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APP > SEC Filings for APP > Form 10-Q on 14-Nov-2012All Recent SEC Filings

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Form 10-Q for AMERICAN APPAREL, INC


14-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
We are a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel. We design, manufacture and sell clothing, accessories and personal care products for women, men, children and babies through retail, wholesale and online distribution channels. As of September 30, 2012, we operated a total of 251 retail stores in the United States, Canada and 18 other countries. Our wholesale business is a leading supplier of T-shirts and other casual wear to screen printers and distributors. In addition, we operate an online retail e-commerce website at www.americanapparel.com where we sell our clothing and accessories directly to consumers.
We conduct our primary manufacturing operations out of an 800,000 square foot facility in the warehouse district of downtown Los Angeles, California. The facility houses our executive offices, as well as cutting, sewing, warehousing, and distribution operations. We conduct knitting operations at our facilities in Los Angeles and Garden Grove, California, which produce a majority of the fabric we use in our products. We also operate dye houses that provide dyeing and finishing services for nearly all of the raw fabric used in production. We operate a dyeing and finishing facility in Hawthorne, California, which provides fabric dyeing and finishing services. We operate a garment dyeing and finishing facility, located in South Gate, California, which is used in cutting, sewing, dyeing and finishing garments. We operate a fabric dyeing and finishing facility, located in Garden Grove, California, which has been expanded to include knitting, cutting and sewing operations. Because we manufacture domestically and are vertically integrated, we believe this enables us to more quickly respond to customer demand and to changing fashion trends and to closely monitor product quality. Our products are recognized for their quality and fit, and together with our distinctive branding these attributes have differentiated our products in the marketplace.
The results of the respective business segments exclude unallocated corporate expenses, which consist of our shared overhead costs. These costs are presented separately and generally include corporate costs such as human resources, legal, finance, information technology, accounting, and executive compensation. The following sets forth the change in retail store count during the three and nine months ended September 30, 2012 and 2011.

                                       U.S. Retail    Canada     International    Total
Three Months Ended September 30, 2012
Open at June 30, 2012                       140         36             76          252
Opened                                        -          -              -            -
Closed                                        -         (1 )            -           (1 )
Open at September 30, 2012                  140         35             76          251

Three Months Ended September 30, 2011
Open at June 30, 2011                       146         38             70          254
Opened                                        -          -              -            -
Closed                                       (3 )        -             (4 )         (7 )
Open at September 30, 2011                  143         38             66          247



                                      U.S. Retail    Canada     International    Total
Nine Months Ended September 30, 2012
Open at January 1, 2012                    143         37              69         249
Opened                                       -          -               8           8
Closed                                      (3 )       (2 )            (1 )        (6 )
Open at September 30, 2012                 140         35              76         251

Nine Months Ended September 30, 2011
Open at January 1, 2011                    157         40              76         273
Opened                                       -          -               -           -
Closed                                     (14 )       (2 )           (10 )       (26 )
Open at September 30, 2011                 143         38              66         247


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Comparable Store Sales
The table below shows the increase in comparable store sales for our retail and online stores, for the three and nine months ended September 30, 2012 and 2011, and the number of retail stores included in the comparison at the end of each period. Comparable store sales are defined as the percentage change in sales for stores that have been open for more than twelve full months. Remodeled and expanded stores are excluded from the determination of comparable stores for the following twelve month period if the remodel or expansion results in a change of greater than 20% of selling square footage. Closed stores are excluded from the base of comparable stores following their last full month of operation. In calculating constant currency amounts, we convert the results of our foreign operations both in the current period and the prior year comparable period using the weighted-average foreign exchange rate for the prior comparable period to achieve a consistent basis for comparison.

                                         Three Months Ended September 30,        Nine Months Ended September 30,
                                            2012                  2011               2012                2011
Comparable store sales (1)                     20 %                   3 %               17 %                   - %
Number of stores in comparison                242                   244                242                   244

(1) Comparable store sales results include the impact of online store sales.

Executive Summary
Results of Operations
Net sales for the nine months ended September 30, 2012 increased $54.5 million, or 14.0%, to $444.3 million from $389.8 million reported nine months ended September 30, 2011 due to higher sales across all of our segments. Net sales at our U.S. Wholesale segment increased by $16.4 million, or 14.3%, driven by higher sales order volume from a significant number of new and existing customers. Our ability to service orders reliably helped facilitate new account generation, as well as the maintenance of our existing client roster. The launch of a new wholesale catalog and the addition of new products to our wholesale offering attracted a more diversified customer base. We continue our focus on increasing our customer base by targeting direct sales, particularly sales to third party screen printers. Online consumer net sales increased primarily as a result of functional improvements to our website and fulfillment process, and as well as a targeted online advertising and promotion effort. Net sales at our U.S. Retail, Canada and International segments increased by $38.1 million, or 13.9%, due to strong performance across categories, particularly women's fashion and accessories, as well as better inventory composition and promotional strategy for key volume drivers.
Gross margin for the nine months ended September 30, 2012 was 52.7% compared to 54.1% for the nine months ended September 30, 2011. The decrease in gross margin was due to the net sales impact of planned promotional activities and the effect of warehouse type clearance sales as part of our overall inventory reduction strategy. This decrease was partially offset by shift towards higher margin retail sales.
Operating expenses include selling, general and administrative costs, and retail store impairment charges, and as a percentage of sales decreased from 59.5% to 54.1%. Operating expenses were $240.2 million as compared to $232.0 million for the nine months ended September 30, 2012 and 2011, respectively. Excluding the effects of depreciation, amortization and impairment charges between the two periods, operating expenses as a percentage of sales decreased from 54.0% to 50.2%. The decrease as a percentage of sales was primarily due to a reduction in corporate overhead expenses and the fixed cost leverage as a result of increased sales.
Loss from operations was $5.9 million for the nine months ended September 30, 2012 as compared to $20.9 million for the nine months ended September 30, 2011. Net loss for the nine months ended September 30, 2012 was $42.2 million as compared to $28.2 million for the nine months ended September 30, 2011 due primarily to a net increase in non-operating expenses of $28.2 million as well as higher income tax provision expense of $0.9 million. The increase in non-operating expenses was primarily due to the increase in market value of our outstanding warrants at September 30, 2012 as compared with September 30, 2011, resulting in a net change in unrealized loss of $36.5 million. Additionally, we incurred higher interest expense due to a higher average balance of debt outstanding and higher interest rates related to the Crystal Credit Agreement. These were offset by a net $14.7 million gain on extinguishment of debt. See Results of Operations for the nine months ended September 30, 2012 for further details.


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Liquidity Trends
As of September 30, 2012, we had approximately $7.2 million in cash and $3.5 million of availability for additional borrowings under the Crystal Credit Agreement and Bank of Montreal Credit Agreement. Additionally, we had $35.6 million outstanding on a $50.0 million revolving credit facility under the Crystal Credit Agreement, $30.0 million of term loan outstanding under the Crystal Credit Agreement, $5.9 million outstanding on a C$11.0 million revolving credit facility under the Bank of Montreal Credit Agreement, and $103.6 million of term loans outstanding under the Lion Credit Agreement. See Notes 6 and 7 to our condensed consolidated financial statements under Part I, Item 1. On March 13, 2012, we replaced our $75.0 million senior secured revolving credit facility with Bank of America ("BofA") with a $80.0 million senior credit facility with Crystal Financial LLC ("Crystal" and "Crystal Credit Agreement"). The Crystal Credit Agreement calls for the $80.0 million to be allocated between an asset-based revolving credit facility of $50.0 million and term loan of $30.0 million. Proceeds from the Crystal Credit Agreement were used to repay our existing credit facility with BofA, fees and expenses related to the transaction and for general working capital purposes. See Note 6 to our condensed consolidated financial statements under Part I, Item 1.
The Crystal Credit Agreement matures on March 13, 2015 and is collateralized by substantially all of our U.S. and U.K. assets and equity interests in certain of our foreign subsidiaries. Interest under the agreement is at the 90-day LIBOR plus 9.0% and also includes an unused facility fee ranging from 0.375% to 1.00% on the unused portion of the revolving credit facility, as well as an early termination fee if prepaid within the first two years.
In connection with the financing from Crystal, we also entered into an amendment to the Lion Credit Agreement to, among other things: (i) consent to the Crystal Credit Agreement, (ii) fix the maturity date at December 31, 2015, and (iii) modify certain financial covenants, including covenants related to minimum quarterly EBITDA and capital expenditures. In addition, the amendment to the Lion Credit Agreement modifies the Lion Credit Agreement to provide for a minimum of 5% of each interest payment on the outstanding principal in cash commencing on September 1, 2012.
On August 30, 2012, we entered into a second amendment to the Crystal Agreement ("Crystal Second Amendment") and an eighth amendment to the Lion Credit Agreement ("Lion Eighth Amendment"). The Crystal Second Amendment extended until December 31, 2012 the period during which loans under the Crystal Credit Agreement based on the American Apparel brand name may remain outstanding, added a minimum Consolidated EBITDA covenant for the remainder of 2012 and a minimum excess availability covenant for the period of December 17, 2012 through February 1, 2013. In connection with the Crystal Second Amendment, the Lion Eighth Amendment added a second minimum Consolidated EBITDA covenant that conforms to the Crystal minimum consolidated EBITDA covenant. See Notes 6 and 7 to our condensed consolidated financial statements under Part I, Item 1. We entered into a ninth amendment and waiver to the Lion Credit Agreement (the "Lion Ninth Amendment") effective as of September 30, 2012, which among other things, waived our obligation to maintain the minimum Consolidated EBITDA covenants specified in the Lion Credit Agreement, as amended, for the twelve month period ended September 30, 2012. As a result, we were in compliance with the required financial covenants of the Lion Credit Agreement on September 30, 2012.
Our C$11.0 million credit agreement with Bank of Montreal ("Bank of Montreal Credit Agreement") matures in December 2012. There can be no assurances that we will be able to negotiate a renewal or extension of this credit agreement with our existing lender or enter into a replacement credit agreement with new lenders on commercially reasonably terms or at all and we may be required to repay this loan. If we are not able to enter into a renewal, extension or replacement of the Bank of Montreal Credit Agreement prior to its maturity, we would no longer have access to liquidity from such revolving credit facility after its maturity date. While we intend to negotiate an extension of this credit agreement, we do not believe that this credit agreement represents a material component of our current or future capital requirements. Management Plan
We are in the process of executing a plan, which we commenced in 2010, to improve the operating performance and our financial position. This plan includes optimizing production levels at our manufacturing facilities including raw material purchases and labor; streamlining our logistics operations; web platform refinement; reducing corporate expenses; merchandise price rationalization in the wholesale and retail channels; store renovation; and improving merchandise distribution and allocation procedures.
In September 2012, we implemented a new online store platform for our U.S. online store that resulted in functional improvements to our website and fulfillment processes and will allow us to tailor the look and feel of the online store to enhance the customer online shopping experience. The new store platform will also enable faster deployment of online stores to new international regions. We believe that these improvements will contribute to our continued financial growth as our website has the potential to not only increase online sales but also in-store sales.


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In September 2012 we implemented a new production forecasting and inventory allocation system that integrates our sales forecasts with our retail inventory tracking system and therefore allows us to better manage our production schedule so that inventory is maintained at the right amount for the right season. It also gives us greater visibility into seasonal and new trends, which will enable a faster reaction to changes in demand.
The second and the third quarter of 2012 benefited from an adjustment to the global promotional strategy and improvements to our in-stock position at stores. We migrated to targeted promotions, which established pricing incentives for customers to buy multiple items in volume driving categories. Unit sales increased as a result of this change and that increase in selling volume was facilitated by improvements to our allocation and logistics processes. During this period, we also ran successful markdowns on aged and seasonal merchandises. We believe this helped decrease inventory levels in slower turning goods, increase foot traffic, and improve sales to both items on markdown, as well as the full price assortment.
Throughout 2012, we continued to enhance our stores by installing sales conversion tracking device and radio frequency identification (RFID) tracking systems. To date, we have implemented RFID systems at 126 stores worldwide. We believe that these systems will enhance sales and contribute to store productivity through improvements in stock positions and replenishment activities.
In June 2012 we entered into a new operating lease agreement for a new distribution center located in California and expect to fully transition our distribution operations into this new facility in early 2013. We believe that the new distribution center will contribute to processing efficiencies and effectiveness and will reduce operating expenses and cost of sales. We continue to develop other initiatives intended to either increase sales, reduce costs or improve liquidity.
Although our plan reflects improvements in these trends, there can be no assurance that our plan to improve the operating performance and our financial position will be successful.


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Results of Operations

The results of operations of the interim periods are not necessarily indicative of results for the entire year.

    Three Months Ended September 30, 2012 Compared to the Three Months Ended
                               September 30, 2011
The following table sets forth our results of operations from our unaudited
condensed consolidated statements of operations by dollar and as a percentage of
net sales for the periods indicated (dollars in thousands):
                                                         Three Months Ended September 30,
                                             2012        % of net sales       2011       % of net sales
U.S. Wholesale                            $  46,847             28.9 %     $  42,405           30.1  %
U.S. Retail                                  52,714             32.5 %        43,104           30.6  %
Canada                                       16,717             10.3 %        15,264           10.8  %
International                                45,882             28.3 %        40,116           28.5  %
Total net sales                             162,160            100.0 %       140,889          100.0  %
Cost of sales                                76,960             47.5 %        65,898           46.8  %
Gross profit                                 85,200             52.5 %        74,991           53.2  %

Selling expenses                             58,017             35.8 %        52,283           37.1  %
General and administrative expenses          22,566             13.9 %        24,552           17.4  %
Retail store impairment                           -                - %           784            0.6  %

Income (loss) from operations                 4,617              2.8 %        (2,628 )         (1.9 )%


Interest expense                             10,454                            8,832
Foreign currency transaction (gain) loss       (685 )                          1,855
Unrealized loss (gain) on change in fair
value of warrants and purchase rights        13,312                           (6,101 )
Other expense (income)                           36                             (186 )
Loss before income tax                      (18,500 )                         (7,028 )
Income tax provision                            512                              166
Net loss                                  $ (19,012 )                      $  (7,194 )

U.S. Wholesale: Total net sales for the U.S. Wholesale segment increased $4.4 million, or 10.5%, to $46.8 million for the three months ended September 30, 2012 as compared to $42.4 million for the three months ended September 30, 2011. Wholesale net sales, excluding online consumer net sales, increased $3.1 million, or 8.4%, to $39.9 million for the three months ended September 30, 2012 as compared to $36.8 million for the three months ended September 30, 2011 driven by higher sales order volume from a significant number of new and existing customers. Our ability to service orders reliably by keeping appropriate levels of inventory to support any fluctuations in customer demand, helped facilitate new account generation, as well as the maintenance of our existing client roster. The launch of a new wholesale catalog and the addition of new products to our wholesale offering attracted a more diversified customer base. We continue our focus on increasing our customer base by targeting direct sales, particularly sales to third party screen printers.
Online consumer net sales increased $1.4 million, or 24.2%, to $7.0 million for the three months ended September 30, 2012 as compared to $5.6 million for the three months ended September 30, 2011, primarily as a result of improved merchandising, segmented and refined email marketing, extensive email list growth and offering of faster shipping options.
U.S. Retail: Net sales for the U.S. Retail segment increased $9.6 million, or 22.3%, to $52.7 million for the three months ended September 30, 2012 as compared to $43.1 million for the three months ended September 30, 2011. Net sales growth was generated by a stronger inventory position in high volume categories, effectively timed seasonal promotions, success in new women's and unisex fashion and an overall improved presentation of our floor sets. Throughout the period, improvements to logistics and the speed of allocation helped to support a buying strategy that is faster and more proactive. Comparable store sales for the three months ended September 30, 2012 increased by $8.8 million, or 20.9%, while warehouse


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sales consisting primarily of slower moving merchandise contributed an incremental $1.9 million increase from 2011 to 2012. The sales increase was partially offset by a $1.1 million sales decrease as a result of a reduction in the number of stores in operations from 143 at September 30, 2011 to 140 stores at September 30, 2012.
Canada: Total net sales for the Canada segment increased $1.5 million, or 9.5%, to $16.7 million for the three months ended September 30, 2012 as compared to $15.3 million for the three months ended September 30, 2011 as a result of improved performance across all sales channels. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, total revenue for the current period would have been approximately $17.0 million, or $1.8 million higher when compared to the same period last year. Retail sales increased by $1.1 million, or 9.6%, to $13.1 million for the three months ended September 30, 2012 as compared to $11.9 million for the three months ended September 30, 2011 due primarily to a $1.5 million, or 13%, increase in comparable store sales. Since September 30, 2011, the number of retail stores in the Canada segment in operation decreased from 38 to 35. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, retail sales for 2012 would have been approximately $13.3 million, or 17.0% higher when compared to the same period last year. Wholesale net sales increased by $0.2 million, or 8.7%, to $3.2 million for the three months ended September 30, 2012 as compared to $3.0 million for the three months ended September 30, 2011. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, total wholesale net sales for the Canada segment for 2012 would have been approximately $3.5 million, or 7.0% lower when compared to the same period last year.
Online consumer net sales for the three months ended September 30, 2012 and 2011 were $0.4 million. Foreign currency effects were minimal.
International: Total net sales for the International segment increased $5.8 million, or 14.4%, to $45.9 million for the three months ended September 30, 2012 as compared to $40.1 million for the three months ended September 30, 2011. The increase was due to higher sales in the retail sale channel. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, total revenue for the current period would have been approximately $48.9 million, or $8.8 million higher when compared to the same period last year. Retail net sales increased $6.0 million, or 18.1%, to $39.3 million for the three months ended September 30, 2012 as compared to $33.2 million for the three months ended September 30, 2011. The change is mainly attributed to higher sales in the U.K. of $2.2 million, Japan of $1.8 million and Australia of $0.7 million. Comparable store sales for the three months ended September 30, 2012 increased $6.2 million, or 20% as compared to the three months ended September 30, 2011. Since September 30, 2011, the number of retail stores in the International segment increased from 66 to 76 at September 30, 2012. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, retail sales for 2012 would have been approximately $41.9 million, or 25.9% higher when compared to the same period last year. Wholesale net sales decreased $0.7 million, or 25.2%, to $2.1 million for the three months ended September 30, 2012 as compared to $2.8 million for the three months ended September 30, 2011. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, sales for the current period would have been approximately $2.3 million, or 18.5% lower when compared to the same period last year.
Online consumer net sales increased $0.5 million, or 11.5%, to $4.5 million for the three months ended September 30, 2012 as compared to $4.0 million for the three months ended September 30, 2011, due primarily to higher sales in the U.K and Australia. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2011, sales for the current period would have been approximately $4.7 million, or 16.8% higher when compared to the same period last year.
Gross margin: Gross margin as a percentage of net sales was 52.5% and 53.2% for the three months ended September 31, 2012 and 2011, respectively. The decrease in gross margin was due to the net sales impact of planned promotional activities and the effect of warehouse type clearance sales as part of our overall inventory reduction strategy as well as the negative impact of foreign currency exchange rates on the cost of sales at our International segment. This decrease was partially offset by a shift towards higher margin retail sales, lower inventory shrink reserves reflecting the benefits of our RFID implementation and lower costs of production in our manufacturing operations. Selling expenses: Selling expenses increased $5.7 million, or 11.0%, to $58.0 million for the three months ended September 30, 2012 as compared to $52.3 million for the three months ended September 30, 2011. The increase is consistent with improving sales. Additionally, we increased our spending on print, outdoor and online advertising to $5.5 million for the three months ended September 30, 2012 from $3.9 million for the comparable period in 2011 in order to continue the sales momentum. As a percentage of sales, selling expenses decreased to 35.8% in the three months ended September 30, 2012 from


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37.1% in the three months ended September 30, 2011.
General and administrative expenses: General and administrative expenses decreased $2.0 million to $22.6 million for the three months ended September 30, 2012 as compared to $24.6 million for the three months ended September 30, 2011. As a percentage of sales, general and administrative expenses decreased to 13.9% . . .

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