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The Complicated World of American Apparel

American Apparel — a retailer best-known for its sexy ads and controversial leadership — achieved a 10 percent comps improvement for the full 4th quarter.

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American Apparel’s ads often feature company employees and an aesthetic that glamorizes imperfection.

Courtesy Photo

Dov Charney believes these new leotards will be hot sellers.

Dov Charney believes these new leotards will be hot sellers.

Courtesy Photo

A self-portrait by Dov Charney.

A self-portrait by Dov Charney.

Courtesy Photo


Amidst the current retail meltdown, one specialty retailer that has managed to keep its sales up like a pair of spandex-infused leggings is American Apparel. Last week, as most retailers announced dismal December same-store sales — including double-digit declines at competitors such as Abercrombie & Fitch, Gap and Pacific Sunwear — American Apparel managed to pull out a 3 percent gain. For the full fourth quarter, the Los Angeles-based maker of colorful fashion basics posted a 10 percent comps improvement, even as holiday sales industrywide tanked.

Not only have American Apparel’s existing stores been remarkably resilient in the downturn, but the company also has been investing heavily in an ambitious retail expansion. Last year, it opened 81 stores in locales ranging from Scottsdale, Ariz., to Shenzhen, China, bringing the brand’s total door count to 260 stores in 19 countries.

“I think we’ve struck a chord in American culture,” said Dov Charney, who founded the company in 1997 as a blank T-shirt maker and opened his first branded store just five years ago in Echo Park, Calif. “I think it’s about authenticity, in the way that Levi’s is authentic.”

American Apparel’s resonant brand appeal stems largely from a unique business model and deft marketing strategy fashioned by the energetic, voluble and controversial Charney, who is both the company’s chief executive officer and guiding light. Unlike its peers, American Apparel is a vertically integrated manufacturer, wholesaler and retailer that produces all of its garments domestically in Los Angeles — an impressive feat in an era when even iconic Levi Strauss shuttered its last North American factories in 2003. The retailer says it is the largest sweatshop-free apparel manufacturer in North America, pays the industry’s highest factory wages and provides health care benefits for all its line workers. The company emphasizes this socially responsible production process in its marketing, and that halo has hit a nerve with the brand’s hip, urban consumer base.

Looming in the background of this appealing business story, however, is a salacious group of well-documented lawsuits, both new and old, which long have been virtual catnip for the tabloids and mainstream business press. The multiple suits have painted American Apparel as a singular company not for its innovative sourcing strategy or muscular growth trajectory, but rather for an allegedly sexually charged workplace where Charney runs amok in his underwear, regularly harassing female employees.

Further, in two new suits filed in November and December, two former employees — Bernhard-Axel Ingo Brake, the former managing director of much of American Apparel’s European operations, and Robert Hernandez, a former IT worker at the company’s Los Angeles headquarters — ratchet up the charges by including claims of financial malfeasance, in addition to the oft-repeated stories of Charney’s alleged indecorous behavior. The new charges come at a particularly sensitive time for the company, because, despite its impressive top-line growth, American Apparel carries a large debt load and, like many of its competitors, is being squeezed by the current credit crunch. The company is in the midst of negotiating new financing arrangements, and its legal entanglements and the attendant publicity can’t exactly help its image with lenders.

During its years battling these lawsuits, American Apparel and Charney – who still owns 50 to 55 percent of the firm – vigorously have denied the charges against them, and none of the cases have ever reached a final verdict. (However, the company maintains a $20 million insurance policy to cover possible liabilities related to employment suits.) Charney, 39, has remained largely unapologetic about his unconventional management style — which includes living with young subordinates in a Los Angeles mansion and serving as the company fit model for the underwear design process — chalking it up to the looser mores and creative atmosphere of the fashion industry in general, and his company in particular. However, since going public in December 2007, American Apparel has faced more serious ramifications from the multiple lawsuits as they potentially impact not only its business relationships but also its stock price.

“I think they’ve taken a lot of time away from people who work at this company. It’s a nuisance and a distraction,” said Charney of the legal issues, which he and his lawyers emphatically characterize as ambulance-chasing by disgruntled employees and opportunistic lawyers, all out to make a quick buck off the American Apparel gravy train. “The worse thing you can do is try to employ sexual shame tactics. Is this what JFK had in mind for Title VII?” he asked, referencing the section of the Civil Rights Act of 1964 that created protected classes and allows workers to sue for sexual harassment.

Ironically, it’s American Apparel’s carefully calculated, sexually expansive branding that might have contributed to much of the publicity surrounding the lawsuits. Overlaid on the company’s image as a socially progressive manufacturer is a more controversial element stoked by its provocative advertising, much of it lensed by Charney himself. The campaigns — which abound in indie magazines and zines, on billboards in urban centers and increasingly on style-centric blogs — feature nubile models in come-hither poses sporting American Apparel’s underwear, leotards and tank tops. (A recent spate of ads, however, are more notable for what’s not being worn than what is.) The campaigns are a hipster riff on the hormone-drenched tactics that have bolstered brands such as Calvin Klein and Abercrombie & Fitch, but unlike the airbrushed-to-perfection aesthetic of the latter two, American Apparel embraces a more democratic, downtown ethos.

“American Apparel has always had at its core a very distinct aesthetic — one based in reality and accessibility that does not shy from the things that make us human, including our flaws,” explained Marsha Brady, a creative director at the company. Indeed, the models used in the ads are often American Apparel employees, shot in the raw, intimate style of faddish photographers such as Terry Richardson and Ryan McGinley.

Whatever its effect on his legal headaches, Charney isn’t backing away from his sexually suggestive branding. After all, it’s been remarkably successful in imbuing the company’s simple, minimally designed basics with an aura of youthful vitality and effortless cool. Clearly, Charney is an astute reader of the cultural zeitgeist, and American Apparel speaks to a sweet spot among Generations X and Y: style-savvy consumers coming of age in the dress-down Internet era, who want clothes that allow their own personalities to come through, rather than a logo or other identifiable designer flourish. Never mind that the American Apparel look — comfortable but colorful basics with a retro Seventies or Eighties flair — has become somewhat of a uniform itself at this point.

It’s this focus on a youthful, urban demographic that has helped the company weather the current economic downturn better than most, according to Charney. (Urban Outfitters stores, which target similar consumers, also have posted positive comps throughout the downturn.) “American Apparel is dealing with metropolitan adults. Our customers are educated, sophisticated, creative types who adapt to economic dislocation,” Charney explained. “They don’t own cars. They don’t own stocks. They probably don’t have a lot of dependents. They don’t have a lot of savings, but they probably don’t have a lot of debt, either.”

The company’s stores, like its merchandise and advertising, embrace a practical aesthetic with both modern and retro influences. “Our shops take as much inspiration from the comical hard sell of sex shops as they do from high-tech and the Italian Radical Architectural groups of the late Sixties and early Seventies,” noted Brady. “We don’t spend fortunes on custom fixturing — we use the standard gridwall displays that are universally available to the point of seeming banal. But in the right hands, a basic set of elements can be used to create a very distinct environment that is at once simple and sublime.”

Brady pointed out that the American Apparel consumer tends to spend a lot of time online at sites such as Craigslist and Facebook, which present information in a very simple interface. “This demographic is not accustomed to spending time in environments that are too grand,” she noted.

The retail formula has worked for American Apparel, and its stores that have been open for at least a year average $1.5 million in sales annually, with newer stores performing “above plan,” according to the company. And, while the company’s strict domestic sourcing is costly, gross margin in U.S. stores was a healthy 76.2 percent of sales in the most recent quarter. Companywide, including the lower-margin wholesale segment, it was 50.1 percent.

To fuel growth and keep the brand relevant, Charney is aiming to slowly expand American Apparel’s product offerings — a move he feels is important as his consumer base grows older and less interested in flashy fashions. Now, along with its core assortments of underwear, T-shirts, hoodies and socks, the company has rolled out acid-wash jeans, classic oxford shirts and even peacoats. “I’m desperate to make a cool men’s pant,” said Charney of his latest obsession.

But, despite a newer focus on evolving into more categories, Charney emphasizes that the enduring key items, which customers can repeatedly replenish and come back to for more colors, remain central to American Apparel’s success. “It’s not about a flash in the pan. It’s about something that will last for years. That’s the dream,” he explained. Right now, Charney is particularly hot on high-cut leotards for women, which he thinks are going to be the next big thing.

Another key to American Apparel’s merchandising strategy is that, by and large, it’s a seasonless store. “It’s always spring in here,” said Charney. “We sell stuff year-round. If you try to make too much stuff for winter, that’s when you get in trouble.”

While product rarely goes on sale in American Apparel stores, the company does operate a handful of closeout stores to dispose of out-of-season merchandise, including one at its Los Angeles headquarters and units in Napa and Gilroy, Calif., among others. Additionally, the American Apparel e-commerce site is used as another outlet for older product, according to a spokesman.

Still, Charney would rather warehouse something that’s not selling — midriff-baring T-shirts, for example — and offer them again at a later date when they’re trendy again, as those midriff Ts are right now. He also will take nonsellers and alter them — such as transforming a long skirt into a miniskirt — and restock the items at full price.

Microtransfers of product between stores is another important merchandising tactic, added Charney, with styles selling poorly in one store moved to another where they might sell better. “There’s always one store where something will be really trendy,” he explained — his irrepressible inner merchandiser coming alive — “like these amazing nylon pants that, out of nowhere, started checking out of Washington, D.C. — like 200 to 300 a week. Every skinny, hip, young man wanted them. It was like an epidemic. It was a Malcolm Gladwell moment. Stuff like that happens.”

While American Apparel has carved out a remarkable niche in the fashion retail landscape — who else could unload several hundred pairs of skinny men’s nylon pants so quickly? — the company also is undergoing challenging growing pains. Last month, the firm faced a serious liquidity crisis and was involved in a high-stakes renegotiation of its loans, which have helped support its retail growth. Moreover, the company is looking for additional financing, a tough task in today’s unforgiving credit market.

As of Sept. 30, the company had a total of $111.6 million in debt and $13.9 million in cash on its balance sheet. Of that debt, $51 million is a loan owned by SOF Investments, and the remainder is part of a $75 million revolving credit facility with Bank of America.

Under terms of the Dec. 19 refinancing, American Apparel extended the maturity date of its SOF loan by three months to April. In exchange, American Apparel is limiting capital expenditures to $17.8 million this year, and is paying SOF fees of $2.6 million plus one million warrants exercisable at $3 a share, with the possible addition of two million more warrants if it doesn’t raise $16 million more in financing by March.

Additionally, American Apparel is paying Bank of America an undisclosed fee and a 200 basis point increase on its credit facility. Crucially, if American Apparel cannot successfully extend or refinance its credit agreement with SOF by March 21, all of its Bank of America obligations would immediately become due, causing yet another liquidity crisis.

“The terms are tougher,” acknowledged Charney of the company’s new borrowing arrangements. He remains confident that additional financing will come through this winter, but it may come at a cost. Last month, retail analyst Todd Slater of Lazard Capital Markets reduced his 2009 earnings per share estimate to 51 cents, down from 60 cents, with 5 cents of the decrease related to the higher financing costs, and 4 cents related to lowered sales estimates in both retail and wholesale. Slater said the refinancing terms were under “conditions reserved typically for extremely distressed entities.”

Still, Slater remains bullish on the company and believes its creditors will continue to support it, as American Apparel is more valuable to them as a going concern than a bankrupt one. He is predicting 2009 revenues will increase 16 percent and earnings before interest, taxes, depreciation and amortization should advance 25 percent. “American Apparel is one of the top growth retail brands. It is gaining in global cachet, with the potential to quadruple its base to 800 stores,” he wrote in a Dec. 22 note. “The company’s popularity spans a wide variety of cultures and attracts a well-insulated, metro-centric demographic.”

Charney believes he can reach that goal of 800 stores in five to eight years, but for 2009, the company is slowing retail expansion to focus on enhancing the performance of its existing assets – plus it doesn’t have the cash to open as many stores. This year, the firm plans to open 20 or fewer stores. “Our overriding goal for 2009 is to generate free cash flow from operations,” emphasized Adrian Kowalewski, chief financial officer, on a conference call with analysts in November.

Cost savings were behind the layoffs of several hundred workers over the past few months, after the company hired about 2,300 new employees earlier last year. Due to its unique sourcing strategy, American Apparel’s employee head count is large compared with that of competitors. The company employs 10,000 workers while generating $786.5 million in total revenue for the trailing 12 months ended Sept. 30. In comparison, J. Crew employs a workforce of just 8,700 while generating $1.44 billion in revenue, and Polo Ralph Lauren employs 15,000 workers and generated $5.05 billion.

Asked if the company can profitably grow a business built on selling fashion basics at a relatively low price while maintaining high-cost domestic manufacturing, Charney is optimistic that he can. However, he doesn’t dismiss the idea of moving some sourcing outside the U.S. if necessary, noting he’d be willing to produce in China if the company could re-create the same working conditions it has in Los Angeles. “I think the idea of America is a global one,” he explained.

In a powerful gesture of appreciation to its workers, American Apparel in the most recent third quarter distributed 1.9 million shares of company stock to its manufacturing employees, and is distributing 800,000 shares to administrative and retail employees in the current fourth quarter. The stock distribution depressed third-quarter earnings to $2.3 million, down from $6 million in the year-ago quarter. Excluding the $13.2 million in onetime costs related to the stock distribution, earnings climbed 85 percent to $11.1 million, as total sales advanced 45.2 percent to $154.8 million.

Charney is particularly mindful of the shares his employees now hold when discussing the pending lawsuits against him and the company, as he believes the suits have impacted the value of American Apparel stock. (Shares closed on Friday at $2.39, down from a 52-week high of $13.25.)

Bearing the brunt of Charney and his lawyers’ animus is Keith A. Fink, a Los Angeles attorney who they charge has created a cottage industry of suing American Apparel on behalf of disgruntled former employees, and counting on the negative media reports to drive the company into settling out of court. Fink is representing four plaintiffs in California state court against American Apparel: the aforementioned Brake and Hernandez; Mary Nelson, a former sales rep who filed suit in 2005, and Nikki Yang, a former custom order manager, who filed suit last month. Fink also is involved in additional arbitration cases against American Apparel, which he declined to detail.

Other cases pending against American Apparel but not filed by Fink include an employment discrimination case filed in California Superior Court last summer by Jeneleen Floyd, a former public relations employee who is represented by noted feminist attorney Gloria Allred, and a case now in arbitration filed last summer by former employee Chris Renfro.

At times, Charney seems worn down by the ongoing lawsuits, which charge him and American Apparel with a range of misconduct, from creating a hostile workplace environment to wrongful terminations, breach of contracts and intentional infliction of emotional distress. He compared his legal travails with both President Bill Clinton being doggedly pursued by special prosecutor Kenneth Starr and, in perhaps a less favorable analogy, to Michael Jackson’s multiple legal battles involving allegations of sexual misconduct.

American Apparel and Charney are vigorously contesting the suits against them, and the company has two suits of its own pending against Brake and Yang. Additionally, the company has set out on a determined mission to raise questions about Fink, who has been an intractable thorn in the side of American Apparel since 2005.

“We are not sitting back anymore. We are taking a proactive stance,” said Joyce Crucillo, general counsel of American Apparel. “These lawsuits are baseless, and we will not succumb to shakedown attempts for quick settlements.”

In both the Hernandez and Brake cases, the plaintiffs claim American Apparel engaged in attempted fraud, financial irregularities and other illegal activities. In the latter case, Brake — who was the managing director of American Apparel’s operations in Germany and eight other European markets for five years, until he was fired in September — claims he was terminated because he repeatedly complained about illegal employment practices in the company’s European stores. He also charges that the company did not want to pay him the more than $1 million in commissions and bonuses that Charney allegedly promised him over the years.

In his complaint, Brake, 53, alleges that the company paid parts of employee compensation under the table to avoid taxes, and provides e-mails that help support that claim. He also highlights the alleged incompetence of a group of young female employees, whom he dubs “Dov’s girls” or “friends of Dov,” who allegedly receive preferential treatment and illegal monetary payments from company funds, while lavishly wasting American Apparel resources, because of what he claims are sexual relationships with Charney.

“The tasks assigned to his ‘girls’ resulted in the mismanagement of the retail store operations to the financial detriment of American Apparel and its shareholders in the hundreds of thousands of dollars,” Brake charged in his filing.

One of those “girls” is Brady, who joined the company in 2004 and now oversees retail expansion in certain European, Asian and U.S. markets. In a seven-page e-mail to WWD, she responded that many of the most prurient claims in Brake’s complaint were not related to the actionable legal claims he filed against the company. “It should be clear to any reasonable person that these accusations were maliciously included to fulfill some kind of personal vendetta,” she wrote. “The notion that we are being run like some sort of harem or anything other than an efficient business doesn’t pass even the most basic logic test. Our company has expanded to 19 countries in less than five years, all while managing to pay the best wages and benefits in the industry. If these preposterous allegations were even remotely true, the company would never have accomplished what it has.”

In its own suit against Brake — which was filed in October in Germany, two months before Brake filed his suit in Los Angeles — American Apparel charges that the former managing director embezzled well over 250,000 euros, or $342,250 at current exchange, from the company, which was the reason for his termination. The retailer alleges that he misused company credit cards, bought personal items such as a washer and dryer with company funds and received kickbacks from construction companies involved in building out American Apparel’s European stores.

Brake denied taking kickbacks and said employees were authorized to use company credit cards for personal charges as long as they reimbursed the firm.

The American Apparel suit also claims that Brake hired his mistress, Irene Cuppone, and overpaid her by putting her on two separate payrolls in Germany and Switzerland, while also leasing an apartment and car for his gravely ill wife with company funds. Similarly, the suit charges that Brake hired his daughter, Annina Brake, to work in a retail store and paid her large, unwarranted bonuses in another effort to enrich himself.

In an interview, American Apparel’s general counsel Crucillo, 38, questioned Brake’s claim that Charney verbally promised him a three percent commission on all international sales. “If someone promised you a commission like that, wouldn’t you get that in writing somewhere along the way? In an e-mail, or at least on a napkin?” she queried.

Fink, meanwhile, counters that American Apparel trumps up claims against litigants who have legitimate grievances against the company. “American Apparel is a gorilla that will stop at nothing,” he fumed. “They’ll hatch any claim to try to get some media spin on these cases. Ninety-nine percent of lawyers pass on these cases, but I’m the one guy who stands up to them. They attempt to demonize people. Isn’t it interesting that every person who sues them is then painted as a poor employee?”

Indeed, American Apparel has claimed that Hernandez was a substance abuser who was terminated during a companywide layoff due to poor work performance. Hernandez, who worked with the accounting department but was not an accountant, is suing American Apparel for wrongful termination. He alleges that he was fired in 2006 after he refused to pad inventory figures that would make the company appear more profitable while it was in the process of going public. In its official answer to the Hernandez complaint, American Apparel provided documentation from supervisors criticizing Hernandez’s work performance.

As in the Brake case, Hernandez’s suit includes a litany of salacious allegations that, if true, paint a picture of a bizarre and stressful work environment. He charges he was forced to meet with Charney while the latter was nude, showering or even defecating. Charney also is said to operate a workplace littered with pornography, constant verbal abuse of women and expletive-laden screaming jags at employees.

In the Yang case — where the former customer order manager is suing for sexual harassment, as well as company stock and money she alleges Charney promised her — she repeats similar claims, throwing in allegations of physical abuse. Charney and Yang were romantically involved at one point (Yang details Charney’s alleged fetish for Asian women in her court papers), but she later married another American Apparel employee.

American Apparel has filed a suit of its own against Yang for unjust enrichment and fraud. Both sides essentially agree that Yang was an important early employee of American Apparel, who helped the company through its initial lean years by using her personal credit to help tide the company over during cash shortages. However, American Apparel charges that Yang’s work performance deteriorated dramatically in later years as her demands for compensation increased, as did unauthorized personal purchases with company funds, which led to her termination.

“She asked me for a $5 million loan after she was fired. Would you ask someone who sexually harassed you for a loan?” said Charney of Yang.

Fink has yet to win any American Apparel money for his clients — or to help pay off the millions in legal fees he is owed from the almost four years of litigation — but the clothing maker has settled cases in the past. In 2005, it settled a sexual harassment case brought by former employees Heather Pithie and Rebecca Brinegar for an undisclosed sum. Another suit brought in 2005 by former employee Julie Carrozzi was dismissed by a judge at the request of the plaintiff.

Fink’s oldest case, involving Mary Nelson, who is suing for sexual harassment and unlawful termination, was on the brink of a $1.3 million settlement last year. However, that deal fell apart in a somewhat complicated and unseemly manner after Nelson and Fink decided not to follow through with an arbitration hearing where it was predetermined that American Apparel would be absolved of any wrongdoing, and could then publicize that fact. Fink dubbed the proceedings a sham, but American Apparel claims it was Fink’s idea in the first place in order to secure the settlement.

The case is now back in arbitration (without a predetermined outcome), but American Apparel received plenty of negative press when the somewhat fishy-looking deal came to light. The company claims it agreed to the settlement only to expedite a vexing court case, and not as an admission of any wrongdoing.

Discussing the multiple suits against American Apparel, Crucillo pointed out that plaintiffs and their attorneys are protected by “litigation privilege” and can allege almost anything they want in a complaint, with immunity from defamation claims. “Courts don’t want people to be afraid of making legitimate claims,” she explained. “But that opens the door to abuse, and when the media reports on the claims that are baseless, some people will believe it.”

To help combat the rash of suits against it, American Apparel now requires all employees to agree to mandatory arbitration in any employment disputes. It also has resorted to some brass-knuckle tactics against Fink, digging up old cases where he has been sued by his own clients and sending them to journalists. Additionally, a Google search of Fink’s law firm, Keith A. Fink & Associates, turns up several paid anti-Fink sites, including one titled “The Worst Lawyer Ever.” Fink said he has evidence to suggest that American Apparel is behind those sites, and he is planning to file a defamation suit against American Apparel.

Most recently, American Apparel bought a full-page ad on Thursday in The Daily Bruin, the college paper of UCLA, where Fink teaches a class, lambasting the attorney. In the ad, a portrait of Fink is accompanied by the headline, “The Lawyer Who Confirms All Bad Stereotypes About Lawyers.”

Charney may feel that the insulting and intrusive advertisement is fair payback for the public humiliation Fink’s lawsuits have helped heap on him — as in a recent “Saturday Night Live” skit that had Fred Armison playing Charney, lasciviously rubbing himself all over “Weekend Update” anchors Amy Poehler and Seth Meyers. The American Apparel ceo admits to being emotionally affected by the public image the lawsuits have created — however, looking forward, he strikes an upbeat vision for the company.

“I have so much positive energy. I was just born with it. I have OCD for apparel,” Charney said enthusiastically. “I can be passionate about a sock. Fashion is all about enjoying life and colorfulness and optimism. This may be a time of retrenchment, and nobody believes in tomorrow, but I do.”

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