Home Furniture Outlook COVID-19 Edition – Interview with Terry McNew, CEO of Klaussner Manufacturing
What were the first indications that COVID-19 was going to have an impact on Klaussner?
We became concerned in early January, right after the Chinese New Year, when we saw our Asian suppliers start to push out delivery dates. Over the course of the next four weeks, more and more Asian suppliers began to shut down. Fortunately, we ordered heavily right before the Chinese New Year, so we knew we had at least 12 weeks supply of raw materials on site for manufacturing in North Carolina. However, it became evident through early March that the pandemic was going to be larger in impact globally and longer in duration than originally anticipated. Business was strong in January, February and the first half of March. But in the last two weeks of March, Klaussner’s orders fell by nearly 80% as shelter-in-place orders forced nearly all brick and mortar furniture stores to close. Even e-commerce orders fell during the first four weeks of the crisis.
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?
Initially, we had two primary thoughts. How do we protect our employees and their safety, and how can we protect cash flow and our business for our investors? By the beginning of April, we made the decision to furlough nearly 700 employees from a base of 1,325 pre Covid to match the 80% fall off in demand. In the beginning, we were heavily focused on communicating with and protecting our employees. We wanted to make sure they weren’t traveling to customers and vendors, and we focused on creating a safe environment for those employees working in our facilities. We established protocols for every aspect of our business, from establishing CDC approved cleaning procedures and social distancing requirements for remaining employees, to travel restrictions and cost reductions. We then began extending payment terms with our vendors. Our expectation was that demand was going to take a significant hit in the second quarter as the virus spread to the U.S., with a slow recovery for the remainder of the calendar year. We drew down on our revolving line of credit to ensure we had a high level of cash to see us through the crisis. We stopped all unnecessary spending on capital expenditures and all PO’s were, and continue to be, reviewed by myself and the Company’s CFO. We were also incredibly tight around inventory purchases given our long supply chain and we deferred rent payments on our showroom facilities in North Carolina, Chicago and Nevada. We also put together a robust, rolling 13-week cash flow forecast, which helped us ensure cost containment initiatives were flowing to the bottom line and liquidity.
How have you seen Covid affect your supply chain?
As mentioned, we experienced a supply disruption from our Chinese suppliers in January, but our inventory on hand at the beginning of the crisis was more than adequate to see us through until demand began to return in mid-May. Nonetheless, we accelerated resourcing and near sourcing initiatives that had been mapped out prior to the crisis during the slow-down in April and May. We have thought for some time now that we needed to reduce supply lines and improve cash flow and that sourcing domestically, or at least in North America, and reducing our supply lines from Asia was strategically the right direction for us to pursue. Currently, we are looking at several options to source furniture components in the U.S. and Mexico that will allow us to keep our costs under control, enhance our speed to market, and mitigate our supply risk.
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?
The low point in sales for us was in April. We forecasted sales to be down 80% in April from budgeted levels, down 80% in May and down 50% in June. April was down nearly 80% and the first half of May was soft. However, in mid-May the order flow from our e-commerce customers, mainly Wayfair and the e-commerce brands we serve, began to increase substantially. Their orders continue to grow at an accelerated rate and we now believe Klaussner’s e-commerce business in 2020 will end up at least 30% higher than 2019 sales. Brick and mortar furniture stores did not begin to reopen until mid-June, so their orders are just now beginning to pick up. In total, June orders were down only 5% from budget and were therefore much stronger than our forecast. We’ve called back over 60% of the employees who were furloughed, and we continue to call back more each week. Business came back so strong and so fast that our backlog has grown substantially. Currently, we are booked out into the middle of the fourth quarter.
Wayfair and other e-commerce retailers have seen tremendous growth throughout the crisis. How do you think consumers will view e-commerce as a channel to purchase furniture post-crisis?
The pandemic has made people more risk averse and has probably accelerated the shift to online ordering that was already taking place before the crisis. Due to lock downs for extended periods of time throughout the United States, many people were forced to learn how to take advantage of online ordering for everything from toilet paper to couches. Our top two customers are well known e-commerce platforms and their business is up 90% over last year. In addition, consumers appear to be shifting their discretionary incomes away from travel and hospitality to home improvement, and that trend is clearly benefiting the furniture industry. The top three categories for online purchases are apparel, groceries and furniture. The number of people who buy custom-made furniture online is staggering. We think that shift will remain in place for years.
How have you been able to service your customers in new and unique ways during the crisis?
As I mentioned earlier, our backlog has climbed substantially, which is a negative for customers, especially online customers. But it’s not only us, it’s the entire furniture industry, and honestly, many industries are seeing longer lead times for fulfillment as the economy reopens. We were able to help our retail partners by prudently extending payment terms for a select group of customers as the economy began to open up in May. Cash flow is king, and many of our retail partners needed help during the lock down in April and May, and we were able to assist them without taking undue credit risk. Helping customers manage through the crisis strengthened our relationships with our retail partners and demonstrated our commitment to them and to our partnership.
What is the operating status of your facilities? How much of the workforce have you brought back?
As I’ve mentioned previously, we are operating full time, six days a week in order to reduce our backlog. We have brought back over 60% of our pre-Covid workforce and are bringing back more employees every week. We’re also using outside contractors to help us in areas where we are temporarily constrained. At the same time, we’re keeping an eye on the resurgence of Covid and looking to see if consumer spending pulls back as the virus surges in many states. Currently, about 30 states have either slowed reopening programs or pulled back on them entirely. In all likelihood, the resurgence of the virus will slow customer demand at some point, and we will need to be prepared to flex our operations with demand as we navigate to a vaccine, a clearer treatment for Covid or some form of herd immunity.
How has Klaussner been able to help utilize its manufacturing capacity to aid in the COVID fight?
Early in April, we began cutting and sewing medical masks and gowns for the medical industry. We cut over 400,000 pieces a week through May. At the end of May, we redirected our capacity to meet the surge in our base business demand that began mid-May. We were pleased to be able to support the medical industry and help reduce the shortage of masks and gowns in April and May, and we will return to mask and gown production in the future if we have any free sewing capacity.
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?
Demand began to surge mid-May and if it doesn’t slow down due to a second wave of Covid in the latter half of this year, we believe we could be back to pre-Covid levels of output and sales sometime in the first quarter of 2021. We’re forecasting to be down by about 10% in sales for calendar 2020. Even though orders are up now, we dropped to such low levels in April and May that we won’t be able to return to pre-Covid levels on a rolling 12-month basis until early 2021. Of course, if the current resurgence of the virus or a second wave in the fall shuts down the economy for another extended period, all bets are off and a full recovery of the furniture industry may take much longer.
How will the business operate differently going forward?
Our business will be a much leaner and more efficient business going forward. We’ve learned a lot during the crisis and will continue to drive working capital improvements and to eliminate waste in every part of our business, from new product development to manufacturing and sourcing. We implemented a strategic portfolio management process in March, which is helping to optimize product portfolios in all five categories we serve within the furniture industry. We’ve also begun to rationalize and reduce SKUs across all categories, which will improve our speed to market and further reduce net working capital needs and increase cash flow. All of these crisis-driven actions will help lower our breakeven point and make our costs much more flexible. And a more flexible cost structure will allow Klaussner to deliver high-quality custom furniture much faster and more profitably as the market continues to evolve.
What were some lessons or insights you gathered over the past few months that will stay with you going forward?
I think the crisis accelerated changes we were planning on incorporating into our business. It drove us to execute changes faster and better with fewer resources. Cash is always king in any business and continuous review of the business is necessary at every stage of the business cycle. We’ve reduced non-value-add activities within our business and now we’re even more motivated to put processes in place to ensure waste doesn’t creep back into our business. That will make us stronger and more vibrant long-term, a better partner for furniture retailers across the industry and a winning investment for our owners.
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