What was Dennis Hernreich thinking? Four years ago, Hernreich, then CFO and chief operating officer of the sputtering Designs Inc., was part of a management team that set out to revitalize a dying retail clothing company by buying another failing clothing company.
In 2002, he and the company’s chief executive officer, David Levin, orchestrated the acquisition of a bankrupt retail chain called Casual Male. That year, the combined company reported a net income loss of $38 million. “We wanted to bring [Designs Inc.] back to life, and the growth strategy we found for it was Casual Male,” asserted Hernreich.
The unusual strategy worked. In its 2006 second quarter filing, the company, now known as Casual Male Retail Group (CMRG), reported net income of $1.4 million, a radical turnaround from the $1.9 million net income loss it reported during for the same quarter last year. Quarterly sales are up as well, hitting $103 million in the second quarter of this year, which is a 5 percent gain in comparison to the same quarter of 2005.
The company’s reach has expanded too. CMRG now operates two chains in the U.S. and Canada: Casual Male XL, which carries moderately priced clothing, and the higher-end Rochester Clothing, which it acquired in 2004. Both units also operate catalog and Web businesses.
Last year, CMRG reported net income of $10.8 million. According to Hernreich, since the acquisition of Casual Male, he and Levin have “been busy.”
A Chicago native, Hernreich, now CMRG’s finance chief and COO, is an Arthur Andersen-trained accountant. He learned how to be a CFO while working in the oil and gas business, becoming a finance chief of an independent exploration-and-production company during the late 1970s and early 1980s, until oil dropped to $10 a barrel. He then moved to The Equity Group, where he worked on mergers and acquisitions. After that Hernreich became the CFO of a regional Midwest discount retailer owned by The Equity Group, and eventually came east to take the top finance post at Loehmann’s, a clothing retailer in New York.
CFO.com caught up with Hernreich to ask him about the turnaround, the metrics he keeps an eye on, balancing the CFO and COO positions, and how his mid-cap company has dealt with Sarbanes-Oxley. Here’s what he had to say.
CFO.com: CMRG got off to a rocky start—not unexpectedly, since you combined a financially failing company with a bankrupt one. Why did you pursue that strategy?
Dennis Hernreich: David (Levin) and I were working together at Designs Inc., which owned and operated the Levi’s/Dockers outlet stores. Levi’s sales had been declining for over a decade. The proliferation of branded denim, like Polo, Nautica, American Eagle, and Abercrombie [and Fitch] were eating away at Levi’s market share. There was no growth future for Designs Inc. based upon its current business plan.
So you bought another failing clothing business?
Yes. [Casual Male’s parent company] J. Baker had a sick balance sheet, and in the summer of 2001 it went bankrupt. But the bankruptcy created an opportunity for us. We liked Casual Male for a number of reasons. It had a dominant market position, being the primary specialty company in the big-and-tall-man space. It was over expensed and over invested in infrastructure, and the brand was tired, and not being developed. We thought the company was a ripe acquisition, and that if managed right, could reach its full potential.
Where did you start?
CMRG divested the businesses [linked] to the old Designs Inc. That included the Levi’s business. We had a lot of diversion, distractions, and losses as a result of those businesses. We also installed new information technology systems at CMRG. The Casual Male was run on old IBM mainframes using COBOL. We replaced the mainframe with mini computers and client seats. By July 2004, the new systems were up and running supply-chain and merchandising-planning applications, as well as warehouse-management systems. We also installed a CRM [customer relationship management] database operation—we’re a big direct-mail marketer.
Are you saying that computer efficiencies brought the business back to life?
We are more efficient and manage inventory better. But the systems allow us to cater to our niche—the big and tall guy. The new systems gave us the ability to micro-merchandise. Our customer comes from all walks of life, all demographics and market segments. So understanding him, catering to him, finding him, is elusive. He tends to blend into his neighbors where he lives. So theoretically, there should be no one [Casual Male XL store that looks alike. From a practical perspective that’s a bit of a stretch, but a Miami store should be different than a Chicago store, which should be different from an L.A. store. With the new [IT] infrastructure in place, the company’s operating metrics begun to improve.
Which metrics do you track?
It’s hard to be comprehensive, but let me give you some key examples. Before the new systems were installed, Casual Male’s year-over-year sales—
something the industry refers to as comparative store sales—was declining at a rate of, say, 5 percent annually. Now we’ve shown 10 consecutive quarters of positive [comparative store] sales growth. Market share is growing too. And why not: I tell Wall Street all the time that our share is only 7.5 percent of the total big and tall market, and we’re number one by far. So as long as we continue to provide the right sizes, the right seasonal colors and styles, in the right stores, our market share will improve. Every one percentage-point improvement in market share represents a top-line improvement of 15 percent. That’s a ton, so you know where our heads are at.
What about the expense side of the equation?
Hold on, let’s talk about gross margin. Gross margin, in effect, is the amount of money that we make on the product that we sell. It is sales less cost of goods sold. Our gross margins improved last year by just over 200 basis points for the year. And we are on track to see another 150 bp to 200 bp improvement this year. Why is that? Because of technology. We are getting the right merchandise into the right place; we don’t have to discount merchandise that’s out of season because we bought too much for that one store. We don’t have to discount to entice customers to come into the store. The nature of our marketing is changing because our product selection for each store is more appropriate, and that’s having a positive impact on our gross margins.
Did you also make cuts to get that kind of margin improvement?
Early on we cut expenses. But the new computer systems allowed us to run the business with fewer people while giving us a tremendous amount of operating capacity. As we add to the top line, we’re adding very little to the expense line. We can now handle more business with our existing infrastructure. But it is not only application software. We changed our business processes. If you don’t change your processes, you’re just emulating the old way you did business, and all you’ve done is waste your money. We changed the way we run logistics and manage our inventory to match the capabilities of our new software.
Management’s efficiency can often be measured by calculating operating margins (operating income divided by total income). Do you see an improvement in operating margins?
When we took over the business, operating margins were less than 2 percent. Last year we got to 4.5 percent, and this year, if you look at Wall Street reports on us, some analysts say we can reach as high as 7 percent. We have said continuously that our operating margins are growing toward the 10 percent rate. Only the healthiest of retailers operate at that level. So for a niche business, that’s pretty good. We have the tools in place to be able to drive our market share to something more respectable.
Certainly I’d be happy reaching 10 percent over the next couple of years. Why not 15 percent, right? Well, 15 percent of a $6 billion market is a big number. That would make us a $1 billion company. I’m not saying that’s not possible, but right now we reported $421 million in sales, and going to $1 billion is a big move. But we do have the infrastructure to do that.
Where does cash flow fit into your metric hierarchy?
I live by cash flow. To me, cash flow is a better measure of performance than net income. The trouble with net income is that, sometimes, you muck things up with accounting, as where cash is cash. Cash also tells you how the company is managing working capital. I think all CFOs watch [cash flow]. I don’t think Wall Street talks much about it though. It’s always earnings-per-share or operating income.
Let’s move away from quantitative questions. I’d like to know how you handle the dual role of CFO and COO.
I think it’s a great partnership because one makes the other more effective. Having the CFO title helps me, as a COO, identify opportunities, at least in terms of performance. And being a COO gives me an intimate knowledge of how the numbers are generated from an operations perspective. Going forward, I would not be surprised to see more [small and mid-size] companies combine the positions.
As a mid-cap company, did you find compliance with the Sarbanes-Oxley Act oppressive?
It was a killer financially. I don’t object to the underpinnings of Sarbanes-Oxley, I object to the degree [of compliance detail] that was imposed upon companies in such a short period of time. We were in the middle of the turnaround, so we outsourced our internal-audit function. We spent exorbitant amounts of money on compliance, but much less than many other companies. In the year of adoption, we spent $445,000. This year we spent $330,000.
What do you think is the biggest Sarbox benefit for your company?
It keeps us aware of our internal controls, which is important. And during the turnaround, we weren’t necessarily focused on that.