10-Q 1 app0331201410q.htm 10-Q APP 03.31.2014 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 001-32697  
 
American Apparel, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 

Delaware
20-3200601
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
747 Warehouse Street, Los Angeles, California
90021
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including area code: (213) 488-0226
 
 
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x    No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer” and “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  
Large accelerated filer
o
Accelerated filer
x
 
 
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
The number of shares of the registrant's common stock issued and outstanding as of May 1, 2014 was approximately 175,228,823 and 173,497,302, respectively.



AMERICAN APPAREL, INC.
TABLE OF CONTENTS
 
Item 1.
 
Condensed Consolidated Balance Sheets - March 31, 2014 and December 31, 2013
 
Condensed Consolidated Statements of Operations and Comprehensive Loss - Three Months Ended March 31, 2014 and 2013
 
Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2014 and 2013
 
Item 2.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Mine Safety Disclosures
Item 5.
Item 6.
 
 

 

2


Unless the context requires otherwise, all references in this report to the “Company,” “Registrant”, “we,” “our,” and “us” refer to American Apparel, Inc., a Delaware corporation, together with its wholly owned subsidiary, American Apparel (USA), LLC, and its other direct and indirect subsidiaries.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q, including the documents incorporated by reference herein, contains forward-looking statements within the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. All statements in this Quarterly Report on Form 10-Q other than statements of historical fact are “forward-looking statements” for purposes of these provisions. Statements that include the use of terminology such as “may,” “will,” “expects,” “believes,” “plans,” “estimates,” “potential,” or “continue,” or the negative thereof or other and similar expressions are forward-looking statements. In addition, in some cases, you can identify forward-looking statements by words or phrases such as “trend,” “potential,” “opportunity,” “believe,” “comfortable,” “expect,” “anticipate,” “current,” “intention,” “estimate,” “position,” “assume,” “outlook,” “continue,” “remain,” “maintain,” “sustain,” “seek,” “achieve,” and similar expressions.
Any statements that refer to projections of our future financial performance, our anticipated growth and trends in our business, our goals, strategies, focuses and plans and other characterizations of future events or circumstances, including statements expressing general expectations or beliefs, whether positive or negative, about future operating results or the development of our products and any statement of assumptions underlying any of the foregoing are forward-looking statements. Forward-looking statements in this report may include, without limitation, statements about:
our future financial condition, results of operations, our plans and our prospects, expectations, goals and strategies for future growth, operating improvements and cost savings and the timing of any of the foregoing;
our ability to make our debt service payments and remain in compliance with financial covenants under our financing arrangements and obtain appropriate waivers or amendments with respect to any noncompliance;
our liquidity and projected cash flows;
our plan to make continued investments in advertising and marketing; 
our growth, expansion and acquisition prospects and strategies, the success of such strategies, and the benefits we believe can be derived from such strategies; 
the outcome of investigations, enforcement actions and litigation matters, including exposure, which could exceed expectations;
our intellectual property rights and those of others, including actual or potential competitors, our personnel, consultants, and collaborators; 
operations outside the United States; 
trends in raw material costs and other costs both in the industry, and specific to the Company;
the supply of raw materials and the effects of supply shortages on our financial condition, results of operations, and cash flows;
economic and political conditions; 
overall industry and market performance; 
the impact of accounting pronouncements; 
our ability to maintain compliance with the listing requirements of NYSE MKT, LLC;
our ability to improve manufacturing efficiency at our production facilities;
our ability to improve efficiency and control costs at our distribution facility located in La Mirada, California;
management's goals and plans for future operations; and 
other assumptions described in this Quarterly Report on Form 10-Q underlying or relating to any forward-looking statements.
The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to place undue reliance on any such forward-looking statements, which are qualified in their entirety by this cautionary statement. Forward-looking statements are subject to numerous assumptions, events, risks, uncertainties and other factors, including those that may be outside of our control and that change over time. As a result, actual results and/or the timing of events could differ

3


materially from those expressed in or implied by the forward-looking statements and future results could differ materially from those expressed in or implied by the forward-looking statements and future results could differ materially from historical performance. Such assumptions, events, risks, uncertainties and other factors include, among others, those described under Part II, Item IA and elsewhere in this report and in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 (filed with the United States Securities and Exchange Commission (the “SEC”) on April 1, 2014) as well as in other reports and documents we file with the SEC and include, without limitation, the following:
our ability to generate or obtain from external sources sufficient liquidity for operations and debt service;
our financial condition, operating results and projected cash flows;
consequences of our significant indebtedness, including our relationship with our lenders and our ability to comply with our debt agreements and generate cash flow to service our debt, and the risk of acceleration of borrowings thereunder as a result of noncompliance;
disruptions in the global financial markets;
our ability to maintain compliance with the exchange rules of the NYSE MKT, LLC;
adverse changes in our credit ratings and any related impact on financial costs and structure;
continued compliance with U.S. and foreign government regulations, legislation, and regulatory environments, including environmental, immigration, labor, and occupational health and safety laws and regulations;
loss of U.S. import protections or changes in duties, tariffs and quotas, and other risks associated with our foreign operations and foreign supply sources, including disruption of markets and foreign supply sources, changes in import and export laws, currency restrictions, and currency exchange rate fluctuations;
the highly competitive and evolving nature of our business in the U.S. and internationally;
changes in the level of consumer spending or preferences or demand for our products;
our ability to pass on the added cost of raw materials and labor to customers;
our ability to attract customers to our stores;
the availability of store locations at appropriate terms and our ability to identify locations and negotiate new store leases effectively and to open new stores and expand internationally;
loss or reduction in sales to our wholesale or retail customers or financial nonperformance by our wholesale customers;
risks that our suppliers or distributors may not timely produce or deliver our products;
changes in the cost of materials and labor, including increases in the price of raw materials in the global market and increases in minimum wages;
our ability to effectively carry out and manage our strategy, including growth and expansion both in the U.S. and internationally;
technological changes in manufacturing, wholesaling, or retailing;
our ability to successfully implement our strategic, operating, financial and personnel initiatives;
changes in key personnel, our ability to hire and retain key personnel, and our relationship with our employees;
our ability to maintain the value and image of our brand and protect our intellectual property rights;
our ability to improve manufacturing efficiency at our production facilities;
our ability to operate our distribution facility located in La Mirada, California without further unanticipated costs or, negative sales impacts, including the ability to achieve, as and when planned, labor cost reductions;
location of our facilities in the same geographic area;
the risk, including costs and timely delivery issues associated therewith, that information technology systems changes may disrupt our supply chain or operations and could impact our cash flow and liquidity, and our ability to upgrade our information technology infrastructure and other risks associated with the systems that operate our online retail operations;
our ability to effectively manage inventory levels;

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our ability to renew leases at existing locations on economic terms;
risks associated with the recent downturn in apparel spending in the United States;
litigation and other inquiries and investigations, including the risks that we, our officers, or directors in cases where indemnification applies, will not be successful in defending any proceedings, lawsuits, disputes, claims or audits, and that exposure could exceed expectations or insurance coverages;
tax assessments by domestic or foreign governmental authorities, including import or export duties on our products and the applicable rates for any such taxes or duties;
the adoption of new accounting standards or changes in interpretations of accounting principles;
seasonality and fluctuations in comparable store sales and wholesale net sales, and associated margins;
general economic conditions, including increases in interest rates, geopolitical events, other regulatory changes and inflation or deflation;
disruptions due to severe weather or climate change; and
disruptions due to earthquakes, flooding, tsunamis or other natural disasters.
All forward-looking statements included in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statements.

5


PART I-FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
American Apparel, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Amounts and shares in thousands, except per share amounts)
(unaudited)
 
 
March 31, 2014
 
December 31, 2013*
ASSETS
 
 
 
CURRENT ASSETS
 
 
 
Cash
$
16,683

 
$
8,676

Trade accounts receivable, net of allowances of $2,281 and $2,229 at March 31, 2014 and December 31, 2013, respectively
22,041

 
20,701

Prepaid expenses and other current assets
13,367

 
15,636

Inventories, net
163,652

 
169,378

Income taxes receivable and prepaid income taxes
350

 
306

Deferred income taxes, net of valuation allowance
604

 
599

Total current assets
216,697

 
215,296

PROPERTY AND EQUIPMENT, net
65,607

 
69,303

DEFERRED INCOME TAXES, net of valuation allowance
2,425

 
2,426

OTHER ASSETS, net
46,761

 
46,727

TOTAL ASSETS
$
331,490

 
$
333,752

LIABILITIES AND STOCKHOLDERS' DEFICIT
 

 
 

CURRENT LIABILITIES
 

 
 

Cash overdraft
$
4

 
$
3,993

Revolving credit facilities and current portion of long-term debt
29,469

 
44,042

Accounts payable
40,174

 
38,290

Accrued expenses and other current liabilities
53,952

 
50,018

Fair value of warrant liability
8,287

 
20,954

Income taxes payable
1,837

 
1,742

Deferred income tax liability, current
1,241

 
1,241

Current portion of capital lease obligations
1,177

 
1,709

Total current liabilities
136,141

 
161,989

LONG-TERM DEBT, net of unamortized discount of $5,631 and $5,779 at March 31, 2014 and December 31, 2013, respectively
214,586

 
213,468

CAPITAL LEASE OBLIGATIONS, net of current portion
5,866

 
5,453

DEFERRED TAX LIABILITY
529

 
536

DEFERRED RENT, net of current portion
15,891

 
18,225

OTHER LONG-TERM LIABILITIES
12,149

 
11,485

TOTAL LIABILITIES
385,162

 
411,156

COMMITMENTS AND CONTINGENCIES


 


STOCKHOLDERS' DEFICIT
 

 
 

Preferred stock, $0.0001 par value per share, authorized 1,000 shares; none issued

 

Common stock, $0.0001 par value per share, authorized 230,000 shares; 175,229 shares issued and 173,377 shares outstanding at March 31, 2014 and 113,469 shares issued and 111,330 shares outstanding at December 31, 2013
17

 
11

Additional paid-in capital
215,135

 
185,472

Accumulated other comprehensive loss
(4,777
)
 
(4,306
)
Accumulated deficit
(261,890
)
 
(256,424
)
Less: Treasury stock, 304 shares at cost
(2,157
)
 
(2,157
)
TOTAL STOCKHOLDERS' DEFICIT
(53,672
)
 
(77,404
)
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
$
331,490

 
$
333,752

* Condensed from audited financial statements.
See accompanying notes to condensed consolidated financial statements.

6


American Apparel, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations and Comprehensive Loss
(Amounts and shares in thousands, except per share amounts)
(unaudited)

 
Three Months Ended March 31,
 
2014
 
2013
Net sales
$
137,096

 
$
138,060

Cost of sales
65,122

 
65,192

Gross profit
71,974

 
72,868

Selling expenses
54,062

 
55,463

General and administrative expenses (including related party charges of $160 and $217 for the three months ended March 31, 2014 and 2013, respectively)
24,909

 
27,804

Retail store impairment
499

 
78

 
 
 
 
Loss from operations
(7,496
)
 
(10,477
)
 
 
 
 
Interest expense
10,039

 
11,214

Foreign currency transaction loss
132

 
713

Unrealized (gain) loss on change in fair value of warrants
(12,667
)
 
23,645

Other income
(8
)
 
(5
)
Loss before income taxes
(4,992
)
 
(46,044
)
Income tax provision
474

 
467

Net loss
$
(5,466
)
 
$
(46,511
)
 
 
 
 
Basic and diluted loss per share
$(0.05)
 
$(0.42)
Weighted average basic and diluted shares outstanding
111,554
 
109,918
 
 
 
 
Net loss (from above)
$
(5,466
)
 
$
(46,511
)
    Other comprehensive loss item:
 
 
 
    Foreign currency translation loss, net of tax
(471
)
 
(1,504
)
        Other comprehensive loss, net of tax
(471
)
 
(1,504
)
Comprehensive loss
$
(5,937
)
 
$
(48,015
)

See accompanying notes to condensed consolidated financial statements.
 

7


American Apparel, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(unaudited)

 
Three Months Ended March 31,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Cash received from customers
$
136,815

 
$
137,654

Cash paid to suppliers, employees and others
(130,984
)
 
(139,649
)
Income taxes (paid) refunded
(403
)
 
9

Interest paid
(1,521
)
 
(4,040
)
Other
8

 
18

Net cash provided by (used in) operating activities
3,915

 
(6,008
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Capital expenditures
(3,958
)
 
(7,354
)
Proceeds from sale of fixed assets
30

 
12

Restricted cash

 
(622
)
Net cash used in investing activities
(3,928
)
 
(7,964
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash overdraft
(3,989
)
 
1,340

(Repayments) borrowings under revolving credit facilities, net
(14,557
)
 
7,624

Repayments of term loans and notes payable
(50
)
 
(3
)
Payments of debt issuance costs
(372
)
 
(1,678
)
Net proceeds from issuance of common stock
28,554

 

Payment of payroll statutory tax withholding on share-based compensation associated with issuance of common stock
(125
)
 
(112
)
Repayments of capital lease obligations
(137
)
 
(176
)
Net cash provided by financing activities
9,324

 
6,995

 
 
 
 
EFFECT OF FOREIGN EXCHANGE RATE ON CASH
(1,304
)
 
(300
)
 
 
 
 
NET INCREASE (DECREASE) IN CASH
8,007

 
(7,277
)
CASH, beginning of period
8,676

 
12,853

CASH, end of period
$
16,683

 
$
5,576


See accompanying notes to condensed consolidated financial statements.

8



American Apparel, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (continued)
(Amounts in thousands)
(unaudited)
 
Three Months Ended March 31,
 
2014
 
2013
RECONCILIATION OF NET LOSS TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
 
 
 
Net loss
$
(5,466
)
 
$
(46,511
)
Depreciation and amortization of property and equipment, and other assets
6,715

 
6,031

Retail store impairment
499

 
78

Loss on disposal of property and equipment

 
13

Share-based compensation expense
1,115

 
3,547

Unrealized (gain) loss on change in fair value of warrants
(12,667
)
 
23,645

Amortization of debt discount and deferred financing costs
597

 
2,610

Accrued interest paid-in-kind
1,030

 
4,564

Foreign currency transaction loss
132

 
713

Allowance for inventory shrinkage and obsolescence
121

 
254

Bad debt expense
139

 
139

Deferred rent
(2,222
)
 
(448
)
Changes in cash due to changes in operating assets and liabilities:
 
 
 
Trade accounts receivables
(420
)
 
(545
)
Inventories
5,445

 
(4,811
)
Prepaid expenses and other current assets
2,288

 
220

Other assets
(235
)
 
(1,825
)
Accounts payable
2,424

 
3,999

Accrued expenses and other liabilities
4,349

 
1,859

Income taxes receivable / payable
71

 
460

Net cash provided by (used in) operating activities
$
3,915

 
$
(6,008
)
 
 
 
 
NON-CASH INVESTING AND FINANCING ACTIVITIES
 
 
 
Property and equipment acquired, and included in accounts payable
$
1,040

 
$
3,433


See accompanying notes to condensed consolidated financial statements.


9



American Apparel, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
For the Three and Months Ended March 31, 2014 and 2013
(Amounts and shares in thousands, except per share amounts)
(unaudited)

Note 1. Organization and Business
American Apparel, Inc. and its subsidiaries (collectively the “Company”) is a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel products and designs, manufactures and sells clothing and accessories for women, men, children and babies. The Company sells its products through the wholesale distribution channel supplying t-shirts and other casual wear to distributors and screen printers, as well as direct to customers through its retail stores located in the United States, and internationally. In addition, the Company operates an online retail e-commerce website. At March 31, 2014, the Company operated a total of 249 retail stores in 20 countries: the United States, Canada and 18 other countries.
Liquidity and Management's Plan
As of March 31, 2014, the Company had approximately $16,683 in cash and $16,762 of availability for additional borrowings under a $50,000 asset-backed credit facility with Capital One Business Credit Corp. ("Capital One" and such facility, the "Capital One Credit Facility") (as defined in Note 6). As of April 30, 2014, the Company had $18,261 available for borrowing under the revolving credit agreement.
On March 25, 2014, the Company entered into the Fifth Amendment to the Capital One Credit Facility which, effective upon the receipt of net proceeds from the March 31, 2014 equity offering (see below), among other things: waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three month periods ended December 31, 2013 and March 31, 2014; reset for future periods the fixed charge coverage ratio, the maximum leverage ratio and the maximum capital expenditures allowed; added a minimum EBITDA covenant; increased the interest rate payable under the credit agreement by 0.5% per annum to either LIBOR plus 5.0% or the bank's prime rate plus 4.0% (at the Company's option); and increased the fees payable upon early termination.
On March 31, 2014, the Company completed a public offering of approximately 61,645 shares of its common stock at $0.50 per share for net proceeds of $28,554.
On April 14, 2014, the Company paid $13,390 in interest on Senior Secured Notes due 2020 (the "Notes").
The Company believes that it has sufficient financing commitments to meet funding requirements for the next twelve months.
The Company continues to develop other initiatives intended to either increase sales, reduce costs or improve liquidity. In the fourth quarter of 2013 and continuing through the first quarter of 2014, significant reductions were made in payroll and related costs associated with manufacturing and administrative overhead. The Company also instituted a program towards the end of the first quarter of 2014 to limit capital expenditures. Additionally, the Company intends to continue to drive productivity improvements from its new distribution center, reduce inventories, reduce store labor costs, and evaluate further consolidation of administrative and manufacturing functions. Efforts to identify additional ways to reduce costs and improve productivity will be ongoing.
Although the Company has made significant improvements under this plan, the Company's cash flows are dependent upon meeting future sales growth projections and reducing certain expenses. There can be no assurance that planned improvements will be successful.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of American Apparel, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation. Certain reclassifications have been made to the prior year's condensed consolidated financial statements and related footnotes to conform them to the 2014 presentation.
The accompanying unaudited condensed consolidated financial statements of the Company and its wholly owned subsidiaries have been prepared by the Company, in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, and are presented in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X, and have not been audited. Accordingly, these unaudited condensed consolidated financial

10


statements do not include all of the information and notes required by GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended December 31, 2013 included in the Company's Annual Report on Form 10-K. In the opinion of management, the interim unaudited condensed consolidated financial statements included herein contain all adjustments, including normal recurring adjustments, considered necessary to present fairly the Company's financial position, the results of operations and cash flows for the periods presented.
The operating results and cash flows of the interim periods presented herein are not necessarily indicative of the results to be expected for any other interim period or the full year.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The most complex and subjective estimates include: inventory valuation and obsolescence; valuation and recoverability of long-lived assets, including the values assigned to goodwill, and property and equipment; fair value calculations, including derivative liabilities such as the Lion warrants; contingencies, including accruals for the outcome of current litigation and assessments and self-insurance; income taxes, including uncertain income tax positions and recoverability of deferred income taxes; and cash flow projections in assessing future performance related to financial standards requiring a prospective analysis in valuing and classifying assets and liabilities.
On a regular basis, management reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience, and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments, which potentially subject the Company to credit risk consist primarily of cash (the amounts of which may, at times, exceed Federal Deposit Insurance Corporation limits on insurable amounts) and trade accounts receivable (including credit card receivables), relating substantially to the Company’s U.S. Wholesale segment. The Company mitigates its risk by investing through major financial institutions. The Company had approximately $5,758 and $7,374 held in foreign banks at March 31, 2014 and December 31, 2013, respectively.
The Company mitigates its risks related to trade receivables by performing on-going credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information. The Company also maintains an insurance policy for certain customers based on a customer’s credit rating and established limits. Collections and payments from customers are continuously monitored. One customer in the Company's U.S. Wholesale segment accounted for 19.7% and 14.2% of the Company’s total accounts receivables as of March 31, 2014 and December 31, 2013, respectively. The Company maintains an allowance for doubtful accounts, which is based upon historical experience and specific customer collection issues that have been identified. While bad debt expenses have historically been within expectations and allowances established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.
Fair Value Measurements
The Company’s financial instruments are primarily composed of cash, restricted cash, accounts receivable (including credit card receivables), accounts payable, revolving credit borrowings, its senior secured notes, term loans and warrants. The fair value of cash, restricted cash, accounts receivable and accounts payable closely approximates their carrying value due to their short maturities and variable rates. The fair value of fixed-rate borrowings not based on quoted prices is estimated using a discounted cash flow analysis.
The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related asset or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities.

11


Whenever possible, the Company utilizes observable market inputs (quoted market prices) when measuring fair value.
For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company's accounting and finance department determines its valuation policies and procedures. Their determinations are approved by the Chief Financial Officer.
As of March 31, 2014, there were no transfers in or out of Level 2 and Level 3 from other levels.
The fair value of fixed rate borrowings not based on quoted prices are estimated using a projected discounted cash flow analysis based on unobservable inputs including interest payments, principal payments and discount rate, and is classified within Level 3 of the valuation hierarchy. An increase or decrease in the stock price and the discount rate assumption can significantly decrease or increase the fair value of the fixed rate borrowings. See Note 8.
The fair value of each warrant is estimated using the Binomial Lattice option valuation model. Significant observable and unobservable inputs include stock price, exercise price, annual risk free rate, term, and expected volatility, and were classified within Level 3 of the valuation hierarchy. An increase or decrease in these inputs could significantly increase or decrease the fair value of the warrants. See Notes 8 and 11.
The fair value of indefinite-lived assets, which consists exclusively of goodwill, is measured in connection with the Company’s annual goodwill impairment test or when events occur that indicate a potential for impairment.  The fair value of the reporting unit to which goodwill has been assigned, is determined using a projected discounted cash flow analysis based on unobservable inputs including gross profit, discount rate, working capital requirements, capital expenditures, depreciation and terminal value assumptions, and are classified within Level 3 of the valuation hierarchy. An increase or decrease in the discount rate assumption and/or the terminal value assumption, in isolation, can have a significant effect on the fair value of the reporting unit.
Retail stores that have indicators of impairment and whose carrying value of assets are greater than their related projected undiscounted future cash flows, are measured for impairment by comparing the fair value of the assets against their carrying value. Fair value of the assets is estimated using a projected discounted cash flow analysis based on unobservable inputs including gross profit and discount rate, and is classified within Level 3 of the valuation hierarchy.  The key assumptions used in the estimates of projected cash flows were sales, gross margins, and payroll costs. These forecasts were based on historical trends and take into account recent developments, as well as the Company's plans and intentions. An increase or decrease in the discount rate assumption and/or projected cash flows, in isolation, can significantly decrease or increase the fair value of the assets, which would have an effect on the impairment recorded.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements.  Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The Company estimates the degree to which tax assets and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction.  A valuation allowance for such tax assets and loss carryforwards is provided when it is determined that such amounts will more likely than not go unrealized.  If it becomes more likely than not that a tax asset will be realized, any related valuation allowance of such assets would be reversed.
During the three months ended March 31, 2014 and 2013, the Company incurred losses from operations. Based upon these results, and trends in the Company's performance projected through 2014, it is more likely than not that the Company will not realize any benefit from the deferred tax assets recorded by the Company in previous periods arising from net operating loss carry-forwards.  The Company did not record income tax benefits in the condensed consolidated financial statements for the three months ended March 31, 2014 and 2013 as the Company determined that it was more likely than not that sufficient taxable income in the future will not be generated in the respective jurisdictions to realize the deferred income tax assets. 
Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability.  In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions.  In management's opinion, adequate provisions for income taxes have been made for all years.  If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
The Company's foreign domiciled subsidiaries are subject to foreign income taxes on earnings in their respective jurisdictions. The Company elected to have its foreign subsidiaries, except for its subsidiaries in Brazil, Canada, China, Spain, Italy, Ireland and South Korea, consolidated in the Company's U.S. federal income tax return.  The Company will generally be eligible to receive tax credits on its U.S. federal income tax return for most of the foreign taxes paid by the Company's entities included in the United States Federal income tax return.

12


The Company accounts for uncertain tax positions in accordance with ASC 740 - “Income Taxes.” Gross unrecognized tax benefits at March 31, 2014 and December 31, 2013 are included in current liabilities in the accompanying condensed consolidated balance sheets.  The Company accrues interest and penalties on unrecognized tax benefits as components of the income tax provision in the accompanying condensed consolidated statements of operations. In accordance with ASC 740, the Company evaluates whether a valuation allowance should be established against the net deferred tax assets based upon the consideration of all available evidence and using a “more likely than not” standard. Significant weight is given to evidence that can be objectively verified. The determination to record a valuation allowance is based on the recent history of cumulative losses and current operating performance. In conducting the analysis, the Company utilizes an approach, which considers the current year loss, including an assessment of the degree to which any losses are driven by items that are unusual in nature and incurred to improve future profitability. In addition, the Company reviews changes in near-term market conditions and any other factors arising during the period, which may impact its future operating results.
Accounting Standards Updates
Recently issued accounting standards updates are not expected to have a material effect on the Company's condensed consolidated financial statements.
Subsequent Events
The Company has evaluated events that occurred subsequent to March 31, 2014 and through the date the financial statements were available to be issued. Management concluded that no additional subsequent events required disclosure in these financial statements other than those disclosed in these notes to these financial statements.
Note 3. Inventories
The components of inventories are as follows:  
 
March 31, 2014
 
December 31, 2013
Raw materials
$
20,134

 
$
23,199

Work in process
3,382

 
2,596

Finished goods
143,036

 
146,361

 
166,552

 
172,156

Less reserve for inventory shrinkage and obsolescence
(2,900
)
 
(2,778
)
Total, net of reserves
$
163,652

 
$
169,378

Inventories are stated at the lower of cost or market. Cost is primarily determined on the first-in, first-out (FIFO) method. The cost elements of inventories include materials, labor and overhead. For the three months ended March 31, 2014 and 2013, no one supplier provided more than 10% of the Company’s raw material purchases.
The Company identifies potentially excess and slow-moving inventories by evaluating turn rates, inventory levels and other factors and provides reserves for lower of cost or market reserves for such identified excess and slow-moving inventories. At March 31, 2014 and December 31, 2013, the Company had a lower of cost or market reserve for excess and slow-moving inventories of $1,921 and $1,951, respectively.
The Company establishes a reserve for inventory shrinkage for each of its retail locations and its warehouse. The reserve is based on the historical results of physical inventory cycle counts. The Company had a reserve for inventory shrinkage in the amount of $979 and $827 at March 31, 2014 and December 31, 2013, respectively.
Note 4. Property and Equipment
Depreciation and amortization expense relating to property and equipment (including capitalized leases) is recorded in cost of sales and operating expenses. For the three months ended March 31, 2014 and 2013, depreciation and amortization expense was $6,715 and $6,031, respectively.
Based upon the results of its retail store impairment analysis, for the three months ended March 31, 2014 and 2013, the Company recorded impairment charges of $499 and $78, respectively.

13


Note 5. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows:
 
March 31, 2014
 
December 31, 2013
Compensation, bonuses and related taxes
$
10,479

 
$
11,773

Accrued interest
12,953

 
6,064

Workers' compensation and other self-insurance reserves (Note 14)
6,372

 
6,383

Sales, value and property taxes
1,912

 
3,868

Gift cards and store credits
6,612

 
7,391

Loss contingencies
1,177

 
1,177

Deferred revenue
942

 
1,258

Deferred rent
3,479

 
3,363

Other
10,026

 
8,741

Total accrued expenses
$
53,952

 
$
50,018


Note 6. Revolving Credit Facilities and Current Portion of Long-Term Debt
The following table presents revolving credit facilities and current portion of long-term debt:
 
March 31, 2014
 
December 31, 2013
Revolving credit facility (Capital One), maturing April 2018
$
29,452

 
$
43,526

Revolving credit facility (Bank of Montreal), matured on March 31 2014

 
443

Current portion of long-term debt (Note 7)
17

 
73

Total revolving credit facilities and current portion of long-term debt
$
29,469

 
$
44,042

The Company incurred interest charges of $10,039 and $11,214 for the three months ended March 31, 2013 and 2014, respectively, for all outstanding borrowings. The interest charges subject to capitalization for the three months ended March 31, 2014 and 2013 were not significant.
Revolving Credit Facility - Capital One
As of March 31, 2014, the Company had $29,452 outstanding on a $50,000 asset-backed revolving credit facility with Capital One and $16,762 available for additional borrowings. The Capital One Credit Facility matures on April 4, 2018, subject to a January 15, 2018 maturity if excess availability is less than $15,000 at the time of notice to Capital One of a determination by the Company that an Applicable High Yield Discount Obligation ("AHYDO") redemption will be required pursuant to Section 3.01(e) of the indenture governing the Notes (as defined in Note 7). Borrowings under the Capital One Credit Facility bear interest equal to LIBOR plus 5.0% or the bank's prime rate plus 4.0% (at the Company's option) and are subject to maintenance of specified borrowing base requirements and covenants. The Capital One Credit Facility is secured by a lien on substantially all of the assets of the Company's domestic subsidiaries and equity interests in certain of the Company's foreign subsidiaries, subject to some exceptions. As of March 31, 2014, the Company had $1,230 of outstanding letters of credit secured against the Capital One Credit Facility.
Among other provisions, the Capital One Credit Facility requires that the Company maintain a lockbox arrangement and contains certain subjective acceleration clauses. In addition, Capital One may at its discretion, adjust the advance restriction and criteria for eligible inventory and accounts receivable. The Capital One Credit Facility contains cross-default provisions whereby an event of default under the indenture governing the Notes or other indebtedness, in each case of an amount greater than a specified threshold, would cause an event of default under the Capital One Credit Facility.
The Company is required to maintain a minimum fixed charge coverage ratio of not less than 0.85 to 1.00 for the period of April 1, 2014 to June 30, 2014 and 1.00 to 1.00 for the remainder of 2014 and is also required to not exceed certain maximum leverage ratio thresholds, both determined as at the end of each fiscal quarter. Additionally, the Company's domestic subsidiaries are subject to an annual limitation of certain specified capital expenditure amounts as determined at the end of each fiscal year.
On March 25, 2014, the Company entered into the Fifth Amendment to the Capital One Credit Facility which, effective upon the receipt of net proceeds from the March 31, 2014 equity offering (see Note 11), among other things: waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three month periods ended December 31, 2013

14


and March 31, 2014; reset for future periods the fixed charge coverage ratio, the maximum leverage ratio and the maximum capital expenditures allowed; added a minimum EBITDA covenant; increased the interest rate payable under the credit agreement by 0.5% per annum to either LIBOR plus 5.0% or the bank's prime rate plus 4.0% (at the Company's option); and increased the fees payable upon early termination.
Revolving Credit Facility - Bank of Montreal
The Company's wholly-owned Canadian subsidiaries had a revolving credit facility with Bank of Montreal. Outstanding amounts under the credit facility were repaid, and on March 31, 2014 the agreement expired by its terms.

Note 7. Long-Term Debt
Long-term debt consists of the following:
 
March 31, 2014
 
December 31, 2013
Senior Secured Notes due 2020 (a)
$
204,443

 
$
203,265

Long-term debt with Lion, maturing October 2018 (b)
9,865

 
9,865

Other
295

 
411

Total long-term debt
214,603

 
213,541

Current portion of debt
(17
)
 
(73
)
Long-term debt, net of current portion
$
214,586

 
$
213,468

(a) Includes accrued interest paid in-kind of $4,074 and $3,044 and net of unamortized discount of $5,631 and $5,779 at March 31, 2014 and December 31, 2013, respectively.
(b) Including accrued interest paid in-kind of $365 at both March 31, 2014 and December 31, 2013.
      
Senior Secured Notes due 2020
On April 4, 2013, the Company issued the Notes in an aggregate principal amount of $206,000 at 97% of par value. The Notes mature on April 15, 2020 and bears interest at 15% per annum, of which 2% is payable in-kind until April 14, 2018 and in cash on subsequent interest dates. As of March 31, 2014, the amount outstanding under the Notes was $204,443, which includes accrued interest paid in-kind of $4,074 and is net of unamortized discount of $5,631.
Interest on the Notes approximating $13,500 per payment period (in 2014), is payable semi-annually, in arrears, on April 15 and October 15 of each year, beginning on October 15, 2013. On April 14, 2014, the Company paid $13,390 in interest on the Notes.
On or after April 15, 2017, the Company may, at its option, redeem some or all of the Notes at a premium decreasing ratably to zero as specified in the indenture, plus accrued and unpaid interest to, but not including, the redemption date. Prior to April 15, 2017, the Company may, at its option, redeem up to 35% of the aggregate principal amount of the Notes with the net cash proceeds of certain equity offerings at a redemption price of 113% of the aggregate principal amount of the redeemed notes plus accrued and unpaid interest to, but not including, the redemption date. In addition, at any time prior to April 15, 2017 the Company may, at its option, redeem some or all of the Notes by paying a "make whole" premium, plus accrued and unpaid interest to, but not including, the redemption date. If the Company experiences certain change of control events, the holders of the Notes will have the right to require the Company to purchase all or a portion of the Notes at a price in cash equal to 101% of the principal amount of such Notes, plus accrued and unpaid interest to, but not including, the date of purchase. In addition, the Company is required to use the net proceeds of certain asset sales, if not used for specified purposes, to purchase some of the Notes at 100% of the principal amount, plus accrued and unpaid interest to, but not including, the date of purchase. On each interest payment date after April 4, 2018, the Company will be required to redeem, for cash, a portion of each Note then outstanding equal to the amount necessary to prevent such Note from being treated as an “applicable high yield discount obligation” within the meaning of the Internal Revenue Code. The redemption price will be 100% of the principal amount plus accrued and unpaid interest thereon on the date of redemption.
The Notes are guaranteed, jointly and severally, on a senior secured basis by the Company's existing and future domestic subsidiaries. The Notes and the related guarantees are secured by a first-priority lien on the Company's and its domestic subsidiaries' assets (other than the Credit Facility Priority Collateral, as defined below, subject to some exceptions and permitted liens). The Notes and the related guarantees also are secured by a second-priority lien on all of Company's and its domestic subsidiaries' accounts receivable, inventory, cash, and certain other assets (collectively, the "Credit Facility Priority Collateral"), subject to certain exceptions and permitted liens. The Notes and the guarantees, respectively, rank equal in right

15


of payment with the Company's and its domestic subsidiaries' senior indebtedness, including indebtedness under the Capital One Credit Facility, before giving effect to collateral arrangements.
The Notes impose certain limitations on the ability of the Company and its domestic subsidiaries to, among other things, and subject to a number of important qualifications and exceptions, incur additional indebtedness or issue disqualified capital stock or preferred stock (with respect to restricted subsidiaries), grant liens, make payments in respect of their capital stock or certain indebtedness, enter into transactions with affiliates, create dividend or other payment restrictions affecting subsidiaries, merge or consolidate with any other person, sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets or adopt a plan of liquidation. The Company must annually report to the trustee on compliance with such limitations. The Notes also contain cross-default provisions whereby a payment default or acceleration of any indebtedness in an aggregate amount greater than a specified threshold would cause an event of default with respect to the Notes.
As of March 31, 2014, the Company was in compliance with the required covenants of the Senior Notes Indenture.
Lion Loan Agreement
The Company has a loan agreement with Lion (the “Lion Loan Agreement”). The term loans under the Lion Loan Agreement mature on October 4, 2018 and bear interest at 20% per annum. Interest under the loan agreement is payable in cash or, to the extent permitted by the Company’s other debt agreements, in-kind. As of March 31, 2014, the amount outstanding under the Lion Loan Agreement was $9,865, which includes accrued interest paid in-kind of $365.
The Lion Loan Agreement contains cross-default provisions whereby a payment default or acceleration of any indebtedness in an aggregate amount greater than a specified threshold would cause an event of default. As of March 31, 2014, the Company was in compliance with the required covenants of the Lion Loan Agreement.

Note 8. Fair Value of Financial Instruments
The fair value of the Company's financial instruments are measured on a recurring basis. The carrying amount reported in the accompanying condensed consolidated balance sheets for cash, accounts receivable, accounts payable and accrued expenses approximates fair value because of the short-term maturity of those instruments. The carrying amount for borrowings from Capital One approximates fair value because of the variable market interest rate charged to the Company for these borrowings. The fair value of the Notes was calculated based on the quoted market price of the Notes. The fair value of the Lion Loan Agreement was estimated using a discounted cash flow analysis and a yield rate that was estimated using yield rates for publicly traded debt instruments of comparable companies with similar features. The fair value of warrants was estimated using Binomial Lattice option valuation model.  
The Company did not have any assets or liabilities categorized as Level 1 as of March 31, 2014.
The following table presents carrying amounts and fair values of the Company's financial instruments as of March 31, 2014 and December 31, 2013:
 
 
March 31, 2014
 
 
Carrying Amount
 
Fair Value
Senior Secured Notes due 2020, net of discount of $5,631 and including interest paid-in-kind of $4,074
Level 2 Liability
$
204,443

 
$
184,113

Lion Loan due 2018 including interest paid-in-kind of $365
Level 3 Liability
9,865

 
8,949

Lion Warrant
Level 3 Liability

(a)
8,287

 
 
$
214,308

 
$
201,349

 
 
 
 
 
 
 
December 31, 2013
 
 
Carrying Amount
 
Fair Value
Senior Secured Notes due 2020, net of discount of $5,779 and including interest paid-in-kind of $3,044
Level 2 Liability
$
203,265

 
$
191,065

Lion Loan due 2018 including interest paid-in-kind of $365
Level 3 Liability
9,865

 
9,773

Lion Warrant
Level 3 Liability

(a)
20,954

 
 
$
213,130

 
$
221,792

(a) No cost is associated with these liabilities (see Note 11)


16


The following table summarizes the activity of Level 3 inputs measured on a recurring basis:
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
Three Months Ended March 31,
 
2014
 
2013
Balance at January 1,
$
20,954

 
$
17,241

Adjustment resulting from change in value recognized in earnings (a)
(12,667
)
 
23,645

Balance at March 31,
$
8,287

 
$
40,886

(a) Adjustment resulting from change in fair value is the amount of total gains or losses for the period attributable to the change in unrealized gains or losses relating to liabilities held at the reporting date. The unrealized gain or loss is recorded in unrealized loss on change in fair value of warrants in the accompanying condensed consolidated statements of operations.
Note 9. Income Taxes
Income taxes for the three months ended March 31, 2014 were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management.
The Company incurred a loss from operations for the three months ended March 31, 2014 and 2013. Based upon recent history of cumulative losses for the prior three years combined with the loss from operations for the three months ended March 31, 2014 and 2013, the Company's management believes that it is more likely than not deferred tax assets in certain jurisdictions are not fully realizable. Accordingly, the Company will not record any income tax benefits in the condensed consolidated financial statements until it is determined that the Company will generate sufficient taxable income in the respective jurisdictions to realize the deferred income tax assets. As a result of the analysis, the Company determined that a full valuation allowance against the net deferred tax assets in certain jurisdictions, primarily in the U.S., and a partial valuation allowance in certain foreign jurisdictions, is required.
Section 382 of the Internal Revenue Code, as amended, in the United States imposes annual limitation on the utilization of net operating losses ("NOL") carryforwards, other tax carryforwards, and certain built-in losses as defined under that Section, upon an ownership change. The Company performed an analysis determining it is more likely than not that an ownership change has not occurred through December 31, 2013 and, accordingly, NOL carryforwards through such date are not subject to an annual Section 382 limitation. On March 31, 2014, the Company completed a public offering of approximately 61,645 shares of its common stock. As of March 31, 2014, the Company has not completed an analysis whether an ownership change occurred under Section 382, which, if it did occur, could substantially limit its ability in the future to utilize its NOLs and other tax carryforwards.
Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions.
The Company is currently open to audit under the statute of limitations by the Internal Revenue Service for the calendar years ended December 31, 2010 through December 31, 2013. The IRS is currently auditing the Company's tax return for the year ended December 31, 2011. The Company completed an audit with the IRS through December 31, 2010. The Company's state and foreign tax returns are open to audit under similar statute of limitations for the calendar years ended December 31, 2008 through 2013.
In management's opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.

Note 10. Related Party Transactions
See Note 7 for a description of loans made by Lion to the Company and Note 11 for a description of the warrants issued by the Company to Lion.
Personal Guarantees by the Company’s CEO
As of March 31, 2014, the CEO of the Company has personally guaranteed the obligations of American Apparel under seven property leases aggregating $16,639 in obligations. Additionally, the CEO of the Company has personally guaranteed the obligations of the Company with two vendors aggregating $1,000.

17


Lease Agreement Between the Company and a Related Party
The Company is party to an operating lease, expiring in November 2016, for its knitting facility with a related company (“American Central Plaza, LLC”), which is partially owned by the CEO and the Chief Manufacturing Officer ("CMO") of the Company. The Company's CEO holds an 18.75% ownership interest in American Central Plaza, LLC, while the CMO holds a 6.25% interest. The remaining members of American Central Plaza, LLC are not affiliated with the Company. Rent expense (including property taxes and insurance payments) related to this lease for the three months ended March 31, 2014 and 2013 were $104 and $155, respectively.
Payments to Morris Charney
Morris Charney, (“Mr. M. Charney”), is the father of the Company's CEO and serves as a director of American Apparel Canada Wholesale Inc. and a director of American Apparel Canada Retail Inc. Day to day operations of these two Canadian subsidiaries are handled by management and other employees of these subsidiaries, none of whom performs any policy making functions for the Company. Management of American Apparel sets the policies for American Apparel and its subsidiaries as a whole. Mr. M. Charney does not perform any policy making functions for the Company or any of its subsidiaries. Instead, Mr. M. Charney only provides architectural consulting services primarily for stores located in Canada and, in limited cases, in the U.S. Mr. M. Charney was paid architectural consulting and director fees amounting to $56 and $62 for the three months ended March 31, 2014 and 2013, respectively.

Note 11. Stockholders' Deficit
Public Offering
On March 31, 2014, the Company completed a public offering of approximately 61,645 shares of its common stock at $0.50 per share for net proceeds of $28,554.
Common Stock Warrants
Lion Warrants
As of March 31, 2014, Lion held warrants (the "Lion Warrants") to purchase 24,511 shares of the Company's common stock, with an exercise price of $0.66 per share. These warrants will expire on February 18, 2022.
On March 31, 2014, as a result of the public offering of the Company's common shares, Lion received the right to purchase an additional 2,905 shares of the Company's common stock under their existing warrants to purchase 21,606 shares of the Company's common stock and the exercise price of all of Lion's warrants was adjusted from $0.75 per share to approximately $0.66 per share. Such adjustments were required by the terms of the existing Lion warrants.
The Lion Warrants, as amended, contain certain anti-dilution protections in favor of Lion providing for proportional adjustment of the warrant price and, under certain circumstances, the number of shares of the Company's common stock issuable upon exercise of the Lion Warrant, in connection with, among other things, stock dividends, subdivisions and combinations and the issuance of additional equity securities at less than fair market value, as well as providing for the issuance of additional warrants to Lion in the event of certain equity sales or debt for equity exchanges.
As of March 31, 2014, the fair value of the 24,511 Lion Warrants, estimated using the Binomial Lattice option valuation model, was $8,287 and was recorded as a current liability in the accompanying condensed consolidated balance sheets. The calculation as of March 31, 2014 assumed a stock price of $0.50, exercise price of $0.66, volatility of 71.92%, annual risk free interest rate of 2.44%, a contractual remaining term of 8 years and no dividends.
The following table summarizes common stock warrants issued, forfeited, expired and outstanding (shares in thousands):
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Contractual Life (Years)
Outstanding - January 1, 2014
21,606

 
$
0.75

 
8.2

 
Issued (1)
24,511

 
0.66

 
8.0

 
Forfeited (1)
(21,606
)
 
0.75

 

 
Expired

 

 

 
Outstanding - March 31, 2014
24,511

 
$
0.66

 
8.0

 
Fair value - March 31, 2014
$
8,287

 
 
 
 
 
(1) Issued and forfeited warrants represents repriced shares.


18


Earnings Per Share
The Company presents earnings per share (“EPS”) utilizing a dual presentation of basic and diluted EPS. Basic EPS includes no dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
The Company had common stock under various options, warrants and other agreements at March 31, 2014 and 2013. The weighted average effects of 40,385 and 53,456 shares at March 31, 2014 and 2013, respectively, were excluded from the calculations of net loss per share for the three months ended March 31, 2014 and 2013, because their impact would have been anti-dilutive.
A summary of the potential stock issuances under various options, warrants and other agreements that could have a dilutive effect on the shares outstanding as of March 31, 2014 and 2013 are as follows:
 
2014
 
2013
SOF warrants

 
1,000

Lion warrants
24,511

 
21,606

Shares issuable to Mr. Charney based on market conditions (1)
13,611

 
20,416

Contingent shares issuable to Mr. Charney based on market conditions (2)

 
2,112

Contingent shares issuable to Mr. Charney based on performance factors (3)

 
5,000

Employee options & restricted shares
2,263

 
3,322

 
40,385

 
53,456

(1) Charney Anti-Dilution Rights pursuant to the April 26, 2011 Investor Purchase Agreement, of which 6,805 expired unexercised on April 15, 2014.
(2) Pursuant to the March 24, 2011 conversion of debt to equity, which expired unexercised on March 24, 2014.
(3) Pursuant to Mr. Charney's employment agreement commencing April 1, 2012
The table above does not include additional warrants that may be issuable to Lion pursuant to the anti-dilution provisions under the Lion Loan Agreement such as in the event anti-dilutive shares are issued to Mr. Charney pursuant to the Charney Anti-Dilution Rights.
Note 12. Share-Based Compensation
Plan Description - The American Apparel, Inc. 2011 Omnibus Stock Incentive Plan (the "2011 Plan") authorizes the granting of a variety of incentive awards, the exercise or vesting of which would allow up to an aggregate of 17,500 shares of the Company's common stock to be acquired by the holders of such awards and authorizes up to 3,000 shares that may be awarded to any one participant during any calendar year. The purpose of the 2011 Plan is to provide an incentive to selected employees, directors, independent contractors, and consultants of the Company or its affiliates, and provides that the Company may grant options, stock appreciation rights, restricted stock, and other stock-based and cash-based awards. As of March 31, 2014, there were approximately 13,301 shares available for future grants under the 2011 Plan.
Restricted Share Awards - The following table summarizes shares of restricted stock that were granted, vested, forfeited and outstanding (shares in thousands):
 
Number of Restricted Shares
 
Weighted Average Grant Date Fair Value
 
Weighted Average Remaining Vesting Period (in years)
Non-vested - January 1, 2014
1,850

 
$
1.46

 
0.9
Granted
285

 
0.64

 
 
Vested
(402
)
 
1.18

 
 
Forfeited
(170
)
 
1.61

 
 
Non-vested - March 31, 2014
1,563

 
$
1.36

 
0.9
Vesting of the restricted share awards to employees are generally either immediately upon grant or over a period of three to five years of continued service by the employee in equal annual installments. Vesting is immediate in the case of members of the Board of Directors. Share-based compensation is recognized over the vesting period based on the grant-date fair value.

19


Stock Option Awards - The following table summarizes stock options granted, forfeited, expired and outstanding (shares in thousands):
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Contractual Remaining Life (Years)
 
Aggregate Intrinsic Value
Outstanding - January 1, 2014
700

 
$
0.82

 
7.8

 
 
Granted

 

 

 
 
Forfeited

 

 

 
 
Expired

 

 

 
 
Outstanding - March 31, 2014
700

 
$
0.82

 
7.5

 
 
Vested - March 31, 2014
700

 
$
0.82

 
7.5

 
$

Non-vested - March 31, 2014

 
$

 


 
$

Share-Based Compensation Expense - During the three months ended March 31, 2014 and 2013, the Company recorded share-based compensation expense of $1,115 and $3,547, respectively, related to its share-based compensation awards that are expected to vest. No amounts have been capitalized. As of March 31, 2014, unrecorded compensation cost related to non-vested awards was $3,852, which is expected to be recognized through 2017.
CEO Anti-Dilution Rights - During the three months ended March 31, 2014 and 2013, the Company recorded share-based compensation expense (included in the above) associated with Mr. Charney's certain anti-dilution rights of $689 and $2,071, respectively. As of March 31, 2014, unrecorded compensation cost was $1,295, which is expected to be recognized through 2015. On April 15, 2014, the last day of the first measurement period, the Company determined that the vesting requirements for such period were not met, and as a result, 6,805 of the 20,416 anti-dilution rights expired unexercised.
CEO Performance-Based Award - Pursuant to an employment agreement with Mr. Charney commencing on April 1, 2012, the Company provided to the CEO rights to 7,500 shares of the Company's stock. The shares are issuable in three equal installments, one per each measurement period, only upon the achievement of certain EBITDA targets for each of fiscal 2012, 2013 and 2014. For the fiscal 2012 measurement period, the Company achieved the target EBITDA and Mr. Charney received 2,500 shares on June 25, 2013. For the fiscal 2013 measurement period, the Company did not achieve the target EBITDA. For the fiscal 2014 measurement period, based on currently available information, the Company does not believe that the target EBITDA will be achieved. As of March 31, 2014, there was no unrecorded compensation cost related to this EBITDA award.
The grant date fair value of the award was based on the share price of $0.75. During the three months ended March 31, 2014 and 2013, the Company recorded share-based compensation expense of $0 and $859, respectively.
Non-Employee Directors
On April 1 and January 2, 2014, the Company issued a quarterly stock grant to each non-employee director for services performed of approximately 20 and 8 shares of the Company's common stock, based on grant date fair values of $0.50 and $1.21 per share, respectively.
Note 13. Commitments and Contingencies
Operating Leases
The Company conducts retail operations under operating leases, which expire at various dates through November 2023. The Company's primary manufacturing facilities and executive offices are currently under a long-term lease, which expires on July 31, 2019. Operating lease rent expense (including real estate taxes and common area maintenance costs) was approximately $19,012 and $19,902 for the three months ended March 31, 2014 and 2013, respectively. The Company did not incur any significant contingent rent during these periods. Rent expense is allocated to cost of sales (for production-related activities), selling expenses (primarily for retail stores) and general and administrative expenses in the accompanying condensed consolidated statements of operations.

20


Customs and duties
The Company is being audited by German customs authorities for the years ended December 31, 2009 through December 31, 2011. In connection with the audit, the German customs has issued retroactive assessments on the Company's imports totaling $4,997 at the March 31, 2014 exchange rates (assessment was issued in Euros). The size of the retroactive assessments are largely due to member countries of the European Union (“E.U.”) limited right to impose retaliatory duties on certain imports of U.S. origin goods into the E.U., based upon the World Trade Organization's (“WTO”) Dispute Settlement procedures and the related WTO arbitrator rulings brought into place as a result of EU complaint against the U.S. "Continued Dumping and Subsidy Offset Act of 2000" (the "CDSOA") usually referred to as "the Byrd Amendment." Consequently, the German customs authorities are attempting to impose a substantially higher tariff rate than the original rate that the Company had paid on the imports, approximately doubling the amount of the tariff that the Company would have to pay.
The Company believes that it has valid arguments to challenge the merit of the German customs assessment and has filed litigation in German courts to contest such assessment. However, as the case is ongoing, the Company is unable to reasonably estimate the financial outcome of the matter at this time as it cannot predict whether the outcome will be favorable or unfavorable to the Company, or if the Company will be required to advance material amounts during the pendency of the litigation, and accordingly has not recorded a provision for this matter. No assurance can be made that this matter will not result in a material financial exposure in connection with the audit, which could have a material adverse effect on the Company's financial condition, results of operations or cash flows.
New York Stock Exchange Compliance
The Company's common stock is currently traded on the NYSE MKT. On February 28, 2014, the Company received a letter from NYSE MKT indicating that it was not in compliance with the continued listing standards of NYSE MKT set forth in Section 1003(a)(iv) of the NYSE MKT LLC Company Guide. In order to maintain its listing, the Company submitted a plan of compliance by addressing how it intended to regain compliance with Section 1003(a)(iv) of the Company Guide by April 15, 2014. On April 15, 2014 the Exchange issued a letter to the Company indicating the Company had regained compliance with the Exchange's listing standards.
Advertising
At March 31, 2014 the Company had approximately $1,753 in open advertising commitments, which primarily relate to print advertisements in various newspapers and magazines, as well as outdoor advertising. The majority of these commitments are expected to be paid during the remainder of 2014.
Note 14. Workers' Compensation and Other Self-Insurance Reserves
The Company uses a combination of third-party insurance and/or self-insurance for a number of risks including workers’ compensation, medical benefits provided to employees, and general liability claims. General liability costs relate primarily to litigation that arises from store operations. Self-insurance reserves include estimates of both filed claims carried at their expected ultimate settlement value and claims incurred but not yet reported. The Company’s estimated claim amounts are discounted using a rate of 1.03% with a duration that approximates the duration of the Company’s self-insurance reserve portfolio. As of March 31, 2014 the undiscounted liability amount was $16,910. The Company’s liability reflected on the accompanying condensed consolidated balance sheets represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. In estimating this liability, the Company utilizes loss development factors based on Company specific data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claim settlements and reported claims. These projections are subject to a high degree of variability based upon future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. Although the Company does not expect the amounts ultimately paid to differ significantly from its estimates, self-insurance reserves could be affected if future claim experience differs significantly from the historical trends and the assumptions applied.
The workers' compensation liability is based on an estimate of losses for claims incurred, but not paid at the end of the period. Funding is made directly to the providers and/or claimants by the insurance company. To guarantee performance under the workers' compensation program, as of March 31, 2014 and December 31, 2013, the Company had issued standby letters of credit in the amount of $450, with insurance companies being the beneficiaries, through a bank, and cash deposits of $16,124 in favor of insurance company beneficiaries. At March 31, 2014, the Company recorded a total reserve of $16,432, of which $4,283 is included in accrued expenses and $12,149 is included in other long-term liabilities on the accompanying condensed consolidated balance sheets. At December 31, 2013, the Company recorded a total reserve of $15,356, of which $3,871 is included in accrued expenses and $11,485 is included in other long-term liabilities on the accompanying condensed consolidated balance sheets.
The Company self-insures its health insurance benefit obligations while the claims are administered through a third party administrator. The medical benefit liability is based on estimated losses for claims incurred, but not paid at the end of the

21


period. Funding is made directly to the providers and/or claimants by the insurance company. At March 31, 2014 and December 31, 2013, the Company's total reserve of $2,089 and $2,512, respectively, was included in accrued expenses in the accompanying condensed consolidated balance sheets.
Note 15. Business Segment and Geographic Area Information
The Company reports the following four operating segments: U.S. Wholesale, U.S. Retail, Canada, and International. The Company believes this method of segment reporting reflects both the way its business segments are managed and the way the performance of each segment is evaluated. The U.S. Wholesale segment consists of the Company's wholesale operations of sales of undecorated apparel products to distributors and third party screen printers in the United States, as well as the Company's online consumer sales generated in the U.S. The U.S. Retail segment consists of the Company's retail operations in the United States, which comprised 140 retail stores operating in the United States, as of March 31, 2014. Canada segment includes retail, wholesale and online consumer operations in Canada. As of March 31, 2014, the retail operations in the Canada segment comprised 32 retail stores. The International segment includes retail, wholesale and online consumer operations outside of the United States and Canada. As of March 31, 2014, the retail operations in the International segment comprised 77 retail stores operating in 18 countries outside the United States and Canada. All of the Company's retail stores sell the Company's apparel products directly to consumers.
The Company's management evaluates performance based on a number of factors; however, the primary measures of performance are net sales and income or loss from operations of each business segment, as these are the key performance indicators reviewed by management. Operating income or loss for each segment does not include unallocated corporate general and administrative expenses, interest expense and other miscellaneous income/expense items. Corporate general and administrative expenses include, but are not limited to: human resources, legal, finance, information technology, accounting, executive compensation and various other corporate level expenses.
The following tables represent key financial information of the Company's reportable segments before unallocated corporate expenses:
 
Three Months Ended March 31, 2014
 
U.S. Wholesale 
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
38,237

 
$

 
$
1,909

 
$
1,800

 
$
41,946

Retail net sales

 
42,465

 
7,759

 
29,678

 
79,902

Online consumer net sales
10,500

 

 
792

 
3,956

 
15,248

Total net sales to external customers
48,737

 
42,465

 
10,460

 
35,434

 
137,096

Gross profit
17,305

 
26,766

 
5,609

 
22,294

 
71,974

Income (loss) from segment operations
9,720

 
(4,714
)
 
(345
)
 
(899
)
 
3,762

Depreciation and amortization
2,178

 
3,114

 
401

 
1,022

 
6,715

Capital expenditures
1,205

 
1,139

 
112

 
1,502

 
3,958

Retail store impairment

 
49

 

 
450

 
499

Deferred rent benefit
(447
)
 
(1,632
)
 
(48
)
 
(95
)
 
(2,222
)
 
 
 
 
 
Three Months Ended March 31, 2013
 
U.S. Wholesale
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
34,708

 
$

 
$
2,579

 
$
1,941

 
$
39,228

Retail net sales

 
44,344

 
9,112

 
30,452

 
83,908

Online consumer net sales
9,714

 

 
666
 
4,544

 
14,924

Total net sales to external customers
44,422

 
44,344

 
12,357

 
36,937

 
138,060

Gross profit
12,327

 
29,191

 
7,420

 
23,930

 
72,868

Income (loss) from segment operations
5,383

 
(2,447
)
 
(652
)
 
813

 
3,097

Depreciation and amortization
1,603

 
2,970

 
433

 
1,025

 
6,031

Capital expenditures
3,076

 
2,900

 
183

 
1,195

 
7,354

Retail store impairment

 
78

 

 

 
78

Deferred rent expense (benefit)
20

 
(212
)
 
(131
)
 
(125
)
 
(448
)

22


Reconciliation of reportable segments combined income from operations for the three months ended March 31, 2014 and 2013 to the consolidated loss before income taxes is as follows:  
 
Three Months Ended March 31,
 
2014
 
2013
Consolidated income from operations of reportable segments
$
3,762

 
$
3,097

Unallocated corporate expenses
(11,258
)
 
(13,574
)
Interest expense
(10,039
)
 
(11,214
)
Foreign currency transaction loss
(132
)
 
(713
)
Unrealized gain (loss) on change in fair value of warrants
12,667

 
(23,645
)
Other income
8

 
5

Consolidated loss before income taxes
$
(4,992
)
 
$
(46,044
)
 
Net sales by geographic location of customers for the three months ended March 31, 2014 and 2013, are as follows:
 
Three Months Ended March 31,
 
2014
 
2013
United States
$
91,202

 
$
88,766

Canada
10,460

 
12,357

Continental Europe
15,021

 
15,069

United Kingdom
9,461

 
9,595

South Korea
2,331

 
2,169

China
1,528

 
1,494

Japan
3,337

 
4,438

Australia
2,092

 
2,575

Other foreign countries
1,664

 
1,597

Total consolidated net sales
$
137,096

 
$
138,060


Note 16. Litigation
The Company is subject to various claims and contingencies in the ordinary course of business, including those related to litigation, business transactions, employee-related matters and taxes, and others. When the Company is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, the Company will record a liability for the loss. In addition to the estimated loss, the recorded liability includes probable and estimable legal costs associated with the claim or potential claim. There is no assurance that such matters will not materially and adversely affect the Company's business, financial position, and results of operations or cash flows.
Individual Actions
On November 5, 2009, Guillermo Ruiz, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of all current and former non-exempt California employees (Guillermo Ruiz, on behalf of himself and all others similarly situated v. American Apparel, Inc., Case Number BC425487) in the Superior Court of the State of California for the County of Los Angeles, alleging the Company failed to pay certain wages due for hours worked, to provide meal and rest periods or compensation in lieu thereof and to pay wages due upon termination to certain of the Company's employees. The complaint further alleges that the Company failed to comply with certain itemized employee wage statement provisions and violations of unfair competition law.  The plaintiff is seeking compensatory damages and economic and/or special damages in an unspecified amount, premium pay, wages and penalties, injunctive relief and restitution, and reimbursement for attorneys' fees, interest and the costs of the suit.
On June 21, 2010, Antonio Partida, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of current and former non-exempt California employees (Antonio Partida, on behalf of himself and all others similarly situated v. American Apparel (USA), LLC, Case No. 30-2010-00382719-CU-OE-CXC) in the Superior Court of the State of California for the County of Orange, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation. The complaint further alleges that

23


the Company failed to timely pay wages, unlawfully deducted wages and failed to comply with certain itemized employee wage statement provisions and violations of unfair competition law. The plaintiff is seeking compensatory damages and economic and/or special damages in an unspecified amount, premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit.
On or about December 2, 2010, Emilie Truong, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of current and former non-exempt California employees (Emilie Truong, individually and on behalf of all others similarly situated v. American Apparel, Inc. and American Apparel LLC, Case No. BC450505) in the Superior Court of the State of California for the County of Los Angeles, alleging the Company failed to timely provide final paychecks upon separation.  Plaintiff is seeking unspecified premium wages, attorneys' fees and costs, disgorgement of profits, and an injunction against the alleged unlawful practices.
On or about February 9, 2011, Jessica Heupel, a former retail employee filed suit on behalf of putative classes of current and former non-exempt California employees (Jessica Heupel, individually and on behalf of all others similarly situated v. American Apparel Retail, Inc., Case No. 37-2011-00085578-CU-OE-CTL) in the Superior Court of the State of California for the County of San Diego, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation.  The plaintiff is seeking monetary damages as follows: (1) for alleged meal and rest period violations; (2) for alleged failure to timely pay final wages, as well as for punitive damages for the same; and (3) unspecified damages for unpaid minimum wage and overtime.  In addition, Plaintiff seeks premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit. This matter is now proceeding in arbitration. On or about September 9, 2011, Anthony Heupel, a former retail employee initiated arbitration proceedings on behalf of putative classes of current and former non-exempt California employees, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation.  The plaintiff is seeking monetary damages in an amount in excess of $3,600, as follows: (1) for alleged meal and rest period violations; (2) for alleged failure to timely pay final wages, as well as for punitive damages for the same; and (3) unspecified damages for unpaid minimum wage and overtime.  In addition, Plaintiff seeks premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit.
The Company does not have insurance coverage for the above matters. Each of the aforementioned wage and hour cases have been proceeding in arbitration. All of these cases have been settled on an aggregate and class-wide basis for a payment by the Company in the total amount of $875, most of which will be paid to class members and to their attorneys. Certain class members have opted out of the settlement and so may proceed with individual claims. Also, the settlement has been approved by the arbitrator and also is subject to approval of one or more of the California Superior Courts. There is no guarantee that such approvals will be obtained.
Additionally, the Company is currently engaged in other employment-related claims and other matters incidental to the Company's business.  The Company believes that all such claims against the Company are without merit or not material, and the Company intends to vigorously dispute the validity of the plaintiffs' claims. While the ultimate resolution of such claims cannot be determined, based on information at this time, the Company believes, but the Company cannot provide assurance that, the amount, and ultimate liability, if any, with respect to these actions will not materially affect the Company's business, financial position, results of operations, or cash flows. Should any of these matters be decided against the Company, the Company could not only incur liability but also experience an increase in similar suits and suffer reputational harm.
Derivative Matters
Two shareholder derivative lawsuits (Case No. CV106576 GAF (JCx) and Case No. CV107518 RSWL (FFMx)) were filed in the United States District Court for the Central District of California which were subsequently consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. CV106576 (the “Federal Derivative Action”).  Plaintiffs in the Federal Derivative Action allege a cause of action for breach of fiduciary duty arising out of (i) the Company's alleged failure to maintain adequate accounting and internal control policies and procedures; (ii) the Company's alleged violation of state and federal immigration laws in connection with the previously disclosed termination of over 1,500 employees following an Immigration and Customs Enforcement inspection; and (iii) the Company's alleged failure to implement controls sufficient to prevent a sexually hostile and discriminatory work environment.  The Company does not maintain any direct exposure to loss in connection with these shareholder derivative lawsuits. The Company's status as a “Nominal Defendant” in the actions reflects the fact that the lawsuits are maintained by the named plaintiffs on behalf of American Apparel and that plaintiffs seek damages on the Company's behalf. The Company filed a motion to dismiss the Federal Derivative Action which was granted with leave to amend on July 31, 2012. Plaintiffs did not amend the complaint and subsequently filed a motion to dismiss each of their claims, with prejudice, for the stated purpose of taking an immediate appeal of the Court's July 31, 2012 order. On October 16, 2012, the Court granted the Plaintiffs' motion to dismiss and entered judgment accordingly. On November 12, 2012, Plaintiffs filed a Notice of Appeal to the Ninth Circuit Court of Appeals where the case is currently pending.

24


Four shareholder derivative lawsuits (Case No. BC 443763, Case No. BC 443902, Case No. BC 445094, and Case No. BC 447890) were filed in fall of 2010 in the Superior Court of the State of California for the County of Los Angeles which were subsequently consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. BC 443763 (the "State Derivative Action"). 
Three of the matters comprising the State Derivative Action allege causes of action for breach of fiduciary duty arising out of (i) the Company's alleged failure to maintain adequate accounting and internal control policies and procedures; and (ii) the Company's alleged violation of state and federal immigration laws in connection with the previously disclosed termination of over 1,500 employees following an Immigration and Customs Enforcement inspection.  The fourth matter alleges seven causes of action for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets also arising out of the same allegations.  On April 12, 2011, the Court issued an order granting a stay (which currently remains in place) of the State Derivative Action on the grounds that the case is duplicative of the Federal Derivative Action, as well as the Federal Securities Action currently pending in the United States District Court for the Central District of California (see below).
Both the Federal Derivative Action and State Derivative Actions are covered under the Company's Directors and Officers Liability insurance policy, subject to a deductible and a reservation of rights.
Other Proceedings
Four putative class action lawsuits, (Case No. CV106352 MMM (RCx), Case No. CV106513 MMM (RCx), Case No. CV106516 MMM (RCx), and Case No. CV106680 GW (JCGx)) were filed in the United States District Court for the Central District of California in the Fall of 2010 against American Apparel and certain of the Company's officers and executives on behalf of American Apparel shareholders. On December 3, 2010, the four lawsuits were consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Litigation, Lead Case No. CV106352 MMM (JCGx) (the “Federal Securities Action”). The lead plaintiff filed a consolidated class action complaint on April 29, 2011 on behalf of shareholders who purchased the Company's common stock between November 28, 2007 and August 17, 2010. The lead plaintiff alleges two causes of action for violations of Section 10(b) and 20(a) of the 1934 Act, and Rule 10b-5 promulgated under Section 10(b), arising out of alleged misrepresentations contained in the Company's press releases, public filings with the SEC, and other public statements relating to (i) the adequacy of the Company's internal and financial control policies and procedures; (ii) the Company's employment practices; and (iii) the effect that the dismissal of over 1,500 employees following an Immigration and Customs Enforcement inspection would have on the Company. Plaintiff seeks damages in an unspecified amount, reasonable attorneys' fees and costs, and equitable relief as the Court may deem proper.  The Company filed two motions to dismiss the Federal Securities Action which the court granted with leave to amend. Plaintiffs filed a Second Amended Complaint on February 15, 2013. The Company filed a motion to dismiss the complaint on March 15, 2013. The hearing on the motion was held on June 3, 2013, at which time, the Court took the matter under submission. On August 8, 2013, the court issued its final order granting the motion to dismiss in regards to certain claims. Defendants answered the complaint's remaining claims on September 27, 2013. On November 6, 2013, the Court issued an order staying the case pending ongoing settlement discussions between the parties. Plaintiff filed an unopposed Motion of Preliminary Approval which was granted on April 16, 2014 without oral argument. The court set a settlement fairness hearing for July 28, 2014. If approved, the settlement will result in a payment by the Company's insurance carrier of $4,800.
Should any of the above matters (i.e., the Federal Derivative Action, the State Derivative Action, or the Federal Securities Action) be decided against the Company in an amount that exceeds the Company's insurance coverage, or if liability is imposed on grounds which fall outside the scope of the Company's insurance coverage, the Company could not only incur a substantial liability, but also experience an increase in similar suits and suffer reputational harm.  The Company is unable to predict the financial outcome of these matters at this time, and any views formed as to the viability of these claims or the financial exposure which could result may change from time to time as the matters proceed through their course. However, no assurance can be made that these matters, either individually or together with the potential for similar suits and reputational harm, will not result in a material financial exposure, which could have a material adverse effect upon the Company's financial condition, results of operations, or cash flows.
The Company has previously disclosed arbitrations filed by the Company on or about February 17, 2011, related to cases filed in the Supreme Court of New York, County of Kings (Case No. 5018-1) and Superior Court of the State of California for the County of Los Angeles (Case Nos. BC457920 and BC460331) against American Apparel, Dov Charney and certain members of the Board of Directors asserting claims of sexual harassment, assault and battery, impersonation through the internet, defamation and other related claims.  The Company settled one of these cases with no monetary liability to the Company.  In another case, the Company prevailed on its argument that certain claims had been released by the plaintiff, and the remaining claims were recently settled.  In another case, the arbitrator rejected the Company’s argument that certain claims had been released, and a hearing will be held in the future on the merits of the parties’ claims.  In another case, the arbitrator ruled that both American Apparel and the plaintiff had established certain claims and damages against one another resulting in a net

25


inconsequential amount awarded to the plaintiff, and the arbitrator is considering a request to award attorneys’ fees and costs to the plaintiff.  The Company is awaiting the arbitrator's ruling on the outstanding attorney's fees and cost issue in this case.  In a different case, the arbitrator has held an evidentiary hearing on the parties’ respective claims and the Company is waiting for the arbitrator’s ruling.  The Company cannot provide assurance that, the amount and ultimate liability, if any, with respect to these remaining cases will not materially affect the Company's business, financial position, results of operations, or cash flows. 

Note 17. Condensed Consolidating Financial Information
The Notes (see Note 7), which constitute debt obligations of American Apparel Inc. (the "Parent") are fully and unconditionally guaranteed, jointly and severally, and on a senior secured basis, by the Company's existing and future 100% owned direct and indirect domestic subsidiaries, subject to customary automatic release provisions, including the satisfaction and discharge, or defeasance, or payment in full of the principal of, premium, if any, accrued and unpaid interest on the Notes, or, in certain circumstances, the sale or other disposition of substantially all of the assets of the subsidiary guarantor.
The following presents the condensed consolidating balance sheets as of March 31, 2014 and December 31, 2013, the condensed consolidating statements of operations for the three months ended March 31, 2014 and 2013, and the condensed consolidating statements of cash flows for the three months ended March 31, 2014 and 2013 of the Parent, the Company's material guarantor subsidiaries and the non-guarantor subsidiaries, and the elimination entries necessary to present the Company's financial statements on a consolidated basis. These condensed consolidating financial information should be read in conjunction with the accompanying condensed consolidated financial statements of the Company.


26


Condensed Consolidating Balance Sheets
March 31, 2014
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$

 
$
10,471

 
$
6,212

 
$

 
$
16,683

Trade accounts receivable, net

 
17,812

 
4,229

 

 
22,041

Intercompany accounts receivable, net
275,589

 
(254,707
)
 
(20,882
)
 

 

Inventories, net

 
126,005

 
37,668

 
(21
)
 
163,652

Other current assets
953

 
8,055

 
5,313

 

 
14,321

Total current assets
276,542

 
(92,364
)
 
32,540

 
(21
)
 
216,697

PROPERTY AND EQUIPMENT, net

 
50,562

 
15,045

 

 
65,607

INVESTMENTS IN SUBSIDIARIES
(103,710
)
 
18,077

 

 
85,633

 

OTHER ASSETS, net
9,014

 
28,353

 
11,819

 

 
49,186

TOTAL ASSETS
$
181,846

 
$
4,628

 
$
59,404

 
$
85,612

 
$
331,490

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
 
 
 
 
 
 
Revolving credit facilities and current portion of long-term debt
$

 
$
29,456

 
$
13

 
$

 
$
29,469

Accounts payable

 
36,771

 
3,403

 

 
40,174

Accrued expenses and other current liabilities
12,927

 
28,585

 
12,440

 

 
53,952

Fair value of warrant liability
8,287

 

 

 

 
8,287

Other current liabilities

 
2,489

 
1,770

 

 
4,259

Total current liabilities
21,214

 
97,301

 
17,626

 

 
136,141

LONG-TERM DEBT, net
214,308

 

 
278

 

 
214,586

OTHER LONG-TERM LIABILITIES

 
28,693

 
5,742

 

 
34,435

TOTAL LIABILITIES
235,522

 
125,994

 
23,646

 

 
385,162

STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
Common stock
17

 
100

 
492

 
(592
)
 
17

Additional paid-in capital
215,135

 
6,726

 
7,716

 
(14,442
)
 
215,135

Accumulated other comprehensive (loss) income
(4,781
)
 
(407
)
 
(1,137
)
 
1,548

 
(4,777
)
(Accumulated deficit) retained earnings
(261,890
)
 
(127,785
)
 
28,687

 
99,098

 
(261,890
)
Less: Treasury stock
(2,157
)
 

 

 

 
(2,157
)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY
(53,676
)
 
(121,366
)
 
35,758

 
85,612

 
(53,672
)
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
$
181,846

 
$
4,628

 
$
59,404

 
$
85,612

 
$
331,490


27



Condensed Consolidating Balance Sheets
December 31, 2013
(Amounts in thousands)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$

 
$
512

 
$
8,164

 
$

 
$
8,676

Trade accounts receivable, net

 
15,109

 
5,592

 

 
20,701

Intercompany accounts receivable, net
247,414

 
(224,181
)
 
(23,233
)
 

 

Inventories, net

 
129,716

 
39,736

 
(74
)
 
169,378

Other current assets
97

 
10,442

 
6,002

 

 
16,541

Total current assets
247,511

 
(68,402
)
 
36,261

 
(74
)
 
215,296

PROPERTY AND EQUIPMENT, net

 
53,424

 
15,879

 

 
69,303

INVESTMENTS IN SUBSIDIARIES
(94,161
)
 
18,158

 

 
76,003

 

OTHER ASSETS, net
9,282

 
27,934

 
11,937

 

 
49,153

TOTAL ASSETS
$
162,632

 
$
31,114

 
$
64,077

 
$
75,929

 
$
333,752

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
 
 
 
 
 
 
Revolving credit facilities and current portion of long-term debt
$

 
$
43,586

 
$
456

 
$

 
$
44,042

Accounts payable

 
34,738

 
3,552

 

 
38,290

Accrued expenses and other current liabilities
5,952

 
28,344

 
15,722

 

 
50,018

Fair value of warrant liability
20,954

 

 

 

 
20,954

Other current liabilities

 
6,830

 
1,855

 

 
8,685

Total current liabilities
26,906

 
113,498

 
21,585

 

 
161,989

LONG-TERM DEBT, net
213,130

 
47

 
291

 

 
213,468

OTHER LONG-TERM LIABILITIES

 
29,711

 
5,988

 

 
35,699

TOTAL LIABILITIES
240,036

 
143,256

 
27,864

 

 
411,156

STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
Common stock
11

 
100

 
492

 
(592
)
 
11

Additional paid-in capital
185,472

 
6,726

 
7,685

 
(14,411
)
 
185,472

Accumulated other comprehensive (loss) income
(4,306
)
 
(543
)
 
(671
)
 
1,214

 
(4,306
)
(Accumulated deficit) retained earnings
(256,424
)
 
(118,425
)
 
28,707

 
89,718

 
(256,424
)
Less: Treasury stock
(2,157
)
 

 

 

 
(2,157
)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY
(77,404
)
 
(112,142
)
 
36,213

 
75,929

 
(77,404
)
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
$
162,632

 
$
31,114

 
$
64,077

 
$
75,929

 
$
333,752








28


Condensed Consolidating Statement of Operations and Comprehensive (Loss) Income
For the Three Months Ended March 31, 2014
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
Net sales
$

 
$
99,997

 
$
45,893

 
$
(8,794
)
 
$
137,096

Cost of sales

 
59,100

 
14,878

 
(8,856
)
 
65,122

Gross profit

 
40,897

 
31,015

 
62

 
71,974

Selling expenses

 
32,072

 
21,990

 

 
54,062

General and administrative expenses
237

 
16,211

 
8,461

 

 
24,909

Retail store impairment

 
49

 
450

 

 
499

(Loss) income from operations
(237
)
 
(7,435
)
 
114

 
62

 
(7,496
)
Interest expense and other expense
(3,842
)
 
1,553

 
(215
)
 

 
(2,504
)
Equity in loss (earnings) of subsidiaries
9,071

 
242

 
4

 
(9,317
)
 

(Loss) income before income taxes
(5,466
)
 
(9,230
)
 
325

 
9,379

 
(4,992
)
Income tax provision

 
129

 
345

 

 
474

Net (loss) income
$
(5,466
)
 
$
(9,359
)
 
$
(20
)
 
$
9,379

 
$
(5,466
)
Other comprehensive (loss) income, net of tax
(471
)
 
136

 
(466
)
 
330

 
(471
)
Comprehensive (loss) income
$
(5,937
)
 
$
(9,223
)
 
$
(486
)
 
$
9,709

 
$
(5,937
)


Condensed Consolidating Statement of Operations and Comprehensive (Loss) Income
For the Three Months Ended March 31, 2013
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
Net sales
$

 
$
95,404

 
$
49,889

 
$
(7,233
)
 
$
138,060

Cost of sales

 
57,111

 
15,798

 
(7,717
)
 
65,192

Gross profit

 
38,293

 
34,091

 
484

 
72,868

Selling expenses

 
32,242

 
23,221

 

 
55,463

General and administrative expenses
376

 
18,120

 
9,324

 
(16
)
 
27,804

Retail store impairment

 
78

 

 

 
78

(Loss) income from operations
(376
)
 
(12,147
)
 
1,546

 
500

 
(10,477
)
Interest expense and other expense
31,962

 
3,632

 
(27
)
 

 
35,567

Equity in (earnings) loss of subsidiaries
14,173

 
(1,219
)
 

 
(12,954
)
 

(Loss) income before income taxes
(46,511
)
 
(14,560
)
 
1,573

 
13,454

 
(46,044
)
Income tax (benefit) provisions

 
(43
)
 
510

 

 
467

Net (loss) income
$
(46,511
)
 
$
(14,517
)
 
$
1,063

 
$
13,454

 
$
(46,511
)
Other comprehensive (loss) income, net of tax
(1,504
)
 
(1,227
)
 
(1,577
)
 
2,804

 
(1,504
)
Comprehensive (loss) income
$
(48,015
)
 
$
(15,744
)
 
$
(514
)
 
$
16,258

 
$
(48,015
)







29



Condensed Consolidating Statement of Cash Flows
For the Three Months Ended March 31, 2014
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
 
 
 
 
 
 
Net cash (used in) provided by operating activities
$
(1,241
)
 
$
1,777

 
$
3,379

 
$

 
$
3,915

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
 
 
 
 
 
 
Capital expenditures

 
(2,340
)
 
(1,618
)
 

 
(3,958
)
Proceeds from sale of fixed assets

 

 
30

 

 
30

Restricted cash

 

 

 

 

Net cash used in investing activities

 
(2,340
)
 
(1,588
)
 

 
(3,928
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
 
 
 
 
 
 
Cash overdraft

 
(3,989
)
 

 

 
(3,989
)
Repayments under revolving credit facilities, net

 
(14,128
)
 
(429
)
 

 
(14,557
)
Repayments of term loans and notes payable

 
(47
)
 
(3
)
 

 
(50
)
Net proceeds from issuance of common stock
28,554

 

 

 

 
28,554

Payment of payroll statutory tax withholding on share-based compensation associated with issuance of common stock
(125
)
 

 

 

 
(125
)
Payments of debt issuance costs
(69
)
 
(303
)
 

 

 
(372
)
Repayments of capital lease obligations

 
(121
)
 
(16
)
 

 
(137
)
Advances to/from affiliates
(27,119
)
 
29,110

 
(1,991
)
 

 

Net cash provided by (used in) financing activities
1,241

 
10,522

 
(2,439
)
 

 
9,324

EFFECT OF FOREIGN EXCHANGE RATE CHANGES ON CASH

 

 
(1,304
)
 

 
(1,304
)
NET INCREASE (DECREASE) IN CASH

 
9,959

 
(1,952
)
 

 
8,007

CASH, beginning of period

 
512

 
8,164

 

 
8,676

CASH, end of period
$

 
$
10,471

 
$
6,212

 
$

 
$
16,683