American Apparel suffers growing pains

American Apparel Inc., the Los Angeles clothing maker and retailer known for its colorful fashions, racy advertising and outspoken chief executive, is fraying at the edges.

The company's fourth-quarter profit plunged 21% to $3.05 million, and its stock closed Thursday at $3.16 -- less than half its high of $6.97 late last April. By comparison, rivals such as H&M, Gap and Urban Outfitters in the young-adult sector are performing well.

Analysts say that though competitors rode out the recession by selling cheaper clothes, the pricey urban-chic clothier offered few discounts or deals. Lenders kept a tight leash on costs, causing the company to struggle to expand. And manufacturing efficiency has slowed ever since American Apparel was forced to dismiss 1,500 workers from its downtown Los Angeles factory in September.

"The core fundamentals continue to deteriorate," said Lazard Capital Markets analyst Todd Slater in a report last week. Like other industry experts, he is skeptical about the company's current financial health but remains a believer in its "long-term viability."

Chief Executive Dov Charney acknowledged the company's difficult position amid the nation's stubborn economic downturn, but he is optimistic.

"There are a lot of things we learned from this year," Charney said. "It's a very sophisticated business model, but it's in its infancy. There's probably another five years of work here before we can say that we've landed the plane."

Among his intended tactics: bringing talented replacement workers up to speed, making factories more productive and attracting more sales to existing stores. Charney bristles at suggestions that the brand is straining to stay afloat.

"It's so silly -- we're a flourishing, growing company," Charney said. "American Apparel has had a positive cash flow this year. I'm producing, I'm making, I'm opening stores."

Though American Apparel carries many classic, basic items for men and women in its 281 stores, it's better known for risque collections, including lace bodysuits and skintight leggings that are often sprawled across edgy billboards.

On a recent weekday afternoon, the population at the American Apparel store on Melrose Avenue consisted of mostly mannequins and a few shoppers.

Amid the thumping hip-hop music, shopper Natalie Tran, 24, of South Pasadena said she has been visiting the chain for six years. She thinks the advertisements are "scandalous but brilliant" and loves the "simple and basic items that everyone needs."

"It's overpriced for what it is -- $30 for a plain white T-shirt is kind of ridiculous," she said. "But it's something about the cut and material that keeps making me want to buy it."

The company is anticipating a 10% slip in same-store sales, or sales at stores open at least a year, in the first quarter, which ended Wednesday.

Same-store sales fell 7% in the fourth quarter and 10% for the year.

Executives still have "a great deal of work ahead" to restore the business to "prior levels of productivity," Chief Financial Officer Adrian Kowalewski said in a conference call last week about the company's plummeting fourth-quarter earnings.

The challenging year, which included a "difficult consumer environment," a fluctuating dollar and a sharp decline in wholesale sales, was a sharp contrast to 2008.

As other clothing retailers sank deeper and deeper, American Apparel was raking in stellar same-store sales. Sales jumped 25% in July 2008 compared with a year earlier and continued a double-digit growth streak through October, according to the International Council of Shopping Centers.

But the firm's blistering growth took its toll last year when a slew of new stores had a "cannibalization" effect on older locations, Kowalewski said. Internationally, the chain has opened 147 locations and closed just 13 since early 2007.

The company's fourth-quarter earnings report issued last week showed American Apparel heading from one rough financial quarter directly into another while competitors such as Gap Inc. and Urban Outfitters Inc. are starting to enjoy healthier sales and stock performance.

The company's insistence on maintaining high prices during a recession didn't help. A simple ribbed tank top that costs $17 at American Apparel goes for as low as $5 at Gap.

Though Charney said the unemployment rate had wreaked havoc with his clientele, he said that avoiding markdowns and deals was "a creative choice." Still, stores are now offering some discounts for bulk purchases.

"We felt we had reasonable prices," he said. "But we're still searching for what to do, being more careful about what we produce."

U.S. Immigration and Customs Enforcement last year found that many employees at the downtown facility appeared to be unauthorized to work in the U.S. As a result, Charney said, the company lost more than 2,000 workers overall.

Charney, a Canadian native who is a vocal proponent of legalizing undocumented workers, initially said that business would barely be affected. He has since changed his tune, now saying that the personnel cuts were "a big setback" to the company and its plans to make more sophisticated products.

Financing has been no breeze either, he said. British private equity firm Lion Capital, a major shareholder, has kept a vise-like grip on American Apparel's finances, so landing and making investments has been difficult, analysts said.

Lion, which declined to comment, gave American Apparel an $80-million infusion last year to pay off a problem debt that in late 2008 had pushed Kowalewski to e-mail a colleague about a potential bankruptcy.

In documents filed with the Securities and Exchange Commission on Wednesday, the retailer said its debt situation could limit its ability to add stores and product lines while making it more vulnerable in downturns.

The economy has been hard on the company and its balance sheet is still under pressure, said Edward J. Yruma, an analyst with KeyBanc Capital Markets. "But long term, it's a compelling growth story," he said.

Charney, who opened his first store in 2003, said the American Apparel model of local manufacturing and distribution in Los Angeles is still a "futuristic" concept that is competing with brands that have been around for decades as well as with cheaper Asian producers. But it's also a "first mover, a kind of West Coast pioneer approach."

The same is often said of Charney, an eccentric character with his ubiquitous aviator glasses and, staff members say, often less-ubiquitous clothes. The provocative executive has held meetings in his underwear and has also been the subject of several sexual harassment and wrongful-termination lawsuits. Most were dismissed or dropped; one was settled out of court, and another is pending.

"All of the California-based companies looked crazy in the beginning," Charney said. "But there are many, many chapters left in this story. I think we're going to have a great year."

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