In a busy year, School Specialty got its cheque book out in 2004 to boost its acquisition growth strategy. CEO David Vander Zanden gives OPI the heads up on what the future holds and why it doesn’t worry about the power channel
OPI: David, let’s start with how much the school supplies market is currently worth?
DVZ: We estimate the US marketplace for supplemental products to be about $6.5 billion to $7 billion.
OPI: I know funding in the market is hugely important. Can you tell us about this?
DVZ: It’s the key driver. If you break down the source of funds from schools, it’s 50 per cent state and 40 per cent from local real estate taxes that are assessed against personal property. Seven per cent from the Feds and then there are some other monies around – grants and so forth – for the other three per cent.
So if the states run into funding issues and the school budget for states represents about 50 per cent of the expenditure for the states on average, it’s half of the revenue the districts receive and half of the expense of the states. That’s a big number on both sides and if the economy is down a bit and people are laid off and don’t pay income tax, the states have less money and consequently schools get less as well. Once you’re through those economic cycles it’s fairly consistent and it’s a very predictable business to be in. We probably had the lowest part of our cycle in many, many years in 2003. Let’s hope funding is a little better this year, but it probably won’t be back to normal until next year.
OPI: Typically, how do things change, if at all, in terms of who the party is in power in the US? Are things better under the Democrats or the Republicans?
DVZ: Things don’t change a lot on education. The funding doesn’t change much. Politicians don’t get into office by cutting education for kids, so both of them tend to have a positive platform on education, and the funding party to party doesn’t change a real lot. The budget for education is fairly stable.
What happens in our industry is that we tend to go into a recession on a year lag from the general economy. This is based on the way the tax collections occur and we come out on a year lag. Last year many companies in the US were performing very well, but we were at the bottom of our funding cycle. This year we’re kind of in a middle year as we call it. We think spending has improved a little bit, but it’s not back to normal. And, by the next cycle, as jobs continue to be created and more tax payers get on the rolls, we’ll be back to normal funding next year.
OPI: How has School Specialty developed since the days when it was part of the now defunct USOP? How has it grown as a company? Has it strategically changed?
DVZ: Yes. I think we probably have more focus on education. Our core business as we call it internally, "the traditional business", is still less than half of our revenues. But most of the growth has come on the specialty side of the business where we develop our own products for education.
There has been a slight shift toward education and away from office products, because we’re still very interested in the space, but there has probably been a little higher focus on educational products.
OPI: How much of your business would you say is simply office supplies?
DVZ: That’s a hard category to nail down all the way. I would say probably less than ten per cent just in the office category, but if you include furniture as part of that – this would be school furniture not necessarily just the traditional office furniture – it’s probably 20 per cent or 25 per cent.
OPI: What are your annual revenue profit goals for the year?
DVZ: If you look at the guidance on the street – we have a number of analysts that follow the company – I think the consensus there is for us to reach the $1 billion mark this year in revenues, and we have done quite a few acquisitions as well.
OPI: And in terms of profit for the year? Do you have a profit forecast?
DVZ: We finished the prior year at EPS of $1.94. The range this year is EPS of between $2.30 and $2.50.
OPI: Do you feel that you have put a particular spin on School Speciality since taking the reins, following the death of former CEO Dan Spalding in March 2002?
DVZ: Yes, again focusing a little bit more on education. That’s probably been the most fundamental change. Dan was with the business about 13 or 14 years before he passed away, so his vision of creating the largest specialist school supply company in the US is still alive and well. We have only about 15 per cent of furniture, so we continue to focus on these markets because we think we have a long way to go. Dan formulated that vision and we’re continuing to execute it.
OPI: How has the school supplies industry stood up to the economic slowdown, because I guess the perception is that it’s fairly recession proof?
DVZ: You don’t get hit quite as hard in education on the downturns but, unfortunately, the upsides are more limited as well. As we went through what some people described as the worst funding market since World War II last year, our internal growth was down one per cent, so our revenues were about flat.
And there are other parts of the education business. If you followed software providers that sell products in schools or to the textbook companies, they had much more significant declines. If you look at our overall revenues, they are up, and the increase that we are showing in 2004 is primarily driven by acquisitions.
OPI: How has your back-to-school season been this year?
DVZ: It’s been good. Again, funding has improved. We don’t think it’s back to normal yet, but it’s better than it was last year, and we’re satisfied with how we’re doing so far.
OPI: Would you say you’re on target for what you were hoping for?
DVZ: Pretty much, yes.
OPI: In terms of how you act within the back-to-school season, do you feel any kind of a burn at all from the large office products companies – the Staples and the Depots – and what they do in the back-to-school season?
DVZ: There are two back-to-school seasons that they have. They’re focused more on the consumer and that’s not a core market of ours. We’re strictly for the institutions, so we really don’t compete with them there. We do see them in schools, but more in the larger than the smaller districts. We have about 600 field salespeople out in the market and see their guys once in a while that way. We also send about 45 million catalogues to educators every year, as direct marketing is important to us as well.
On the direct marketing side, they all have catalogues, but with our specialty business we go to market a little bit differently. If you look at the number of products – the actual SKU count – that we cross over with the likes of Office Depot and Staples, it’s probably less than 1,500 products and we have a total of about 80,000 products. The thing to bear in mind when thinking about the office products business inside of schools is that’s it’s an interesting market but it’s not huge. I would estimate this side of the market to be approximately $1 billion or so. The big players have to decide really whether they’re interested in office products in schools or whether they want more of the overall school business which, again, means more product offering.
OPI: So you are not getting too worried about them, even if they did look to grow that side of their business?
DVZ: No. We don’t compete with these guys in the large cities. They’re $12-$14 billion-sized companies, so their buying power is better than ours, and of course they have the stores as well. But in the small towns where most school districts are – and almost every town has a school – we’re very competitive and we do very well with office products.
If you take the US market and break down the size of schools, the top 200 schools in the country have a third of the population and there are 16,000 districts, so the balance of those districts are small – typically a number of elementary schools, a middle school and a high school. And that’s the core of our business. We’re strong in the smaller districts.
OPI: Have you thought about doing a crossover into the consumer back-to-school market?
DVZ: We’ve talked about it, but again, we’ve tried to stay focused on education. With a 15 per cent market share, the consumer market may be something we’re interested in down the road, but not today.
We bought the children’s publishing unit from McGraw-Hill last January. Part of that business is sold through Wal-Mart and Sam’s Club, as well as Barnes & Noble and Borders and those kinds of stores. We’re using that to understand the market a little bit more as a possible channel for us to take a look at at a later stage.
OPI: How much of a private label offering do you have?
DVZ: We started to do quite a bit more importing about two years ago. Now about seven per cent of our revenues is coming from importing products under our private labels. I would expect that this figure will approach or exceed ten per cent in the next cycle. We’ve got a lot of work to do there yet but again, we’ve only been in it a couple of years, so there are lots of opportunities in front of us.
OPI: Typically, what type of products are private label?
DVZ: It’s real basic products on the office supplies side – staples and scissors, glue sticks… We also use our Classroom Select private label on a line of furniture that we produce ourselves.
OPI: How does your private label offering sit with your suppliers?
DVZ: Well, there are some of them that will produce products for us for the private label domestically, and others get a bit nervous when we go there, as you might expect. It’s threatening for them. But so far it hasn’t cost us any business disruption or anything.
OPI: A lot of your growth comes from acquisitions. Are you looking at further purchases?
DVZ: Yes, our target is generally to acquire between $70 million and $100 million worth of revenues per year. There are still thousands of small companies in our marketplace and plenty of opportunities. The cash flow that’s generated by our business is just about high enough to finance the acquisitions which means we don’t need any more bank debt. It’s been a goal of ours for a while that we can self-fund acquisitions.
OPI: Can you tell me something about the acquisitions that you’ve made recently – say in the last year – and also give me some idea of how well the integration is going?
DVZ: Firstly, we bought the children’s publishing from McGraw-Hill in January. That’s a company with about 5,000 proprietary children’s book titles which produces a lot of workbooks for classroom use and those kinds of products and markets them through some of the mass merchants. It also markets in teachers’ stores which end up in the hands of educators, and then directly to companies like us. That was a bit of a vertical integration play for us as the company was one of our suppliers.
We also bought a company at the end of January called Califone. It designs and develops wireless listening centres and presentation systems for schools – products like battery powered microphones which can be taken outside to a track meet as an example. The products are 100 per cent produced in China and imported. Califone was also a supplier of ours.
In September we also acquired a company called Guidance Channel. It is a publisher and producer of products on self-improvement for kids – on character education and things like that. That supplements the business we have with our Premier Student Agendas whereby we sell 27 million student agendas to schools, and the content that’s inside the agendas is built on character education.
So three acquisitions so far this year and all of them were just about 100 per cent proprietary product.
OPI: What was the total revenue that’s been brought in by those companies?
DVZ: About $100 million.
OPI: Obviously you’ve got an acquisition growth strategy there. Do you think that this is the only way to grow the business – through acquisition?
DVZ: No. Again, in the last couple of years growth rates for us have been a little softer with the recession, but we have been growing internally even without acquisitions this year – in the first quarter anyway – at about four per cent. Acquisitions go on top of that. Normal growth rates without acquisitions for us are six per cent to eight per cent. And we do expect funding to improve next year. OPI: Do you stock any jan/san or facilities management product lines?
DVZ: Yes. We have a programme called Projects By Design. We will go into schools around the country and help educators make decisions about the furniture needs of the entire building. Then there’s the Turnkey programme whereby we will help them go through the bidding process and make selections. Of course, we have a product package that we offer as part of that service and we do all the installations. Finally, we do quite a bit of work on facilities management.
OPI: Is that a growth area for you?
DVZ: Yes, it is. It’s growing very well.
OPI: You send out a phenomenal amount of catalogues. How sound are they environmentally, something that is a pretty hot topic?
DVZ: At the moment, the majority of our catalogues contain some degree of post consumer waste. However, beginning in January next year, every catalogue we print will contain some level of post consumer waste content.
OPI: Just to round things up, where would you like to go from here? Is there a larger scheme? Would you think about maybe expanding to overseas markets? Could that possibly happen at some stage?
DVZ: Possibly. We’ve expanded into Canada in the last couple of years. A little bit further down the road, I’m sure we’ll look offshore more.
OPI: What might be the catalyst of that? Seeking growth?
DVZ: Yes, I think so. Once we feel that we’ve accomplished what we set out to do in in the US, we will look for opportunities offshore. The product that’s used in foreign markets is a bit different from the education products here. If we went to some European countries we would have language issues to deal with, so not from a selling standpoint, but more from a product standpoint there would be differences. But when we’re ready to focus on those kinds of things, I’m sure we’ll take this step.
OPI: Can you give me a progress report on how things are going in Canada?
DVZ: They’re going well. We have introduced all of our specialty business into Canada. A few years ago, we acquired a company (Premier Student Agendas) that had about 20 salespeople on the ground in Canada.
OPI: So you’re looking to be really dominant there.
DVZ: Yes, kind of the same position we have in the United States we’d like to have in Canada.
OPI: That’s great David, thanks for your time and good luck in the future.