Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Adrian Kowalewski – Director of Corporate Finance and Development.

Dov Charney – Chief Executive Officer

Analysts

Todd Slater – Lazard Capital

Matthew Wiger – Monness, Crespi, Hart

Mickey Schleien – Ladenburg

American Apparel, Inc. (APP) Q3 2008 Earnings Call November 8, 2008 5:00 PM ET

Operator

Welcome to the American Apparel, Inc. third quarter 2008 earnings conference call. For opening remarks and introductions, I would like to turn the call over to Miss Jane Fontana of Integrated Corporate Relations.

Jane Fontana

I'm going to read the Safe Harbor before we get started. I would like to remind you of the language. The statements contained in this conference call which are historical fact may be deemed to constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Actual future results might differ materially from those projected in such statements due to a number of risks and uncertainties all of which are described in the company's filing with the SEC. We're going to allow about an hour for this call, so we'll close it down around 6:00 p.m.

And now, I'll turn the call over to Adrian Kowalewski, the company's Director of Corporate Finance and Development.

Adrian Kowalewski

Good afternoon everyone. I'm joined today by Dov Charney, CEO and Bill Gochnauer, Interim CFO. After my opening remarks, I plan to go through the third quarter financial results in detail and then turn the call over to Dov for Q&A.

I'd like to just start out briefly by saying we're very pleased with our financial results for the third quarter. Revenues totaled $154.8 million, a 45.2% increase over the third quarter of 2007. This was driven by a 24% comp in the period on top of a 27% comp the year before.

During the third quarter, we recognized a $13.2 million merger related stock based compensation expense due to the grant of approximately $1.9 million shares of common stock to our manufacturing employees. This stock grant was pursuant to the terms of the merger agreement with Endeavor and represents $12.1 million of stock based compensation expense, and $1.1 million of employee related payroll taxes.

Net income for the quarter was $2.3 million or $0.03 per share after taking into account the impact of stock based comp expense. Backing out the stock based compensation expense; net income would have been $11.1 million or $0.16 per share.

During the third quarter, we opened a total of 33 new retail stores including our first stores in China, Brazil and Austria. In the company's five years of retail operation, this is the largest number of stores the company has opened in a single calendar quarter. We also opened all eight of the Sharper Image stores we mentioned on our last conference call.

As of September 30, we had opened a total of 48 stores on the year and with the seven additional stores opened in October, we have already achieved the high end of our guidance range with 55 store openings on the year.

Looking back at the third quarter, we continue to make progress toward our other goals in our first year as a publicly traded company. We significantly increased our production capacity in the third quarter. Our total manufacturing head count increased by 750 people, including over 450 people in selling, and approximately 150 people each at our garment dye facility in Southgate, and the former U.S. Dye and Finishing facility in Garden Grove.

We also moved raw material storage from our headquarters facility to the Imperial Toy Factory building we leased at the beginning of July and added additional selling foot prints at headquarters.

On the systems side, we are moving forward with phase two of the implementation of our ERP system, phase two as we mentioned on our last call, will cover distribution, warehouse management, MRP and advanced forecasting, order entry and advanced quality control for manufacturing.

With respect to phase one, we are starting to see some of the efficiencies on the MRP side with the visibilities the ERP system has given us on our inventory position. In the accounting department, we've made three key hires in the quarter; one being an experienced controller for our manufacturing operation, the second being an experienced controller for our international business, and the third an assistant corporate controller. All three have CPA's and two have a background in audit at big four firms.

As part of our efforts to improve the timeliness of our financial reporting, we also began the implementation process for a financial consolidation software platform on which we plan eventually to supplement with a planning and budgeting module.

On the finance side, with the hiring of a financial planning manager in Q3, we are currently in the beginning stages of our budgeting process for 2009 which we believe will lead to tighter expense controls and more rigorous capital allocation going forward. On the Sarbanes-Oxley front, we continue to be on track and continue to expect to demonstrate significant progress through mediating deficiencies by year end.

Overall, the filling in of our infrastructure continues to be a high priority. We believe we have made significant strides in that regard over the past six months in particular, although we realize there is still much work to be done. Despite the global economic down turn, we believe that our business is as well positioned as it has ever been.

Switching gears now, I will turn to our third quarter financial results in more detail. For the third quarter of 2008, net sales totaled $154.8 million, an increase of 45% over the third quarter of '07. Total comparable store sales increased 24% for the third quarter on a constant currency basis.

We are very pleased with the performance of our existing stores so far this year which delivered a 36% comp sales increase in Q1, 23% in Q2 and an accelerated result in Q3 despite a tougher comparison. The increase in Q3 was on top of a 27% comp in Q3 of '07 and made more impressive due to a large number of new stores opened in the third quarter of '08.

The average sales productivity for stores opened for more than 12 months for period ended 9/30/08 was approximately $1.5 million. Our newly opened stores are also performing above plan.

Gross margin in the third quarter including the $13.2 million merger related to dot com compensation expense decreased by 510 basis points to 50.1%. Excluding the impact of the stock award, gross margin for the third quarter was 58.7%, an increase of 350 basis points over the same period last year. This increase is mainly due to a higher mix of retail and on line consumer sales, resulting from our continued store expansion in the U.S. and in international markets as these sales generate a higher gross margin.

Due to the more rapid growth of our retail business the U.S. wholesale site represented just 29.9% of sales in the third quarter versus 37.6% a year ago.

Operating expenses increased 50.1% to $70.8 million or 45.7% of sales representing an increase of 150 basis points. Operating expenses increased due to higher payroll, rents and occupancy expense related to the increase of the number of retail stores and our operation of the past 12 months, leases signed on approximately 40 stores in our pipe line and an increase in advertising expense.

Pre-store openings expenses for retail stores were $4.4 million in the third quarter of '08 versus $0.9 million in the same period last year. Approximately $0.8 million of deferred rent expense was included in the pre-opening expenses in the third quarter of '08.

Operating expenses were also higher due to an increase in corporate expense of approximately $3.1 million related to an increase in accounting and professional fees as a result of American Apparel operating as a public company in 2008, additional payroll and increased IT and other office related expenses.

Operating income for the third quarter excluding the $13.2 million stock based compensation expense increased 71.1% to $20 million from $11.7 million in the prior year period. These operating results represent a 200 basis point increase over the same period last year. Including the impact of the stock based compensation expense; operating income was $6.8 million.

Interest expense for the third quarter totaled $3.2 million as compared to $4.4 million for the third quarter of '07. The decrease in the interest expense is primarily due to a lower LIBOR rate in which the company's asset base revolver borrowings are determined. Interest expense for the period included approximately $0.8 million of loan fees.

Our tax rate for the period was 26.9% due to federal and state enterprise zone tax credits arising from the company's expanded hiring and manufacturing operations in downtown Los Angeles. The effective tax rate for the nine month ended September 30, 2008 was 33.5%.

Net income for the third quarter adjusted for the stock based compensation expense was $11.1 million or $0.16 per diluted share as compared to $6 million or $0.12 per diluted share in the same period a year ago.

Including the stock based comp expense earnings per share were $0.03 per diluted share for the third quarter of '08. Weighted average fully diluted shares outstanding were 70.3 million for the quarter versus 48.4 million shares last year.

I will not briefly go into the operating results for each of our four business segments. Sales for our U.S. retail segment increased 48.5% to $46.7 million. We ended the period with 129 stores in the U.S. up from 96 stores in the same period last year. Comparable store sales in our U.S. retail division were up 24% during the third quarter. Gross profit also rose 48.4% to $35.6 million.

Gross margin was 76.2% as compared with 76.3% through the third quarter of 2007 representing a decline of 10 basis points. Operating income grew 47% to $10.6 million or 22.8% of sales as compared to $7.2 million or 23% of sales in the same period last year. Pre-store opening expenses for U.S. retail were $2.9 million in the quarter versus $0.7 million in the quarter a year ago.

Sales for our Canada segment increased 63% to $19.9 million. At the end of the period we had 34 stores in Canada up from 25 stores a year ago. Comparable store sales in our Canada segment were up 39%. Gross profit rose 90% to $13.9 million and gross margin was 69.9% as compared to 59.9% in the third quarter of 2007 driven by a decrease in the percentage of sales coming from wholesale.

Operating income increased $5.1 million to $6.4 million or 32.2% of net sales as compared to $1.3 million or 10.3% of sales in the same period last year. Pre-store opening expenses were approximately $0.2 million in the current quarter.

Sales for our international segment increased 83.5% to $42 million. We finished the quarter with 65 stores in 17 countries, up from 42 stores a year ago. Comparable store sales in our international segment were up 17%. Gross profit rose 95.4% to $31.6 million and gross margin was 75.1% as compared to 70.5% for the third quarter of 2007 representing an increase of 460 basis points, driven by an increase in mix attributable to retail sales and selective price increases put through in the third quarter of 2008.

Operating income increased 151% to $10.4 million or 24.8% of sales as compared to $4.1 million or 18.1% of sales. Pre-store opening expenses were approximately $1.3 million in the current quarter.

Net sales for the company's U.S. wholesale division increased 15.3% to $46.2 million driven by a 9.5% increase in wholesale sales and a 62.1% increase in on line consumer sales. The wholesale segment benefited from an improved inventory position as production was ramped up during the period while the increased on line consumer sales is attributable to higher levels of strategic advertising and greater brand recognition.

On line consumer sales in the U.S. were $7.2 million for the quarter versus $4.4 million in the same quarter a year ago. Adjusted for the stock based compensation expense, gross profit decreased $1.6 million or 4.2% to $9.8 million.

Gross margin was 21.2% in the third quarter in 2008 versus 28.5% in the same period of 2007. The decrease in the wholesale gross margin was primarily due to the continued hiring of a significant number of new manufacturing employees in the period and increased manufacturing costs due to increased production volumes of retail products.

The margin was favorably impacted by $1.1 million or 2.4% due to the decrease in inventory reserves given the expansion of the company's outlet store operation and improved inventory composition.

Operating income excluding the share grant totaled $2 million or 4.3% of net sales as compared to $5.6 million or 13.9% of sales in the same period last year.

Turning to liquidity, we finished the quarter with $111.6 million of debt on our balance sheet and $13.9 million in cash. As of September 30, we had approximately of $7.1 million of excess availability of our revolver. Our $51 million second lien term loan matures in January 2009. If that loan can not be refinanced in a manner acceptable to our senior lender, the senior revolver comes due a month prior to that on December 19.

We are currently in discussions with a number of parties including our current second lien lender on a possible extension of the existing credit facility or alternative financing options.

Capital expenditures for the period were approximately $21 million and inventory increased approximately $26 from the end of the second quarter to support continued growth in retail and wholesale. We believe that the current inventory levels are more than adequate to support our business going forward and anticipate holding at this level of inventory or lower through the balance of the year.

As we mentioned in our earnings release, we are maintaining our earnings guidance for the year. The company continues to expect diluted earnings per share in the range of $0.32 to $0.36 before giving effect to the compensation expense arising from the merger related [dot brand] out of which 800,000 shares are expected to be distributed in the fourth quarter of 2008 to eligible administrative and retail employees.

Turning to our store opening guidance, since we've been able to expedite the opening of a large number of stores in the third quarter, we are ahead of where we expected to be with respect to our retail expansion. We currently have a pipeline of approximately 40 signed leases for new retail stores and anticipate that approximately 25 of these stores will be opened before the end of the year, which will bring us to approximately 80 store openings by year end.

While we recognize that the overall economic climate is difficult particularly in retail, the sales performance of the stores we opened during the period has exceeded our expectation and to the end of October, overall we have not experienced any discernable weakening in demand at our retail business.

Nevertheless, since the beginning of September we have not initiated any new retail leases and we plan to work through our remaining pipe line before committing to a significant number of new locations. With the greater than anticipated number of store openings falling into 2008 rather than 2009, we expect the number of store openings in 2009 to be lower but our average annualized store growth rate should come in closer to our original longer term goal of 20% to 25% unit growth per year.

We believe that by slowing the pace of expansion, we will position ourselves to better take advantage of a potential improvement in leasing terms in 2009. We also believe that a slower expansion next year, perhaps weighted toward the back half of the year, will also allow us to better assess whether the economic down turn is having an affect on our customer base, thereby giving us the flexibility to calibrate our expansion accordingly.

Our overriding goal for 2009 is to generate significant free cash flow from operations. We expect to share more about our outlook for 2009 in January at the ICR Exchange Conference and when we report our 2008 year end results.

With that, I will turn it over to Dov and open it up to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Todd Slater – Lazard Capital.

Todd Slater – Lazard Capital

My first question is just about the guidance. I think you're about $0.28 year to date and you maintain your annual guidance of $0.32 to $0.36 which means a fourth quarter of $0.06 to $0.12, and you said you see no discernable change in demand, so I'm wondering if the fourth quarter revs are in line where we think they are and where the third quarter, is there something about the fourth quarter in terms of profit either on the margin, gross margin side or leverage side that you think is going to change sequentially? I know we're focused on year over year but given the same type of revenue, what would cause that much of a contraction in the margin if you were to hit those numbers.

Adrian Kowalewski

One of the things you have to keep in mind is that our wholesale business typically trails off in the Q4 and if you look at just the trend of earnings last year, there was a deceleration of profitability in the fourth quarter as we manufacture more winter styles and more retail styles. So it's both a revenue issue and a margin issue.

Todd Slater – Lazard Capital

So if wholesale trails off isn't the wholesale a lower margins business, so wouldn't that positively impact the overall gross margin and net margin?

Dov Charney

We want to be conservative. We don't want to over promise. It's very difficult to calibrate a factory of this many people. We have thousands of employees. If you run into too much overtime, your profit really drops. You could also have an under deployment problem in the factory where if you're running it for four and a half days for example, your profitability drops again because you're not getting leverage on all of the overhead costs of the factory.

So it's a difficult moment to calibrate everything. We think we're going to be successful, and if we're more successful you'll have the upside. If it's not, at least we'll make what we originally said we would make. So we don't want to raise the target for ourselves unnecessarily. We're directing a very large scale manufacturing operation. It's one of the largest clothing factories now in the world.

We're doing a good job at it. We have the new ERP system, some elements of the ERP system in place and each year we'll get better at it. But this is a complex moment for everybody, and we ought to see where there's acceleration, deceleration and so forth in terms of which products are working and which products are not. We're also integrating a lot of new employees, so there's an issue here. But we'll see how it goes.

Todd Slater – Lazard Capital

Are you integrating more people in the fourth quarter than you were in the third?

Dov Charney

No, I think at this point, it's well known that we've hired a lot of employees and it takes years to train these people. We're entering new product categories. We're moving people around. If you saw the same store sales growth that's there, we're also making a lot of new product that we've never made before. We're trying to capture better momentum in cold weather. You see our same store sales in Canada are strong and I think we'll continue to be.

We're going to take years to perfect. We're new at the game. By the way, November marks five years of retail for us, and we're just learning. This company is in its adolescence and it will take some time. I don't want to run this company just for – I want to be able to enter new product categories and there's a learning curve, so that could be an issue.

Absorbing all the new workers is an issue. There's some issues. But I think we're doing very well as Adrian said in the introductory remarks. There's a lot of meat and potatoes for people to get excited about.

Todd Slater – Lazard Capital

It sounds like its more conservatism than anything else.

Dov Charney

I would say that.

Todd Slater – Lazard Capital

On the last call you said the run rate of new stores is tracking at $1.6 million which is a little higher than the older stores. Do you have an update on this? Did you mention that in this call?

Dov Charney

I don't think we touched upon it on this call, but definitely just because a lot of the new stores we picked out are more mature retail locations. We have some very good numbers right out of the box, especially in some of the higher grossing malls where we've opened in major cities. We opened a store on 27th, so I think it's near SIT on Seventh Avenue and 30th Street, and that store is pretty strong right out of the gate.

We have a store that's going to open up on Broadway and Howard. It's one of our higher rentals in the entire portfolio stores we have. We think that's going to be a very high run rate store. Naturally some of the new stores are still trending up, maybe even beyond $1.6 million, but I don't have that number in front of me.

But I can tell anecdotally, we're not interested in opening slow maturing stores right now. We've had some of those and we've nurtured some of them through poor performance, but we're more interested in taking on larger revenue grossing stores.

Adrian Kowalewski

One of the reasons we didn't put out that number was because a lot of the stores that we just recently opened have only been open for a month or two and so we thought that it wouldn't really be helpful because it's going to take awhile for those stores to really come into their own to see how they're going to be performing.

The other thing to keep in mind is that early in the year when we gave out our run rate for the new stores, it was heavily weighted towards international locations which historically on average, tend to gross higher than the U.S. locations. So third quarter of '08, we opened up a lot of U.S. locations, so on average those tend to be a little bit lower.

Todd Slater – Lazard Capital

Okay, maybe you can update us at ICR. Can you talk a little bit about the effects of the strengthening dollar or currency movements and how we should think about that going forward?

Dov Charney

I think the fact that we're diversified through many countries is a positive thing. Not all currencies are down. The Japanese Yen seems to be holding its ground. Also, understand that only 25% of our cost of goods is in U.S. dollars. We have more rental and payroll expenses outside the United States like per dollar sold than in the cost of goods itself.

I think if you do some research and compare us to other clothing companies within our concept, I think you'll find that our cost of goods is lower than anybody else, so the upside to that, is that if the Canadian dollar drops for example and cost of goods is only 20% to 25% of the sell price, we're not that affected. We're not that affected by the currency change.

Also, we feel confident we can raise prices because we have a made in U.S.A. product. People understand if it's $15.00 in the States, and the Canadian dollar is trading at $0.80, that's got to be $17.00 to $18.00 in Canada. People are comfortable with that.

So we might even be able to – we don't think we're going to have much impact as a result of the currency movement. If we do, there's going to be some temporary impact, but as the dollar moves, we can increase pricing and also we have some SG&A leverage on the international scene as you saw from Adrian's introductory remarks.

The sales for our international segment increased 83.5% to $42 million. Sales for our Canada segment increased 63% to $19.9 million. Those increases in those territories for example, we're going to have a lot of profitability leverage that's going to take place as a result of SG&A decreasing as a percentage of sales.

I think overall, we're going to perform well on the international scene and just because the currency drops in one territory, you also may have high performance. Like China, the currency is dropping, but same store sales are very high. We're experiencing right now some of our highest same store sales in Canada at this time.

I can't give you all the numbers, but I'll give you a segway into what's going on over there. The currency is dropping but it seems like we're making more money anyway. One situation kind of offsets the other.

Operator

Your next call comes from Matthew Wiger – Monness, Crespi, Hart.

Matthew Wiger – Monness, Crespi, Hart

Is it possible that I can get a break down of the selling warehouse and distribution G&A?

Adrian Kowalewski

That should be in the 10-Q I think is going to be filed if not now, tomorrow morning. I don't have it in front of me right now.

Matthew Wiger – Monness, Crespi, Hart

Can we get a breakdown of the pre-opening international versus U.S. for $4.4 million?

Adrian Kowalewski

For the third quarter it was $2.9 million in the U.S., about $200,000 in Canada and $1.3 million in international segment.

Matthew Wiger – Monness, Crespi, Hart

And the split for Q4 in terms of openings, international versus U.S.?

Adrian Kowalewski

We expect probably 25 store openings before the end of the year. It's a little bit weighted towards the U.S., but historically it's been 50/50 but it might be a little bit skewed towards the U.S. in the remaining months.

Matthew Wiger – Monness, Crespi, Hart

It's a pretty big surge in the accounting and professional fees. You said $2.9 million increase year on year and $3.3 million last quarter, it felt like a run rate. What are we looking at? Is that going to come in a little bit from here forward?

Adrian Kowalewski

Part of that is related to like we said, the increased professional that we have as a public company. Some of that is Sarbanes-Oxley work. I think going forward as we bring in more people in house or outside contractors, we're going to get a better handle on those costs. It's also going to reduce our outside fees such as our audit fees and so forth.

It's obviously something that we're carefully monitoring and it is higher than we'd like right now but we're hopeful we can bring it down.

Matthew Wiger – Monness, Crespi, Hart

What was to total amount for the quarter? It's $2.9 million year on year for the accounting and professional fees?

Adrian Kowalewski

I don't have it broken down by category. That aggregates a lot of different numbers.

Matthew Wiger – Monness, Crespi, Hart

Advertising expense increase you alluded to, what was the actual increase or the total amount?

Adrian Kowalewski

I don't have that in front of me either. It's all disclosed in the 10-Q.

Operator

Your next question comes from Mickey Schleien – Ladenburg.

Mickey Schleien – Ladenburg

What is the status of the renewal of the lease on the headquarters building? The same store sales for next year, I realize you haven't introduced guidance for 2009 but you've given us a bit of a hint given that you're not committing to new leases going into next year given how weak the economy appears to be. With that in mind, can you give us a sense of what you're thinking in terms of same store sales for 2009? Can you continue to accomplish the sort of growth rates that we've seen this year and last, or are we starting to see a point in terms of revenue per store where it's going to become more of an organic store as time goes by in terms of store growth.

Dov Charney

The first question regarding the situation with the real estate in Los Angeles, there's a surplus of industrial real estate in downtown Los Angeles so we have an enormous amount of optionality there. We obviously have some loyalties to our current landlord. We're going to see what we can do there.

There could be some savings in that arena or we could look at some other alternatives in the area, like we've just rented a toy building and there's an additional industrial space we rented as well, and we're seeing rents way down on that in terms of the industrial real estate in Los Angeles. So I think we're going to be okay over there.

The second thing you asked about as far as sales, could you rephrase the question more precisely and I'll give you a precise answer.

Mickey Schleien – Ladenburg

I want to make sure I understand what you're saying on the headquarters. My understanding was that that lease is almost up, I don't know if it's December or January but it's pretty near term. Wouldn't this be something you'd have to resolve very soon in order to avoid a dramatic disruption of your production?

Dov Charney

I don't want to get into it on the call, but I think we're going to be okay over there. We have a lot of optionality, and I don't want to disclose the terms and conditions of all of that. I think that we'll work that out. Adrian and others will have to get involved and there's a little bit of negotiation that needs to take place, but I don't think that's a concern.

Mickey Schleien – Ladenburg

My second question was same store sales in 2009. Given that you've told us that you're not going to commit to entering into new lease agreements in 2009 until you see how things shake out.

Dov Charney

I don't say that we're not going to enter into new lease agreements in 2009. We currently have leases that are going to – there are stores that we need to open in early 2009, leases that we've signed right now. We haven't entered into too many lease agreements in the last 30 to 45 days but we intend to continue signing strategic leases. There's a lot of good deals out there and if we can find diamonds, we're planning to sign some leases.

I still think we're going to see, and many of the stores we've opened now in 2008 relate to part of our 2009 plan. They're just early opens because we felt compelled to open up stores as quickly as possible. I still think you're going to see square footage go up in 2009 and I think actually you'll see a 20% square footage.

If you take into account the extra stores that we might have opened in November and December this year, because they really should be packaged into 2009. That we got them open early is to our credit and it gives us a longer run time into 2009.

Mickey Schleien – Ladenburg

The rest of that question was, you look at your revenue per store at this point and benchmark it against some of your peers, you're already doing extremely well, and that's thanks to some very solid same store numbers this year and last year. What I'm asking is, are we approaching some sort of saturation level in terms of the productivity that you can generate out of your stores on average?

Dov Charney

No, because if you think about it, this year by December 31, we're going to have 70 to 80 stores open. Those stores are far from mature. They need a lot of work, and the average store, there's a lot of opportunity there. I walk into a store, I sometimes see, or some of my colleagues walk into a store, we feel there's 20%, 30% 40% growth opportunity in units that are one year, two year, even three years old.

We have not seen a deceleration yet or a plateauing of productivity growth. We're leaning how to merchandise the stores better, arrange them better, but we're trying to optimize product mix at each store. We're trying also not just optimize sales at the store, we're also trying optimize the expenses at the store, trying to create fluidity between merchandise employees, inventory employees, sales employees, where people have to cross over into different departments.

Or if there's a store – for instance, if Soho's is busy and Broadway is not, transferring employees across town, trying to create fluidity between the different stores in order to create efficiencies with the store payroll that we haven't had before. Every week that goes by we learn more about our business.

I'm inside my stores seven days a week. And it's not just me. There's dozens of people that have the same commitment as far as getting in the stores and learning about them and trying to figure out how to be more efficient; where to put the bathing suits, how to deal with seasonal shifts, temperature shifts, how to deal with the impact of Halloween, if Halloween is on a Wednesday or it's on a Friday and what that means.

We're trying to learn the buyer in each store individually and really take advantage of the opportunity to build top line, but also how to build now bottom line at each individual store.

There's also all kinds of allocation techniques, micro transfers. We have a lot of tricks up our sleeve so we feel good about that.

Mickey Schleien – Ladenburg

Despite the fact that the U.S. economy is almost definitely in a recession and Europe may be as well, do you then expect positive same store sales in 2009?

Dov Charney

Absolutely. There's been economic recessions but if you don't drive a car and you don't own any property and you rent your apartment, you might be able to get a better rental now. Unemployment has gone from 5, 6, 7, 8, let's say it goes to 8% or 9%. It doesn't mean that our customer base, young, developing their careers in New York City or London are suddenly going to be out of work because our employment has gone from 6% to 9%.

We feel strongly about our category. If you look at Urban Outfitters today, there's a question of anthropology but nobody is questioning Urban Outfitters just yet. I think young adults are shopping. There's a generational shift going on in the market place right now. You can attribute that to how many young people voted for Obama.

Young people are out there. They're not necessarily buying cars. They're not necessarily worried about stock portfolios or even understand the stock market that well. They're the new generation coming up, especially in big cities.

McCain had country first, and if you look at Obama [inaudible] is what it's about. It's about cities first. That's our market. It's young, urban adults in Beijing, Tokyo, Hong Kong, where ever it is, we're not in Hong Kong yet, hopefully one day we'll be there, it's about young, upwardly mobile, urban adults and we want to service that market.

We don't see, there's going to be some job loss there but there's also opportunities for new things to happen, and I think you're seeing it. A lot of companies that cater to young adults are doing well right now, and we think we're one of them.

I wanted to get back to Matt Wiger's question on advertising. I don't have the compare on last year in front of me, but I think it illustrates another important point about our strategy right now. For the third quarter that we just finished, we had about $5.5 million of advertising expense compared with $3.6 million from a year ago. While it's an increase, it's still down as a percentage of sales, and right now we've been selectively paring back our advertising spend because we believe our brand has come a long way in certain markets.

We're doing that. We're also optimizing our web ad spend and doing other things to make sure that we're getting a better return on our advertising dollars.

Operator

You have a follow up question from Todd Slater – Lazard Capital.

Todd Slater – Lazard Capital

Can we go over the pre-open expense a little bit? You had a great EPS number, $0.16 after all this pre-open. I'm calculating $0.06 a share which sort of gives you a sense of how strong the underlying business is outside of that. Do you have the year to date number and what that compares to last year? It's got to be up. You have a lot more stores open, but I was just trying to calculate the increment year over year.

Adrian Kowalewski

On a year to date basis, the total pre-opening cost is $8.7 million.

Todd Slater – Lazard Capital

Do you have a sense of what it was last year?

Adrian Kowalewski

I don't have that number if front of me. I'll get it to you though. It's all disclosed in the 10-Q.

Todd Slater – Lazard Capital

I think the 10-Q just crossed so we'll check that out. The same thing on the advertising side, for the quarter you mentioned 5.5 versus 3.6, how is it year to date for the first nine months versus LY. If you could try to find that, it would be helpful.

Dov Charney

We significantly ramped up our ad spend in Q2 and Q3 of 2007 so it's going to be higher just because we didn't have all that ad spend in Q1 of '07.

Todd Slater – Lazard Capital

So this year for the three quarters will obviously be much higher than last year.

Dov Charney

For the nine months this year it was $14.6 million versus $8.3 million last year.

Todd Slater – Lazard Capital

A broader question on the technology side, like the use of labor optimization, or distribution, or those kinds of systems, how early in the curve are you in implementing those types, any state of the art systems to help you manage the product and the labor and what kind of an opportunity do you see there?

Adrian Kowalewski

I think we're very early in the stage. I think it's going to take a number of years to fully harness the power of some of this ERP software. We're making strides there, but I think we have to have a 36 month opportunity here. It's a data in, but it's not just a data in. It's how you analyze the data, how you build the reports.

We are transforming to have more of a retail focus than wholesale focus, so that changes the sensibilities. There's a big learning curve here. So I don't want to promise that it's a tomorrow thing, but I think we're making a lot of progress and I think there's an efficiency that will take place over time that will help optimize the use of inventory and the composition of inventory each day, the composition of inventory in terms of a textile point of view, raw materials point of view, factory inventory point of view, in transit point of view and at each store.

I think it's not a short term scenario. But I think there's incremental opportunities. Sometimes just to implement these new elements of ERP it costs more on a short term basis that's actually damaging to earnings, not accredited. But over time, it's the right thing to do, and it's about having a long term vision.

Todd Slater – Lazard Capital

Do you still feel in terms of the operating margin for '09 that, you said you thought you should be able to drive positive comps next year even on these levels even in a recession? Do you feel the operating margin should still be able to grow next year even on a mid single digit type of comp?

Dov Charney

I'm certain it will improve because you have less stores in the pipe line because we're opening them faster. We're signing fewer leases. We're searching for stores that we can open more quickly. The percentage of unopened stores is naturally, even if it were to remain stable which I'm saying we're going to reduce the number of unopened stores in the pipe line.

But the percentage of stores will naturally decline as we gain leverage on that. There's a spirit of cost control going on throughout the market place as you saw. Adrian says we're going to try to run the business to produce some cash. I think as you do that, you cut out the fat and you realign some of the expenses, bring in the advertising a little bit, start learning what works and what doesn't, cut out the bad and accelerate the good.

I still think, it's my personal goal to make sure that the EBIT margin increases and that's my job here as CEO of American Apparel, and we're doing that. We're going to make that happen. That's a must do. I've got my work cut out for me but I think we'll be successful.

Dov Charney

There's an email question – I'm interested in the details of the $51 million loan due on January '09. They said it could pull forward a month early if B of A forces the issue. I'm wondering if I heard that correctly or what happens if that happens?

Adrian Kowalewski

Basically, the second lien term loan matures in January. If there isn't a successful refinancing to the satisfaction of a senior lender, their facility comes due December so their maturity comes first.

Obviously we're in negotiations with a number of parties regarding a refinancing so it doesn't get to that point. Currently because of the high level of collateral we have, meaning essentially our inventory, under our asset based revolver formula, we have approximately of additional lending capacity we would be able to tap into if we had a larger line of credit with our lender group.

We've also been talking to a number of commercial banks about a potential participation in that syndicate to get access to that availability. Additionally, we have approximately $10 million of manufacturing equipment we purchased earlier in the year which we've been in discussions regarding equipment advancing.

We believe that agreement our commitment for the junior debt will expedite additional secured financing, so that's one of the things we're working on.

Dov Charney

Basically, I've had personal visits with most of the lenders in the syndicate and as well as our junior lender and I feel confident just based on the face to face visits that we've had that we're going to be able to negotiate some kind of situation that's positive for the company and helps us continue the development of our business.

I just think with the results that we've had and the support that we've had, at least the support that I've experienced when I've met with these people face to face, I feel like we can get something done that helps propel us into the next few years. Naturally there's some fine tuning and negotiation that needs to take place.

But this has been something that's been on our minds for some time and I feel will be resolved in a positive way.

Operator

There are no further questions. I would like to turn the conference back over to Mr. Charney for any additional or closing remarks.

Dov Charney

We want to thank you again for your interest in American Apparel and we're obviously very pleased with the way we are performing in the current environment and even excited about the foundation we're laying around the world for our brand to really prosper over the next decade.

We feel confident that we will reach the $75 million EIBTDA mark for 2009 that we projected when we announced our deal with Endeavor almost two years ago and looking forward to building on top of that in the future.

I want to wish every one a happy holiday and we are looking forward to seeing many of you in January and I just want to reiterate I'm super proud of where we're going, and I'm super proud of the team; the financial level, the manufacturing level and the retail level. I think we're going to have a fantastic 2009 and I want to make everybody proud and I want to bring a lot of good spirits to the family of American Apparel and all the stakeholders involved.

So thank you very much. I appreciate everybody's support and not going to let anybody down. Have a good evening and proud to be on the call with everyone. Thank you very much.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: American Apparel, Inc. Q3 2008 Earnings Call Transcript
This Transcript
All Transcripts