Wednesday, May 19, 2010

American Apparel off 30% on earnings warning, debt warning...(APP)

Shares of American Apparel (APP) are down big today, after preliminary results for the March quarter showed gross margins 7% lower than the prior year period. The company announced that they will continue to spend like drunken sailors, unconcerned that it may lead to breaking their debt covenants.

From the press release:
American Apparel reported net sales for the first quarter ended March 31, 2010 of $121.8 million, a 6.6% increase over net sales of $114.3 million for the first quarter ended March 31, 2009.
Gross margin for the first quarter of 2010 was 50.4% as compared to 57.2% for the prior year first quarter. Gross margin was negatively impacted by a shift in mix from retail to wholesale net sales, which generate lower margins, and by reduced labor efficiency at the company’s production facilities in the first quarter of 2010 compared to the prior year period. The reduction in labor efficiency was a result of the dismissal of over 1,500 experienced manufacturing employees in the third and fourth quarters of 2009 following the completion of an I-9 inspection by U.S. Immigration and Customs Enforcement, as well as the impact of an increase in the mix of more complex retail styles produced. The unfavorable decline in gross margin was partially offset by the effect of the depreciation of the U.S. dollar versus foreign currencies in the first quarter of 2010 as compared to the first quarter of 2009.
Operating expenses for the first quarter of 2010 were $79.0 million, or 64.9% of net sales, as compared to $69.3 million, or 60.6% of net sales for the prior year period. The increase in operating expenses was primarily caused by increased occupancy, payroll, and depreciation expenses from having an additional 16 retail stores in operation at the end of the first quarter of 2010, compared to at the end of the first quarter of 2009.
Sooo, the company went ahead and spent an extra $10million in operating expenses, knowing full well that it could result in covenant violations. Hmm, how about some math. Gross margin of 50.4% on $121million in sales is about $61million in gross profit. Then subtract $79million in operating expenses and you're looking at an "operating" loss of 25cents per share, versus the consensus estimate at -11cents. To be fair, there's only 2 estimates out there...

While the company's founder Dov Charney see's his firm as an "industrial revolution," it's turned out to be more of an industrial wreck. Featured prominently on the company's site is their LA-based workforce, a refreshing change from the recent focus (no doubt by the pervert founder) on the "best bottom" promotion.

The company's discussion of breaking their covenants, as well as the "highly uncertain" sales trends basically everywhere they do business:

As of March 31, 2010, based on the preliminary financial results for the first quarter of 2010, the company was in compliance with all covenants under its credit facilities. However, based on the company’s preliminary financial results for the first quarter ended March 31, 2010, and based on existing trends, the company anticipates that it will not be in compliance with the Total Debt to Adjusted EBITDA covenant under its credit agreement with its second lien lender at June 30, 2010. The company plans to continue to work with the second lien lender to obtain the appropriate amendments prior to the anticipated covenant default; however, the company can provide no assurances that it will be successful in securing such amendments or, if secured, the terms thereof. Additionally, noncompliance with financial covenants under the company’s second lien credit agreement constitutes an event of default under the terms of the company’s U.S. revolving credit facility, which could result in the company being unable to make borrowings under its revolving credit facility, and potentially both credit facilities being declared immediately due and payable. There can be no assurance that if either or both of these events were to take place, that the company would be able to obtain the additional sources of liquidity required to continue operations.
Based on the continued uncertainty regarding the reduced manufacturing efficiency being experienced at the company’s production facilities, due to the impact that the projected covenant non-compliance at June 30, 2010 may have on the company’s ability to carry out its operating plan for 2010, and due to highly uncertain sales trends in the company’s different sales channels, the company is deferring providing financial guidance for 2010 until it can better ascertain the impact of these factors on its projected financial performance for the year.
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