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AMERICAN APPAREL, INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) (All dollar and share amounts in the Item 2 are presented in thousands, except for per share items and unless otherwise specified.) Overview We are a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel and accessories for women, men, children and babies. We are based in downtown Los Angeles, California. As of March 31, 2014, we had approximately 10,000 employees and operated 249 retail stores in 20 countries: the United States, Canada, Mexico, Brazil, United Kingdom, Ireland, Austria, Belgium, France, Germany, Italy, Netherlands, Spain, Sweden, Switzerland, Israel, Australia, Japan, South Korea, and China. We also operate a global e-commerce site that serves over 60 countries worldwide at www.americanapparel.com. In addition, American Apparel operates a leading wholesale business that supplies high quality T-shirts and other casual wear to distributors and the imprintable industry. We conduct our primary apparel 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 and warehousing operations. We conduct knitting operations 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 currently provide dyeing and finishing services for nearly all of the raw fabric used in production. We operate a fabric dyeing and finishing facility in Hawthorne, California. We also operate a cutting, sewing, garment dyeing and finishing facility located in South Gate, California. We operate a fabric dyeing and finishing facility, located in Garden Grove, California, which also includes cutting, sewing and knitting operations. Since 2013 we have conducted our warehousing and distribution operations out of La Mirada, California. Because we manufacture domestically and are vertically integrated, we believe this enables us to more quickly respond to customer demand and changing fashion trends and to closely monitor product quality. Our products are noted for their quality and fit, and together with our distinctive branding these attributes have differentiated our products in the marketplace. "American Apparel®" is a registered trademark of American Apparel (USA), LLC. 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 management. The following table details, by segment, the change in retail store count during the three months ended March 31, 2014 and 2013. U.S. Retail Canada International Total Three Months Ended March 31, 2014 Open at January 1, 2014 139 32 77 248 Opened 2 - 1 3 Closed (1 ) - (1 ) (2 ) Open at March 31, 2014 140 32 77 249 Three Months Ended March 31, 2013 Open at January 1, 2013 140 35 76 251 Opened 1 - 1 2 Closed (2 ) (1 ) (1 ) (4 ) Open at March 31, 2013 139 34 76 249 Comparable Store Sales The table below shows the increase in comparable store sales for our retail and online stores, for the three months ended March 31, 2014 and 2013, 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. 32-------------------------------------------------------------------------------- Table of Contents In calculating constant currency amounts, we convert the results of our foreign operations both in the three months ended March 31, 2014 and the prior year comparable periods using the weighted-average foreign exchange rate for the current comparable periods to achieve a consistent basis for comparison. Three Months Ended March 31, 2014 2013 Comparable store sales (1) (5 )% 8 % Number of stores in comparison 236 238 (1) Comparable store sales results include the impact of online store sales. Executive Summary Results of Operations Net sales for the three months ended March 31, 2014 decreased $964, or 0.7%, to $137,096 from $138,060 for the three months ended March 31, 2013 due to lower sales at our U.S. Retail, Canada and International segments. Net sales at our U.S. Wholesale segment increased by $4,315, or 9.7%, to $48,737 for the three months ended March 31, 2014 as compared to $44,422 for the three months ended March 31, 2013, driven by higher sales order volume from our existing customers. This increase was attributed to the continued strength of our product offerings and improved service levels. Additionally, in early 2013, we released a new wholesale catalog and updated the catalog with quarterly style guides. We continue our focus on increasing our customer base by targeting direct sales, particularly sales to third party screen printers. Our online consumer net sales increased primarily as a result of targeted promotion efforts and improved merchandising. Net sales for the U.S. Retail segment decreased $1,879, or 4.2%, to $42,465 for the three months ended March 31, 2014 as compared to $44,344 for the three months ended March 31, 2013, primarily due to the unseasonably cool temperatures throughout much of the country and later timing of Easter in 2014. Net sales for the Canada segment decreased $1,897, or 15.4%, to $10,460 for the three months ended March 31, 2014 as compared to $12,357 for the three months ended March 31, 2013, as a result of lower sales volumes from store closures, lower wholesale orders and the negative impact of foreign currency fluctuations. Net sales for the International segment decreased $1,503, or 4.1%, to $35,434 for the three months ended March 31, 2014 as compared to $36,937 for the three months ended March 31, 2013, due to lower sale volume in Japan and Australia as well as the negative impact of foreign currency fluctuations. Gross margin for the three months ended March 31, 2014 was 52.5% as compared to 52.8% for the three months ended March 31, 2013. Operating expenses decreased $3,875 to $79,470 for the three months ended March 31, 2014 from $83,345 for the three months ended March 31, 2013. Operating expenses include selling, general and administrative costs, and retail store impairment charges, and as a percentage of sales were approximately 58.0% for the three months ended March 31, 2014 and 60.4% for the three months ended March 31, 2013. Excluding the effects of share-based compensation and depreciation, amortization and impairment charges, operating expenses as a percentage of sales decreased from 54.2% to 51.9% from the three months ended March 31, 2013 to the same period in 2014. The decrease is due to a reduction in payroll and related costs of $1,042 from the effect of our cost reduction efforts. Additionally, tight control over advertising expenditures resulted in a decrease in advertising and marketing expenses of $1,021. Loss from operations was $7,496 for the three months ended March 31, 2014 as compared to $10,477 for the three months ended March 31, 2013. Lower sales volume was offset by decrease in our operating expenses as discussed above. Net loss for the three months ended March 31, 2014 was $5,466 as compared to $46,511 for the three months ended March 31, 2013 primarily as a result of lower operating expenses and unrealized gain on change in fair value of warrants. See Results of Operations for the three months ended March 31, 2014 for further details. Liquidity Trends As of March 31, 2014, we had approximately $16,683 in cash and $16,762 of availability for additional borrowings under the credit facility with Capital One Business Credit Corp. ("Capital One" and such facility, the "Capital One Credit Facility"). Additionally, we had $29,452 outstanding on a $50,000 asset-backed revolving credit facility under the Capital One Credit Facility. See Note 6 to our condensed consolidated financial statements under Part I, Item 1. As of April 30, 2014, we had $18,261 available for borrowing under the revolving credit agreement. 33-------------------------------------------------------------------------------- Table of Contents On March 25, 2014, we entered into the Fifth Amendment to the Capital One Credit Facility which, effective upon our receipt of net proceeds from the March 31, 2014 equity offering (see below), among other things: waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three month periods ended December 31, 2013 and March 31, 2014; reset for future periods the fixed charge coverage ratio, the maximum leverage ratio and the maximum capital expenditures allowed; added a minimum EBITDA covenant; increased the interest rate payable under the credit agreement by 0.5% per annum to either LIBOR plus 5.0% or the bank's prime rate plus 4.0% (at the Company's option); and increased the fees payable upon early termination. On March 31, 2014, we completed a public offering of approximately 61,645 shares of our common stock at $0.50 per share for net proceeds of $28,554. On April 14, 2014, we paid $13,390 in interest on the Notes. Management Plan We continue to develop initiatives to either increase sales, reduce costs or improve liquidity. In the fourth quarter of 2013 and continuing through today, significant reductions were made in payroll and related costs associated with manufacturing and administrative overhead. We also instituted a program towards the end of the first quarter of 2014 to limit capital expenditures. Additionally, we intend to continue to drive productivity improvements from our new distribution center, further reduce inventories, reduce store labor costs, and evaluate further consolidation of administrative and manufacturing functions. Efforts to identify additional ways to reduce costs and improve productivity will be ongoing. Some of our key initiatives recently completed and/or in progress include: Completed RFID implementation - As of the end of 2013, we completed the enhancement of our stores by installing sales conversion tracking device and radio frequency identification (RFID) tracking systems at all of our stores worldwide. We believe that these systems will enhance sales through improvements in stock positions and replenishment activities. New e-commerce platform - During the third quarter of 2012 we implemented a new online store platform for our U.S. online stores 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. As of the end of 2013, we have implemented this system for our Canada, United Kingdom, Europe (Euro zone countries), Australia, Hong Kong and Singapore online stores. We intend to implement this system to our remaining online stores by the middle of 2014. The new system offers a complete e-commerce software platform that speeds response times and enables us to deliver a personalized customer buying experience and 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. In conjunction with the implementation of the Oracle ATG Web Commerce application discussed above, we replaced our existing payment processing system with new electronic payment services from CyberSource. In addition, we implemented a payment fraud detection solution. We intend to complete the upgrade of our payment processing system by the middle of 2014. In addition to completing the implementation of the Oracle ATG Web Commerce application for our retail online stores, we intend to roll-out a new business-to-business online platform for our wholesale channel in 2014. The new system will improve distributors' ability to place sales order and will be mobile optimized, which we believe will enhance the shopping experience for our distributors. During 2012 and 2013 we successfully completed the virtualization of over 300 servers, including all of our key servers. We plan to complete the virtualization of our servers and move our data center to an off-site location during 2014. We believe that this not only maximizes our server resources but will also enhance system performance and enable faster uptime in a disaster recovery situation. New distribution center - In June 2012 we entered into a new operating lease agreement for a new distribution center located in La Mirada, California and fully transitioned our distribution operations into this new facility during 2013. Related to these efforts, we installed the High Jump warehouse management system for all distribution activities. Although we incurred significant transition costs and implementation delays associated with this transition, we believe that the new distribution center will contribute to processing efficiencies and effectiveness and will reduce operating expenses and cost of sales as it offers an improved distribution platform to scale both retail and wholesale sales channels. The transition to the new center was successfully completed during the fourth quarter of 2013. The center is now fully operational and labor costs have been reduced. Although we have made significant improvements under this plan, there can be no assurance that further planned improvement will be successful. 34-------------------------------------------------------------------------------- Table of Contents Results of Operations The results of operations of the interim periods are not necessarily indicative of results for the entire year. Three Months Ended March 31, 2014 Compared to the Three Months Ended March 31, 2013The 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 March 31, 2014 % of net sales 2013 % of net sales U.S. Wholesale $ 48,737 35.5 % $ 44,422 32.2 % U.S. Retail 42,465 31.0 % 44,344 32.1 % Canada 10,460 7.6 % 12,357 9.0 % International 35,434 25.8 % 36,937 26.8 % Total net sales 137,096 100.0 % 138,060 100.0 % Cost of sales 65,122 47.5 % 65,192 47.2 % Gross profit 71,974 52.5 % 72,868 52.8 % Selling expenses 54,062 39.4 % 55,463 40.2 % General and administrative expenses 24,909 18.2 % 27,804 20.1 % Retail store impairment 499 0.4 % 78 0.1 % Loss from operations (7,496 ) (5.5 )% (10,477 ) (7.6 )% Interest expense 10,039 11,214 Foreign currency transaction gain 132 713 Unrealized (gain) loss on change in fair value of warrants (12,667 ) 23,645 Other expense (8 ) (5 ) Loss before income tax (4,992 ) (46,044 ) Income tax provision 474 467 Net loss $ (5,466 ) $ (46,511 ) U.S. Wholesale: Total net sales for the U.S. Wholesale segment increased $4,315, or 9.7%, to $48,737 for the three months ended March 31, 2014 as compared to $44,422 for the three months ended March 31, 2013. Wholesale net sales, excluding online consumer net sales, increased $3,529, or 10.2%, to $38,237 for the three months ended March 31, 2014 as compared to $34,708 for the three months ended March 31, 2013, driven by higher sales order volume from our existing customers. This increase was attributed to the continued strength of our product offerings and improved service levels. Additionally, in early 2013, we released a new wholesale catalog and updated the catalog with quarterly style guides. 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 $786, or 8.1%, to $10,500 for the three months ended March 31, 2014 as compared to $9,714 for the three months ended March 31, 2013, primarily due to targeted online advertising and promotional efforts as well as improved merchandising of the web store. U.S. Retail: Net sales for the U.S. Retail segment decreased $1,879, or 4.2%, to $42,465 for the three months ended March 31, 2014 as compared to $44,344 for the three months ended March 31, 2013, primarily due to a $3,683 or 8.7% decrease in comparable store sales due to the unseasonably cool temperatures throughout much of the country and later timing of Easter in 2014. The decrease of $614 in net sales relating to closures of our six stores was offset by an increase of $1,986 from our nine new stores. Canada: Total net sales for the Canada segment decreased $1,897, or 15.4%, to $10,460 for the three months ended March 31, 2014 as compared to $12,357 for the three months ended March 31, 2013, due to lower sales in the retail and wholesale channels. Additionally, the impact of foreign currency changes contributed to the sales decrease: holding foreign currency 35-------------------------------------------------------------------------------- Table of Contents exchange rates constant to those prevailing in the comparable period in 2013, total revenue for the current period would have been approximately $11,439, or 7.4% lower when compared to the same period last year. Retail net sales decreased by $1,353, or 14.8% to $7,759 for the three months ended March 31, 2014 as compared to $9,112 in 2013. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, retail sales for the current period would have been approximately $8,485, or 6.9% lower when compared to the same period last year. Comparable store sales decreased by $281, or 3.6%, primarily due to the unseasonably cool temperatures and later timing of Easter in 2014. Additionally, the closure of retail stores in the Canada segment resulted in decreased sales of $396. These decreases were partially offset by warehouse sales during the first quarter of 2014, which generated $228 in net sales; there were no warehouse sales during the comparable quarter in 2013. Wholesale net sales decreased by $670, or 26.0%, to $1,909 for the three months ended March 31, 2014 as compared to $2,579 for the three months ended March 31, 2013. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, total wholesale net sales for the current period would have been approximately $2,088, or 19.0% lower when compared to the same period last year. The decrease is due to a tightening focus on customers that can generate higher margins as well as a dip in sales orders as a result of order fulfillment delays associated with transition issues at the La Mirada distribution center during the fourth quarter of 2013. Online consumer net sales increased by $126, or 18.9%, to $792 for the three months ended March 31, 2014 as compared to $666 for the three months ended March 31, 2013. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, total online consumer net sales for the current period would have been approximately $866, or 30.1% higher when compared to the same period last year. The increase is primarily attributable to the implementation of a new e-commerce platform for our Canadian online sales portal in late 2013. The enhanced functionality of the website drove an increase in sales orders. Additionally, sales benefited from more targeted promotion efforts and email advertising campaigns. International: Total net sales for the International segment decreased $1,503, or 4.1%, to $35,434 for the three months ended March 31, 2014 as compared to $36,937 for the three months ended March 31, 2013 due to lower sales in the wholesale and retail channels. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, total revenue for the current period would have been approximately $34,955, or 5.4% lower when compared to the same period last year. Retail net sales decreased $774, or 2.5%, to $29,678 for the three months ended March 31, 2014 as compared to $30,452 for the three months ended March 31, 2013. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, retail sales for the current period would have been approximately $29,352, or 3.6% lower when compared to the same period last year. The decrease was mainly due to the unseasonably cool temperatures and later timing of Easter in 2014. Lower sales of $736 in Japan and $484 in Australia due to lower sales order volume were partially offset by higher sales of $467 in Continental Europe as a result of new store openings. . Wholesale net sales decreased $141, or 7.3%, to $1,800 for the three months ended March 31, 2014 as compared to $1,941 for the three months ended March 31, 2013, primarily as a result of a decrease in wholesale sales in Continental Europe. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, sales for the current period would have been approximately $1,716, or 11.6% lower when compared to the same period last year. Online consumer net sales decreased $588, or 12.9% to $3,956 for the three months ended March 31, 2014 as compared to $4,544 for the three months ended March 31, 2013. Holding foreign currency exchange rates constant to those prevailing in the comparable period in 2013, sales for the current period would have been approximately $3,887, or 14.4% lower when compared to the same period last year. The decrease is primarily due to lower sales order volume for Japan, United Kingdom and Continental Europe. Gross margin: Gross margin for the three months ended March 31, 2014 was 52.5% as compared to 52.8% for the three months ended March 31, 2013. Selling expenses: Selling expenses decreased $1,401, or 2.5%, to $54,062 for the three months ended March 31, 2014 as compared to $55,463 for the three months ended March 31, 2013. As a percentage of sales, selling expenses decreased from 40.2% to 39.4%. The decrease is due to $1,042 lower distribution and selling payroll from our cost reduction efforts. Additionally, tight control over advertising expenditures resulted in a $1,021 reduction of such costs. General and administrative expenses: General and administrative expenses decreased $2,895 to $24,909 for the three months ended March 31, 2014 as compared to $27,804 for the three months ended March 31, 2013. As a percentage of sales, general and administrative expenses decreased to 18.2% for the three months ended March 31, 2014 from 20.1% for the three months 36-------------------------------------------------------------------------------- Table of Contents ended March 31, 2013. The change was mainly due to a decrease in stock compensation expenses of $2,306 and a reduction in legal and accounting professional fees of $827, partially offset by higher leased equipment expenses of $1,008. Retail store impairment: For the three months ended March 31, 2014 and 2013, we recorded an impairment charges of $499 and $78, respectively. Interest expense: Interest expense decreased $1,175 to $10,039 for the three months ended March 31, 2014 from $11,214 for the three months ended March 31, 2013, primarily due to a lower average interest rate on our debt outstanding. Interest expense for the three months ended March 31, 2014 related primarily to interest accrued on the Notes. Amortization of debt discount and deferred financing cost were approximately $597. Interest paid in cash was $1,521 and related primarily to interest on the Capital One Credit Facility. Foreign currency transaction loss: For the three months ended March 31, 2014, our foreign currency transaction loss totaled $132 as compared to a loss of $713 for the three months ended March 31, 2013. The change related to the exchange rate fluctuations of the U.S. Dollar relative to functional currencies used by our subsidiaries. Unrealized (gain) loss on change in fair value of warrants: We recorded a $12,667 gain in the fair value of the Lion warrants for the three months ended March 31, 2014 associated with the fair value measurements of our warrants. We recorded a $23,645 loss in the fair value of the Lion and SOF warrants for the three months ended March 31, 2013. Income tax provision: The provision for income taxes was $474 for the three months ended March 31, 2014 as compared to $467 for the three months ended March 31, 2013. Although we incurred a loss before income taxes on a consolidated basis for the three months ended March 31, 2014, some of our foreign domiciled subsidiaries reported income before income taxes and will be taxable on a stand-alone reporting basis in their respective foreign jurisdictions. As a result, we recorded a provision for income tax expense for the three months ended March 31, 2014. There were no charges or benefits recorded to income tax expense for valuation allowances. 37-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources As of March 31, 2014, we had approximately $16,683 in cash and $16,762 of availability for additional borrowings under the credit facility with Capital One Business Credit Corp. ("Capital One" and such facility, the "Capital One Credit Facility"). Additionally, we had $29,452 outstanding on a $50,000 asset-backed revolving credit facility under the Capital One Credit Facility. See Note 6 to our condensed consolidated financial statements under Part I, Item 1. As of April 30, 2014, we had $18,261 available for borrowing under the revolving credit agreement. On March 25, 2014, we entered into the Fifth Amendment to the Capital One Credit Facility which, effective upon our receipt of net proceeds from the March 31, 2014 equity offering (see below), among other things: waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three month periods ended December 31, 2013 and March 31, 2014; reset for future periods the fixed charge coverage ratio, the maximum leverage ratio and the maximum capital expenditures allowed; added a minimum EBITDA covenant; increased the interest rate payable under the credit agreement by 0.5% per annum to either LIBOR plus 5.0% or the bank's prime rate plus 4.0% (at the Company's option); and increased the fees payable upon early termination. On March 31, 2014, we completed a public offering of approximately 61,645 shares of our common stock at $0.50 per share for net proceeds of $28,554. On April 14, 2014, we paid $13,390 in interest on the Notes. Over the past years, our operations have been funded through a combination of borrowings from related and unrelated parties, bank and other debt, lease financing, proceeds from the exercise of purchase rights and issuance of common stock. As discussed under Management Plan above, we continue to develop initiatives intended to either increase sales, reduce costs or improve liquidity. In the fourth quarter of 2013 and continuing into January of 2014, significant reductions were made in payroll and related costs associated with manufacturing and administrative overhead. We also instituted a program towards the end of the first quarter of 2014 to limit capital expenditures. Additionally, we intend to continue to drive productivity improvements from our new distribution center, further reduce inventories, reduce store labor costs, and evaluate further consolidation of administrative and manufacturing functions. Efforts to identify additional ways to reduce costs and improve productivity are ongoing. Our principal liquidity requirements are for working capital interest payments, capital expenditures and to fund operations. We fund our liquidity requirements primarily through cash on hand, cash flow from operations and borrowings under our credit facilities. Our credit agreements have from time to time contained covenants requiring us to meet specified targets for measures related to earnings, limits on capital expenditures, minimum fixed charge coverage ratios and maximum leverage ratios, and our inability to achieve such targets or to obtain a waiver of compliance would negatively impact the availability of credit under those credit facilities or result in an event of default. We believe that we have sufficient financing commitments to meet funding requirements for the next twelve months. |