American Apparel, Inc.

Background

American Apparel, Inc. was founded by CEO Dov Charney in 1998. By 2004, with a continued focus on producing high-quality and trendsetting clothes, Charney began receiving many awards including Entrepreneur of the Year and Man of the Year. Between 2004 and 2008, the company experienced tremendous growth, and Charney and the company continued to make achievements such as the Top Trendsetting Brand and Retailer of the Year. American Apparel placed a lot of emphasis on vision, passion, and intensity, as well as fair wages, solar power, recycling, and creativity. From the inception of the company in 1998 all the way up until 2008, the company experienced growth both domestically and internationally. Between 2006 and 2008, the company grew from 147 stores to 260 stores. However, in 2009, due to immigration issues with many of the company’s workers, 2,000 employees had to be laid off, and this was the beginning of the company’s downfall. Operating profit decreased from $36 million in 2008 in $3 million in 2009. By 2010, the company had a net loss of $86 million. Things got better in 2012, but 2013 was by the far the worst financial year with a net loss of $106 million. In 2014, Johannes Minho Roth, CEO of FiveT, purchased $26 million in shares of American Apparel, becoming the second largest shareholder of the company. This inflow of funds helped the company, but only in the short-term as it barely covered their debt and interest payments owed that year. In April of that year, after the awful financial performance in 2013, the board of the company accused and dismissed Charney as CEO because of multiple sexual assault and sexual harassment cases.

Our goal of this memo is to show how this successful company became one that was debt ridden in a matter of years. There are many factors that are at play in this case, and we hope to pinpoint what exactly caused the demise of the company, as well as offer suggestions for the company to stabilize its financial performance. There is no doubt that the company is in trouble, but at this point, there is only one direction for American Apparel to go… Up.

Issues

Currently, the main issue facing this company is debt. In 2008, which was one of the company’s best years, its total liabilities were $197,197,000. In just five years, this number swelled dramatically to $411,156,000 by 2013, which was the company’s worst year. In 2008, the company had zero long-term debt. By 2013, they owed $213,468,000 to lenders, and due to their financial struggles over the time-period, that debt came with extremely high interest rates. Interest expense was $22 million in 2009, and almost doubled to roughly $40 million by 2013. The more obvious issue facing the company is operating income, net income, and cash flow from operations. As debt and interest were drastically increasing, although sales were generally increasing, operating income, net income, and cash flow from operations were all steadily decreasing. The company had an aggressive growth strategy that they financed almost entirely with debt, and the results from this strategy haven’t come into fruition. A look at common-size financial statements as well as financial ratios will help us shed more light on the financial condition of American Apparel.

Analysis

The common-size balance sheet for American Apparel shows balance sheet line items as a percentage of total assets (and total liabilities and stockholders’ equity). In 2008, long-term liabilities accounted for 28% of total liabilities and stockholders’ equity. By 2013, this number was 74.66%. In 2008, total liabilities accounted for 59% of total liabilities and stockholders’ equity. By 2013, because of continuous losses going into retained earnings and stockholders’ equity, total liabilities accounted for 123% of total liabilities and stockholders’ equity. See Exhibit 1 in the Appendix for the common-size balance sheet for American Apparel. The common-size income statement for American Apparel shows income statement line items as a percentage of net sales. Between 2009 and 2013, cost of sales, selling expenses, and general and administrative expenses all increased as a percentage of sales, as did interest expense. In 2013, the company also had a loss on the extinguishment of their debt that amounted to 5% of sales alone. See Exhibit 2 for the common-size income statement. A look at some financial ratios also shows that the company’s performance has decreased over time. Although their short-term liquidity is relatively good when looking at the current ratio over time, the company has a lot of inventory on hand, and this shows in their quick ratio. Without considering inventory, in 2013, American Apparel’s current