprint continues to be an asset to our current and prospective customers, as Kauffman has been able to win new business from companies that are re-evaluating their supply chains and bringing some business back from Asia.
We have also accelerated our efforts to simplify the business, as I alluded to earlier. These efforts will continue as we reassess our manufacturing network, supply base, and technology infrastructure. Additionally, we have found that we can work remotely and don’t need all functions in our headquarters, nor do we always need to travel across state lines to meet customers face-to-face. To be clear, though, while more customer interactions will be handled remotely in the near term, I continue to believe the face-to-face contact is important and helpful for building relationships with all of our stakeholders.

What opportunities do you see coming out of the crisis?
On the commercial side, the crisis should position us to grow our business with companies that are re-evaluating their supply chains in the face of delays, discontinuity, lack of visibility and poor quality. As such, we are discussing new opportunities with several customers who are either moving products back to North America from Asia or looking for more redundancy in their vendor base to protect supply. Our geographically diverse footprint is viewed as a strength with such customers as well as with customers who are looking for production in both the US and Mexico for risk mitigation purposes.
Internally, the crisis has given us a catalyst to accelerate some of the changes we needed to make to simplify our business, such as consolidating our facility footprint, streamlining our supply base and reducing the number of IT systems used across the company.

What were some lessons or insights you gathered over the past few months that will stay with you going forward?
The crisis has been a real learning opportunity for all of us and provided several insights. First, COVID has provided the new management team a unique opportunity to learn where the organization’s strengths and weaknesses lie. We were also able to see who our leaders are and where we have weak spots within our team. Going forward, succession planning will be important.
Second, one may not always realize it, but Kauffman really is an essential business and provides mission critical products, even life-saving products in some cases. This has been a good reminder that what we do every day is important both inside and outside of Kauffman.
Third, our employees are a great strength, and they were understanding as we worked through ways to maintain production and improve our liquidity position in the face of unexpected declines in demand. They really care about the business and are willing to make sacrifices for the long-term health of the business.
Fourth, we learned that constant communication is critical during this fast-changing situation to ensure that we are in-sync with all of our key stakeholders, including our employees, customers, unions, suppliers, local government officials, lenders and shareholders.
Lastly, and as discussed previously, the crisis presented a tangible catalyst to advance our agenda. It opened up opportunities to grow with our customers who value our US and Mexican footprint; it pushed us to be more resourceful, nimble and creative in reaching our goals; and it showed the management team that we need to take steps to simplify the business at a faster pace.
We still have some hard work ahead, but these insights will stay with us and make us a better business on the other side of it all.

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