Cash flow note for sale

Linda Wachner wants Warnaco to become the "Coca Cola of the bra business." Is that New Coke or Classic Coke?

The apparel business, like Rodney Dangerfield, doesn't always get respect. But with few barriers to entry and stiff competition from imports, it can be unforgiving. Carrying a mountain of debt during an economic downturn in such a business can prove fatal. The Campeau empire and Macy's, among others, learned this expensive lesson the hard way. With such colorful figures as Ralph Lauren, Calvin Klein, and Donna Karan, it's an industry in which fashion talent tends to overshadow management skills.

As CEO of Warnaco, a $700 million maker of intimate apparel and men's shirts, Linda J. Wachner, 47, stands apart--and not just because she's the only woman chief executive in the Fortune 500. Wachner understands cash management. Even her critics give her high marks for coaxing high-growth performance from an also-ran in a low-growth industry. How did she acquire a cash-flow discipline? "Simple," she immediately replies. "When your personal wealth is guaranteeing the loan, you get the discipline." During management meetings, Wachner used the term EBIT (earnings before interest and taxes) so frequently that one executive told her she sounded like a frog. Wachner later used the frog as a company mascot in re-orienting employees.

A short report card since taking the company private in a hostile leveraged buyout in 1986 and transforming it five years later when it went public looks like this:

* Raised EBITDA from $49.6 million in 1986 to $109.6 million in 1992 with a compound annual growth rate of 14 percent.

* 30 percent return on earnings in 1992 versus 12 percent industry average.

* 7 percent return on assets in 1992 versus 4 percent industry average.

* Reduced debt by 35 percent and lowered effective interest rate on debt from 14 percent in 1991 to 7.5 percent in 1992 and to 6.0 percent in 1993.

* Increased shareholders equity to $141 million from negative figures of $2 million in 1991 and $91 million in 1990.

* Paid over $720 million in interest expense, debt amortization, and preferred stock dividends.

Lest you think Wachner's head is buried only in the balance sheet, think again. There is hardly a bra, panty, jogging outfit, or men's dress shirt in the Warnaco product line that she hasn't scrutinized. Warnaco's brands, some of which, like Hathaway, are more than 150 years old, are increasing market share in department stores, a traditional channel for the company. The trouble is that department stores are, according to market observers Kurt Salmon Associates, under great pressure, their share of intimate apparel sales virtually flat compared to discounters and other outlets. Warnaco is countering with alternative distribution deals, including its three-year agreement with Avon, and talks with QVC, and by licensing new price-conscious brands such as Fruit of the Loom, which is sold in such channels as Wal-Mart.

While giving the former Max Factor corporate president high marks for pulling off a recapitalization plan that was crucial to the company's survival, observers note that her intense, impatient, Harold Geneen-like managerial style, complete with "do-it-now" notebooks, will require tempering as Warnaco shifts gears in its development.

Because Wachner's pay (a $3.6 million salary and bonus package shooting up to $6.73 million with long-term options using Black-Scholes calculations) generates much heat, CE asked compensation specialists Personnel Corp. of America to analyze the pay versus performance question. (The annual $600,000 fee from sportswear spin-off Authentic Fitness Co. was not included.) PCA CEO Dave Meredith allows that while the package may be "stratospheric," so is Wachner's performance: 59.8 percent versus an industry performance of -4.6 percent. Also, her pay is highly sensitive to stock price performance with a leverage index of 2.89 versus an industry median of 1.93.

CE's J.P. Donlon recently caught up with Wachner in the midst of a frantic Authentic Fitness new store opening in Warnaco's New York headquarters building on Park Avenue.

LEAVE IT TO EBIT

How were you able to de-leverage a fragile LBO in a time of tough competition, boosting cash flow and increasing stock price by some 75 percent?

By running the company as a turnaround even if it wasn't and by focusing on EBIT. We look at every line on the profit-and-loss statement, scrutinizing where our business comes from--the gross profit side or the material side or the labor side, the overhead of the cost of the goods, and what it costs us to market them.

Right after the hostile takeover, we changed the product mix of our business from 75 percent regular price and 25 percent off-price to a 90-10 split. Then we reduced selling, general, and administrative costs from about 24 percent of sales down to 19 percent. At the same time, many of our customers--major department stores--filed for Chapter 11, because they were expanding too much and not watching their cash flows.

What was the point of taking this company LBO and then making it public again?

We did a hostile tender offer back in 1986, for all cash. We paid a fair price--$46.50 a share for 10 million shares outstanding. The brands we acquired--including Warners and Olga--were worth everything to us.

At that time, interest rates were between 12 percent and 14 percent. We were servicing $600 million worth of debt. We'd been servicing $500 million plus the revolving facility for working capital, and we had an operating EBIT of about $35 million to $40 million the year before. We had to go to over $60 million worth of EBIT in the first full year, otherwise we wouldn't have reached our hurdle rate.

I can't say it often enough: The biggest thing was teaching people about cash flow. In order to improve cash flow, you have to collect your receivables. We tied our bonus plan to EBIT and cash flow. Warnaco senior executives need to do three things: Get the product right, cut overhead, and maximize cash flow.

When you are managing for cash to retire a mountain of debt, you have to forsake other goals. What did you give up?

We didn't expand some of the businesses that would have cost us more cash. We got out of the women's sportswear business, for example, even though it was earning between 5 percent and 8 percent. We got out of every business that wasn't giving us enough EBIT in percentage to service the debt.

Over the past six years, through the end of 1992, we paid over $720 million in interest, debt amortization, and preferred stock dividends. That's a huge amount from a company that wasn't bringing in $720 million a year in revenue. About $250 million of that came from the public offerings, $100 million from the sale of assets, and the rest from operating cash flow. We reduced our debt by 35 percent, even though our interest was so high. At one point, we were paying $72 million a year in interest, not including anything that had to do with debt amortization, which was $30 million to $40 million. So, now our $72 million in interest has decreased to about $38 million or $39 million, because we've refinanced. We're going to be out of debt in about 4 1/2 or 5 1/2 years. What's your target debt-to-equity ratio?

We are at 3-to-1 now. That translates into a rating of double-B plus--one notch below investment grade. Our target is to get to 2-to-1--which is investment grade.

Has the takeover changed your priorities?

No, they're the same. Maintaining cash flow, paring down debt, and turning out high-quality products are the top priorities. Along with Warnaco presidents, I edit every product before it hits the market.

So what do your product development people do?

They do. I edit. I push them to think of the next big idea. My job is to challenge them and say, "OK, push-up bras are good today. What's going to happen tomorrow? Will stretch lace be as good tomorrow as it is today?"

I'm not second-guessing my people. I'm trying to expand their peripheral vision toward consumer marketing.

BRANDS IN THE FIRE

Leading brands are under attack in a lot of different consumer markets. What are you doing to meet this challenge?

I don't think brands in the U.S. are dying; rather they have been mismanaged. In any case, our brands are not commodities. The reliability and durability of our brands is sensational. Warners is over 110 years old. Olga is 70 years old. These products have lived through the life cycles of consumers--brands passed down from mother to daughter through the generations.