American Apparel Opens the Kimono

American Apparel has long been one of our favorite companies, for a variety of reasons.  For one, CEO Dov Charney is an "interesting" fellow.

He openly displays his passion for his company... and sexy women.  When he decides to wear clothes, he dresses like a '70s-era porn star, and defends his right to run a "sexually free" workplace.  This includes walking around in his briefs, and exposing himself eight times to a reporter.  As expected this has led to some legal issues, which he's vigorously defending.

But our main reason is that American Apparel has bucked the trend of clothing companies outsourcing to Asian sweatshops.

All of American Apparel's items are made a the plant in Los Angeles where he started the company.  He pays 3,500 people up to $18 an hour, making them the world's highest-compensated garmet workers.  Charney stresses vertical integration.  Operations are consolidated at the LA headquarters, allowing for close control of costs, quality, customer service, and flexibility.  The company can design a shirt and have it in stores in less than a week.

T-shirts and underwear.  Not exactly high margin products, but Dov has created a company that manufactures in a high-cost area of a high-cost state... in the United States.  And makes a very nice profit.  How much profit?  Well... that's an interesting question.  But even after the last re-accounting it is still a very nice profit.

The front page of the Wall Street Journal this morning describes the excitement at American Apparel ever since the company went public to raise cash to fund further expansion... which of course means that the inner financial workings of the company had to be disclosed.  But first someone had to figure out what the inner workings actually were... and that's some fascinating reading.

First, from the pre-public days...

In early 2005, chief financial officer Mark Schlein died unexpectedly of heart failure, and Mr. Charney and others say a replacement wasn't found for a year. An interim CFO was later hired, though Mr. Charney only remembers that "he had gray hair and quit after a week." Mr. Charney delegated bookkeeping to a few younger staff members and continued to open stores.

No real internal financial acumen for what was a $100 million company at the time.  Could you pull that off?  But let's move on.

So, American Apparel began shopping for another source of cash. In spring 2006, Plainfield Asset Management, a private firm that was considering an investment, requested an outside audit, prompting the company to begin its own internal audit. The internal auditors found American Apparel had inflated its 2005 earnings by nearly 30%, according to the company's chronology.

Which reduced pre-EBITDA earnings to $18 million.  Still not too shabby for a company manufacturing in such a high cost area.

By the middle of 2006, Mr. Charney began looking for ways to boost his finance staff. He offered an $800-a-week internship to Adrian Kowalewski, a recent University of Chicago business-school graduate who had briefly spoken with Mr. Charney about an academic paper the month before. Mr. Kowalewski's task: to devise a plan to save the company's deteriorating finances.

Rather than contact an executive recruiter, Mr. Charney bought a classified ad in his hometown newspaper, The Gazette of Montreal. Mr. Cieply, a former toy-industry executive, responded to the ad and got the job. The CFO says he soon discovered what he called "a lack of accounting knowledge" pervading the company. Mr. Cieply says he was forced to recant the company's earnings statement for the first half of that year.

In November [2006], the chronology shows U.S. Bank forced the company to hire a turnaround consultant. "It was a big waste of time," says Mr. Charney. The books underwent another readjustment just after Thanksgiving 2006, reducing year-to-date earnings before interest, taxes, depreciation and amortization by $1.5 million to $24.5 million.

Still nicely positive.  But the story continues...

That fall, Mr. Charney turned to Mr. Kowalewski -- now his corporate finance director -- for a solution. Having tried, and failed, to court other lenders, Mr. Kowalewski says he knew a traditional IPO was out of the question, given the rigorous accounting scrutiny involved and Mr. Charney's lack of a proven executive team.  Mr. Kowalewski came up with a solution: an untraditional "blank check" initial public offering, in which a shell firm, known as a "special purpose acquisition company," acquires a private firm.

On Dec. 12, the company began trading on the American Stock Exchange. Mr. Charney was now worth more than $580 million.

Since going public last December, the company has conceded it suffers a number of "material weaknesses." According to a filing with the Securities and Exchange Commission, these include "inadequate expertise in the application of U.S. generally accepted accounting principles."

In an interview March 20, Mr. Charney said his current chief financial officer, Ken Cieply, "has no credibility" in the retail apparel industry and is a "complete loser."

But Mr. Cieply stays on.  Perhaps because it is such a fascinating place to work.

Mr. Charney grew increasingly public about his lifestyle, making himself the brand's mascot and provocateur. He entered into relationships with employees and on occasions walked through the factory in his underwear to model new designs, he says. Billboards springing up across the country quickly gained attention for their racy layouts. In one ad, a woman spreads her legs for the camera in company stockings and underwear on a white bed -- Mr. Charney's bed.

Sporting vintage glasses and tight shirts, the 39-year-old Mr. Charney seems almost a living resurrection of the free-spirited 1970s. He sees himself as crusading against today's puritanical conventionality and likens himself to Larry Flynt, the Hustler magazine publisher who fought many First Amendment battles.

Mr. Charney stages provocative photo shoots in the basement of his Los Angeles mansion -- a hilltop perch filled with stacks of his vintage porn magazines. On a recent evening there, a young female employee served Mr. Charney tomatoes over rice while another, dressed in underwear and a T-shirt, was quizzed by her boss on competing brands.

Perhaps he's on to something with this style of leadership?

Mr. Charney insists his leadership style provides a model of authenticity for young people looking for alternatives to a "Baby Boomer economy which is collapsing."

Perhaps not.  But we still like American Apparel for having the guts, and apparently the manufacturing knowledge, to do what most clothing companies can't: manufacture profitably from the United States.

At a time when many large clothing makers were moving their manufacturing overseas, Mr. Charney attracted attention to the brand by electing to make all of the company's clothes in a Los Angeles factory and by championing social causes like immigration reform and universal health care. Tailors at American Apparel's factory receive subsidized health-care benefits and generally make twice the minimum wage. The factory's proximity also allows Mr. Charney to create new designs, and get them to stores, the week after he's conceived them, a speed unheard of in the industry.

If only Charney would hire a decent finance staff.  Or perhaps the lack of people whose traditional GAAP-driven mindset often flies in the face of business reality... or opportunity... is his hidden competitive advantage?

Comments

[Matthieu]

Kind of a chicken-an-egg thing, right? Is he able to make a nice profit despite being in the US because he is such an outside-of-the-box thinker, or is he making such a low profit despite having a superb lean strategy because he lacks business rigor.

[Mark Graban]

It's great how he emphasizes speed to market and responsiveness instead of just focusing on cost. Could he reduce his costs by manufacturing in Vietnam? Sure, but he couldn't get new products to market in a week anymore.

I hope the whole thing doesn't collapse because of his, um, questionable behavior. The guy needs some adult supervision, it seems.

[Andy Wagner]

Interesting. Given what we read about "accounting for lean" it wouldn't surprise me if this guy was on to something. Unfortunately, I think we'd all feel more comfortable if he, and his accountants, knew what it was. Similar to Henry Ford, he's running fast and loose with his own money, which is fine, until he either runs out, or tries to go public. I imagine there are some lean accounting fans that would be thrilled with the clean slate opportunity to straight out American Apparel's books.