Flexible by design Featured

8:00pm EDT April 25, 2007
When Ken Treaster was hired at Interior Specialists Inc. in August 1994, his original assignment was to learn the business and help the owner-operated firm expand outside of San Diego.

At the time, ISI was a local firm generating about $18 million in annual revenue, mainly from carpeting sales to new homeowners. The founder was looking for a little more time on the golf course; Treaster was just looking for a job.

Since Treaster was hired, the company has been sold twice, both times to venture investment groups, and he was named president and CEO of ISI in September 2000.

“When I exited college, I really didn’t have any specific goals except to move up the corporate ladder,” says Treaster. “Then when I got up there, I really wanted to move back down. I think part of the reason that I’ve stuck it out is the quality of the people involved in carpet manufacturing and the culture.”

The private equity investors sensed an opportunity when they initially purchased the firm. The industry was primarily made up of family-owned businesses, which were providing flooring, window coverings and countertop products to new home buyers.

Homebuilders were expanding their operations throughout the southwestern United States, in search of less saturated countercyclical markets, and an expanded ISI could ride on the coattails of the builders and capitalize further through unrealized revenue potential.

While builders usually have a transactional sales relationship with their customers that ends when the home is purchased, design services offer both repeat and adjunct sales prospects for other products and services needed by homeowners. The key to increased sales would be through owning the customer relationship.

Under Treaster’s watch, the Carlsbad-based firm has grown to more than $450 million in annual revenue, mainly through acquisitions, and has become one of the largest providers of outsourced interior design services in the country.

Maximizing the expansion opportunity required Treaster to acquire design firms with strong customer relationships that needed to be maintained through the assimilation process, as well as working closely with the private equity firms to maintain growth.

Finding the right match
The acquisition process starts with communication.

“When I speak with the management team from a prospective firm during the acquisition process, I am looking mostly for similarities in philosophy,” says Treaster. “I’m looking for great relationships with the builders, a good customer service level and a book of business that has been developed on value, not price. While I obtain most of my information about their philosophy through one-on-one meetings, I then validate many of the prospect’s assertions through a review of the financial data and by speaking with their vendors.”

Treaster says he has an advantage when he conducts interviews with a prospect in a new market because he can inquire about its bidding price points without being a competitive threat. Knowing the industry, he says that he can tell by the prices it is submitting in response to bid proposals what its true pricing philosophy is. If he hears that the owner often competes by bidding down the price, he expects that a review of the financials will show lower margins, and that may translate to less than desirable customer relationships.

If a prospective firm doesn’t look great on paper, that doesn’t necessarily rule it out as an acquisition prospect. The data analysis may reveal places where ISI could bring expertise or resources that would make the new acquisition financially successful because the solidity of the customer relationships has value.

“In 2002, we purchased a firm in Las Vegas that wasn’t making money, but they had good customer relations,” says Treaster. “We thought that we could improve their buying power, which would increase their margins and improve their back office function, which would improve their return on cash, all of which would make them more profitable.

“Another way that I evaluate an acquisition is looking at their data to see how aggressively they have pursued their turn on cash. I like to get down into the detail and classify which customers are paying slowly. If they are also paying slowly with other competing design firms that we’ve looked at, then they are probably a bad customer. If we’ve seen that the customer is turning invoices more quickly elsewhere, then we know we can move up the DSO [days sales outstanding, a measure of how quickly a company collects receivables] through process improvement.”

Treaster also has to take into account what his investors are looking for.

“One thing I’ve learned from working with private equity firms is to find out where their comfort level is and bring them deals that make sense to them and to remain flexible,” says Treaster. “In this case, the comfort level consists of deals in highly populated markets within the 11 Western states.”

Treaster says he has developed an acquisition sweet spot that seems to work well for the owners of the firm that he’s acquiring, as well as for ISI’s venture capital owners.

“What works best for us is acquiring firms that are $25 to $50 million in revenue, as they tend to have an owner who is over 50 years old and who has a limited exit strategy, because we can help with the succession of the business,” says Treaster. “Our model is to have the owner stay intact with the business for two to four years to make certain we maintain the customer relationships.”

Maintaining customer relationships
A prevailing wisdom among CEOs is to leverage the newly acquired acquisition debt by eliminating redundant functions and reducing costs through back office consolidation, especially when private equity firms want to see a return on their investments sooner rather than later. Treaster says that he originally went down this same path but soon learned that it often caused damage to locally built customer relationships.

“When we did our first assimilations, we centralized everything because we thought it would be easier to manage and it would save on costs,” says Treaster. “We found out that it just doesn’t work that well having someone from California call a customer in Arizona to collect cash.

“Also, the job-costing process isn’t as customer-friendly. So we refocused and put a local payables/receivables person in each of the local branches, and they develop relationships with the local builders. The result of the change is that we have experienced a higher level of acceptance in the local market, a more rapid turn on cash, and the customer relationships are better.”

During the due diligence process, Treaster reviews each customer and defines who in the organization owns the relationship. He also makes certain that the customer is introduced to ISI management during the assimilation period, reducing the possibility of customer loss down the road when the original business owner transitions out of the firm.

Treaster’s decision-making flexibility plays a vital role during the development of his assimilation plan. He says that he treats each situation differently and adapts his consolidation strategies for each acquisition using a centralized/decentralized model. He generally centralizes functions that don’t touch the customers and leaves the rest within the control of the local firm.

While the downside is running at a higher cost, Treaster says changing something that is working well for the customer is a mistake.

“What I’ve learned is that when companies are acquired, the last thing that 80 percent of the customers and employees want is change,” says Treaster. “So I’ve learned to change as little as possible that touches the customer. Centralizing functions can take the heart and soul out of the company you just bought.”

Managing growth
While effective assimilation is important, it can be a great challenge for CEOs to create a corporate infrastructure that can withstand rapid growth and to develop a management team that can handle hundreds of millions of dollars of increased business. Treaster says that the key to managing growth has been building a management team that has experience in rapid-growth environments.

With that primary selection criteria defined, Treaster has added a CFO with significant acquisition experience and a COO who has experience in a rapid-growth environment. They assist him in the due diligence process and make suggestions where to consolidate functions and develop the company’s operational infrastructure.

As an example, ISI has made significant investments in IT infrastructure. This provides newly acquired firms with greater data prowess and increases technical support while facilitating an operational cost reduction without negatively impacting customer relationships because the data can be accessed from anywhere.

“The most important ingredient in successfully managing growth is the quality of the people you have on your team,” says Treaster.

“They don’t have to be from the same industry, because floor covering is not brain surgery, but they have to have been around other environments that were supporting rapid growth, either through acquisitions or organic growth, and they have to thrive on it.”

Because part of ISI’s acquisition plan is to facilitate exit strategies for the owners of the companies it purchases, Treaster says that long-term growth in the acquired firms will be achieved by replacing the original owners with more professional business managers. While he says developing those managers is still a work in progress, he recently instituted a mentoring program with the goal of developing managers in- house for those opportunities, as well as increasing the firm’s bench strength.

Both moves will help take the company to the next level and reduce vulnerability resulting from owner or management departures.

Success with equity firms
Treaster says listening is key, not only with customers but also with investors.

“I think I’ve shown that I’m adaptable because I made the decision to centralize most of the back office functions post-acquisition and then reversed it,” says Treaster. “I think you have to learn to listen first and then formulate your plan.”

Treaster says that he developed his philosophy through experience. He says he learned early on, when he brought an acquisition prospect to the table that was located in Florida, that the private equity executives were not comfortable starting with such a broad geographic expansion right out of the gate. He refocused closer to home and found his suggestions were more on target.

“The private equity industry operates in a pretty high-risk, high-reward type of environment,” says Treaster. “I have learned not to give them any surprises so they feel comfortable that I am making good decisions.”

The “no surprises rule” has created a relationship built on trust, and so far, Treaster and his team have made decisions that have played out well, a situation that also keeps Treaster in the driver’s seat and the private equity firm in a supporting role.

“As for why my style is a good fit in working with equity firms, I think it’s because I don’t have an ego that has ever gotten in the way of making a good sound business decision,” says Treaster.

HOW TO REACH: Interior Specialists Inc., www.isidc.com