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American Apparel, Inc. (NYSEMKT:APP)

Q2 2009 Earnings Call

August 13, 2009 5:00 pm ET

Executives

Jean Fontana – Integrated Corporate Relations

Adrian Kowalewski – Chief Financial Officer, Executive Vice President & Director

Dov Charney – Chairman of the Board, President & Chief Executive Officer

Glenn A. Weinamn – Senior Vice President, General Counsel & Secretary

Analysts

Analyst for Todd Slater – Lazard Capital Markets

Edward Yruma – Keybanc Capital Markets

Mimi Bartow – Telsey Advisory Group, LLC.

Operator

Welcome to today’s American Apparel, Inc. second quarter 2009 earnings conference. Just as a reminder today’s call is being record. At this time for opening remarks I’d like to turn the call over to Jean Fontana.

Jean Fontana

Sorry for the delay, we had a small issue with the filing of the Edgar press release. I’m now going to read the Safe Harbor and then I’ll turn the call over to Adrian. This press release may contain forward-looking statements which are based upon the current belief and expectations of our management team that are subject to risks and uncertainties that could cause actual results and/or the timing of events to differ materially from those set forth in the forward-looking statements.

These risks are detailed in our filings with the Securities & Exchange Commission including our 2008 annual report on Form 10K. Our filings with the SEC are available at www.SEC.gov. You are urged to consider these factors carefully in evaluating the forward-looking statements herein and are cautioned not to place undue reliance on such forward-looking statements which are qualified in their entirety by their cautionary statements.

The forward-looking statements speak only as of the date on which they are made and the company undertakes no obligation to publically update such forward-looking statements to publically update such forward-looking statements to reflect subsequent events or circumstances.

With that, I will now turn the call over to Adrian Kowalewski, the company’s CFO.

Adrian Kowalewski

Joining me today on the call are Dov Charney, President and Chief Executive Officer and Glenn Weinman, Senior Vice President and General Counsel. After my opening remarks and review of the second quarter financial results, Dov and I will open the call to Q&A. We are now half way through 2009 and while we have been able to complete or make progress on many of our initiatives like capitalizing the business, appointing new auditors, completing and going live with phase II of our ERP implementation and continuing to open new stores that are immediately profitable our overall sales trends have obviously not met our expectations.

We continue to feel the impact of the global recession in the second quarter which includes high unemployment rates for our target young customers, significant cannibalization from our significant store growth in 2008 and an overall reduction of consumer spending on apparel. Along with negative same store sales earnings for the second quarter and the first half of the year were also impacted by a decline in our wholesale business which impacts both the sales and efficiency of our factory and the impact of the appreciation of the US dollar on our international profits.

Looking ahead these same issues are likely to continue in to the third quarter but we will be begin to anniversary some of the biggest drivers in our business such as cannibalization and currency effects towards the end of the year. Meanwhile, the company’s creative team is constantly updating and realigning the branding and advertising of American Apparel in our largest metropolitan markets such as New York, Paris, London and Toronto where sales continue to grow and same store cannibalization will be anniversaryed later this year.

We’re also giving more focus to stores in peripheral markets by working on staffing, merchandising and minor remodeling projects when necessary. We also continue to work on new product and updates to our core basics to keep our brand one or two steps ahead of the competition and our unique and productive website is also continuing to be updated and improved.

Our goal for new store openings in 2009 remains at 30 stores. We currently have four leases signed and will work on the next six additional stores that would get us to 30 by the end of the year. We will only sign leases that will meet our profitability requirements and also allow us to take advantage of the current beneficial leasing environment. We are confident that all our newer stores opened in 2009 will benefit in being early in the maturity curve next year which when combined with a controlled number of new store openings in 2010 should help us rebuild our top line momentum.

The wholesale business is expected to remain challenging and the additional retail revenue will be necessary to fill factory’s capacity that we loss because of wholesale declines. Many of our challenges in the second quarter will continue in to Q3 but we are working towards being in a position to focus on improving store productivity through a combination of our internal efforts, natural maturity of new stores and hopefully the recession easing later in the year.

Our goals for 2010 will be to earn back some of the operating margin deterioration we are experiencing this year, generate cash for the business and to make sure that the brand is positioned for profitable growth when overall conditions improve.

Now, turning to the financials, for the second quarter ended June 30, 2009 total retail sales increased 13.4% year-over-year to $92.2 million as compared to $81.3 million a year ago. Total comparable store sales declined 10% on a constant currency basis versus a 23% increase in the second quarter of 2008. Comparable store sales were weakest in the US retail segment where we experienced the highest degree of cannibalization to existing stores who were also impacted by a weak consumer environment.

We ended the quarter with 272 stores, a net increase of eight stores for the quarter as compared to 195 stores at the end of Q2 a year ago. Total wholesale sales were down 17.3% for the quarter to $35.5 million from $43 million a year ago due to continued weakness among our distributor and screen printer accounts. Total online consumer sales were down approximately 3.8% for the quarter to $8.4 million from $8.7 million a year ago. The decline in online consumer sales was primary in the US market due to a significant reduction in marginally productive online ad spending which began in the third and fourth quarter of 2008 as well as well as the impact of cannibalization on our online sales as a result of significantly increased store footprint in the United States.

In the second half of 2008 the company added 39 retail stores in the US, an increase of approximately 36% in the number of stores open at the end of Q2 ’08. Gross profit for the second quarter increased by $2.3 million or 2.9% to $80.2 million. Gross margin was 59% for the quarter, an increase of approximately 40 basis points over the same period in 2008. This increase was mainly due to a favorable shift in mix from wholesale to retail sales as a decline in wholesale sales in the second quarter reduced its share of total shares from 32.3% to 26.1%.

The increase in gross margin was reduced significantly by declines in gross margin of our Canada international business segments due to unfavorable currency shifts as a result of the depreciation of the US dollar relative to last year’s second quarter. Lower capacity utilization of the company’s manufacturing facilities in light of the lower demand in the wholesale business and a higher proportion of higher mix of retail sales resulting from our continued store expansion in the US and international markets also led to this change.

The benefit of the mix shift was partially offset by lower capacity utilization and margins in the wholesale segment were negatively impacted by an increase in production of more complicated product styles. Gross margin was also negatively impacted by the declines in gross margins in the Canada international business segments due to unfavorable currency shifts.

Operating expenses for the quarter increased by $10.6 million over the first quarter of 2008 to $72.9 million. As a percentage of sales, operating expenses increased 670 basis points from 46.9% in the second quarter 2008 to 53.6% in the second quarter of 2009. Selling expenses increased $6.4 million to $45.7 million as compared to $39.3 million a year ago. As a percentage of sales, selling expenses increased to 33.6% of sales as compared to 29.5% a year ago, an increase of 400 basis points.

The major increases in the components of selling expense included an increase in rents and occupancy costs of $6.5 million and an increase in payroll of $3.1 million. This increase was offset by a decrease in advertising expenses to $2.1 million from $4.5 million a year ago and a decrease in store pre-opening expenses to $.9 million from $2.3 million a year ago.

Warehouse and distribution costs increased $400,000 to $4.4 million as compared to $4 million a year ago. As a percentage of sales these costs increased to 3.3% of sales as compared to 3.1% a year ago. This was largely due to increasing staffing levels to support the company’s increased volume of retail shipments. General administrative expenses increased $3.8 million to $22.8 million as compared to $19 million a year ago. As a percentage of sales G&A increased to 16.8% of sales as compared to 14.3% a year ago an increase of 250 basis points.

The major components in the increase in G&A were $2.6 million increase in depreciation and amortization due to a higher number of stores in operation in the second quarter of 2009 and a $1 million increase in accounting and professional fees over the previous year. Operating income for the quarter was $7.3 million compared to operating income of $15.6 million in the second quarter a year ago. Operating margin declined to 5.4% compared to 11.8% a year ago.

Consolidated adjusted EBITDA declined to $14.8 million for the quarter versus $20.3 million a year ago. Adjusted EBITDA margin declined from 15.3% to 10.9%. The reduction in operating margin and adjusted EBITDA margin was due to the effect of declining comparable store sales, declines in the wholesale business and the unfavorable impacts of the appreciation of the [inaudible].

During the second quarter of 2009 the company recognized foreign currency transaction gains of $2.8 million as compared to foreign currency transaction losses of $.5 million in the second quarter of 2008. Foreign currency gains or losses are generated by US dollar settlements of intercompany balances. The loss is primarily due to the strengthening of the US dollar during the second quarter of 2009 against almost all of the major currencies in the countries in which the company operates as well as due to the timing of the settlement of certain intercompany balances within the company’s foreign subsidiaries.

The company’s income tax provision in the second quarter was $1.2 million as compared to $3.7 million in the second quarter of 2008. The company’s effective tax rate declined to 21.3% compared to 35.2% in the second quarter of 2008. Net income for the second quarter was $4.5 million or $0.06 per diluted commons share which compares to $6.8 million in net income or $0.10 per diluted common share for the second quarter of 2008.

I will now briefly go in to the operating results for each of our four reportable business segments. Sales for our US retail business segment in the second quarter increased 15.5% to $45.1 million. Comparable store sales in our US retail division were down 22% during the second quarter. At the end of the period we operated 155 stores in the US as compared to 109 stores at the end of Q2 2008.

During the second quarter the company opened five retail stores in the US in: Malibu; the Mall at Short Hills in New Jersey; Wellington Green in Wellington Florida; and outlet stores at the Riverhead and Wrentham Outlets. Gross margin in the US retail segment declined to 73.2% as compared to 75.3% for the second quarter of 2008 as a result of increased production variances being realized by the increased production of retail styles.

Operating income for the second quarter was $3.2 million compared to $8 million in the quarter ended June 30, 2008. Operating margin for the period was 7.2% compared to 20.6% for the same period last year. EBITDA for the quarter was $6.9 million versus $9.5 million a year ago and the EBITDA margin was 15.3% versus 24.3%. Pre-store opening expenses during the second quarter for US retail were $200,000 in the quarter versus $1.1 million a year ago.

The primary drivers of the operating income and EBITDA decline were the negative comparable store sales in the quarter due to cannibalization from the new store openings in the US since the end of Q2 2008 and the increased payroll, rent, occupancy and depreciation expenses for new stores which has not reached maturity.

The sales from our Canada business segment increased by 1% to $16.7 million for the second quarter. Comparable store sales decreased 4% on a constant currency basis. At the end of the period, we operated 38 stores in Canada up from 29 stores a year ago. During the quarter we opened one location at the Von Mills Mall at the Toronto metropolitan area. Gross margin for this Canada segment declined to 55.3% from 69.2% a year ago primarily as a result of the appreciation of the US dollar relative to the second quarter of last year as most of the company’s production costs are incurred in US dollars and the impact of an increase in manufacturing variances being transferred to the Canadian subsidiaries.

For the second quarter operating income was $5.1 million versus $8.3 million a year ago. Operating margin fell to 12.5% versus 22.9% a year ago. EBITDA for the segment was $2.9 million versus $4.8 million in Q2 of ’08 and the EBTIDA margin declined from 28.9% to 17.3%. The appreciation in the US dollar and its resulting effect on reducing SG&A as presented in US dollars mitigated the decline in gross profit but was also offset by the decline in comparable store sales in the period.

Sales for the international business segment increased 11.6% to $40.6 million for the quarter. Comparable store sales increased 4% on a constant currency basis. The international segment finished the quarter with 79 stores in 18 countries compared to 56 stores at the end of the same period of last year. We opened two new store locations during the quarter one in Dresden Germany and another store in Osaka Japan which is our second store in Osaka.

Gross margin for the international segment was 66.9% versus 73% in the second quarter of ’08. Gross margin was adversely affected by the appreciation of the US dollar as well as an increase in the amount of manufacturing variances absorbed by the international subsidiaries. Our operating income was $5.1 million versus $8.3 million a year ago. Operating margin declined to 12.5% versus 22.9% last year.

Moving on the US wholesale business segment, net sales declined 18% to $33.6 million. The reduction in revenues as we mentioned was the result of continued weakness among our distributor and screen printer accounts. Online consumer sales in the US were $4.7 million for the quarter versus $5.4 million in the same quarter a year ago as a result of our significantly reduced online ad spend and also due to cannibalization from our newly opened retail locations in the United States.

Gross profit for the US wholesale segment for the second quarter increased to $10.8 million versus $10.5 million in the second quarter of ’08. Gross margin increased from 25.7% to 32.1% for the quarter largely due to a shift in mix towards higher margin online consumer sales as well as increased manufacturing variances being transferred to the retail and international subsidiaries. Increased manufacturing variances resulted due to lower capacity utilization of the company’s production facilities and the manufacturing of a greater volume of more complex retail styles.

Turning to liquidity, we finished the second quarter with $119.3 million of debt on our balance sheet and $8.8 million of cash. As of June 30, 2009 we had approximately $47 million outstanding under the US revolving credit facility and $10 million of availability. On June 30th we PIK the quarterly interest payment to Lion Capital of approximately $3 million. A the end of the second quarter the balance of the Lion Capital loan as recorded on the balance sheet stood at $60.4 million. At the end of Q2, inventories for the $159.3 million versus $147 million at the end of Q1 due to a seasonal increase in inventory levels. Capital expenditures for the period were $6.5 million versus $19.5 million a year ago.

Now, turning to our revised 2009 guidance, with our business having tracked below plan in the second quarter particularly in the back half of the quarter and based on continuing challenging conditions in both the retail and wholesale sectors we now expect net sales for the year in the range of $540 to $555 million, income from operations in the range of $25 to $30 million and net income in the range of -$1 million to $4 million. These estimates are before any non-cash stock-based compensation expense from any equity awards that may be made to employees under the 2007 performance equity plan. The company still expects approximately $20 to $25 million of capital expenditures for the year.

Also, on last quarter’s call we mentioned that the company was evaluating with our auditors the balance sheet classification of our revolving credit facility which caused us not to be able to file a 10Q for the first quarter on a timely basis. Since then the company has determined that it would need to restate its previously issued consolidated financial statements for the year ended December 31, 2008 in order to reclassify its revolving credit facility as a current liability. The restatement resulted in $33.4 million of the revolving credit facility being reclassified from long term debt to a current liability although this restatement did not have any impact on the company’s previously reported net cash flow position, revenues, net income or comparable store sales.

Earlier today we filed a 10K for 2008 which gives effect to the restatement. We also filed our 10Q for the first quarter of 2009 which is being held up because of this evaluation. These filings bring us back in to compliance with the listing rules of the NYSE [inaudible]. With that I will turn it over to Jean for Q&A.

Operator Instructions

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Todd Slater – Lazard Capital Markets.

Analyst for Todd Slater – Lazard Capital Markets

I’ve got a couple of questions, first it looks like the forex benefit, will that reverse itself in the next quarter because last quarter I think that guidance assumed a $3 million forex transaction loss for the year and now I think for the first half you’re tracking about a $1 million gain?

Adrian Kowalewski

There’s two issues that are in play because of foreign currency, the first one is the foreign currency transaction gain or loss and that’s strictly due to transfers of intercompany amounts during the time where there are changing exchange rates. In the first quarter we had a negative foreign currency exposure or foreign currency loss because we had sold merchandise to our foreign subsidiaries and since that period the US dollar appreciated so when those dollars were remitted we took a loss.

In the second quarter what we saw was the reverse of that, we saw the foreign currency depreciation against the dollar so we had the opposite impact. When those invoiced amounts, those subsidiaries remitted back to the United States they were done at an exchange rate that was more favorable and therefore we picked up a again. That’s the foreign transaction gain or loss that shows up on the income statement.

What is perhaps a bigger impact is the effect of translating the financial results for the period on the exchange rates that are prevalent during the period. So, when you look at Q2 2009 versus Q2 2008, Q2 2008 was translated at exchange rates where the dollar was at a lower level than it is today so the impact was that relative to today the results of the international subsidiaries from a revenue and EBITDA standpoint were higher. [Inaudible] where the currency was the other way where the dollar appreciate the revenue from the foreign subsidiaries and EBITA declined.

Analyst for Todd Slater – Lazard Capital Markets

So I’m just talking about the transaction, the foreign currency transactions. So, right now for the first half you’ve got about a $1 million gain for forex transactions, right?

Adrian Kowalewski

That’s because we had a $2.8 million transaction gain in the second quarter because the dollar appreciated significantly.

Analyst for Todd Slater – Lazard Capital Markets

So last quarter you had said that your full year guidance assumed a $3 million forex transaction loss so should we change that?

Adrian Kowalewski

Well, I think that given that exchange rates are very volatile in this environment, it’s very difficult to predict. I think based on where we are today I don’t think we’re going to forecast any type of change in the exchange rates. We’re basically looking at everything based on the exchange rates that are in effect today and any variance of that will bring about variances to our results. So, in our guidance that we gave of operating profit and net income were basically assuming that there’s no further impact from any transaction gain or loss.

Analyst for Todd Slater – Lazard Capital Markets

So assume no impact in the back half?

Adrian Kowalewski

Yes.

Analyst for Todd Slater – Lazard Capital Markets

Then it looks like you might have reclassified something between gross margin and SG&A in the second quarter last year, can you tell me what that was?

Adrian Kowalewski

We can go in to further detail but there were amounts that were in cost of goods sold that should have been in SG&A and they were successfully reclassed.

Analyst for Todd Slater – Lazard Capital Markets

Then could you explain a little about the US wholesale gross margins, you said that you moved some of those expenses? I guess with the lower factory utilization I would have expected US wholesale gross margins to be lower. Can you explain the movement from US to international?

Adrian Kowalewski

Because we’ve been upgrading our accounting systems and our accounting staff we’ve been better able – such as the ERP system to track the cost of inventory, as it gets shifted over to different subsidiaries. We’ve been able to track the variances much better with our new [AX] system. So, because of that we’re able to allocate those production variances to international subsidiaries.

Analyst for Todd Slater – Lazard Capital Markets

So it may make more sense if on a segment model we look at total wholesale margins instead of by country?

Adrian Kowalewski

Well we don’t break out [inaudible] on the P&L. A larger driver or also a significant driver is the wholesale gross margin in the second quarter was that because the decline in the third party wholesale business, the screen printers and distributors and those types of customers as opposed to online consumer which has a much higher margin, because there was an increased mix from online consumer sales, that has a much higher margin and if you look at just on the revenue base where we’re at we just have a higher gross margin because there’s more online.

Operator

Your next question comes from Edward Yruma – Keybanc Capital Markets.

Edward Yruma – Keybanc Capital Markets

I had a couple of quick questions about the top line guidance, it looks pretty significantly wide and particularly on the low end I’m a little bit surprised it implies a pretty significant deceleration of trends you’ve seen in the first half of the year. Can you kind of walk me through the difference scenarios that would kind of drive the high and the low end of that guidance?

Adrian Kowalewski

Well, the variables that at this point difficult to predict are first the same store sales performance through the end of the year which we’re forecasting somewhere in the range of -10% to -15% and what the impact of foreign currency is going to be because it has a significant impact on our top line. If you just look at the second quarter of this year the currency shift from the second quarter of ’08 had $9.6 million impact on our top line. So, had the currency exchange rates that had been in effect last year been in effect this year our revenue would have been higher by $9.6 million.

Edward Yruma – Keybanc Capital Markets

Could you give us a quick update on the status of your production particularly given some of the immigration issues that you suffered from? Did you see any disruption and kind of what were the expenses that were associated with that?

Adrian Kowalewski

Well, given that we received an updated communication from ICE towards the end of the quarter, it sort of had no financial impact on the second quarter.

Edward Yruma – Keybanc Capital Markets

But your guidance does embed some type – I guess maybe if you could just give us an update on kind of what impact you’ve seen?

Adrian Kowalewski

When we disclosed the ICE notice on July 1st we indicated that at the time, despite the fact that it was difficult to estimate what the impact would be on our results, we didn’t believe that it would have a material impact given the fact that we had effectively hired significant amounts of people through the end of Q2 ’08. So, with the decline in wholesale we were in a situation where we had more labor than was really justified by the amount of business or unit volume that we were seeing.

So, if we were forced to reduce our work force, the way that we would mitigate that would be by increasing the days per week of our employees on the selling force. That would virtually pick up all of the reduction in labor that we might see if we had a loss in workers. I think at this point we don’t have an update on what the financial impact would be. I think we would basically just reiterate what we said at the beginning of July which was at this point it’s difficult to estimate but we do not believe that it’s material.

Edward Yruma – Keybanc Capital Markets

My final question, I noticed that you commented that you PIK the interest on the Lion Capital note, I know you also indicated you had $10 million available under the revolver. Is there a specific targeted liquidity level? I mean, at what point do you actually make cash interest payments back to Lion?

Adrian Kowalewski

Well, I think given that we have $10 million in availability, that’s a level that’s perhaps higher than it had been in the past but I don’t believe that’s a normal cushion for most companies of our size and that going forward we would probably want to have a larger cushion of availability especially as we transition from the summer season going in to the fall where business conditions become more difficult on a seasonal basis and often advance rates on revolving credit facilities get depressed.

So, because the Lion Capital note is repayable at any time with no penalty we view it as prudent to take the PIK interest and then in the future if we have to access liquidity we would communicate that. I mean, if you would speak with our bank representatives at B of A they would probably say that we should have more availability and I think that’s right. It’s north of $10, possibly $20 million but it depends on where we are in the season as well.

Operator

Your next question comes from Mimi Bartow – Telsey Advisory Group, LLC.

Mimi Bartow – Telsey Advisory Group, LLC.

First, how should we be thinking about pre-opening expense for the back half of this year?

Adrian Kowalewski

Well Mimi, we’ve only committed to 30 stores, we’ve opened through today about 20 stores and we have four committed. So, with only about 10 stores left, Dov can speak to this but we’ve been getting very efficient about opening stores and doing so at a reduced cost. So, given that we are only opening 30 versus 80 last year I think the total store opening cost is going to be significantly less. Last year’s figure was in the range of $10 to $11 million so we’re only going to be looking at something maybe in the range of $3 to $4 million or less.

Mimi Bartow – Telsey Advisory Group, LLC.

Then just the advertising market spend, how are you guys thinking about that? You mentioned that there were some effects from pulling back there and I know Dov has kind of talked about maybe opportunistically putting some advertising back on. Could you just talk about that and how that plays in to the guidance?

Dov Charney

As far as playing in to the guidance, I would leave that for Adrian to say but I do think there are some advertising opportunities that – we need to get back in to the game of advertising a little bit better than we have been during the first and second quarter. I think if it’s carefully done it can be a revenue generator. We’re looking at billboards – again, advertising costs are down so we want to cherry pick a few things. I don’t know to what extent that it would affect the guidance by that much because we [inaudible] a lot of dollars there but we’re definitely looking to do a little bit more advertising than we have been.

Adrian Kowalewski

I think we would it in a way that it would be accretive to profitability and I think there’s an opportunity for that if we do it the right way. I don’t think, like I said, it would change our guidance.

Mimi Bartow – Telsey Advisory Group, LLC.

Then just thinking about the productivity of some of the newer stores versus – well, I guess the comp stores currently, some of the stores that are now going to fall in to the comp base and I guess some of the more recent stores you’ve opened, what are you seeing there?

Adrian Kowalewski

Well, a lot of the recent store openings have been in pretty highly productive locations. We opened at the Mall at Short Hills, we opened a store at Ala Moana Center in Honolulu so if you take them as a whole it looks like our new stores are more productive than the existing store base. It’s strictly dependent of the sample sites that you’re looking at and whether we’re going to have those types of opportunities going forward is difficult to predict.

Dov Charney

Are you asking what about the stores that are maturing now to their 13th month?

Mimi Bartow – Telsey Advisory Group, LLC.

Yes, the three classifications first is the comp store base, those that were moving in as Adrian noted in to a significant amount of stores falling in to the base and then yes, the newer stores which Adrian just commented on.

Dov Charney

It’s going to be interesting to see how it all plays out. On the optimistic side I think that the stores that hit the 13 months on one hand I’ve seen one or two of them fall in to play and they were very positive particularly I know one in Zurich is up above 30, I’ve seen that happen. But, we have to see how it comes together because not enough of them come in to play where I want to cast a definitive prediction but I feel like we could move in to a potentially positive situation on the newer stores.

A lot of it depends on the work of [inaudible] and retail managers and how they play ball in the back-to-school, Halloween and Christmas season. But, I’ve seen some signals of optimism at some locations, other locations – there are some locations that [inaudible] have been effected by the slowed economy. But, we’ll see. I’m seeing some mixed signals so I don’t want to say for sure but there have been some signs of positivity.

Operator

Your next question comes from Analyst for Todd Slater – Lazard Capital Markets.

Analyst for Todd Slater – Lazard Capital Markets

Dov, I was wondering if you could talk a little bit about some of the more fashion items that you have. For instance, some of the dresses, we’ve noticed some more of that? And then also, I guess how you feel about the brand in general? I know that the economy has been weak but based on our store checks we still see a lot of people shopping in the stores so I guess wondering how you feel about that?

Dov Charney

I think the brand is in a very strong position and we’ve been working hard to update the brand continuously. A lot of the manufacturing challenges stem from the fact that we’ve updated the product line – I think we did more updating in the – the last 15 months we’ve moved in to more product segments than we plan to go in to the next 15 months but I definitely think we’re trying to mature with our customer. It’s a little bit less [inaudible] and a more groomed look if you want to take it that way. It’s getting a little bit more preppy and cleaning up the brand a little bit in terms of trying to bring a little bit of elegance to the brand.

We’re going in to woven shirts, button down shirts for men, we’re one of the last producers in the country of the men’s made in the US button down. We’re looking also at we have developed a jacket last year that I plan to bring back this year. It’s a good winter jacket, it may not be good for the coldest days in New York but it will work for many winter days. So, just updating the brand, bring a little bit more elegance to the brand. At the same time we want to refocus on very well constructed basics.

We’re looking to clean up the store, possibly take out 1,200 to 1,500 SKUs just by selling them down to zero. Our outlet business is pretty strong right now. We’re learning now to take advantage of our outlets. We’re learning how to control our inventories better as far as making the right products at the right time. I’m very hopeful that the brand will not only continue to resonate but I think we can adopt new customers. We’re working hard to update the imagery on the website and just offer solutions to young adults as they get older and as they want to brush their hair and tuck in their shirt to get a new job as they get out of school.

That’s where we’re going with it. I feel that the index of popularity of the brand is stable and improving. That’s my thoughts. I think we’re going to be adopting more customers. As you know our sales to consumers in the world are up. We’re selling more people garment now than we were a year ago. Excluding wholesale, it’s a different situation, but we’re selling more people and I think we’ll continue to and we’re searching for ways to improve the customer experience and improve the product line all the time.

What you’ve seen in the past is one thing but the future is another. I think this brand is here to stay and I think this brand will be around in 20 years and more. We’re going to work hard to keep our customer with strong basics and we want to grow with them.

Analyst for Todd Slater – Lazard Capital Markets

Speaking of the future, your goal still is kind of that double digit operating margin?

Dov Charney

Oh absolutely. There are two things that we’ve got to do, first of all we’ve got to grow the volume of the business, we need an economy of sale at manufacturing, we’re a made in the US manufacturing. We’re competing with factories in China. Forget the fact that they have cheap labor, they are manufacturing millions of units, we’ve got to continue to grow our top line from the manufacturing efficiency point of view and we will do that. We will exploit the outlets that we have now, the supply chain we have now and we will build additional stores cautiously and that will help us achieve that goal.

As the economy improves and our ability to sell garments improve in the existing outlets we have plus growing the base of stores, I think we’ll get that economy of scale. Then, on top of that we hope to bring some efficiencies to the corporate SG&A. We are set up to do more business than we’re doing. We have the real estate, we have the management team, we have enough business structure to roll an $800 million business in spite of the fact that we’re guiding to a smaller business.

So, when the economy comes back, as we get better at doing what we do, I feel we will get back to those double digit margins. The third thing we need to do is we’re learning how we run each individual store more efficiently from planning the scheduling of employees, as far as looking at units per sale, we’re going to be looking at conversion rates, we’re going to do some traditional work that more mature retailers have done to figure out exactly what makes the customer tick and learn how to sell them better.

It might be opening the changing rooms faster, it might be learning sales techniques, but we plan to – there are three things to improve: one, is to improve the individual store productivity; one, is to improve the productivity from an SG&A point of view of talking about the corporate overhead for the retail chains; and the third thing, to improve manufacturing efficiencies all together. As those three things improve we’re going to get back to where we were pre-recession and we’re going to score a touchdown on net margins. It’s going to come and that will be one of those things I plan to achieve here to prove the viability of this business as a sustainable entity for decades to come.

Operator

That concludes today’s question and answer session. I would like to turn the call back over to Dov Charney for closing remarks.

Dov Charney

Well, I appreciate everybody’s support and I urge people to understand that American Apparel is has a complex business on its hands. We’re early in our growth phase, there’s a lot of maturity that’s going to come to the stores that we’ve opened and I think we’ve got a great opportunity. Of course, there’s some reorganization that’s taking place as a result of a changed economy but I think this changed economy is only going to make American Apparel stronger. We’re working on efficiencies, exploiting things like the ERP software we now have and learning how to manipulate it to our advantage.

The management team is growing at all levels. I believe the quality of the store staff is improving and while there are some challenges out there I believe we’re becoming more competitive and I’m looking forward as the economy improves to really take back some of the glory that we’ve had before and I think we’ll have a very good run over the next six to 30 months. It’s a very good time for American Apparel where we’re getting ready to get to a higher level.

Again, I think the company has a good foundation here and we just need to drive some more sales through the operation. There’s a top line story too, of course we want to be cautious on spending, we want to be cash positive, we want to be conservative but, we want to take advantage of opportunities because ultimately growth is very important to this company at this stage of its development. I thank everybody for coming to the call. Thank you Adrian, you worked hard and we welcome [inaudible] auditors. There’s been some challenges of course with a new auditor but we’re getting familiar with everything and it’s a good move for the company. Thank you Glenn as well and thanks everyone, all the shareholders, customers and employees. Thank you very much and we look forward to seeing you again on our next quarterly call.

Operator

That concludes today’s conference. We thank you for joining us.

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Source: American Apparel, Inc. Q2 2009 Earnings Call Transcript
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