AMERICAN APPAREL: DROWNING IN DEBT?

GROUP 5

PBS19101077 ATIQAH ZULAIKA BT AHMAD ZAIDI

PBS19101086 HONG YU SHEN
PBS19101063 ONG SIEW WEI
PBS19101087 SIU JIAN VUI WILLIS
PBS19101020 HEE TEN KIT
PBS19101075 KONG HUI FANG

MAKING DECISSION WITH ACCOUNTABILITY (ACC 7101)

ASSOC PROF DR AHMED RAZMAN BIN ABDUL LATIFF
PUTRA BUSINESS SCHOOL

10 NOVEMBER 2019
 AMERICAN APPAREL: DROWNING IN DEBT

TABLE OF CONTENTS

1. Assignment Submission Group………………………………………………………………………1

2. American Apparel Case Study……………………………………………………………………….2

3. Executive Summary………………………………………………………………………………...10

4. Method of Accounting Analysis……………………………………………………………………14

5. Results & Interpretation…………………………………………………………………………….41

6. References…………………………………………………………………………………………..47

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 SUBMISSION OF ASSIGNMENT
(GROUP)
MARKS
PART A: TO BE COMPLETED BY STUDENT

Course Name/
MAKING DECISION WITH ACCOUNTABILITY / ACC 7101
Course Code:

Lecturer: ASSOC PROF DR AHMED RAZMAN BIN ABDUL LATIFF

Title of AMERICAN APPAREL: DROWNING IN DEBT?

Assignment:

Submission Date: 10 NOVEMBER 2019

PART B: DECLARATION

We hereby declare that the assignment is based on our work except for quotations and citations that have been
duly acknowledged. We also declare that this assignment has not been previously or concurrently submitted for
credit, either at Putra Business School or elsewhere. We understand that if we are found guilty of plagiarizing or
cheating in this assignment, we will fail this course.

Name Matric No. Signature

ATIQAH ZULAIKA BINTI AHMAD ZAIDI PBS19101077
HONG YU SHEN PBS19101086
ONG SIEW WEI PBS19101063
SIU JIAN VUI WILLIS PBS19101087
HEE TEN KIT PBS19101020
KONG HUI FANG PBS19101075

Date: 10 NOVEMBER 2019

PART C: FOR OFFICE/LECTURER USE

Accepted by:

Signature: ____________________________________________

Name: Date:

Remarks:

Updated: 12/08/2015
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W16208

AMERICAN APPAREL: DROWNING IN DEBT?1

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Anupam Mehta wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective
or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to
protect confidentiality.

This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the
permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights

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organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western
University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com.

Copyright © 2016, Richard Ivey School of Business Foundation Version: 2016-04-14

On April 3, 2014, the cash-crunched American retailer, American Apparel, Inc., needed to pay $13.4
million2 in interest and other debt repayments. With a net loss of $106 million in 2013, a substantial increase
over its net loss of $37 million in 2012, the company had been struggling for survival. It had not been
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profitable since 2009. Its net sales increased marginally in 2013, but the company still ended up with a
bigger loss than ever before. During the same period, the shares of the company plummeted from $15 per
share to $0.56 per share, losing 95 per cent of its share value (see Exhibit 1). The company’s controversial
chief executive officer (CEO), Dov Charney, had been able to sustain the business with continued
borrowing at an exorbitant rate (as high as 18 per cent interest) and additional capital. In March 2014, the
company raised $28.5 million by selling more than 61 million shares at 50 cents each.3 American Apparel
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also renegotiated with its existing lenders. As a result, the company acquired some relief from its credit
payments. What actions could save the company?
The CEO and founder Dov Charney stated:

We invested substantially in our infrastructure in 2012 and 2013, and almost all of these projects
have been implemented. We expect 2014 to be a year where we return our full focus to exploiting
the strength of our brand and delivering exceptional service to our retail and wholesale customers.
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We are committed to delivering a return on the investments we have made in our business.4

ABOUT THE COMPANY

“American Apparel is about vision, passion, intensity, brand-free, sustainable, fair wages, solar power,
recycling, creativity and the can-do spirit,” according to CEO Dov Charney.5

1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
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presented in this case are not necessarily those of American Apparel or any of its employees.
2
All currency amounts are in U.S. dollars unless otherwise stated.
3
M. Townsend, “American Apparel Finds Latest Believer in Form of Swiss Firm,” Businessweek, April 8, 2014, accessed
May 12, 2014, www.businessweek.com/news/2014-04-08/american-apparel-ceo-finds-latest-believer-in-form-of-swiss-firm.
4
“American Apparel, Inc., Provides Preliminary Financial Results for 2013; EBITDA Forecast for 2014; and Preliminary
February Sales Results,” Reuters, March 6, 2014, accessed December 9, 2015, www.reuters.com/article/ca-american-
apparel-idUSnBw066419a+100+BSW20140306#P7l54EHUtBZjHD0c.97.
5
“American Apparel’s Dov Charney Speaks for First Time Since Firing,” The Daily Beast, June 24, 2014, accessed June 26,
2014, www.thedailybeast.com/articles/2014/06/24/american-apparel-s-dov-charney-speaks-for-first-time-since-firing.html.

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Based in downtown Los Angeles, American Apparel was a vertically integrated manufacturer, distributor,

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and retailer of branded basic fashion apparel and accessories for women, men, children, and babies. As of
February 28, 2014, the company had approximately 10,000 employees and operated 246 retail stores in 20
countries. The company had businesses in 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. The company operated an e-commerce website,

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www.americanapparel.com, with 12 localized online stores in seven languages that served customers from
30 countries worldwide. The company had four operating segments: wholesale, U.S. retail, Canada, and
international. “American Apparel” was a registered trademark of American Apparel (USA), LLC.6 Since
2006, the company had been listed on the New York Stock Exchange. The apparel manufacturing
operations were spread across the 800,000 square-foot facilities in the warehouse district of downtown Los
Angeles, California.

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Business Model

American Apparel’s mission was to make great quality clothing without using cheap “sweatshop” labour
and exploiting workers:

We are trying to rediscover the essence of classic products like the basic T-shirt, once an icon of
Western culture and freedom. Our goal is to make garments that people love to wear without having
to rely on cheap labor. Every aspect of the production of our garments, from the knitting of the
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fabric to the photography of the product, is done in-house. By consolidating this entire process, we
are able to pursue efficiencies that other companies cannot because of their overreliance on
outsourcing.7

Growth Strategy
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The company focused on growing by enhancing the number of stores, building a good online sales platform,
buying new merchandise for consumers, and creating strong information systems to support its operations.

The company had the core business strengths of unique designs, advertising and branding, speed to market,
quality products, and broad appeal to consumers of various demographics.8

About the CEO and Founder

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Dov Charney founded the garment business in 1998.9 Charney had been focused on high-quality and
trendsetting clothes. He also had a strong business sense, and his vertically integrated business model
provided the company with an extra advantage of responding quickly to market changes and consumer
needs. Ernst & Young named Charney Entrepreneur of the Year in 2004. Apparel Magazine, the Fashion
Industries Guild, and the Advertisement Specialty Industry each awarded him the title “Man of the Year.”
Charney was included in the Los Angeles Times’ “100 Most Powerful People of Southern California” list,
and Details Magazine inducted him into its “Power 50.” For the first annual Los Angeles Fashion Awards,
Charney was recognized for Excellence in Marketing. In 2008, an independent research report placed
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6
American Apparel, “American Apparel, Inc., Form 10-K (Annual Report),” Edgar Online, Los Angeles, CA, 2014.
7
“Conscience Undercover,” American Apparel, August 23, 2004, accessed June 28, 2014,
www.americanapparel.net/presscenter/articles/20040823outgeneration.html.
8
American Apparel, “American Apparel, Inc., Form 10-K (Annual Report),” Edgar Online, accessed March 27, 2016.
9
S. Maheshwari, “Dov Charney Dreams Big for American Apparel Even as Its Stock Trades Under $1,” BuzzFeed, February
10, 2014, accessed June 2, 2014, www.buzzfeed.com/sapna/dov-charney-dreams-big-for-american-apparel-even-as-its-stoc.

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 Page 3 9B16B008

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American Apparel as the Top Trendsetting Brand, second only to Nike.10 In 2008, the company’s CEO was

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named “Retailer of the Year” at the 15th Annual Michael Awards for the Fashion Industry, following Calvin
Klein and Oscar de la Renta. In contrast to his achievements, Charney was also known for the use of
sexually provocative advertisements in the marketing of the company’s products. Charney was associated
with several controversial lawsuits, although none had been proven in court.11

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AMERICAN APPAREL’S PAST PERFORMANCE

From being the top trendsetting brand in 2008 to becoming a debt-ridden company, the journey of American
Apparel had been very difficult. The aggressive expansion of the company, the explicit use of sexually
provocative advertising, and good-quality products had paid well in terms of the profitability of the
company. The company created strong brand recognition and its products appealed to the young, with its
trendsetting designs and Charney’s unique fashion sense. Based on the company’s growth strategy,

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American Apparel continued to expand through organic growth, internal initiatives, and acquisitions. The
company grew from 147 stores in 2006 to 260 stores in 2008, while expanding both domestically and
internationally. Sales increased by a massive 40 per cent compared with the previous year. The rapid
expansion of stores and retail centres made American Apparel one of the fastest growing companies in the
retail sector.

Year 2009 and Afterwards: A Struggle for Survival

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American Apparel’s success story continued until 2009. During 2009, a federal investigation uncovered
irregularities in the identity documents of workers when they had been hired by American Apparel.12
Because of the immigration issues, the company was required to terminate the employment of 2,000
American Apparel workers from its factory, leading to its inability to both complete orders on time and
meet demand. As a result, production was badly hit, which led to stock-outs.
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The operating profit decreased from $36 million in 2008 to $3 million in 2009, a massive decrease of 92
per cent. The company’s net profit fell dramatically from $14 million in 2008 to $1 million in 2009, a
decline of 93 per cent (see Exhibit 2, which contains the details of the company’s income statements; also
see Ivey product 7B16B008).

The impact of the labour termination of employment was so severe that the company could not fully recover.
The global recession made the recovery all the more difficult. For the first time, the company’s sales
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declined (from $558 million in 2009 to $532 million in 2010). The operating income fell from $24 million
in the year 2009 to negative $50 million in 2010. American Apparel went from a net profit of $1.11 million
to a net loss of $86 million.

Shattered by the losses and lack of liquidity, American Apparel’s money situation worsened by the first
quarter of 2011, and the company stated that it might file for protection against bankruptcy under Chapter
11. Desperate for funds, Charney was able to bring in investors for the company at the last moment and
saved it from default. However, the loan taken by the company was excessively costly.
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10
American Apparel, “Company Information,” American Apparel, accessed June 1, 2014,
www.americanapparel.net/presscenter/pressCompanyInfo.html.
11
J. Edwards, “Those Sex Harassment Lawsuits Against American Apparel CEO Dov Charney Have Mostly Come To
Nothing,” Business Insider, March 12, 2013, accessed February 9, 2015, www.businessinsider.com/sex-harrassment-
lawsuits-against-american-apparel-ceo-dov-charney-2013-3.
12
J. Preston, “Immigration Crackdown with Firings, Not Raids,” The New York Times, September 29, 2009, accessed May
30, 2014, www.nytimes.com/2009/09/30/us/30factory.html?_r=0.

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 Page 4 9B16B008

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Despite all of this debt, the company kept enhancing its stores. Because of significant efforts, the net loss

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declined in 2011 to $39 million compared with $86 million the previous year.

In 2012, the company undertook efforts to upgrade its production forecasting and allocation system, which
would enhance the logistics using a demand planning solution. At the same time, it continued building
stores. The total net loss decreased from $39 million in 2011 to $37 million in 2012. Sales had also started
increasing; net sales of the company increased from $547 million in 2011 to $617 million in 2012 (see

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Exhibits 2 and 3).

Financial Results in 2013

In 2013, American Apparel experienced its worst financial year. In this year, the company implemented
two important strategic initiatives in the area of inventory management and the new distribution centre in

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Los Angeles. The company also completed its radio-frequency identification system and implementation
of the Oracle Web Commerce application for its e-commerce platform. The company had difficulties
transitioning to a new distribution centre, which led to a significant increase in operating costs, while
deliveries were disrupted.13 The cost of goods sold increased from $289 million in 2012 to $313 million in
2013, crushing both net and gross margins. The net loss increased to a massive $106 million, with sales
growth at a marginal 3 per cent from $617 million in 2012 to $633 million in 2013. Already pressurized by
extremely high interest rates and debt repayments, the company had only $8 million in cash on December
31 (see Exhibit 4). (For information on stores in 2013, see Exhibit 5.) At the end of 2013, the company had
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huge debt. Prominent lender Lion Capital had loaned funds at an extremely high rate and had maintained
strict terms and conditions, which could be increased, and the debt could be called back in the event of any
top management changes.

APPAREL INDUSTRY
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The apparel industry in general was highly fragmented and highly volatile. According to PEC Research,
the sales growth over the previous five years had been eroded (−0.5 per cent compound annual growth rate
[CAGR] domestically and 1.4 per cent CAGR overall).14 In addition, the industry inventory levels had been
increasing steadily over the previous five years from approximately 12 per cent of sales in 2008 to 14 per
cent of sales in 2011 because of the increased cost of raw materials and inventory management, which
affected the overall pricing of inventory. The U.S market was almost stagnant; international sales had grown
by a CAGR of 11.3 per cent over the same period. The CAGR for total sales (combining international and
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domestic sales) over this period was approximately 1.6 per cent.

According to IndustryWeek, the apparel industry in the United States had lost more than 80 per cent of its
jobs, and the post-recession recovery was extremely slow.15 Many U.S. companies were sustained by the
vertical integration model because of their strong ability to move and respond quickly to consumers’
preferences and needs. The ability of the company often depended on its capability to capture domestic and
international sales. Any failure in predicting fashion trends could prove fatal for the company.
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13
American Apparel, “Company Information,” accessed June 1, 2014,
www.americanapparel.net/presscenter/pressCompanyInfo.html.
14
PEC Research, “US Branded Retail Apparel Industry,” Yale School of Management, September 16, 2012, accessed June
8, 2014, http://analystreports.som.yale.edu/reports/BrandedApparel2012.pdf.
15
B. Bland, “A New, Sustainable Model for Apparel Manufacturing in the U.S.,” IndustryWeek, October 17, 2013, accessed
June 8, 2014, www.industryweek.com/leadership/new-sustainable-model-apparel-manufacturing-us.

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 Page 5 9B16B008

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In the apparel industry, American Apparel faced stiff competition from Gap, Urban Outfitters, American

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Eagle, and Express. Some of these competitors had better financial power as well as good access to reduced
costs because of an outsourcing model.

FUTURE AHEAD: 2014 FIRST QUARTER RESULTS AND THE OUTLOOK FOR THE YEAR

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For the first quarter ended March 31, 2014, American Apparel’s net sales decreased to $137.1 million,
because of a reduction of both comparable stores and wholesale net sales. Gross profit reduced to $72
million in the first quarter. In the first quarter report of 2014, the company reassured investors of its
commitment to reducing costs by bringing down manufacturing and administrative costs. In that year, the
company also halted its excessive capital expenditure and was more focused on removing inefficiencies
associated with the production process while building up productivity for a profitable future.16

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Charney indicated, “We are encouraged by our first quarter performance with our achieved results ahead
of our 2014 business plan. The results of our cost control efforts are being seen in all areas of the business,
and we are now fully focused on measures to improve top line performance.”17 Showing the way forward,
he said, “Its [American Apparel’s] 247 stores could be 20% more productive with the right tweaks; the
online business could double, wholesale could grow by 20% to 30%.”18

Recent Happenings
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On March 25, 2014, to comply with the terms and conditions of debt renegotiation, the company raised
more share capital. CEO Johannes Minho Roth, of FiveT, a Zurich-based firm, purchased $26 million of
the shares and became the second largest outside shareholder, after CEO Dov Charney.

Roth believed that the company was grossly undervalued. Roth, regarding his investment in American
Apparel, stated, “We cannot believe how cheap it is,” especially since, “it’s a lot further in the restructuring
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process than people think . . . he’s a visionary. . . . Dov wants to make it his life goal to make American
Apparel into a successful company. I have a very positive view on him.”19

Although raising funds earned the company some time, which enabled it to pay off its debt, the danger of
default had only subsided and not gone away, with the next big interest payment due in April 2014.

On April 14, 2014, the debt-ridden company suffered one more blow. Based on an internal inquiry, the
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board accused and dismissed Charney because of “willful misconduct” based on sexual assault and sexual
harassment cases. The board clarified that the firing was based on personal misconduct rather than
professional misbehaviour. The firing came at a time when the company was suffocating under its debt
burden. An interest payment of $14 million had to be paid by the end of April 2014. Analysts viewed this
event as the last nail in the coffin, questioning whether Charney’s exit from the company would trigger the
default that the company had been avoiding for so long. Further questions remained regarding which
performance areas had dragged the company down into debt and whether American Apparel had lost its
appeal and Charney had lost his charm.
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16
American Apparel, “Company Information,” op. cit.
17
American Apparel, “American Apparel, Inc. Reports First Quarter Financial Results,” May 12, 2014, accessed June 2,
2014, http://investors.americanapparel.net/releasedetail.cfm?ReleaseID=847307.
18
BiggerCapital, “American Apparel: Our Long Investment Thesis,” Nasdaq, April 23, 2014, accessed February 9, 2015,
www.nasdaq.com/article/american-apparel-our-long-investment-thesis-cm346462.
19
M. Townsend, “American Apparel CEO Finds New Believer Just in Time,” BloombergBusiness, April 9, 2014, accessed
February 9, 2015, www.bloomberg.com/news/articles/2014-04-08/american-apparel-ceo-finds-new-believer-just-in-time.

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 Page 6 9B16B008

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EXHIBIT 1: SHARE PRICES OF AMERICAN APPAREL, 2008 TO 2014

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Share Prices
16
14

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12
Share Prices

10
8
6 Share Prices
4
2
0

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1/7/2008 1/7/2009 1/7/2010 1/7/2011 1/7/2012 1/7/2013 1/7/2014

Source: Yahoo! Finance, “American Apparel Inc. (APP),” Yahoo! Finance, accessed December 23, 2014,
http://finance.yahoo.com/q/hp?s=APP&a=00&b=7&c=2008&d=11&e=8&f=2014&g=m&z=66&y=66.

EXHIBIT 2: AMERICAN APPAREL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF

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OPERATIONS AND COMPREHENSIVE LOSS, 2009–2014

(Amounts and shares in thousands, except per share amounts)

Years Ended December 31,

2013 2012 2011 2010 2009
Net sales $ 633,941 $ 617,310 $ 547,336 $ 532,989 $ 558,775
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Cost of sales 313,056 289,927 252,436 253,080 238,863

Gross profit 320,885 327,383 294,900 279,909 319,912
Selling expenses 241,683 227,447 209,841 218,198 198,518
General and administrative expenses 106,957 97,327 104,085 103,167 93,636
Retail store impairment 1,540 1,647 4,267 8,597 3,343
(Loss) income from operations (29,295) 962 (23,293) (50,053) 24,415
Interest expense 39,286 41,559 33,167 23,752 22,627
Foreign currency transaction loss 1 120 1,679 (686) (2,920)
No

Unrealized loss (gain) on change in fair value

of warrants and purchase rights 3,713 4,126 (23,467) 993 -
Loss (gain) on extinguishment of debt 32,101 (11,588) 3,114 - -
Other expense (income) 131 204 (193) 39 (220)
Loss before income taxes (104,527) (33,459) (37,593) (74,151) 4,928
Income tax provision 1,771 3,813 1,721 12,164 3,816
Net loss $ (106,298) $ (37,272) $ (39,314) $ (86,315) $ 1,112
Basic and diluted loss per share $ (0.96) $ (0.35) $ (0.42) $ (1.21) $ 0.02
Weighted average basic and diluted shares $ (1.21) $ 0.01
outstanding 110,326 105,980 92,599 71,626 71,026
Net loss (from above) $ (106,298) $ (37,272) $ (39,314) $ (86,315) $ 1,112
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Other comprehensive (loss) income item:

Foreign currency translation, net of tax (1,581) 631 (188) (1,085) 620
Other comprehensive (loss) income, net of tax (1,581) 631 (188) (1,085) 620
Comprehensive loss $ (107,879) $ (36,641) $ (39,502) $ (87,400) $ 1,732

Source: Compiled by the author from American Apparel’s annual reports, year 2009 - 2013. American Apparel, Inc., Edgar
Online, accessed March 27, 2016.

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EXHIBIT 3: AMERICAN APPAREL INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET,

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2008–2013

December 31,
(Amounts and shares in thousands, except per share amounts) 2013 2012 2011 2010 2009 2008
ASSETS

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CURRENT ASSETS
Cash $ 8,676 $ 12,853 $ 10,293 $ 7,656 $ 9,046 $ 11,368
Trade accounts receivable 20,701 22,962 20,939 16,688 16,907 16,439
Restricted cash - 3,733
Prepaid expenses and other current assets 15,636 9,589 7,631 9,401 9,994 5,369
Inventories, net 169,378 174,229 185,764 178,052 141,235 148,154
Income taxes receivable and prepaid income taxes 306 530 5,955 4,114 4,494 604
Deferred income taxes, net of valuation allowance 599 494 148 626 4,627 3,935
Total current assets 215,296 224,390 230,730 216,537 186,303 185,869
Property and equipment, net 69,303 67,778 67,438 85,400 103,310 112,408

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Deffered taxes 2,426 1,261 1,529 1,695 12,033 10,137
Other assets, net 46,727 34,783 25,024 24,318 25,933 25,195
TOTAL ASSETS $ 333,752 $ 328,212 $ 324,721 $ 327,950 $ 327,579 $ 333,609
LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
CURRENT LIABILITIES
Cash overdraft $ 3,993 $ - $ 1,921 $ 3,328 $ 3,741 $ 2,413
Revolving credit facilities and current portion of long-term
debt 44,042 60,556 50,375 138,478 6,346 34,318
Accounts payable 38,290 38,160 33,920 31,534 19,705 32,731
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Accrued expenses and other current liabilities 50,018 41,516 43,725 39,028 30,573 22,140
Fair value of warrant liability 20,954 17,241 9,633 993 2,608 8,582
Income taxes payable 1,742 2,137 2,445 230
Deferred income tax liability, current 1,241 296 150 -
Current portion of capital lease obligations 1,709 1,703 1,181 560 1,907 2,616
Total current liabilities 161,989 161,609 143,350 214,151 64,880 102,800
LONG-TERM DEBT, net of unamortized discount of $5,779 and
$27,929 at December 31, 2013 and 2012, respectively 213,468 110,012 97,142 444
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Subordinated notes payble to related party 5,453 2,844 - 4,611 65,997 67,050
Capital lease obligations, net of current portion 1,726 542 4,355 3,292
Deferred tax liability 536 262 96 260 1,020 1,986
Deferred rent, net of current portion 18,225 20,706 22,231 24,924 22,052 16,011
Other long-term liabilities 11,485 10,695 12,046 7,994 11,934 6,058
Total Long -Term Liabilites 249,167 144,519 133,241 38,775 105,358 94,397
TOTAL LIABILITIES 411,156 306,128 276,591 252,926 $ 170,238 $ 197,197
STOCKHOLDERS' (DEFICIT) EQUITY
Shares outstanding at December 31, 2012 11 11 11 8 7 7
Additional paid-in capital 185,472 177,081 166,486 153,881 150,449 131,252
No

Accumulated other comprehensive loss (4,306) (2,725) (3,356) (3,168) (2,083) (2,703)
Accumulated deficit (256,424) (150,126) (112,854) (73,540) 19,012 17,900
Less: Treasury stock, 304 shares at cost (2,157) (2,157) (2,157) (2,157) (10,044) (10,044)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY (77,404) 22,084 48,130 75,024 157,341 136,412
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY $ 333,752 $ 328,212 $ 324,721 $ 327,950 $ 327,579 $ 333,609

Source: Compiled by the author from American Apparel’s 8-K reports for the year 2008–2013.
American Apparel, Inc., Edgar Online, accessed March 27, 2016.
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EXHIBIT 4: CASH FLOW STATEMENTS FOR AMERICAN APPAREL, 2009–2013

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(in thousands)
2013 2012 2011 2010 2009
Net cash (used in) provided by:
Operating activities $ (12,723) $ 23,589 $ 2,305 $(32,370) $ 45,203
Investing activities (25,147) (24,853) (10,759) (15,662) (20,889)

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Financing activities 34,228 4,214 12,582 48,172 (25,471)
Effect of foreign exchange rate changes on cash (535) (390) (1,491) (1,530) (1,165)
Net (decrease) increase in cash $ (4,177) $ 2,560 $ 2,637 $ (1,390) $ (2,322)

Source: Compiled by the author from American Apparel’s 8-K reports for the year 2008–2013.
American Apparel, Inc., Edgar Online, accessed March 27, 2016.

EXHIBIT 5: AMERICAN APPAREL’S COMPARABLE STORE NUMBERS

yo
For the Quarter Ended
Year March 31 June 30 September 30 December 31
Number 2013 238 237 237 235
of 2013 243 244 242 238
stores 2011 249 248 244 241

Source: Compiled by the author from American Apparel’s 8-K reports for the year 2008–2013.
op
American Apparel, Inc., Edgar Online, accessed March 27, 2016.
tC
No
Do

This document is authorized for educator review use only by AHMED RAZMAN, Universiti Putra Malaysia until May 2020. Copying or posting is an infringement of copyright.
[email protected] or 617.783.7860
 AMERICAN APPAREL: DROWNING IN DEBT?

EXECUTIVE SUMMARY

From 2008 until 2015, nine American Apparel’s ads has been banned by the UK’s

advertising watchdog the Advertising Standards Authority (ASA) because it might lead to

sexualized children and normalized sexual predatory behavior (Hammett, 2018). According to

Reuters (2011), a women sued Dov Charney for $250 million by treated her as a sex slave when

she was a teenage sales employee at the clothing chain (Stempel, 2011). According to Reuters

(2014), Dov Charney has been found that violeted company policies and misused company funds

after an internal investigation in company. The bad reputation of the company effect public for

being a customer of American Apparel.

Figure 1 An example of American Apparel’s advertising

10
 AMERICAN APPAREL: DROWNING IN DEBT?

In 2009, American Apparel have opened 27 new stores worldwide in order to bust their

revenue. The company build a unique brand and a wide network of stores across the globe

(Anglo, 2013). However, 2000 illegal employees were terminated, around 1/3 of the workforce

and these employees was paid by the lowest possible salary. This leading to its inability to both

complete orders on time and meet demand. Moreover, in March 2009, the company avoided

Chapter 11 bankruptcy when it sold 18% of the company to private-equity firm Lion Capital

(Carcia, 2015). The company was facing pressure, including loan obligations, after it took $111.6

million in debt to expend over five years.

In 2010, the net loss of company was $ 86,315 thousand. This is caused by 80 million

loan provided by British company Lion Capital and the purpose of the loan was to rescue

company from financial crisis in March 2009. At the same time, the sales of company was down

however company is moving its product mix into clothes that cost high and company pursuing a

discount strategy with Groupon. Therefore, company would not have sufficient liquidity to

sustain operations in next year due to result of operating losses and negative cash flow from

operation and high interest rate of loan.

In 2011 things became worse, when the company started to feel the difficulty even to stay

afloat. Annual report of company stated that operations are at risk and as a going concern.

American Apparel urgently looked for another investors raised substantial doubt that the

company may be able to on going as crisis grew. Dove Charney confronting up to massive debt

load, falling share prices and decreasing margins. The stock price in 2011 went down rapidly.

11
 AMERICAN APPAREL: DROWNING IN DEBT?

American Apparel had a decrease of current assets from 2012 to 2013 form -4.05%.

According to Mehta (2016), 2013 was the worst financial year for the company because the

company had difficulties transitioning to a new distribution center, which led to a significant

increase of operating cost, while deliveries were disrupted (Dafina, 2019). This caused a

decrease of current assets. Total assets had increase from 1.68% in 2013 that was caused by

implementation of two important strategy initiatives in the area of inventory management and the

new distribution center in Los Angeles. Current liabilities have slightly increased from 0.24%,

while total debt of the company is increased by 34.31% from 2012 to 2013 from money

borrowed with high interest rate.

Abstract

The American clothing retailer American Apparel recently experienced a loss of USD106

million and faced huge debt repayments. In addition, the chief executive officer (CEO) and

founder was dismissed because of personal misconduct. Students must evaluate the financial

status of the company and address the impact of the CEO's termination on the financial

performance of the company.

Introduction

The Harvard business review has published the American Apparel Drowning in Debt

Case Study. Like all HBR case studies, the American Apparel Drowning in Debt Case is

designed and drafted in a manner to allow the reader to experience a real-world problem and

solve it accordingly. The case study, like other HBR case studies, will help the reader and

students develop a broader, and a clearer understanding of the business world and dynamics.

12
 AMERICAN APPAREL: DROWNING IN DEBT?

The American Apparel Drowning in Debt Case is based on a current managerial and

strategic problem being faced by the organization, which must be solved tactfully to allow

progression, as well as maintain a competitive position. This paper is written to facilitate the case

solution for the American Apparel Drowning in Debt Case Study.

The case solution for the American Apparel Drowning in Debt Case Study first identifies

the central issue that is elaborated on throughout the case. The case solution then analyses the

case through relevant financial statement analysis including the profitability ratio, liquidity ratio,

efficiency ratio and solvency ratio. This analysis is to help in the identification of a feasible

strategy and solution for the American Apparel Drowning in Debt Case Study. Alternative

solutions are also proposed in the case solution, primarily because alternative solutions often act

as contingency plans.

13
 AMERICAN APPAREL: DROWNING IN DEBT?

METHODS OF ACCOUNTING ANALYSIS

CASE STUDY

From being the top trendsetting brand in 2008 to becoming a debt-ridden company, the

journey of the fashion empire American Apparel has been a rise and fall complete with the

ouster of its founder and CEO Dov Charney, a handful of ugly sexual harassment lawsuits,

two rounds of bankruptcy filings and finally its acquisition by Gildan Activewear, a Canada

company for $88 million. The question is how did a company that was deemed one of the

fastest growing companies in the United States, boasting a rate of growth of 440% over a

three-year period at one point and annual revenues that topped $211 million, get to this point?

The present case depicts the struggle of its CEO to revive the company with his recovery

mechanism to improve the financial performance of the company. A comprehensive case

study is delivered herein to analyse the financially troubled company’s performance in the

following ratio and trend analysis followed by our original interpretation and observation.

14
AMERICAN APPAREL: DROWNING IN DEBT?

INCOME STATEMENT

15
AMERICAN APPAREL: DROWNING IN DEBT?

BALANCE SHEET

16
 AMERICAN APPAREL: DROWNING IN DEBT?

 LIQUIDITY MEASURES

● This ratio measures AA’s ability to meet its short- term obligations

1. Working Capital

Liquidity 2013 2012 2011 2010 2009 2008

Working $ $ $ $ $ $

Capital 53,307 62,781 87,380 2,386 121,423 83,069

● Working capital = current assets - current liabilities

● Working capital is lowest in year 2010

Working Capital
$140,000

$120,000

$100,000

$80,000

$60,000

$40,000

$20,000

$-
2008 2009 2010 2011 2012 2013

2. Current Ratio

Liquidity 2013 2012 2011 2010 2009 2008

1.61 1.01
Current ratio 1.329 1.388 2.872 1.808
0 1

● Current ratio measures AAs current assets against its current liabilities

● Current ratio = current asset / current liability

17
 AMERICAN APPAREL: DROWNING IN DEBT?

● Current ratio = company can pay off its short-term liabilities in an emergency by

liquidating its current assets

● Low current ratio = AA have hard time paying its current liabilities in the short run

and deserves further investigation

● When current ratio < 1, means even if AA liquidizes all its current assets at the

recorded value, it would still unable to cover its current liabilities

Current ratio
3.500

3.000

2.500

2.000

1.500

1.000

0.500

0.000
2008 2009 2010 2011 2012 2013

3. Acid-test-Ratio / Quick ratio

Year 2013 2012 2011 2010 2009

Acid-test
0.181 0.222 0.218 0.114 0.400
ratio

● ACID-TEST RATIO = more stringent that current ratio

● ACID-TEST RATIO = CASH (including temporary cash investment) + AR divided

by CURRENT LIABILITIES

● In this event, we assume the restricted cash is expected to be used within one year of

the company's most recent balance sheet date, it is classified as a current asset.

18
 AMERICAN APPAREL: DROWNING IN DEBT?

Prepaid expenses are excluded from liquid assets as they cannot be converted into

cash within a few days of time

● Acid-test ratio is lowest 0.114 in year 2010. Acid test ratio of 1.0 is considered an

adequate liquidity. Means AA can only cover 11.4% of current liabilities by using

ALL CASH ON HAND

● Major line item excluded in the acid test ratio is inventory. During time of stress,

high inventories in AA may make selling inventory difficult. (refer to inventory

turnover ratio). The drop from 0.4 to 0.1137 is due to decrease in cash and increase

current liabilities

Acid-test ratio
(Quick Ratio)
0.450
0.400
0.350
0.300
0.250
0.200
0.150
0.100
0.050
0.000
2008 2009 2010 2011 2012

4. Cash ratio

Year 2013 2012 2011 2010 2009 2013

Cash
0.05 0.10 0.07 0.04 0.14 0.11
ratio

● The cash ratio is 0.04x, means AA can only cover 4% of its current liabilities with its

cash and short-term marketable securities

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 AMERICAN APPAREL: DROWNING IN DEBT?

Cash ratio
0.16

0.14

0.12

0.10

0.08

0.06

0.04

0.02

0.00
2008 2009 2010 2011 2012 2013

 SOLVENCY MEASURES

● AA’s ability to meet its longer-term obligations.

● Allows investors to see whether AA has adequate cash flow to consistently pay

interest payments and other fixed charges

● If AA doesn't have enough cash flows, its likelihood AA is overburdened with debt

and bondholders may force the company into default

1. Debt-to-assets ratio

Year 2013 2012 2011 2010 2009 2008

Debt-to-asset ratio 1.232 0.933 0.852 0.771 0.520 0.59

20
 AMERICAN APPAREL: DROWNING IN DEBT?

● Measuring & of AA’s total assets financed by debt.

● Debt-to-Asset Ratio = total liabilities / total assets

● High ratio = AA is using large amount of financial leverages, which increases its

financial risk in interest-bearing and principal requirements of the debts.

● Debt ratio started to increase from 77% (2010) to 123.2% (2012). The debt ratio of

1.232 at fiscal year 2013 means that the entity's total assets is unable to meet its total

debts obligations.

● No subordinated notes in year 2011?

● Increase of net margin in year 2011 due to store expansion however the debt-to-asset

ratio increase dramatically at the same time.

Debt-to-assets
1.40

1.20

1.00

0.80

0.60

0.40

0.20

0.00
2008 2009 2010 2011 2012 2013

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 AMERICAN APPAREL: DROWNING IN DEBT?

2. Debt-to-equity ratio

Year 2013 2012 2011 2010 2009 2008

Debt-to-equity
-5.31 13.86 5.75 3.37 1.08 1.45
ratio

● Debt-to-Asset Ratio = Total Liabilities / Total Stockholder's Equity

● Ratio > 1 means AA uses exceeds amount of debt as equity = creditors have to claim

to all assets, leaving nothing for shareholders in the event of theoretical liquidation

● The entity was in high financial leverage all the time with value >1. This situation

became significant from fiscal year 2010 with 3.37 to 13.86 in fiscal year 2012. In

fiscal year 2013, the entity's has deficit equity, the value is -5.31

Debt-to-equity
15.00

10.00

5.00

0.00
2008 2009 2010 2011 2012 2013

-5.00

-10.00

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 AMERICAN APPAREL: DROWNING IN DEBT?

3. Interest Coverage Ratio

Year 2013 2012 2011 2010 2009

Interest Coverage
-1.66 0.19 -0.13 -2.12 1.22
Ratio

● Measures AA’s cash flows generated compared to its interest payments

● Interest coverage of 1.22x means AA’s earnings before interest and taxes is 1.22x

interest obligations for a period

● Interest coverage deteriorates quickly in year 2010 and recovers on Year 2012 due to

new investor’s onboard

Interest coverage
TIMES INTEREST EARNED
1.500

1.000

0.500

0.000
2009 2010 2011 2012 2013
-0.500

-1.000

-1.500

-2.000

-2.500

 EFFICIENCY MEASURES

1. Inventory Turnover

Year 2013 2012 2011 2010 2009

Inventory Turnover (in

1.82 1.61 1.39 1.59 1.65
days)

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 AMERICAN APPAREL: DROWNING IN DEBT?

● Inventory turnover = COGS / average inventory

● Higher rate = inventory sold at a faster rate, signaling inventory management

effectiveness

● Inventory turnover slows down in Year 2011 as AA is badly hit with termination of

worker employment due to ID issue.

Inventory turnover
2.00
1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
2008 2009 2010 2011 2012 2013

2. Receivables Turnover

Year 2013 2012 2011 2010 2009

Receivables Turnover (in

11.92 13.58 13.96 11.43 11.04
days)

● Receivables Turnover = net revenue / average receivables

● Ratio – how quickly and efficiently a company collects on its outstanding bills

● Higher rate = inventory sold at a faster rate, signaling inventory management

effectiveness

● Averagely 11 – 14 days in receivables turnover, cash collected more quickly for use

in company

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 AMERICAN APPAREL: DROWNING IN DEBT?

Receivables turnover (days)

16.000

14.000

12.000

10.000

8.000

6.000

4.000

2.000

0.000
2008 2009 2010 2011 2012

3. Payable turnover

Year 2013 2012 2011 2010 2009

Payable turnover (in

45.27 47.25 45.92 32.26 41.26
days)

● Company pays off the $ owed to supplier

● On average, payable is made on period of once every 45 days

● Acquiring additional inventory for a large purchase, therefore causes change in

payable turnover in Year 2011 – 2013

● A low payables turnover ratio (a.k.a. longer payable period) indicating AA is having

trouble paying off its bills.

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 AMERICAN APPAREL: DROWNING IN DEBT?

Payable turnover (days)

Inventory
50.000
45.000
40.000
35.000
30.000
25.000
20.000
15.000
10.000
5.000
0.000
2008 2009 2010 2011 2012

4. Number of days’ sales in accounts receivable

Year 2013 2012 2011 2010 2009

Average day’s $ $ $ $ $

sales 1,736,820 1,691,260 1,499,551 1,460,244 1,530,890

Year 2013 2012 2011 2010 2009

No. of days’ in accounts

11.92 13.58 13.96 11.43 11.04
receivable (in days)

● Indicated the efficiency of collection policy relative to credit term

● A 365-day year is usually assumed for the average days’ sales calculation

● Average days’ sales = Annual sales / 365

● Accounts receivable at year-end is the is the trade accounts receivable at December 31

of the fiscal year

● Number of days’ sales in accounts receivable (in days) =

26
 AMERICAN APPAREL: DROWNING IN DEBT?

● On average, accounts receivable are being collected in 12.4 days

Number of days' sales in accounts receivable (in

days)
16.000
14.000
12.000
10.000
8.000
6.000
4.000
2.000
0.000
2009 2010 2011 2012 2013

5. Number of days’ sales in inventory

Year 2013 2012 2011 2010 2009

Average day’s $ $ $ $ $

COGS 857,688 794,321 691,605 693,370 654,419

Year 2013 2012 2011 2010 2009

No. of days’ in accounts

197.5 219.3 268.6 256.8 215.8
receivable (in days)

● Indicated the entity’s ability to control inventories relative to sales

● A 365-day year is usually assumed for the average days’ cost of goods sold (COGS)

● Average days’ COGS = Annual COGS / 365

● Inventory at year-end is the is net inventories at December 31 of the fiscal year

● Number of days’ sales in inventory (in days) =

27
 AMERICAN APPAREL: DROWNING IN DEBT?

● On average, the inventories will remain in stores/warehouse for 231.6 days before it

will be converted to sales

● The number of days’ sales in inventory increased from 218.8 days in fiscal year 2009

to 268.6 days (~9 months) in fiscal year 2011 is the sign of unproductive. However,

the productivity had improved further since year 2012 with 219.3 days to 197.5 days

in year 2013.

Number of days' sales in inventory (in days)

300.000

250.000

200.000

150.000

100.000

50.000

0.000
2009 2010 2011 2012 2013

 PROFITABILITY MEASURES

1. Gross Margin And Net Margin

Profitability % Formula 2013 2012 2011 2010 2009

Gross Income / 0.53 0.57

Gross margin % 0.506 0.530 0.525
Revenue 9 3

- - - -
Net margin net loss Net income /
16.77 6.04 7.18 16.19 0.20
% Revenue
% % % % %

Net margin Net income / - - - - 0.31

28
 AMERICAN APPAREL: DROWNING IN DEBT?

comprehensive loss Revenue 17.02 5.94 7.22 16.40 %

% % % % %

● Gross margin = Gross income / revenue

● Gross margin = Averagely 53.5% gross margin for AA, 53.5% of revenues generated

by the firm are used to pay for the cost of goods sold.

● Net margin = net income / revenue, in this case we analyzed net loss and

comprehensive losses.

● Net profit margin = measures AA’s ability to translate sales into earnings for

shareholders. Investors will look for companies with strong and consistent net profit

margin, in this case is a LOSSES.

● Loss recovering from Year 2011 – 2012.

Gross margin (%)

0.580

0.560

0.540

0.520

0.500

0.480

0.460
2009 2010 2011 2012 2013

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 AMERICAN APPAREL: DROWNING IN DEBT?

Net margin net loss (%)

2.000
0.000
2009 2010 2011 2012 2013
-2.000
-4.000
-6.000
-8.000
-10.000
-12.000
-14.000
-16.000
-18.000

2. Operating Margin

Profitability % Formula 2013 2012 2011 2010 2009

-
Operating income /
Operating margin - 0.00 0.04 - 0.04
Revenue
0.046 2 3 0.094 4

● Operating Margin = Operating income / Revenue

● Irregularities discovered by federal investigations hence OPERATING INCOME is

higher results spike observed in Year 2010

● Reasons behind: During 2009, a federal investigation uncovered irregularities in

identity documents of workers. Termination of employment of 2,000 AA workers,

leads to its inability to both complete orders on time and meet demand. Production

was badly hit, led to stock-out

30
 AMERICAN APPAREL: DROWNING IN DEBT?

Operating Margin (%)

0.060

0.040

0.020

0.000
2009 2010 2011 2012 2013
-0.020

-0.040

-0.060

-0.080

-0.100

-0.120

3. ROA and ROE

ROA and ROE 2013 2012 2011 2010 2009

Return on assets (%) net loss -32.12% -11.42% -12.05% -26.33% 0.34%

Return on assets (%) comprehensive

-32.59% -11.22% -12.10% -26.67% 0.52%
loss

Return on equity (%) net loss 384.30% -106.17% -63.85% -74.29% 0.76%

Return on equity (%) comprehensive

390.02% -104.37% -64.15% -75.23% 1.18%
loss

● ROA = Net Income / Average Total Asset

● ROA = measures how efficiently AA utilizes its assets, in this case it’s financed by

debt and equity

● ROE = Net Income / Average Total Stockholder’s equity

31
 AMERICAN APPAREL: DROWNING IN DEBT?

● ROE = measure level of income attributed to shareholders against the investment that

shareholders put into AA. It takes into account the amount of debt, or financial

leverage

● Financial leverage – magnifies impact of earnings on ROE

● Large amount of discrepancies between ROA vs. ROE = AA is incorporating large

amount of debts, it’s prudent to closely examine the liquidity and solvency ratio

Return on assets (%) net loss

5.00%

0.00%
2009 2010 2011 2012 2013
-5.00%

-10.00%

-15.00%

-20.00%

-25.00%

-30.00%

-35.00%

Return on assets (%) comprehensive loss

0.00%
2009 2010 2011 2012 2013
-5.00%

-10.00%

-15.00%

-20.00%

-25.00%

-30.00%

-35.00%

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 AMERICAN APPAREL: DROWNING IN DEBT?

Return on equity (%) net loss

500.00%

400.00%

300.00%

200.00%

100.00%

0.00%
2009 2010 2011 2012 2013
-100.00%

-200.00%

Return on equity (%) comprehensive loss

350.00%
300.00%
250.00%
200.00%
150.00%
100.00%
50.00%
0.00%
2009 2010 2011 2012 2013
-50.00%
-100.00%
-150.00%

33
 AMERICAN APPAREL: DROWNING IN DEBT?

Summary of results

Chronology of Business Recession is provided just for reference purpose.

Need to include “solution-to-action” – what actions could save the company

Year 2009

● Use Profitability ratio

● Company has not been profitable since Year 2009

Profitability Ratio Formula 2013 2012 2011 2010 2009

- - -
Net income /
Net margin -0.168 0.06 0.07 0.16 0.002
Revenue
0 2 2

Profitability % Formula 2013 2012 2011 2010 2009

-
Operating income /
Operating margin - 0.00 0.04 - 0.04
Revenue
0.046 2 3 0.094 4

● Operating Margin = Operating income / Revenue

● Irregularities discovered by federal investigations hence OPERATING INCOME is

higher results spike observed in Year 2010

● Reasons behind: During 2009, a workplace raid discover that AA’s had hired 2,000

illegal workers and required to immediate dismissal causing the sudden shortage of

34
 AMERICAN APPAREL: DROWNING IN DEBT?

manpower to produce the high order demand of 260 stores on time and hit a huge

sales lost 93%.

Year 2010

● Total liabilities increased greatly in year 2010 due to an increase in total current

liabilities from revolving credit facilities

● Current ratio is lowest 1.01 in year 2010. Current ratio of 2.0 is considered indicative

of adequate liquidity.

Liquidity 2013 2012 2011 2010 2009 2008

Current
1.33 1.39 1.61 1.01 2.87 1.81
ratio

● Acid-test ratio (Quick ratio) is lowest 0.1135 in year 2010. Acid test ratio of 1.0 is

considered an adequate liquidity.

Year 2013 2012 2011 2010 2009

Acid-test ratio 0.181 0.245 0.218 0.114 0.400

Inventory turnover 1.822 1.611 1.388 1.585 1.651

● Inventories is excluded in the acid test ratio, the drop from 0.4 to 0.1137 is due to

decrease in cash and increase current liabilities

● Working capital is lowest in year 2010

● Reasons behind: The operating income in 2010 is -$50 million it may cause by day

to day operation fixed cost such as 260 stores, warehouse, utilities, employees'

salaries and etc which are required to pay even quantity of production is low

35
 AMERICAN APPAREL: DROWNING IN DEBT?

(production cost high) The poor cash flow causing inability to pay suppliers and with

high inventories will struggle to make items solds for cash.

Year 2011

● Shattered by the losses and lack of liquidity, AA’s money situation worsened by the

first quarter of 2011.

● Despite of this debt, company kept enhancing its stores. Because of its significant

efforts, the net loss declined in 2011 to 39 mil compared to 86 mil.

● No subordinated notes in year 2011

● Total long term liabilities increased by $94466 (97142-444) in year 2011 due to hike

in long term debt. Debt used to avoid default payments in 1Q2011, also resulted

increased in total current asset

● Reasons behind: Bring in new investors and get in a high interest loan to support

current business. Further enhance store to increase sales.

Liquidity 2013 2012 2011 2010 2009 2008

Working $ $ $ $ $ $

Capital 53,307 62,781 87,380 2,386 121,423 83,069

36
 AMERICAN APPAREL: DROWNING IN DEBT?

● Proof of possible filing of bankruptcy in 1Q2011. When current ratio < 1, means

even if AA liquidated all its current assets at the recorded value, it would still unable

to cover its current liabilities.

Year 2012

● Net sales increased by $69974 (12.78%) in fiscal year 2012 because of efforts in

upgraded production forecasting and allocation system + stores increased, reflected in

increased of other assets $34783 in balance sheet.

● CAPEX increased in fiscal year 2012 due to expenditure from upgraded production

forecasting and allocation system

● CAPEX increased in fiscal year 2013 due to expenditure in e-commerce platform and

new distribution centre in LA

● No overdraft in 2012 as the entity decided to leverage by warrant $7608 (17241-9633)

● Gain on extinguishment of debt due to amortized discount of long term debt 27929 in

fiscal year 2012

● New investor on board to AA

● Debt ratio started to increase from 77% (2010) to 123.2% (2013). The debt ratio of

1.232 at fiscal year 2013 means that the entity's total assets is unable to meet its total

debt obligations.

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 AMERICAN APPAREL: DROWNING IN DEBT?

2013 2012 2011 2010 2009 2008

1.23 0.93 0.85 0.77 0.52 0.59

● Debt-to-equity ratio

● Use debt-to-equity: TOTAL LIABILITIES / TOTAL STOCKHOLDER'S EQUITY

● Ratio > 1 means AA uses exceeds amount of debt as equity = creditors have to claim

to all assets, leaving nothing for shareholders in the event of theoretical liquidation

2013 2012 2011 2010 2009 2008

-5.31 13.86 5.75 3.37 1.08 1.45

● The entity was in high financial leverage all the time with value >1. This situation

became significant from fiscal year 2010 with 3.37 to 13.86 in fiscal year 2012. In

● fiscal year 2013, the entity's has deficit equity , the value is -5.31

38
 AMERICAN APPAREL: DROWNING IN DEBT?

Year 2013

1. Its net sales increased marginally in 2013, but the company still ended up with a

bigger loss than ever before. Net loss of 106 million in 2013, a substantial increase

over its net loss of 37 million in 2012, company struggling for survival.

2. Drop of Cash in year 2013 $8676, pressured by high interest rate and debt

repayments. Lion Capital could recall back the debt if management change.

3. No restricted cash reserved for specific purpose in fiscal year 2013 because suffered -

$77404 in deficit of stockholders' equity

4. Deficit in stockholders' equity as all the investment (paid-in capital) is insufficient to

cover the accumulated losses and deficit suffered

5. Shares of the company plummeted from $15 per share to $0.56 per share, losing 95%.

CEO of AA continued borrowing an exorbitant rate (as high as 18% interest) and

additional capital.

6. Reason behind : Market competitiveness (competitors - new fashion trend,

outsourcing service) and market demand is decrease (US market is stagnant)

Year 2014

● Need to pay 13.4 million in interest and other debt repayment

● Reason behind : Being sold company shares to FiveT with 26million which is under

market value and become second largest outsider shareholder. Roth have positive

toward AA’s and confident with Dov that AA have potential to growth further better.

This can be proof by the trade accounts receivable or the net sales revenue.

● Dov Charney is “brand” of AA with his significant successful stories and prize

winning recognition record. However, is fading now as being accused that “willful

39
 AMERICAN APPAREL: DROWNING IN DEBT?

misconduct” based on sexual assault and sexual harrassment on personal misconduct

and with this reason he is being fired as affected corporate image with negative

impact.

40
 AMERICAN APPAREL: DROWNING IN DEBT?

RESULTS AND INTERPRETATION

1. Not Generated enough cash from its operation since 2009

Profitability ratio is applied to analyze the company income versus its revenue. During 2009, a

federal investigation uncovered irregularities in identity documents of workers. Termination of

employment of 2,000 American Apparel’s workers, leads to its inability to both complete orders

on time and meet demand. Production was badly hit, led to stock-out.

Proof of bankruptcy on year 2010. Highly leveraged company will be exposed to the risk of

losses or bankruptcy if the return of investment falls below the cost of borrowing. This often

happens in economic recessions and industry business cycle. A global recession happens on 2009

afterwards has made the recovery of American Apparel more difficult.

Solution approach: This situation should not exist for long. To keep operating, American

Apparel should generate cash from investing or financing activities or used some of the cash on

hand at the beginning of the reporting period. It’s overwhelmed operating expenses has led

American Apparel in cash flow issue. Alternatively, American Apparel should obtain a seasonal

bank loan during peak-period to meet order demands.

Profitability
Formula 2013 2012 2011 2010 2009
Ratio

- - -
Net margin Net income / Revenue -0.168 0.002
0.060 0.072 0.162

Operating Operating income / - -

margin Revenue -0.046 0.002 0.043 0.094 0.044

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 AMERICAN APPAREL: DROWNING IN DEBT?

2. Lack of Improvement in Liquidity Ratio, Doorstep to Bankruptcy

Drastic drop on working capital observed on Year 2010. The cash used for investing activities

exceeds the cash provided by operating activities (refer to Exhibit 4), where the difference will

have to be provided by financing activities or come from the cash balance carried forward from

the prior year.

Total liabilities are observed to increase greatly in year 2010 due to increase in total current

liabilities from revolving the credit facilities. Current ratio is lowest 1.01 in year 2010, When

current ratio < 1, means even if American Apparels liquidated all its current assets at the

recorded value, it would still unable to cover its current liabilities

Acid-test ration (Quick ratio) is lowest 0.1135 in year 2010. Inventories is excluded in the acid

test ratio, the drop from 0.4 to 0.1137 is due to decrease in cash and increase current

liabilities.

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 AMERICAN APPAREL: DROWNING IN DEBT?

Liquidity 2013 2012 2011 2010 2009

Working $ $ $ $ $

Capital 53,307 62,781 87,380 2,386 121,423

Current ratio 1.33 1.39 1.61 1.01 2.87

Acid-test ratio 0.181 0.245 0.218 0.114 0.400

Solution approach: By selling inventory for cash, American Apparel will be able to slightly

improve its acid-test ratio because a current asset that is included in the acid test numerator will

replace a current asset that was previously excluded from the acid-test numerator.

3. Unusual High Financial Leverage Position to Survive Competitive Pressure

Shattered by the losses and lack of liquidity, American Apparel’s money situation worsened by

the first quarter of 2011. Despite of this debt, company kept enhancing its stores. Because of its

significant efforts, the net loss declined in 2011 to 39 mil compared to 86 mil.

However, at the same time, total long term liabilities increase by $94466 (97142-444) in year

2011 due to hike in long term debt. Debt used to avoid default payments in 1Q2011, also resulted

increased in total current asset. American Apparel’s CAPEX increased in fiscal year 2012 due to

expenditure from upgraded production forecasting and allocation system. Subsequently, its

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 AMERICAN APPAREL: DROWNING IN DEBT?

CAPEX increased again in fiscal year 2013 due to expenditure in e-commerce platform and new

distribution centre in LA.

The massive expansion has led American Apparel in the debt-ridden company. Its’ Debt ratio

started to increase from 77% (2010) to 123.2% (2013). The debt ratio of 1.232 at fiscal year 2013

means that the entity's total assest is unable to meet its total debts obligations.

Solvency
2013 2012 2011 2010 2009
Ratio

Debt-ratio 1.23 0.93 0.85 0.77 0.52

Debt-to-
-5.31 13.86 5.75 3.37 1.08
Equity ratio

For Debt-to-equity ratio, a ratio > 1 equates American Apparel has used exceeds amount of debt

as equity creditors have to claim to all assets, which leaving nothing for shareholders in the event

of theoretical liquidation. American Apparel was in high financial leverage all the time with

value >1. This situation became significant from fiscal year 2010 with 3.37 to 13.86 in fiscal

year 2012. In fiscal year 2013, the entity's has deficit equity , the value is -5.31. Deficit in

stockholders' equity as all the investment (paid-in capital) is insufficient to cover the

accumulated losses and deficit suffered

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 AMERICAN APPAREL: DROWNING IN DEBT?

Solution Approach: American apparel should review the cost of investment in stores, production

forecasting and allocation systems. These are avoidable cost which directly impact the solvency

ratio of the company. The company should try to shrink the amount of debt by repaying the loan

to minimize liabilities.

American apparel should try to accelerate the collection of account receivables, slow down

payment of accounts payable and accrued expenses. If the sales revenue continues at a very high

rate, American Apparels should secure permanent financing through sale of bond or stock for

production expansion, conservatively.

4. Borrowing money at interest rate less than rate of return

Shares of company plummeted from $15 per share to $0.56 per share, losing 95%. CEO of AA

continued borrowing an exorbitant rate (as high as 18% interest) and additional capital. No

restricted cash reserved for specific purpose in fiscal year 2013 because suffered -$77404 in

deficit of stockholders' equity

Net sales increased by $69974 (12.78%) in fiscal year 2012 because of efforts in upgraded

production forecasting and allocation system + stores increased, reflected in increased of other

assets $34783 in balance sheet. Nevertheless, the return of investment showing in American

Apparel’s report statement were less than the cost of borrowing, the result would be the

reduction of stockholder’s equity (a loss) at best and bankruptcy at worst. Its net sales increased

marginally in 2013, but company still ended up with bigger loss than ever before. Net loss of 106

million in 2013, substantial increase over its net loss of 37 million in 2012, company struggling

for survival.

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 AMERICAN APPAREL: DROWNING IN DEBT?

Profitability Ratio 2013 2012 2011 2010 2009

Operating Margin -0.046 0.002 -0.043 -0.094 0.044

Return on Investment (%) -318% -114% -12.1% -26.3% 0.3%

-
Return on equity (%) net loss
384.30% -106.17% -63.85% -74.29% 0.76%

Return on equity (%) comprehensive -

loss 390.02% -104.37% -64.15% -75.23% 1.18%

Solution Approach: American Apparel should try to limit the debt in capital structure to no more

than 50% of total capital (debt plus stockholder’s equity). By looking at the dramatically

difference between ROI and ROI trend, it’s observed that American Apparel business has been at

stake over the period presented.

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REFERENCES

Anglo. (2013, December 2). American Apparel - The sudden fall and slow recovery.
Retrieved from https://www.slideshare.net/DitaKovarikova/american-apparel-
corfinkovarikovabuithi

Carcia, T. (2015, October 5). 5 reasons American Apparel is now bankrupt. Retrieved from
https://www.marketwatch.com/story/5-reasons-american-apparel-is-bankrupt-2015-
10-05

Dafina. (2019, July 5). American Apparel Financial Analysis. Retrieved from
https://www.platinumessays.com/essays/American-Apparel-Financial-
Analysis/22048.html

Hammett, E. (2018, April 26). From provocative to body positive: The American Apparel
comeback. Retrieved from https://www.marketingweek.com/american-apparel-uk-
comeback/

Stempel, J. (2011, March 10). American Apparel CEO held teen as sex slave: lawsuit.
Retrieved from https://www.reuters.com/article/us-americanapparel-sex-
lawsuit/american-apparel-ceo-held-teen-as-sex-slave-lawsuit-
idUSTRE7285XC20110309

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