10-K 1 app12311010k.htm FORM 10-K WebFilings | EDGAR view


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 __________________________________________________
FORM 10-K
_________________________________________________
 
 (Mark One)
x    Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2010
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 Number 001-32697
 
 __________________________________
American Apparel, Inc.
(Exact name of registrant as specified in its charter)
__________________________________
  
Delaware
 
20-3200601
(State of Incorporation)
 
(I.R.S. Employer Identification No.)
747 Warehouse Street
Los Angeles, California 90021-1106
(Address of principal executive offices) (Zip code)
Registrant’s telephone number, including area code: (213) 488-0226
 
 __________________________________
Securities registered pursuant to Section 12(b) of the Act:
__________________________________
 
 
Common Stock, par value $.0001 per share
 
NYSE Amex
 
(Title of Each Class)
 
(Name of Each Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act: None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  o    No  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  o    No  x
Indicate by check mark whether 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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  o    No  o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x
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 “accelerated filer”, “large 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
 
Smaller reporting company  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  x


The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of June 30, 2010 was approximately $60,436,830 based upon the closing price of the common stock on such date as reported by the NYSE Amex.
The number of shares of the registrant’s common stock outstanding as of March 31, 2011 was approximately 77,745,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the registrant’s 2011 Annual Meeting of Stockholders (the “2011 Proxy Statement”), to be filed within 120 days of the end of the fiscal year ended December 31, 2010, are incorporated by reference into Part III herein. If the 2011 Proxy Statement is not filed in the 120-day period, the Items comprising the Part III information will be filed as an amendment to this Form 10-K not later than the end of the 120-day period. Except with respect to the information specifically incorporated by reference in Part III of this Form 10-K, the 2011 Proxy Statement is not deemed to be filed as part of this Form 10-K.
 
 
 


SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K, 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 Annual Report on Form 10-K 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:
 
•    
future financial condition and operating results;
•    
our ability to remain in compliance with financial covenants under our financing arrangements;
•    
our ability to extend, renew or refinance our existing debt;
•    
our liquidity and losses from operations and projected cash flows and related impact on our ability to continue as a going concern;
•    
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;
•    
the outcome of litigation matters; 
•    
our intellectual property rights and those of others, including actual or potential competitors; 
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our personnel, consultants, and collaborators; 
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operations outside the United States; 
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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 and results of operations;
•    
economic and political conditions; 
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overall industry and market performance; 
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the impact of accounting pronouncements; 
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our ability to improve manufacturing efficiency at its production facilities;
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management’s goals and plans for future operations; and 
•    
other assumptions described in this Annual Report on Form 10-K 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 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 Item 1A and elsewhere in this report, as well as in other reports and documents we file with the United States Securities and Exchange Commission (the “SEC”) and include, without limitation, the following:
 


    
our ability to generate or obtain from external sources sufficient liquidity for operations and debt service;
    
changes in the level of consumer spending or preferences or demand for our products;
•    
disruptions in the global financial markets;
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consequences of our significant indebtedness, including our ability to comply with our debt agreements and generate cash flow to service our debt;
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our ability to regain compliance with the exchange rules of the NYSE Amex, LLC;
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the highly competitive and evolving nature of our business in the U.S. and internationally;
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our ability to effectively carry out and manage our strategy, including growth and expansion both in the U.S. and internationally;
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loss of U.S. import protections or changes in duties, tariffs and quotas and other risks associated with international business;
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retailer consolidation and intensity of competition, both domestic and foreign, from other apparel providers;
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technological changes in manufacturing, wholesaling, or retailing;
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risks that our suppliers and distributors may not timely produce or deliver our products;
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loss or reduction in sales to our wholesale or retail customers or financial nonperformance by our wholesale customers;
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the adoption of new accounting pronouncements or changes in interpretations of accounting principles;
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changes in consumer spending patterns and overall levels of consumer spending;
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our ability to pass on the added cost of raw materials to our wholesale and retail customers;
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the availability of store locations at appropriate terms and our ability to identify and negotiate new store locations effectively and to open new stores and expand internationally;
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our ability to attract customers to our stores;
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disruptions due to severe weather or climate change;
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seasonality and fluctuations in comparable store sales and margins;
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our ability to successfully implement our strategic, operating and personnel initiatives;
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our ability to maintain the value and image of our brand and protect our intellectual property rights;
•    
changes in the cost of materials and labor, including recent increases in the price of raw materials in the global market;
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location of our facilities in the same geographic area;
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our relationships with our lenders and our ability to comply with the terms of our existing debt facilities;
•    
adverse changes in our credit ratings and any related impact on financing costs and structure;
•    
risks associated with our foreign operations and foreign supply sources, such as disruption of markets, changes in import and export laws, currency restrictions and currency exchange rate fluctuations;
•    
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;
•    
the risk that information technology systems changes may disrupt our supply chain or operations;
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our ability to upgrade our information technology infrastructure and other risks associated with the systems that operate our online retail operations;
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litigation and other inquiries and investigations, including the risk that our officers will not be successful in defending any proceedings, lawsuits, disputes, claims or audits;
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ability to effectively manage inventory and inventory reserves;
•    
changes in key personnel, our ability to hire and retain key personnel, and our relationship with our employees;


•    
material weaknesses in internal controls;
•    
costs as a result of operating as a public company; and
•    
general economic conditions, including increases in interest rates, geopolitical events, other regulatory changes and inflation or deflation.
 
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 statement.
 
 


American Apparel, Inc.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 2010
TABLE OF CONTENTS
 
 
 
PART I
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 1B.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
PART II
 
 
 
 
Item 5.
 
 
 
 
 
Item 6.
 
 
 
 
 
Item 7.
 
 
 
 
 
Item 7A.
 
 
 
 
 
Item 8.
 
 
 
 
 
Item 9.
 
 
 
 
 
Item 9A.
 
 
 
 
 
Item 9B.
 
 
 
 
 
 
 
PART III
 
 
 
 
Item 10.
 
 
 
 
 
Item 11.
 
 
 
 
 
Item 12.
 
 
 
 
 
Item 13.
 
 
 
 
 
Item 14.
 
 
 
 
 
 
 
PART IV
 
 
 
 
Item 15.
 
 


PART I
 
Item 1.    Business
Unless the context indicates otherwise, when we refer to (“we”, “us”, “our”, or the “Company”) in this Form 10-K, we are referring to American Apparel, Inc. and its subsidiaries on a consolidated basis. Our year ends on December 31 and references to fiscal 2010, fiscal 2009 and fiscal 2008 refer to the years ended December 31, 2010, 2009 and 2008, respectively.
 
Background of American Apparel, Inc.
 
American Apparel, Inc., a Delaware corporation, was incorporated in Delaware on July 22, 2005 as Endeavor Acquisition Corp., a blank check company formed to acquire an operating business. On December 21, 2005, Endeavor Acquisition Corp. consummated its initial public offering, and on December 18, 2006, entered into an Agreement and Plan of Reorganization, amended November 7, 2007, with American Apparel Inc., a California corporation (“Old American Apparel”), and its affiliated companies. Endeavor Acquisition Corp. consummated the acquisition of Old American Apparel and its affiliated companies on December 12, 2007 (the “Acquisition”) and changed its name to American Apparel, Inc. Pursuant to the Acquisition, Old American Apparel merged with and into AAI Acquisition LLC, a Delaware limited liability company and a wholly owned subsidiary of Endeavor Acquisition Corp. AAI Acquisition LLC survived the acquisition as a wholly owned subsidiary of our and changed its name to American Apparel (USA), LLC.
 
The Acquisition was accounted for as a reverse merger and recapitalization of Old American Apparel. Accordingly, for accounting and financial reporting purposes, Endeavor Acquisition Corp. was treated as the acquired company, and Old American Apparel was treated as the acquiring company. The historical financial information and the historical description of our business, for periods and dates prior to December 12, 2007, is that of Old American Apparel and its affiliated companies.
 
Overview
We are a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel. We design, manufacture and sell clothing and accessories for women, men, children and babies. As of December 31, 2010, we operated a total of 273 retail stores in the United States, Canada, and 18 other countries. We also operate a leading wholesale business that supplies t-shirts and other casual wear to distributors and screen printers. In addition to our retail stores and wholesale operations, we operate an online retail e-commerce website at www.americanapparel.com where we sell our products directly to consumers.
We conduct our primary apparel manufacturing operations out of an 800,000 square foot facility in the warehouse district of downtown Los Angeles, California. The facility houses our executive offices, as well as cutting, sewing, warehousing, and distribution operations. We conduct knitting operations in Los Angeles and Garden Grove, California, which produce a majority of the fabric we use in our products. We also operate dye houses that currently provide dyeing and finishing services for nearly all of the raw fabric used in production. We operate a fabric dyeing and finishing facility in Hawthorne, California. We also operate a cutting, sewing and garment dyeing and finishing facility located in South Gate, California. We operate a fabric dyeing and finishing facility located in Garden Grove, California, which also includes cutting, sewing and knitting operations. Because we manufacture domestically and are vertically integrated, we believe this enables us to more quickly respond to customer demand and to changing fashion trends and to closely monitor product quality. Our products are noted for their quality and fit, and together with our distinctive branding these attributes have differentiated our products in the marketplace. “American Apparel®” is a registered trademark of American Apparel (USA), LLC.
 
Old American Apparel was founded in 1998. Since inception, we have operated a wholesale business. In October 2003, we opened our first retail store in Los Angeles. In 2004, we began our online retail operations, and opened our first retail stores in Canada and Europe. Since 2005, we have opened stores in Asia, Australia, Israel, Latin America, and have further expanded throughout the United States, Canada, Europe, and Asia. All of our retail stores sell the Company's apparel products directly to consumers.
Business Segments
We report the following four operating segments: U.S. Wholesale, U.S. Retail, Canada, and International. We believe this method of segment reporting reflects both the way our business segments are managed and the way the performance of each segment is evaluated. The U.S. Wholesale segment consists of our wholesale operations of sales of undecorated apparel products to distributors and third party screen printers in the United States, as well as our online consumer sales to U.S. customers. The U.S. Retail segment consists of our retail store operations in the United States, which were comprised of 157 retail stores as of December 31, 2010. The Canada segment consists of our retail, wholesale and online consumer operations in Canada. As of December 31, 2010, the retail operations in the Canada segment were comprised of 40 retail stores. The

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International segment consists of our retail, wholesale and online consumer operations outside of the United States, and Canada. As of December 31, 2010, the retail operations in the International segment were comprised of 76 retail stores in the following 18 countries: the United Kingdom, Ireland, Austria, Belgium, France, Germany, Italy, the Netherlands, Spain, Sweden, Switzerland, Israel, Australia, Brazil, Mexico, Japan, South Korea, and China.
The results of the respective business segments exclude corporate expenses, which consist of the shared overhead costs of our Company. These costs are presented separately and generally include information technology, human resources, accounting and finance, executive compensation and legal. Financial information by segment, together with certain geographical information, for the fiscal years ended December 31, 2010, 2009 and 2008 is included in Note 18 to our consolidated financial statements under Part II, Item 8—Financial Statements and Supplementary Data.
Core Business Strengths
American Apparel has relied on a number of core business strengths that it believes have contributed to its past success and will contribute to its future growth:
Design Vision
American Apparel’s design, vision and aesthetic are intended to appeal to young, metropolitan adults by providing them with a core line of iconic, timeless styles offered year-round in a wide variety of colors at reasonable prices. Since its founding, American Apparel has operated with the belief that there is a large potential market among young adults for well-designed, high-quality fashion essentials. Led by Dov Charney, Chairman of the Board of Directors and Chief Executive Officer, our in-house creative team has carefully developed the product line.
Advertising and Branding
American Apparel attracts customers through internally-developed, edgy, high-impact, visual advertising campaigns which use print, outdoor, in-store, and electronic communication vehicles. These advertising campaigns communicate a distinct brand image that differentiates us from our competitors and seek to establish a connection with our customers. Our retail stores are an important part of American Apparel’s branding and convey a modern, internationalist lifestyle. At various times, we have also drawn attention to the “Made in USA” nature of our products and the “Sweatshop Free” environment in which our garments are produced.
 
Speed to Market
Our vertically integrated business model, with manufacturing and various other elements of our business processes centered in downtown Los Angeles, allows us to play a role in originating and defining new and innovative trends in fashion, while enabling us to quickly respond to market and customer demand for classic styles and new products. For our wholesale operations, being able to fulfill large orders with quick turn-around allows American Apparel to capture business. The ability to quickly respond to the market quickly means that our retail operations can deliver on-trend apparel in a timely manner and maximize sales of popular styles by replenishing product that would have otherwise sold out.
Quality
American Apparel prides itself on its use of quality fabrics. We have an active quality control department that oversees the in-house production of fabric at its knitting facilities. The quality control department also supervises outside knitting contractors who work to our strict specifications. The quality control department watches closely over the cutting, sewing, dyeing and finishing of our garments at our Los Angeles area facilities. Because cutting and sewing operations are conducted mostly in-house, we believe we have the ability to exercise greater control over clothing manufacturing than competitors who use contract sewing facilities.
Broad Appeal
While initially targeted towards young, metropolitan adults in the U.S., the clean, simple styles and quality of our garments have helped our products appeal to various demographics around the world. We believe that our products appeal has been augmented by, and should continue to benefit from, growing trends toward casual attire and higher quality apparel.
 
 
 

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Growth Strategy
As we continue to execute our growth strategy, internal initiatives and future acquisitions, we will incur additional material expenses. Two of the key areas in which such increased expenses will likely occur are cost of sales and new merchandise development. Also, in order to grow retail sales, we will have to open new retail locations and hire additional retail personnel to service new retail stores, which will involve an increase in occupancy expense and payroll. In order to grow the wholesale distribution channel, American Apparel will have to hire new sales personnel to service new geographic territories.
To support new merchandise development, expenses will increase as we design new products in existing and new categories. Ongoing infrastructure investment also may be required to support growth. This may include expenditures for new buildings, machinery and equipment, upgraded information systems and additions to our management team.
To reduce the impact of additional material expenses on earnings, we continue to look for ways to improve productivity of current manufacturing operations and to enhance other operating procedures. During 2010, we deployed a new financial reporting system which is expected to add substantial reporting and analytical capabilities to the corporate finance and accounting and resources.
 
We have developed a growth strategy that is designed to capitalize on our strengths. The principal elements contributing to the success of this growth strategy are:
Store Expansion
Our long-term growth strategy and the success of our business depends in part on opening new American Apparel retail stores, the renewal of existing store leases on favorable terms that meet our financial targets, the remodeling of existing stores in a timely manner and the operation of these stores in a cost-efficient manner. In the near-term, we have halted our store expansion activities in light of our recent operating losses and due to unfavorable economic conditions in many of the markets we serve. We closed a net of eight stores in 2010, and as of March 31, 2011, we have not signed lease agreements for any new stores. Once our financial performance and the economic conditions in the markets we serve improve, we plan to expand our presence in the U.S. and significantly increase our store footprint in markets throughout Europe and Asia.
We evaluate proposed sites based on traffic patterns, co-tenancies, average sales per square foot achieved by neighboring stores, lease economics, demographic characteristics and other factors considered important regarding the specific location.
New Merchandise Introduction
As we expand beyond our original product offering of T-shirts, we are increasing the variety of products available to our growing customer base. We have strategically expanded our product offering to include denim, sweaters, jackets and accessories. We also intend to introduce new merchandise to complement these existing products, and attract new customers.
Continue In-Sourcing Manufacturing Activities
We have explored making strategic acquisitions to consolidate our manufacturing operations and continue to produce high quality products. In December 2007, we expanded operations to include a new facility in South Gate, California where, commencing January 2008, we began cutting, sewing and garment dyeing a portion of our production. In May 2008, we acquired a fabric dyeing and finishing plant in Garden Grove, California, and have since added cutting, sewing and knitting operations to the facility. We believe that bringing certain elements of our production process in-house affords us the opportunity to exert higher quality control while also lowering production costs. We may pursue strategic opportunities to further consolidate our operations while maintaining production in the United States; however, we have no such strategic opportunities identified and will not make any such strategic investments until we see a substantial improvement in our financial performance and financial condition
Enhance Information Systems Infrastructure
We successfully completed the first phase of an enterprise resources planning (“ERP”) system in 2008. This phase included the conversion of our systems for manufacturing and warehouse operations, inventory management and control and wholesale operations. We have also completed the second phase of the ERP implementation, which included upgrading the financial accounting and control systems for our U.S. operations. The second phase was completed in 2009. In 2010, we continued to refine and enhance these systems and intend to continue with further enhancements in 2011. The resulting operating information and control systems have represented a substantial improvement over our legacy systems.
During 2010 we installed sales conversion tracking devices in approximately one-third of our stores and we implemented radio frequency identification (RFID) tracking systems at 35 store locations. Both of these systems enhance sales and contribute to store productivity. In 2010, we began implementation work force and labor scheduling optimization systems and

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we anticipate we will continue to enhance our workforce management capabilities in 2011.
Manufacturing Operations
We conduct all of our manufacturing operations in the Los Angeles metropolitan area, and principally at our cutting and sewing facility in downtown Los Angeles. In January 2008, we began cutting, sewing, and garment dyeing a portion of our output in a new facility in South Gate, California which was acquired in December 2007. In May 2008, we acquired an additional facility in Garden Grove, California with dyeing capacity. Knitting, cutting and sewing capacity were subsequently added to this facility.
 
We purchase yarn which is sent to knitters to be knit into “greige” fabric, which is fabric that is not dyed or processed. We currently conduct a portion of our knitting operations in-house at our knitting facilities in Los Angeles and Garden Grove, California. We operate circular and flat knitting machines, producing jersey, piqué, fleece and ribbing using cotton and cotton/polyester yarns. We also utilize third-party commissioned knitters. Our knitting facilities knit approximately 85% of the total fabric used in our garments and has a staff of approximately 100 people, as of December 31, 2010.
Knitted greige fabric produced by our Los Angeles and Garden Grove facilities or by other commissioned knitters is batched for bleaching and dyeing and transported to our dyeing and finishing facilities, or other commissioned dye houses. In some cases, dyed fabric is transferred to subcontractors for fabric laundering. Our dyeing and finishing facilities in the Los Angeles metropolitan area dye approximately 99% of the total fabric used in our garments, and employed a staff of approximately 230 people, as of December 31, 2010.
Most fabric is shipped to our primary manufacturing facility in downtown Los Angeles, where it is inspected and then cut on manual and automated cutting tables, and subsequently sewn into finished garments. Some fabric is purchased directly from third parties, along with all trims. Garments are sewn by teams of sewing operators typically ranging from five to fifteen operators, depending on the complexity of a particular garment. Each sewing operator performs a different sewing operation on a garment before passing it to the next operator. Sewing operators are compensated on a modified piece-rate basis. Quality control personnel inspect finished garments for defects and reject any defective product. We also manufacture certain hosiery products in-house at this facility, where we do knitting and inspection. Washing, boarding and packaging is performed at our South Gate facility. Approximately 3,000 employees were directly involved in the cutting, sewing, and hosiery operations at the downtown Los Angeles facility as of December 31, 2010.
We purchase yarn, certain fabrics and other raw materials from a variety of vendors during the course of a year. We do not have any major suppliers of raw materials that we rely on exclusively to support our production operations. The inputs that we use are produced competitively by a large number of potential suppliers.
In addition to the warehouse and distribution center at our downtown Los Angeles facility, we maintain two other warehouses in the Los Angeles metropolitan area, where we store fabric rolls, trims, and finished goods. We also maintain warehouses in Montreal, Quebec and Neuss, Germany.
Beginning in the first quarter of 2010, the price of yarn and the cost of certain related fabrics began to increase as a result of the compounding effect of added demand, and supply shortages primarily from the effect of severe weather conditions in certain cotton producing countries, and a ban on cotton exports imposed by the government of India. Prices continued to increase throughout 2010 and thus far through the first quarter of 2011. As of March 31, 2011, our per pound cost is approximately two times what it was immediately prior to when cotton prices began to rise. Although to date we have not experienced any meaningful shortages in the supply of yarn and fabrics we cannot predict if any future shortages will occur and if such shortages do occur they could have a material effect on our financial condition and results of operations. Further, in response to increases in our raw material costs we have implemented only modest price increases of certain products. We are unable to predict if we will be able to successfully pass on the added cost of raw materials by further increasing the price of our products to our wholesale and retail customers.
Retail
As of December 31, 2010, our retail operations consisted of 273 retail stores in 20 countries, including the United States, Canada, Mexico, Brazil, United Kingdom, Ireland, Austria, Belgium, Germany, France, Italy, the Netherlands, Spain, Sweden, Switzerland, Israel, Australia, Japan, South Korea and China. Our retail operations principally target young adults aged 20 to 32 through our unique assortment of fashionable clothing and accessories and our compelling in-store experience. We have established a reputation with our customers, who are culturally sophisticated, creative, and independent-minded. The product offering includes women’s and men’s basic apparel and accessories, as well as apparel for children. Stores average approximately 2,500-3,000 square feet of selling space. Our stores are located in large metropolitan areas, emerging neighborhoods, and select university communities.

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We strive to instill enthusiasm and dedication in store management personnel and sales associates through regular communication with the stores.
 
Wholesale
Our wholesale operations sell to over a dozen authorized distributors and approximately 10,000 screen printers and advertising specialty companies. These screen printers and advertising specialty companies decorate our blank product with corporate logos, brands and other images. Our wholesale customers sell imprinted sportswear and accessories to a highly diversified range of end-consumers, including corporations, sporting venues, concert promoters, athletic leagues, and educational institutions, among others. In order to better serve customers, we allow customers to order products by the piece, by the dozen, or in full case quantities. We also, to a lesser extent, fulfill custom and private-label orders. We do not have any major customers that account for ten percent or more of total consolidated net sales.
To serve our wholesale customers, we operate a call center out of our Los Angeles headquarters. The call center is staffed with approximately 35 customer service representatives initiating sales calls, answering incoming phone calls, emails, and faxes, assisting customers in placing orders, checking stock levels, looking for price quotes or requesting adjustments.
While we operate primarily on a “make-to-stock” basis, manufacturing and maintaining a sufficient inventory of products to meet demand, our in-house manufacturing capacity also allows us to fulfill large orders in a timely fashion. We capitalize on our inventory position by providing a quick turn-around on customer orders. Credit approved orders to be shipped by ground service are generally shipped the same day if the order is received before 7:30pm EST while those to be shipped by air are generally shipped the same day when received by 6:30pm EST. The majority of our wholesale and internet customer orders are processed within these parameters. For these reasons, we do not typically maintain a large backlog of orders.
Online Consumer Sales
Since 2004, we have operated an online consumer e-commerce website, which offers our products for purchase. This e-commerce website, located at www.americanapparel.com, has localized storefronts for the United States, Canada, the United Kingdom, Continental Europe, Switzerland, Japan, South Korea, Australia, Mexico and Brazil. For segment reporting purposes, U.S. online consumer sales are included in the U.S. Wholesale business segment. Canada online consumer sales are included in the Canada business segment, and international online consumer sales are included in the International business segment.
Brand, Advertising, and Marketing
Our advertising and direct marketing initiatives have been developed to elevate brand awareness, facilitate customer acquisition and retention and support key growth strategies. Our in-house creative team works to create edgy, high-impact, provocative ads which are produced year-round and are featured in leading national and local lifestyle publications, on billboards, and on specialty online websites. We maintain a photo studio at our headquarters. Content for our website and online store are also generated in-house. While the primary intent of this advertising is to support our retail and online e-commerce operations, the wholesale business also benefits from the greater overall brand awareness generated by this advertising.
For our wholesale operations, we utilize industry trade shows to expand and enhance customer relationships, exhibit product offerings and share new promotions with customers. We participate in approximately two dozen trade shows annually. We also produce print catalogs of our wholesale products, designed to be of the standard of high-end consumer retail catalogs with attractive models, appealing photographs and a clear display of products.
Product Development
We employ an in-house staff of designers and creative professionals to develop updated versions of timeless, iconic styles. Led by our Chief Executive Officer, Dov Charney, this team takes its inspiration from classic styles of the past, as well as the latest emerging fashion trends. Our design team will often continue to update or renew a style long after its launch.
 
Intellectual Property
Our trademarks and service marks, and certain other trademarks, have been registered, or are the subject of pending trademark applications with the United States Patent and Trademark Office and with the registries of many foreign countries and/or are protected by common law. In the United States, we are the registered owner of the “American Apparel®,” “Classic Girl®,” “Standard American®,” “Classic Baby®,” and “Sustainable Edition®” trademarks, among others.
 
 

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Competition
The specialty retail, online retail and wholesale apparel businesses are each highly competitive. The apparel industry is characterized by rapid shifts in fashion, consumer demand, and competitive pressures, resulting in both price and demand volatility. We believe that our emphasis on quality fashion essentials mitigates these factors.
Our retail operations compete on the basis of store location, the breadth, quality, style, and availability of merchandise, the level of customer service offered, and the price of goods for similar brand name quality. While we believe that the fit and quality of our garments, as well as the broad variety of colors and styles of casual fashion essentials that we offer, helps differentiate us, we compete against a wide variety of smaller, independent specialty stores, as well as department stores and national and international specialty chains. Companies that operate in this space include, but are not limited to, The Gap, Urban Outfitters, H&M, Uniqlo and Forever 21. Many of these companies have substantially greater name recognition than American Apparel. Many of these companies also have greater financial, marketing, and other resources when compared to American Apparel.
The wholesale business competes with numerous wholesale companies based on the quality, fashion, availability, and price of our wholesale product offering. These companies include Gildan Activewear, Hanesbrands, Russell Athletic and Fruit of the Loom. Many of these companies have greater name recognition than American Apparel in the wholesale market. Many of these companies also have greater financial and other resources when compared to American Apparel.
Along with the competitive factors noted above, other key competitive factors for American Apparel’s online e-commerce operations include the success or effectiveness of customer mailing lists, advertising response rates, merchandise delivery, web site design and web site availability. The online e-commerce operations compete against numerous web sites, many of which may have a greater volume of web traffic, and greater financial, marketing, and other resources.
Seasonality
We experience seasonality in our operations. Historically, sales during the third and fourth fiscal quarters have generally been the highest, with sales during the first fiscal quarter the lowest. This reflects the combined impact of the seasonality of the wholesale and retail segments. Generally, our retail segment has not experienced the same pronounced sales seasonality as other retailers.
Employees
As of December 31, 2010, we employed a work force of approximately 11,300 employees worldwide. To ensure our long-term success, we must attract, hire, develop, and retain skilled manufacturing, retail, sales, creative, and administrative employees, as well as executives. Competition for such employees can be intense.
We view our employees as long-term investments and adhere to a philosophy of providing employees with decent working conditions in a technology-driven environment which allows us to attain improved efficiency, while promoting employee loyalty. We provide a compensation structure and benefits package for manufacturing employees that includes above-market wages, company-subsidized health insurance, free English language classes, free massage, free parking, as well as other benefits. We also provide for a well-lit working environment that is properly ventilated and heated or cooled in our manufacturing facilities. These working conditions, as well as compensation and benefits packages, are key elements in achieving our desire to be an “employer of choice” in the Los Angeles area. None of our employees are covered by a collective bargaining agreement. We have never had a strike and we believe that our relations with our employees are excellent. We make diligent efforts to comply with all employment and labor regulations, including immigration laws, in the many jurisdictions in which we conduct operations. See “Risk Factors—We are subject to customs, advertising, consumer protection, zoning and occupancy and labor and employment laws that could require us to modify our current business practices and incur increased costs.” Also see “Risk Factors—Litigation exposure could exceed expectations and have a material adverse effect on our financial condition and results of operations.”
Information Technology
We are committed to utilizing technology to enhance our competitive position. Our information systems provide data for production, merchandising, distribution, retail stores and financial systems. Our core business systems, which consist of both purchased and internally developed software, are accessed over a company-wide network providing corporate employees with access to key business applications. We dedicate a significant portion of our information technology resources to web services, which include the operation of our corporate website at www.americanapparel.net and our online retail site at www.americanapparel.com.
 

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To support continued growth, we have initiated a strategic review of our information systems. We have implemented an ERP system that replaced, enhanced and integrated many elements of our existing information systems. We had previously operated a number of unrelated information technology systems that resulted in operational inefficiencies and in some cases increased costs. Implementation of the new ERP system was a multi-phased project with the first phase, covering manufacturing and production planning, having been completed during 2008, and the second phase, covering the financial accounting and wholesale distribution systems of our U.S. operations, having been completed in the first half of 2009. In 2010, we refined and enhanced these systems with the goal of improving efficiency.
Environmental Regulation
Our operations are subject to various environmental and occupational health and safety laws and regulations. Because we monitor, control and manage environmental issues, we believe we are in compliance in all material respects with the regulatory requirements of those jurisdictions in which our facilities are located. In line with our commitment to the environment as well as to the health and safety of our employees, we will continue to make expenditures to comply with these requirements, and do not believe that compliance will have a material adverse effect on our business.
Available Information
We will make available on our website, www.americanapparel.net, under “Investor Relations” free of charge, our annual reports on Form 10-K, as well as the latest quarterly reports on Form 10-Q, the latest reports on Form 8-K, the latest proxy statements and amendments to those documents as soon as reasonably practicable after we electronically file or furnish such materials to the SEC. You can also obtain copies of these materials at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information on the operation of the public reference facilities by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that makes available reports, proxy statements and other information regarding American Apparel that we file electronically with it. By referring to our corporate website, www.americanapparel.net, and our online retail website, www.americanapparel.com, we do not incorporate these websites or their contents into this Form 10-K.
 
 

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Item 1A.    Risk Factors
 
As a result of operating losses and negative cash flows from operations, together with other factors, including the effect on our ability to borrow under our revolving credit agreements as a result of the “going concern” qualification with respect to our 2010 financial statements, we may not have sufficient liquidity to sustain operations and to continue as a going concern.
 
We incurred a substantial loss from operations and had negative cash flows from operating activities for the year ended December 31, 2010. Our current operating plan indicates that we will incur a loss from operations for fiscal 2011 and generate negative cash flows from operating activities. As a result of these factors and the negative comparative store sales results in 2010, together with world-wide economic conditions and significant increases in yarn and fabric prices, among others, there exists substantial doubt that we will be able to continue as a going concern. In addition, we could be prevented from borrowing under our revolving credit agreements and this could have an immediate and significant impact on our liquidity.
 
Our consolidated financial statements for the year ended December 31, 2010 included herein contain a “going concern” explanatory paragraph. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability of assets or the amounts of liabilities that may result should we be unable to continue as a going concern.
 
The BofA Credit Agreement and Bank of Montreal Credit Agreement contain covenants which require us to furnish our audited financial statements and audited financial statements of our Canadian operations, respectively, within 120 days after the fiscal year end without a going concern or like qualification. Our consolidated financial statements for the year ended December 31, 2010 included herein contain a “going concern” explanatory paragraph. Absent a waiver, non-compliance with such covenants could constitute a default under the BofA Credit Agreement and will constitute an event of default under the BoA Credit Agreement within 15 days following notice given from the administrative agent after April 30, 2011. Noncompliance with such covenants could also, absent a waiver, allow the banks to prevent us from making borrowings under the BofA Credit Agreement and the Bank of Montreal Credit Agreement. In addition, all indebtedness under the BofA Credit Agreement and the Bank of Montreal Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. All cash proceeds received by us and the guarantors under the BofA Credit Agreement must be applied to our outstanding obligations under the BofA Credit Agreement. Our daily cash needs are funded through borrowings under the BofA Credit Agreement. If we are unable to borrow under the BofA Credit Agreement, we will be unable to fund our operations. We have made a formal request to BofA and Lion for waivers, however there can be no assurances that we will be successful in obtaining waivers from our lenders.
 
In addition, the BofA Credit Agreement matures in July 2012, and the Bank of Montreal Credit Agreement matures in December 2012, and there can be no assurances that we will be able to negotiate a renewal or extension of these credit agreements with our existing lenders or enter into a replacement credit agreement with new lenders or commercially reasonably terms or at all. If we are not able to enter into a renewal, extension or replacement of the BofA Credit Agreement or the Bank of Montreal Credit Agreement prior to their respective maturities, we would no longer have access to liquidity from such revolving credit facility after its maturity date. As a result, our access to working capital would be limited and this could adversely affect our ability to finance and continue our operations.
 
The Lion Credit Agreement also requires us to furnish our audited financial statements within 120 days after the fiscal year end without a going concern or like qualification. The requirement that such financials statements be delivered without a going concern qualification has been waived for financial statements relating to the 2010 fiscal year; however, such waiver ceases to be in effect if an event of default occurs under the BofA Credit Agreement as a result of a going concern qualification with respect to such financial statements. The Lion Credit Agreement also contains cross-default provisions by which noncompliance with covenants under the BofA Credit Agreement could also constitute an event of default under the Lion Credit Agreement. In addition, all indebtedness under the Lion Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. Based upon the foregoing, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
 
We are currently exploring alternatives for other sources of capital for ongoing cash needs, and we have engaged a financial advisory firm. We are working to develop and implement a plan to improve our operating performance and our cash, liquidity and financial position. This plan includes reduction of seasonal volatility in production levels at our manufacturing facilities in order to reduce direct labor costs and increase production efficiency; streamlining our logistics operations; merchandise price rationalization in our wholesale and retail channels; renegotiating the terms of a number of our retail real estate leases, including possible store closures; lengthening the cycle of payables to certain vendors and landlords; improving merchandise allocation procedures; and rationalizing staffing levels at our retail stores. In addition, we continue to develop other initiatives intended to increase sales, reduce costs and/or improve liquidity. If we cannot meet our capital needs from these actions, we

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may be required to take additional steps such as further modifying our business plan to close additional stores, further reducing production or reducing or delaying capital expenditures or seeking to restructure our existing indebtedness. We also are in the process of seeking additional financing, to the extent available.
 
However, there can be no assurance that our plan to improve our operating performance and financial position will be successful or that we will be able to obtain additional financing on commercially reasonable terms or at all. As a result, our liquidity and ability to timely pay our obligations when due could be adversely affected. In addition, any equity financing or warrants that we may be required to issue in connection with any financing may be substantially dilutive to existing stockholders and may require reductions in exercise prices or other adjustments of our existing warrants. Furthermore, our vendors and landlords may resist renegotiation or lengthening of payment and other terms through legal action or otherwise. If we are not able to timely, successfully or efficiently implement the strategies that we are pursuing to improve our operating performance and financial position, obtain alternative sources of capital or otherwise meet our liquidity needs, we may need to voluntarily seek protection under Chapter 11 of the U.S. Bankruptcy Code.
 
If American Apparel is unable to successfully implement steps to improve its liquidity position, it may need to voluntarily seek protection under Chapter 11 of the U.S. Bankruptcy Code.
 
We are currently experiencing significant liquidity constraints. If we are not able to generate sufficient cash flow from operations or obtain external sources of financing sufficient to fund our debt service requirements and operational needs in the near future, or we are not able to successfully or efficiently implement the strategies that we are pursuing to improve our operating performance and financial position, and may determine that it is in American Apparel's best interests to voluntarily seek relief through a pre-packaged, pre-arranged or other type of filing under Chapter 11 of the U.S. Bankruptcy Code, including prior to the time we would otherwise be required to do so in an acceleration event. Seeking relief under the U.S. Bankruptcy Code, if such relief does not lead to a quick emergence from Chapter 11, could materially adversely affect the relationships between us and our existing and potential customers, employees, suppliers, partners and others. Further, if we were unable to implement a plan of reorganization or if sufficient debtor-in-possession financing were not available, we could be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code.
 
Failure of American Apparel to comply with covenants under its financing arrangements could result in the acceleration of its debt repayment obligations and an inability to borrow under its revolving credit agreements and therefore fund its operations.
 
The financing agreements between us and our lenders contain certain financial and other covenants, including covenants relating to our capital expenditure limitations, availability under our revolving credit facility and minimum Consolidated EBITDA as defined in the agreements. Failure of American Apparel to maintain compliance with any of these covenants can result in American Apparel being unable to borrow under our revolving credit facility, which we utilize to access our working capital, and may adversely affect the ability of American Apparel to finance and continue its operations. Such a failure could also result in acceleration of the outstanding debt in its entirety, and may adversely affect the ability of American Apparel to obtain financing that may be necessary to effectively operate our business and grow the business going forward.
 
In particular, the BofA Credit Agreement and the Bank of Montreal Credit Agreement contain covenants which require us to furnish our audited financial statements and audited financial statements of our Canadian operations, respectively, within 120 days after the fiscal year end without a going concern or like qualification. Our consolidated financial statements for the year ended December 31, 2010 included herein contain a “going concern” explanatory paragraph. Absent a waiver, non-compliance with such covenants could constitute a default under the BofA Credit Agreement and will constitute an event of default under the BoA Credit Agreement within 15 days following notice given from the administrative agent after April 30, 2011. Noncompliance with such covenants will also, absent a waiver, prevent us from making borrowings under the BofA Credit Agreement and the Bank of Montreal Credit Agreement. In addition, all indebtedness under the BofA Credit Agreement and the Bank of Montreal Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. All cash proceeds received by the Company and the guarantors under the BofA Credit Agreement must be applied to our outstanding obligations under the BofA Credit Agreement. Our daily cash needs are funded through borrowings under the BofA Credit Agreement. If we are unable to borrow under the BofA Credit Agreement, we will be unable to fund our operations.
 
The Lion Credit Agreement also requires us to furnish our audited financial statements within 120 days after the fiscal year end without a going concern or like qualification. The requirement that such financials statements be delivered without a going concern qualification has been waived for financial statements relating to the 2010 fiscal year; however, such waiver ceases to be in effect if an event of default occurs under the BofA Credit Agreement as a result of a going concern qualification with respect to such financial statements. The Lion Credit Agreement also contains cross-default provisions by which

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noncompliance with covenants under the BofA Credit Agreement could also constitute an event of default under the Lion Credit Agreement. In addition, all indebtedness under the Lion Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. Based upon the foregoing, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
 
Purchases of retail apparel merchandise are generally discretionary and economic conditions may cause a decline in consumer spending which could adversely affect our business and financial performance.
Our operations and performance depend significantly on worldwide economic conditions and their impact on levels of consumer spending, particularly in discretionary areas, such as apparel, which have recently deteriorated significantly in the United States and many other countries and regions and may remain depressed for the foreseeable future. Our business and financial performance, including our sales and the collection of our accounts receivable, may be adversely affected by the current decrease and any future decrease in economic activity in the United States or in other regions of the world in which we do business that could potentially cause a decline in consumer spending, including a reduction in the availability of credit, increased unemployment levels, higher fuel and energy costs, rising interest rates, adverse conditions in the housing markets, financial market volatility, recession, decreased access to credit, reduced consumer confidence in future economic conditions and political conditions, acts of terrorism, consumer perceptions of personal well-being and security and other macroeconomic factors affecting consumer spending behavior. Consumers are generally more willing to make discretionary purchases, including purchases of fashion products, during periods in which favorable economic conditions prevail. A decrease in consumer discretionary spending as a result of the current economic conditions may decrease the demand for our products. If consumer spending continues to slow down or decrease, we will not be able to improve our same store sales. In addition, reduced consumer spending may cause us to lower prices, suffer significant product returns from our customers or drive us to offer additional products at promotional prices, any of which would have a negative impact on gross profit.
Our ability to meet customers' demands depends, in part, on our ability to obtain timely and adequate delivery of materials, parts and components from our suppliers. The current global financial crisis may materially adversely affect the ability of our suppliers to obtain financing for significant purchases and operations. If certain key suppliers were to become capacity constrained or insolvent as a result of the financial crisis, it could result in a reduction or interruption in supplies or a significant increase in the price of supplies and adversely impact consumer spending and our financial results. Reduced revenues as a result of decreased consumer spending may also reduce our working capital for planned store improvements and to open additional stores in the manner that we have in the past. These and other economic factors could have a material adverse effect on demand for the American Apparel's products and on our financial condition and operating results. In addition, as a result of decreased revenues and working capital, we may be required to seek additional financing which may not be available on acceptable terms or at all. There can be no assurances that government responses to the disruptions in the financial markets will restore consumer confidence, stabilize such markets or increase liquidity and the availability of credit to consumers and businesses. We are not able to predict the duration and severity of the current disruption in the financial markets and adverse economic conditions in the United States and other countries. As a consequence, American Apparel's operating results for a particular period are difficult to predict, and, therefore, prior results are not necessarily indicative of results to be expected in future periods. Any of the foregoing effects could have a material adverse effect on our business, results of operations, and financial condition and could adversely affect our stock price.
Disruptions in the global financial markets could adversely impact our liquidity and our ability to obtain financing, including by affecting the ability of our counterparties and others to perform their obligations to us.
Our liquidity may be negatively impacted if one of our lenders under our credit agreements or other debt agreements, or another financial institution, suffers liquidity issues. In such an event, we may not be able to draw on all, or a substantial portion, of our debt agreements. The current economic environment could cause our lenders, counterparties and others to breach their obligations to us under our contracts with them, which could include failures of banks or other financial service companies to fund required borrowings under our debt agreements, to pay us amounts that may become due under our derivative contracts for interest rates and foreign currencies, and to pay us amounts that may become due under other agreements or our counterparties might limit or place burdensome conditions upon future transactions with our. Any of the foregoing could adversely impact our business, financial condition and results of operations.
 
Also, if we attempt to obtain future financing, the credit market turmoil could negatively impact our ability to obtain such financing. In the event we need access to additional capital to pay our operating expenses, make payments on our indebtedness or pay capital expenditures, our ability to obtain such capital may be limited and the cost of any such capital may be significant. Our access to additional financing will depend on a variety of factors such as market conditions, the general availability of credit, the overall availability of credit to our industry, our credit ratings and credit capacity, as well as the possibility that

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lenders could develop a negative perception of our long-term or short-term financial prospects. If a combination of these factors were to occur, our internal sources of liquidity may prove to be insufficient, and in such case, we may not be able to successfully obtain additional financing on favorable terms or at all. In addition, the credit market turmoil could negatively impact certain of our customers and suppliers which could lead to a decrease in demand for our products and could have a material adverse impact on our financial condition and operating results.
Further, market conditions have resulted in severe downward pressure on the stock and credit markets, which could reduce the return available on invested corporate cash and thereby potentially increase funding obligations, which, if severe and sustained, could have material and adverse impacts on our results of operations and cash flows.
American Apparel has significant indebtedness and a failure to generate significant cash flow could render it unable to service its obligations and may place it at a competitive disadvantage and limit its ability to pursue its expansion plans.
As of December 31, 2010, American Apparel has substantial indebtedness, including $57.2 million of borrowings under our revolving credit facilities and $81.2 million of borrowings under our facility with Lion (as defined below). Our ability to service this indebtedness is dependent on our ability to generate cash from internal operations sufficient to make required payments on such indebtedness. Our level of indebtedness has important consequences to you and your investment in our common stock. For example, our level of indebtedness may:
 
•    
require us to dedicate a substantial portion of our cash flow from operations to pay interest and principal on our debt, which would reduce the funds available to use for operations, investments, future business opportunities and other general corporate purposes; 
 
•    
make it more difficult for us to satisfy our debt obligations, and any failure to comply with such obligations, including financial and other restrictive covenants, could result in an event of default under the agreements governing such indebtedness, which could lead to, among other things, an acceleration of our indebtedness or foreclosure on the assets securing our indebtedness, which could have a material adverse effect on our business or financial condition; 
 
•    
limit our ability to obtain additional financing, or to sell assets to raise funds, if needed, for working capital, capital expenditures, expansion plans and other investments, which may limit our ability to implement our business strategy; 
 
•    
result in higher interest expense if interest rates increase on our floating rate borrowings; 
 
•    
heighten our vulnerability to downturns in our business, the industry or in the general economy and limit our flexibility in planning for or reacting to changes in our business and the retail industry; or 
 
•    
reduce our ability to make acquisitions or take advantage of business opportunities as they arise or successfully carry out our plans to expand our store base, product offerings and sales channels.
 
In addition, the terms of our indebtedness contain, and our future indebtedness may contain, various restrictive covenants that limit our management's discretion in operating our business, including limitations on capital expenditures. See “The terms of our indebtedness contain various covenants that may limit our business activities” below.
It is uncommon for companies involved in the retail apparel business to operate with such a high level of indebtedness due to the underlying volatility of this business. Despite the attendant risks, American Apparel may have to enter into new credit facilities, or possibly issue additional common stock, to finance its planned retail expansion. There can be no assurances that American Apparel will have access to any such financing on commercially reasonable terms or that it will be able to open its planned number of new stores in 2011 or beyond.
If we are unable to gauge fashion trends and react to changing consumer preferences in a timely manner, our sales will decrease.
Our success is largely dependent upon our ability to gauge the fashion tastes of our customers and to provide merchandise that satisfies customer demand in a timely manner. The retail apparel business fluctuates according to changes in consumer preferences dictated, in part, by fashion and season. To the extent we misjudge the market for our merchandise or the products suitable for our market, our sales will be adversely affected. Some of our past product offerings have not been well received by our customer base. Merchandise misjudgments could have a material adverse effect on our image with our customers and on our operating results. Fluctuations in the apparel retail market affect the inventory owned by apparel retailers, since merchandise usually must be manufactured in advance of the season and frequently before fashion trends are evidenced by customer purchases. In addition, the cyclical nature of the retail apparel business requires us to carry a significant amount of inventory, especially prior to peak selling seasons when we build up our inventory levels. As a result, we will be vulnerable to demand and pricing shifts and to suboptimal selection and timing of merchandise production. If sales do not meet expectations, too much inventory may lower planned margins. Our brand image may also suffer if customers believe we are no longer able to

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offer the latest fashion. The occurrence of these events could adversely affect our financial results by decreasing sales.
We operate in the highly competitive retail industry and our market share may be adversely impacted at any time by the significant number of competitors in our industry that may compete more effectively than we can.
The apparel industry is characterized by rapid shifts in fashion, consumer demand and competitive pressures, resulting in both price and demand volatility. The retail apparel industry, in general, and the imprintable apparel market, specifically, is fragmented and highly competitive. Prices of certain products we manufacture, particularly T-shirts, are determined based on market conditions, including the price of raw materials. There can be no assurance that we will be able to compete successfully in the future. We compete with national and local department stores, specialty and discount store chains, independent retail stores and Internet businesses that market similar lines of merchandise, including The Gap, Urban Outfitters, H&M, Uniqlo and Forever 21. Many of our competitors are, and many of our potential competitors may be, larger, have substantially greater name recognition than American Apparel and have greater financial, marketing and other resources and, therefore, may be able to adapt to changes in customer requirements more quickly, devote greater resources to the marketing and sale of their products, generate greater national brand recognition or adopt more aggressive pricing policies than we can. We face a variety of competitive challenges, including:
 
•    
anticipating and quickly responding to changing consumer demands;
•    
maintaining favorable brand recognition and effectively marketing our products to consumers in diverse markets;
•    
developing innovative, high-quality products in sizes, colors and styles that appeal to consumers;
•    
sourcing raw materials and manufacturing merchandise efficiently;
•    
pricing our products to remain competitive while achieving a customer perception of comparatively higher value;
•    
implementing price increases to recover increasing costs of raw materials
•    
providing strong and effective marketing support; and
•    
maintaining high levels of consumer traffic to our retail stores.
 We also face competition in European, Asian and Canadian markets from established regional and national chains. Our success in these markets depends on determining a sustainable profit formula to build brand loyalty and gain market share in these challenging retail environments. If our international business is not successful or if we cannot effectively take advantage of international growth opportunities, our results of operations could be adversely affected.
The wholesale business competes with numerous wholesale companies based on the quality, fashion, availability, and price of our wholesale product offerings. These companies include Gildan Activewear, Hanesbrands, Russell Athletic and Fruit of the Loom. Many of these companies have greater name recognition than American Apparel in the wholesale market. Many of these companies also have greater financial and other resources when compared to American Apparel. If we cannot successfully compete with these companies, our results of operations could be adversely affected.
We depend on key personnel, and our ability to grow and compete will be harmed if we do not retain the continued services of such personnel, or we fail to identify, hire and retain additional qualified personnel.
We depend on the efforts and skills of our management team, and the loss of services of one or more members of this team, each of whom have substantial experience in the apparel industry, could have an adverse effect on our business. Our senior officers closely supervise all aspects of our business, in particular the design and production of merchandise and the operation of our stores. Because we have never operated as a public company prior to the Acquisition, we need to enhance our management team, including those responsible over financial reporting, to address the reporting requirements of a public company. If we are unable to hire and retain qualified management or if any member of our management leaves, such departure could have an adverse effect on our operations and could adversely affect our ability to design new products and to maintain and grow the distribution channels for our products. In particular, we believe we have benefited substantially from the leadership and strategic guidance of Dov Charney. The loss of Dov Charney would be particularly harmful as he is considered intimately connected to our brand identity and is the principal driving force behind our core concepts and designs. He is also the driving force behind our growth strategy.
Our ability to anticipate and effectively respond to changing fashion trends depends in part on our ability to attract and retain key personnel in our design, merchandising and marketing areas, and other functions. In addition, if we experience material growth, we will need to attract and retain additional qualified personnel. The market for qualified and talented design

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and marketing personnel in the apparel industry is intensely competitive, and we cannot be sure that we will be able to attract and retain a sufficient number of qualified personnel in future periods. If we are unable to attract or retain qualified personnel as needed, our growth will be hampered and our operating results could be materially adversely affected.
We rely heavily on immigrant labor, and changes in immigration laws or enforcement actions or investigations under such laws could significantly adversely affect our labor force, manufacturing capabilities, operations and financial results.
We rely heavily on immigrant labor. Adverse changes to existing laws and regulations applicable to employment of immigrants, enforcement requirements or practices under those laws and regulations, and inspections or investigations by immigration authorities or the prospects or rumors of any of the foregoing, even if no violations exist, could negatively impact the availability and cost of personnel and labor to American Apparel. As a result, we could experience very substantial turnover of employees on short or no notice, which could result in manufacturing and other delays. We may also have difficulty attracting or hiring new employees in a timely manner, resulting in further delays. These delays could materially adversely affect our revenues and ability to complete. If we are not able to continue to attract and retain sufficient employees, our manufacturing capabilities, operations and financial results would be adversely affected.
Our growth strategy relies in part on the opening of new stores and the remodeling of existing stores periodically which may strain our resources and adversely impact the performance of our existing store base.
Our growth strategy and the success of our business depends in part on the opening of new American Apparel retail stores, the renewal of existing store leases on terms that meet our financial targets, the remodeling of existing stores in a timely manner and the operation of these stores in a cost-efficient manner. Successful implementation of this portion of our growth strategy depends on a number of factors including, but not limited to, our ability to:
 
•    
identify and obtain suitable store locations and negotiate acceptable leases for these locations;
 
•    
complete store design and remodeling projects on time and on budget; 
 
•    
manage and expand our infrastructure to accommodate growth; 
 
•    
generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plan and remain in compliance with the capital expenditure covenant and other relevant covenants in our credit facilities that may limit our ability to fund such expansion plans; 
 
•    
manage inventory effectively to meet the needs of new and existing stores on a timely basis; 
 
•    
foster current relationships and develop new relationships with vendors that are capable of supplying a greater volume of merchandise; 
 
•    
avoid construction delays and cost overruns in connection with the build-out of new stores; 
 
•    
supply our stores with proper types and quantities of merchandise; and 
 
•    
hire, train and retain qualified store managers and sales people.
 
Our plans to expand our store base and to remodel certain existing stores may not be successful and the implementation of these plans may not result in an increase in our revenues even though they increase our costs. Additionally, new stores that we open may place increased demands on our existing financial, operational, managerial and administrative resources, which could cause us to operate less effectively.
Furthermore, it is possible that by opening a new store in an existing market, we could adversely affect the previously existing stores in that market by drawing away traffic from the previously existing stores. Our new stores may not be immediately profitable and, as such, we may incur losses until these stores become profitable. Any failure to successfully open and operate new stores would adversely affect our results of operations.
The market for real estate in desirable retail store locations is competitive, which could hamper our ability to open new stores.
Our ability to obtain real estate to open new stores in desirable locations depends upon the availability of real estate that meets our criteria, which includes, among other items, projected foot traffic, square footage, demographics and whether we are able to negotiate lease terms that meet our operating budget. In addition, we must be able to effectively renew our existing store leases from time to time. Failure to secure real estate in desirable locations on economically beneficial terms or to renew leases on existing store locations on economically beneficial terms could have a material adverse effect on our results of operations.
 

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Our plans to expand our product offerings and sales channels may not be successful, and implementation of these plans may divert our operational, managerial and administrative resources, which could impact our competitive position.
Our ability to grow our existing brand and develop or identify new growth opportunities depends in part on our ability to appropriately identify, develop and effectively execute strategies and initiatives. Failure to effectively identify, develop and execute strategies and initiatives may lead to increased operating costs without offsetting benefits and could have a material adverse effect on our results of operations. These plans involve various risks discussed elsewhere in these risk factors, including:
 
•    
implementation of these plans may be delayed or may not be successful; 
 
•    
if our expanded product offerings and sales channels fail to maintain and enhance our distinctive brand identity, our brand image may be diminished and our sales may decrease; 
 
•    
if we fail to expand our infrastructure, including by securing desirable store locations at reasonable costs and hiring and training qualified employees, we may be unable to manage our expansion successfully; and 
 
•    
implementation of these plans may divert management's attention from other aspects of our business and place a strain on our management, operational and financial resources, as well as our information systems.
 
In addition, our ability to successfully carry out our plans to expand our product offerings and our sales channels may be affected by, among other things, economic and competitive conditions, changes in consumer spending patterns and changes in consumer preferences and fashion trends. Our expansion plans could be delayed or abandoned, could cost more than anticipated and could divert resources from other areas of our business; any of which could impact our competitive position and reduce our revenue and profitability.
Expanding our business internationally is an important part of our overall growth strategy and our success in this regard is subject to numerous risks, any of which could delay or prevent successful penetration into international markets.
As we expand internationally, we need to effectively and efficiently open and operate stores in international locations. Our international growth will be limited unless we can:
 
•    
identify suitable markets and obtain suitable sites for store locations; 
 
•    
negotiate acceptable lease terms; 
 
•    
complete store design and remodeling projects on time and on budget; 
 
•    
hire, train and retain competent store personnel; 
 
•    
gain acceptance from foreign customers; 
 
•    
manage inventory effectively to meet the needs of new and existing stores on a timely basis; 
 
•    
manage and expand infrastructure to accommodate growth; 
 
•    
generate sufficient operating cash flows or secure adequate capital on commercially reasonable terms to fund our expansion plan; 
 
•    
manage foreign exchange risks effectively; 
 
•    
address existing and changing legal, regulatory and political environments in target foreign markets; and 
 
•    
manage international growth, if any, in a manner that does not unduly strain our financial, operating and management resources.
 
We anticipate that we will incur significant costs related to starting up and maintaining additional foreign operations. Costs may include, and will not be limited to, obtaining prime locations for stores, setting up foreign offices and distribution facilities and hiring experienced management. These increased demands may cause us to operate our business less effectively, which in turn could cause deterioration in the performance of our stores. Furthermore, our ability to conduct business in international markets may be affected by legal, regulatory, political and economic risks.
 
 
 

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If we fail to maintain the value and image of our brand, our sales are likely to decline.
Our success depends on the value and image of the American Apparel brand. The American Apparel name is integral to our business as well as to the implementation of our strategies for expanding our business. Maintaining, promoting and positioning our brand depend largely on the success of our marketing and merchandising efforts and our ability to provide a consistent, high quality customer experience. Our brand could be adversely affected if we fail to achieve these objectives or if our public image or reputation or those of our senior personnel were to be tarnished by negative publicity. Any of these events could result in decreases in sales.
We expect to experience fluctuations in our comparable store sales and margins, which could cause our earnings to decline and make it difficult to gauge our growth at any specific period of time.
Our inability to maintain comparable store sales could cause our earnings to further decline. Our success depends, in part, upon our ability to improve sales, as well as gross margins and operating margins, at American Apparel's existing stores. American Apparel's comparable store sales have fluctuated significantly in the past on an annual, quarterly and monthly basis, and we expect that they will continue to fluctuate in the future. A variety of factors affect comparable store sales, including fashion trends, competition, current economic conditions, pricing, inflation, the timing of release of new merchandise and promotional events, changes in our merchandise mix, the success of marketing programs, timing and level of markdowns and weather conditions. These factors may cause our comparable store sales results to differ materially from prior periods and from our expectations, which could cause a decrease in our earnings. Our ability to deliver strong comparable store sales results and margins depends in large part on accurately forecasting demand and fashion trends, selecting effective marketing techniques, providing an appropriate mix of merchandise for our customer base, managing inventory effectively, using more effective pricing strategies, and optimizing store performance.
Our failure to adequately protect our trademarks and other intellectual property rights could diminish the value of our brand and reduce demand for our merchandise.
American Apparel trademarks and service marks, and certain other trademarks, have been registered, or are the subject of pending trademark applications with the United States Patent and Trademark Office and with the registries of many foreign countries and/or are protected by common law. In the United States, American Apparel is the registered owner of the “American Apparel®,” “Classic Girl®,” “Standard American®,” “Classic Baby®,” and “Sustainable Edition®” trademarks, among others. Our products are noted for their quality and fit, and our edgy, distinctive branding has differentiated it in the marketplace. As such, the trademark and variations thereon are valuable assets that are critical to our success. We intend to continue to vigorously protect our trademark and brand against infringement, but we may not be successful in doing so. In addition, the laws of certain foreign countries may not protect proprietary rights to the same extent as do the laws of the United States. The unauthorized reproduction or other misappropriation of our trademark would diminish the value of our brand, which could reduce demand for our products or the prices at which we can sell our products.
Our ability to attract customers to our stores depends heavily on the success of the shopping areas in which they are located.
In order to generate customer traffic, we locate many of our stores in prominent locations within successful shopping areas. Net sales at these stores are partly dependent on the volume of traffic in those shopping areas. Our stores benefit from the ability of a shopping area's other tenants to generate consumer traffic in the vicinity of our stores and the continuing popularity of the shopping areas. We cannot control the availability or cost of appropriate locations within existing or new shopping areas, competition with other retailers for prominent locations or the success of individual shopping areas. In addition, factors beyond our control impact shopping area traffic, such as economic conditions nationally or in a particular area, competition from internet retailers, changes in consumer demographics in a particular market, the closing or decline in popularity of other stores in the shopping areas where our stores are located, deterioration in the financial conditions of the operators of the shopping areas or developers and consumer spending levels. The slowdown in the U.S. economy has negatively affected consumer spending and reduced shopping area traffic. A significant decrease in shopping area traffic could have a material adverse effect on our financial condition or results of operations. Furthermore, in pursuing its growth strategy, we will be competing with other retailers for prominent locations within the same successful shopping areas. If we are unable to secure these locations or unable to renew store leases on acceptable terms-as they expire from time-to-time-we may not be able to continue to attract the number or quality of customers we normally have attracted or would need to attract to sustain our projected growth. All these factors may also impact our ability to meet our growth targets and could have a material adverse effect on our financial condition or results of operations.
 
 

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Fluctuations in our results of operations from quarter to quarter could have a disproportionate effect on our overall financial condition and results of operations.
We experience seasonal fluctuations in revenues and operating income. Historically, sales during the third and fourth fiscal quarters have generally been the highest, with sales during the first fiscal quarter being the lowest. Any factors that harm our operating results for the second and third fiscal quarters, including adverse weather or unfavorable economic conditions, could have a disproportionate effect on our results of operations for the entire fiscal year.
In order to prepare for our peak selling season, we must produce and keep in stock more merchandise than we would carry at other times of the year. Any unanticipated decrease in demand for our products during our peak selling season could require us to sell excess inventory at a substantial markdown, which could reduce our net sales and gross profit.
The terms of our indebtedness contain various covenants that may limit our business activities.
The terms of our indebtedness contain, and our future indebtedness may contain, various restrictive covenants that limit our management's discretion in operating our business. In particular, these agreements include, or may include, covenants relating to limitations on:
 
•    
dividends on, and redemptions and repurchases of, capital stock; 
 
•    
payments on subordinated debt; 
 
•    
liens and sale-leaseback transactions; 
•    
 
•    
loans and investments; 
 
•    
debt and hedging arrangements; 
 
•    
mergers, acquisitions and asset sales; 
 
•    
transactions with affiliates; 
 
•    
disposals of assets; 
 
•    
changes in business activities conducted by us and our subsidiaries; and 
 
•    
capital expenditures, including to fund future store openings.
 
In addition, our indebtedness requires us to comply with certain financial ratios and maintain certain amounts of unused availability under our revolving credit facility. Such restrictions could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business or acquisition opportunities. See “Risk Factors-Failure of American Apparel to remain in compliance with certain financial covenants under its financing arrangements could result in the acceleration of its debt payment obligations.” Also see “Management's Discussion and Analysis of Financial Condition and Results of Operations-Debt Agreements”.
Compliance with these covenants and these ratios may prevent us from pursuing opportunities that we believe would benefit our business, including opportunities that we might pursue as part of our plans to expand our store base, our product offerings and sales channels.
Substantially all of our assets are used to secure our credit facilities, certain term loans and equipment leasing agreements.
Our credit facilities are secured by substantially all of our assets including cash, inventory and accounts receivable, and our second lien term loan facility is also secured by substantially all assets of our Company. All leasing agreements are secured by equipment provided by the leasing arrangement. In the event of a default on these agreements, substantially all of the assets of American Apparel could be subject to liquidation by the creditors, which liquidation could result in no assets being left for the stockholders after the creditors receive their required payment.
Cost increases in the materials or labor used to manufacture our products could negatively impact our business and financial condition.
The manufacture of our products is labor intensive and utilizes raw materials supplied by third parties. An important part of American Apparel branding and marketing is that our products are made in the United States. The Federal Trade Commission has stated that for a product to be called “Made in USA”, or claimed to be of domestic origin without qualifications or limits on the claim, the product must be “all or virtually all” made in the U.S. The term “United States” includes the 50 states, the District of Columbia, and the U.S. territories and possessions. “All or virtually all” means that all significant parts and

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processing that go into the product must be of U.S. origin. That is, the product should contain no - or negligible - foreign content. We meet the FTC's “Made in USA” standard and from the knitting process to the final sewing of a garment, all of the processes are conducted in the U.S., either directly by us in our knitting, manufacturing, dyeing and finishing facilities located in Los Angeles or through commission knitters, dyers and sewers in the Los Angeles metropolitan area and other regions in the U.S. If the cost of labor materially increases, our financial results could be materially adversely affected and our ability to compete against companies with lower labor costs could be hampered. Material increases in labor costs in the United States could also force us to move all or a portion of our manufacturing overseas, which could adversely affect the American Apparel brand identity. Similarly, increases in the prices we pay to the suppliers of the raw materials used in the manufacturing of our products could adversely affect our financial condition and ability to compete and could force us to seek to offset increased raw material costs by relocating all or a portion of our manufacturing overseas to locations with lower labor costs.
 
Unionization of employees at our facilities could result in increased risk of work stoppages and high labor costs.
Our employees are not party to any collective bargaining agreement or union. If employees at our manufacturing or distribution facilities were to unionize, our relationship with our employees could be adversely affected. We would also face an increased risk of work stoppages and higher labor costs. Accordingly, unionization of our employees could have a material adverse impact on our operating costs and financial condition and could force us to raise prices on our products, curtail operations and/or relocate all or a portion of our operations overseas.
We are subject to customs, advertising, consumer protection, zoning and occupancy and labor and employment laws that could require us to modify our current business practices and incur increased costs.
We are subject to numerous regulations, including customs, truth-in-advertising, consumer protection and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of retail stores and warehouse facilities. We also are subject to numerous federal and state labor laws, such as minimum wage laws and other laws relating to employee benefits. If these regulations were to change or were violated by our management, employees, suppliers, buying agents or trading companies, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our merchandise and hurt our business and results of operations. In addition, changes in federal and state minimum wage laws and other laws relating to employee benefits could cause us to incur additional wage and benefits costs, which could adversely affect our profitability. We are currently defending one wage and hour suit. Should this matter be decided against us, we could incur substantial liability, experience an increase in similar suits, and suffer reputational harm. We are unable to predict the financial outcome of this matter at this time, and any views we form as to the viability of this claim or the financial exposure in which it could result may change. No assurance can be made that this matter, 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 our financial condition and results of operations. See the section entitled “Item 3. Legal Proceedings” for a more detailed discussion of our pending litigation.
Legal requirements are frequently changed and subject to interpretation, and we are unable to predict the ultimate cost of compliance with these requirements or their effect on our operations. We may be required to make significant expenditures or modify our business practices to comply with existing or future laws and regulations, which may increase our costs and materially limit our ability to operate our business.
Current environmental laws, or laws enacted in the future, may harm our business.
We are subject to federal, state and local laws, regulations and ordinances that govern activities or operations that may have adverse environmental effects (such as emissions to air, discharges to water, and the generation, handling, storage and disposal of solid and hazardous wastes). We are also subject to laws, regulations and ordinances that impose liability for the costs of clean up or other remediation of contaminated property, including damages from spills, disposals or other releases of hazardous substances or wastes, in certain circumstances without regard to fault. Certain of our operations routinely involve the handling of chemicals and wastes, some of which are or may become regulated as hazardous substances. Our product design and procurement operations must comply with new and future requirements relating to the materials composition of our products. If we fail to comply with the rules and regulations regarding the use and sale of such regulated substances, we could be subject to liability. The costs and timing of costs under environmental laws are difficult to predict.
As is the case with manufacturers in general, if a release of hazardous substances occurs on or from its properties or any associated offsite disposal locations, or if contamination from prior activities is discovered at any of its properties, We may be held liable. The amount of such liability could be material.
 

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Our manufacturing operations are located and will be located in higher-cost geographic locations, placing us at a possible disadvantage to competitors that have a higher percentage of their manufacturing operations overseas.
Despite the general industry-wide migration of manufacturing operations to lower-cost locations, such as Central America, the Caribbean Basin and Asia, our textile manufacturing operations are still located in the United States, which is a higher-cost location relative to these offshore locations. In addition, our competitors generally source or produce a greater portion of their textiles from regions with lower costs than American Apparel, which also places us at a cost disadvantage. Our competitor's lower costs of production may allow them to offer their products at a lower price than our selling prices for similar products. This could force us to lower our margins or to compete more vigorously with non-price competitive strategies to preserve our margins and sales volume.
Our reliance on operational facilities located in the same vicinity makes our business susceptible to disruptions or adverse conditions affecting the location of our facilities.
We conduct all of our manufacturing operations in the Los Angeles metropolitan area. Specifically, we operate principally out of its 800,000 square foot facility in downtown Los Angeles, which houses our executive offices, as well as our cutting, sewing, and distribution operations. We also operate a knitting facility in Los Angeles, California; a cutting, sewing, garment dyeing and finishing facility in South Gate, California; a fabric dyeing and finishing facility in Hawthorne, California, a cutting, sewing, fabric dyeing and finishing facility in Garden Grove, California; as well as a warehouse facility in Commerce, California and Los Angeles, California. As a result, our operations are susceptible to local and regional factors, such as accidents, system failures, economic and weather conditions, natural disasters, and demographic and population changes, as well as other unforeseen events and circumstances.
Southern California is particularly susceptible to earthquakes. Any significant interruption in the operation of any of these facilities could reduce our ability to receive and process orders and provide products and services to our stores and customers, which could result in lost sales, cancelled sales and a loss of loyalty to our brand. Furthermore, if there were a major earthquake, we may have to cease operations for a significant portion of time due to damages to our factory and the inability to deliver products to our distribution centers.
Third party failure to deliver merchandise to stores and customers could result in lost sales or reduced demand for our merchandise.
The efficient operation of our stores and wholesale business depends on the timely receipt of merchandise from our distribution centers. Independent third party transportation companies deliver a substantial portion of our merchandise to our stores. These shippers may not continue to ship our products at current pricing or terms. These shippers may employ personnel represented by labor unions. Disruptions in the delivery of merchandise or work stoppages by employees or contractors of these third parties could delay the timely receipt of merchandise, which could result in cancelled sales, a loss of loyalty to our brand and excess inventory. There can be no assurance that such stoppages or disruptions will not occur in the future. Any failure by these third parties to respond adequately to our distribution needs would disrupt our operations and could have a material adverse effect on our financial condition and results of operations.
Timely receipt of merchandise by our stores and our customers may also be affected by factors such as inclement weather, natural disasters and acts of terrorism. We may respond by increasing markdowns or initiating marketing promotions, which would decrease our gross profits and net income.
Elimination or scaling back of U.S. import protections would weaken an important barrier to the entry of foreign competitors who produce their merchandise in lower labor cost locations. This could place us at a disadvantage to those competitors.
Our products are subject to foreign competition. Foreign producers of apparel often have significant labor cost advantages, which can enable them to sell their products at relatively lower prices. However, in the past, foreign competitors have been faced with significant U.S. government import restrictions in the form of tariffs and quotas. The extent of import protection afforded to domestic apparel producers has been, and is likely to remain, subject to political considerations, and is therefore unpredictable. Given the number of foreign low cost producers, the substantial elimination or scaling back of the import protections that protect domestic apparel producers such as American Apparel could have a material adverse effect on our business and the financial condition and results of operation.
 
 
 

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Because we utilize foreign suppliers and sell into foreign markets, we are subject to numerous risks associated with international business that could increase our costs or disrupt the supply of our products, resulting in a negative impact on our business and financial condition.
Our international operations subject us to risks, including:
 
•    
economic and political instability; 
•    
restrictive actions by foreign governments; 
•    
greater difficulty enforcing intellectual property rights and weaker laws protecting intellectual property rights;
•    
changes in import duties or import or export restrictions; 
•    
fluctuations in currency exchange rates, which could negatively affect profit margins; 
•    
timely shipping of product and unloading of product through West Coast ports, as well as timely truck delivery to American Apparel's warehouses; 
•    
complications complying with the laws and policies of the United States affecting the exportation of goods, including duties, quotas, and taxes; and 
•    
complications in complying with trade and foreign tax laws.
 These and other factors beyond our control could disrupt the supply of our products, influence the ability of our suppliers to export our products cost-effectively or at all, inhibit our suppliers' ability to procure certain materials and increase our expenses, any of which could harm our business, financial condition and results of operations.
The rising cost of yarn, certain related fabrics, and other raw materials could have a material adverse effect on our financial condition and results of operations.
The price of yarn and the cost of certain related fabrics began to increase in the first quarter of 2010 as a result of added demand and supply shortages arising primarily from the effect of severe weather conditions in certain cotton producing countries and a ban on cotton exports imposed by the government of India. Prices have continued to rise through the first quarter of 2011. While we have yet to experience any meaningful shortages in the supply of yarn and fabrics, we cannot predict if such shortages will occur. Such shortages may result in an increase in our manufacturing costs and could result in a material adverse effect on our financial conditions and results of operations, as we are unable to predict whether we will be able to successfully pass on the added cost of raw materials to our wholesale and retail customers.
Litigation exposure could exceed expectations and have a material adverse effect on our financial condition and results of operations.
We are subject to regulatory inquiries, investigations, claims and suits. We are currently defending a consolidated putative shareholder class action, two consolidated shareholder derivative actions proceeding in federal and state court, respectively, one wage and hour suit, and numerous employment related claims and suits. We are cooperating with investigations by the SEC and by the United States Attorney's Office for the Central District of California and the Southern District of New York. We are also responding to several allegations of discrimination and/or harassment that have been filed with the Equal Employment Opportunity Commission or state counterpart agencies. In the event one or more of these matters are decided against us, we could not only incur a substantial liability but also experience an increase in similar suits and suffer reputational harm. Furthermore, the previous insurer for our employment practices liability insurance policy alleges that a sexual harassment suit is not covered by that insurance policy. We are unable to predict the financial outcome that could result from these matters at this time and any views we form as to the viability of these claims or the financial exposure in which they could result could change from time to time as the matters proceed through their course, as facts are established and various judicial determinations are made. No assurance can be made that these matters will not have material financial exposure, which together with the potential for similar suits and reputational harm, could have a material adverse effect upon our financial condition and results of operations. See the section entitled “Item 3. Legal Proceedings” for a more detailed discussion of American Apparel's pending litigation.
The process of upgrading our information technology infrastructure may disrupt our operations.
We are increasingly dependent on information systems to operate our website, process transactions, respond to customer inquiries, manage inventory and production, purchase, sell and ship goods on a timely basis and maintain cost-efficient operations. We have performed an evaluation of our information technology systems and requirements and have implemented

25


upgrades to our information technology systems supporting the business. These upgrades involve replacing legacy systems with successor systems, making changes to legacy systems or acquiring new systems with new functionality. There are inherent risks associated with replacing and changing these systems, including accurately capturing data and system disruptions. We may experience operational problems with our information systems as a result of system failures, viruses, computer “hackers” or other causes. Any material disruption or slowdown of our systems, including a disruption or slowdown caused by our failure to successfully upgrade our systems, could cause information, including data related to customer orders, to be lost or delayed which could-especially if the disruption or slowdown occurred during the holiday season-result in delays in the delivery of merchandise to our stores and customers or lost sales, which could reduce demand for our merchandise and cause our sales to decline.
Moreover, we may not be successful in developing or acquiring technology that is competitive and responsive to the needs of our customers and might lack sufficient resources to make the necessary investments in technology to compete with our competitors. Accordingly, if changes in technology cause our information systems to become obsolete, or if our information systems are inadequate to handle our growth, we could lose customers.
We have potentially adverse exposure to credit risks on our wholesale sales.
We are exposed to the risk of financial non-performance by our customers, primarily in our wholesale business. Sales to wholesale customers represented approximately 28.4% of total net sales for the year ended December 31, 2010. Our extension of credit involves considerable use of judgment and is based on an evaluation of each customer's financial condition and payment history. We monitor our credit risk exposure by periodically obtaining credit reports and updated financials on its customers. We maintain an allowance for doubtful accounts for potential credit losses based upon historical trends and other available information. However, delays in collecting or the inability to collect on sales to significant customers or a group of customers could have a material adverse effect on our results of operations.
A failure in our Internet operations could significantly disrupt our business and lead to reduced sales and reputational damage.
Our online retail operations accounted for approximately 6.7% of net sales for the year ended December 31, 2010 and are subject to numerous risks that could have a material adverse effect on our operational results. Risks to online revenue include, but are not limited to, the following:
 
•    
changes in consumer preferences and buying trends relating to Internet usage; 
•    
changes in required technology interfaces; 
•    
web site downtime; 
•    
difficulty in recreating the in-store experience on a web site; and 
•    
risks related to the failure of the systems that operate the web sites and their related support systems, including computer viruses, theft of customer information, telecommunication failures and electronic break-ins and similar disruptions.
 Our failure to successfully respond to these risks and uncertainties could reduce Internet sales and damage our brand's reputation.
We have identified certain material weaknesses in our internal control over financial reporting as of December 31, 2010.
We have identified material weaknesses in our internal control over financial reporting as of December 31, 2010, as further described in Item 9A of this Annual Report on Form 10-K. These material weaknesses relate to our control environment and our financial controls and reporting process.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. In addition, due to the identified material weaknesses, management has concluded that as of December 31, 2010, our disclosure controls and procedures were ineffective. The existence of material weaknesses could adversely affect our ability to report our financial condition and results of operations accurately and on a timely basis and, as a result, we may be unable to timely meet our reporting obligations with the SEC. The existence of material weaknesses also could adversely affect the market price of our common stock and subject us to sanctions or investigations by the NYSE Amex, the SEC and other regulatory authorities.
 

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We are currently being audited by government tax agencies regarding our operating activities in previous periods which may result in an assessment of a material amount, the payment of which may adversely impact our financial conditions and operations.
As of December 31, 2010, we are being audited by Government agencies in various jurisdictions in regards to sales, VAT, income, and other taxes for certain previous years. We believe that we properly assess and remit all required sales, VAT, income, and other taxes in the applicable jurisdictions and, we account for any uncertain tax position or tax contingency in accordance with the provisions of ASC 740-“Income Taxes” or ASC 450-“Contingencies” , respectively. We have accrued approximately $2.4 million and $6.5 million as of December 31, 2010 and 2009, respectively, for all uncertain income tax positions and non-income tax contingencies. In determining the amounts related to the uncertain tax position, we recognize the benefits that have a greater than 50% probability of being sustained under audit. The actual amount upheld under audit with the relevant taxing authorities could be materially different than our estimates. At December 31, 2010 and 2009, we have recognized approximately $1.3 million and $5.1 million, respectively, related to uncertain income tax positions. For non-income tax contingencies, we estimate the probability of the related exposure and record a reserve if it is probable that a contingent liability exists. At December 31, 2010 and 2009, we have recorded $1.4 million and $1.0 million, respectively, related to non-income tax related tax contingencies.
 
There will be a substantial number of shares of American Apparel's common stock available for sale in the future that may increase the volume of common stock available for sale in the open market and may cause a decline in the market price of American Apparel's common stock.
 
The consideration issued in the Acquisition to the American Apparel stockholders included 37,258,065 shares of American Apparel common stock that was issued at the closing to Dov Charney. The resale of these shares has not been registered and these shares are restricted securities under the securities laws. All of these shares are subject to lock-up agreements and cannot be sold publicly, in the absence of our consent, until the expiration of the restricted period under the lock-up agreement in December 2013 (which period may be shortened to December 2010 upon the occurrence of certain events). On December 1, 2010, we sold 1,129,576 treasury shares of our common stock to Mr. Charney at approximately $1.48 per share. In addition, on March 24, 2011, we entered into, and closed the transactions under, a purchase agreement pursuant to which (i) Mr. Charney purchased an aggregate of 1,801,802 shares of our common stock at a price of $1.11 per share and (ii) the three promissory notes issued by two subsidiaries of the Company to Mr. Charney, which as of March 24, 2011 had an aggregate of approximately $4.7 million outstanding, were canceled in exchange for an issuance of an aggregate of 4,223,194 shares of our common stock to Mr. Charney at a price of $1.11 per share with 50% of such shares issuable to Mr. Charney only if prior to March 24, 2014, (x) the closing sale price of our common stock on the NYSE Amex exceeds $3.50 for 30 consecutive trading days or (y) there is a change of control of the Company. The presence of these additional shares of common stock eligible for trading in the public market may have an adverse effect on the market price of American Apparel's common stock.
 
In addition, we have outstanding warrants exercisable to purchase an aggregate of 17.8 million shares of its common stock, representing on an as-converted basis approximately 22.9% of the outstanding common stock (after giving effect to the issuance of the shares underlying such warrants). SOF Investments, L.P.-Private IV (“SOF”) holds a warrant ("SOF Warrant"), expiring on December 19, 2013, to purchase 1.0 million shares of American Apparel common stock at an exercise price of $2.816 per share, which exercise price is subject to adjustment under certain circumstances. As a result of the issuance of the New Lion Warrant (as defined below), the exercise price of the SOF Warrant was adjusted to $2.739 per share. In addition, Lion Capital (Guernsey) II Limited (“Lion”) holds a warrant, expiring on March 13, 2016, to purchase 16 million shares of American Apparel common stock at an exercise price of $1.11 per share, which exercise price is subject to adjustment under certain circumstances.
 
On February 18, 2011, the Company entered into a fifth amendment to the Lion Credit Agreement, which among other
things, (i) calls for the amendment of the outstanding warrants to: (a) adjust the term of the outstanding warrants to expire on
February 18, 2018, and (b) adjust the exercise price of the warrants to $1.11, subject to anti-dilution and other adjustments, (ii)
until August 2011, requires the issuance of new warrants to Lion if our Common Stock or Preferred Stock is subsequently sold or a debt-for-equity exchange or conversion is completed in order to ensure Lion's percentage beneficial ownership of our Common Stock remains at least equal to the percentage calculated immediately prior to such action, and (iii) until August 2011, if the Common Stock share sales price implied by the net proceeds received in connection with any equity sale or debt-for-equity exchange or conversion is less than $1.11, requires the exercise price of such new warrants to be reduced to the lowest such implied price.
 
On March 24, 2011, in connection with the sale of common stock to our CEO, Dov Charney, as discussed above, in accordance with the fifth amendment to the Lion Credit Agreement, the Company issued to Lion a new warrant to purchase an aggregate of 759,809 shares of common stock at an exercise price of $1.11 per share, as such price may be adjusted from time

27


to time pursuant to the adjustments specified in the New Lion Warrant or the Lion Credit Agreement.
 
Our stock price may be volatile.
Our stock price may fluctuate substantially as a result of quarter to quarter variations in the actual or anticipated financial results of our or other companies in the retail industry or markets served by our. In addition, the stock market has experienced price and volume fluctuations that have affected the market price of many retail and other stocks and that have often been unrelated or disproportionate to the operating performance of these companies. Failure to meet the expectations of investors, security analysts or credit rating agencies in one or more future periods could reduce the market price of our common stock and cause our credit ratings to decline.
If we are unable to maintain our listing of American Apparel's securities on the NYSE Amex or any stock exchange, it may be more difficult for our stockholders to sell their securities.
Our common stock is currently traded on the NYSE Amex. If for any reason the NYSE Amex should delist our securities from trading on its exchange, and we are unable to obtain listing on the Nasdaq or another national securities exchange, we could face significant material adverse consequences, including:
 
•    
a limited availability of market quotations for our securities; 
•    
a limited amount of news and analyst coverage for our Company; 
•    
a decreased ability to issue additional securities or obtain additional financing in the future; and 
•    
a determination that its common stock is a “penny stock,” if the securities sell for a substantial period of time at a low price per share which would require brokers trading in its common stock to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for our common stock.
 Voting control by our executive officers, directors, lenders and other affiliates may limit your ability to influence the outcome of director elections and other matters requiring stockholder approval.
In connection with the closing of the financing transaction with Lion, Mr. Charney and Lion entered into a voting agreement, dated March 13, 2009 (the “Investment Voting Agreement”), and the Company and Lion entered into an investment agreement, dated March 13, 2009 (the “Investment Agreement”). Pursuant to the Investment Agreement, Lion has the right to designate up to two persons to our Board of Directors and a board observer (or, if our Company increases its board size to 12, Lion has the right to designate up to three persons to our Board of Directors and no board observers), subject to maintaining certain minimum ownership thresholds of, or shares issuable under, the Existing Lion Warrant, as amended by the Existing Lion Warrant Amendment, which gives to Lion a right to purchase 16 million shares of Company common stock at an exercise price of $1.11 per share, and which exercise price is subject to adjustment under certain circumstances. Though no change to the existing Board of Directors composition is required under the Investment Agreement, we may consider changes in lieu of increasing the size of our Board of Directors. Two Lion designees were elected to our Board of Directors at our annual meeting of stockholders, which was held on December 10, 2010. The Investment Agreement also provides that for so long as Lion has the right to designate any person for nomination for election to our Board of Directors pursuant to the Investment Agreement, we will not increase the size of our Board of Directors to more than 10 directors (or 13 directors in the event we elect to increase the size of our Board of Directors to 12 directors as described above).
Pursuant to the Investment Voting Agreement, for so long as Lion has the right to designate any person or persons to the Board of Directors, Mr. Charney has agreed to vote his shares of common stock in favor of Lion's designees, provided that Mr. Charney's obligation to so vote terminates if he owns less than 6,000,000 shares of Company common stock (which number will be adjusted appropriately to take into account any stock split, reverse stock split or similar transaction). In addition, pursuant to the Investment Voting Agreement, for so long as Lion has the right to designate any person or persons to the Board of Directors, Lion has agreed to vote its shares of common stock in favor of Mr. Charney and, each other designee of Mr. Charney, provided that Lion's obligation to so vote terminates if either (i) Mr. Charney beneficially owns less than 27,900,000 shares of Company common stock (which number will be adjusted appropriately to take into account any stock split, reverse stock split or similar transaction) or (ii) (A) Mr. Charney is no longer employed on a full-time basis by our or any subsidiary of our and (B) Mr. Charney is in material breach of the non-competition and non-solicitation covenants contained in the Acquisition Agreement, as extended by a letter agreement, dated March 13, 2009, between Mr. Charney and Lion.
Accordingly, the parties to the Investment Agreement and the Investment Voting Agreement are able to control the election of directors. Mr. Charney beneficially owns approximately 54.3% of our outstanding common stock and voting power (such calculation does not give effect to dilution as a result of any exercise of the Existing Lion Warrant, the New Lion Warrant or the SOF Warrant. This concentration of ownership and the Investment Voting Agreement could have the effect of delaying or

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preventing a change in our control or discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on the market price of our common stock or prevent our stockholders from realizing a premium over the current market price for their shares of our common stock. Furthermore, Mr. Charney and Lion may also have interests that differ from yours and may vote their shares of our common stock in a way with which you disagree and which may be adverse to your interests.
 
Significant fluctuations in exchange rates between the U.S. dollar and foreign currencies may adversely affect our revenues, operating income, net income and earnings per share, as well as future cash flows.
 
We face exposure to adverse movements in foreign currency exchange rates as a result of our international operations. These exposures may change over time as business practices evolve, and they could have a material adverse impact on our financial results and cash flows. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore potentially less competitive in foreign markets. Conversely, lowering our price in local currency may result in lower U.S.-based revenue. A decrease in the value of the U.S. dollar relative to foreign currencies could increase the cost of local operating expenses. We utilize certain foreign currency forward exchange contracts to hedge our foreign currency exposure associated with certain assets and liabilities as well as anticipated foreign currency cash flows. These hedges are designed to reduce, but do not always entirely eliminate, the impact of currency exchange movements. Factors that could have an impact on the effectiveness of our hedging program include the accuracy of forecasts and the volatility of foreign currency markets as well as widening interest rate differentials and the volatility of the foreign exchange market. There can be no assurance that such hedging strategies will be successful and that currency exchange rate fluctuations will not have a material adverse effect on our operating results. In addition, while the hedges are designed to reduce volatility over the forward contract period, the contracts are not treated as hedges for accounting purposes, and therefore can create volatility in earnings during the period. The degree to which our financial results are affected for any given period will depend in part upon our hedging activities.
 
 

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Item 1B.    Unresolved Staff Comments
None.
 
Item 2.    Properties
The following table sets forth the location and use of each of American Apparel’s principal non-retail properties, which are all leased:
 
Los Angeles, California
  
Headquarters, Sewing, Cutting, and Distribution
Los Angeles, California
  
Knitting Facility
Los Angeles, California
  
Warehouse Facility
Hawthorne, California
  
Fabric Dyeing and Finishing Facility
South Gate, California
  
Cutting, Sewing, Garment Dyeing and Finishing Facility
Garden Grove, California
  
Cutting, Sewing, Knitting, Fabric Dyeing and Finishing Facility
Commerce, California
  
Warehouse Facility
Montreal, Quebec
  
Offices, Distribution
Dusseldorf, Germany
 
Offices
Neuss, Germany
  
Distribution
London, England
  
Offices
Tokyo, Japan
  
Offices
Seoul, South Korea
  
Offices
All of our retail stores are leased, well maintained and in good operating condition. Our retail stores are typically leased for a term of five to ten years with renewal options for an additional five to ten years. Most of these leases provide for base rent, as well as maintenance and common area charges, real estate taxes and certain other expenses. Selling space of opened stores will sometimes change due to store renovations that modify space utilization, use of staircases, the configuration of cash registers, and other factors. As well, a number of our store locations have undergone expansions in the past several years.
 

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The following tables set forth American Apparel’s existing retail stores by geographic region, as of December 31, 2010:
Domestic Locations (157)
 
Arizona (3)
Scottsdale
Tempe*
Tucson
 
California (40)
Arcadia
Berkeley (2)
Burlingame*
Camarillo
Claremont
Commerce
Costa Mesa
Gilroy
Los Angeles—
  Echo Park
  Factory Store
  Hollywood
  Little Tokyo
  Los Feliz
  Melrose
  Robertson
  Westwood Village
  West Hollywood
  Huntington Beach
Malibu
Manhattan Beach
Napa
Palo Alto
Pasadena
Rancho Cucamonga
San Diego—
  Fashion Valley
  Gaslamp*
  Hillcrest
  Pacific Beach
San Francisco—
  China Gate
  Haight Ashbury
  Union Street
Santa Ana
Santa Barbara
Santa Clara
Santa Cruz
Santa Monica—
  Main Street
  Third Street Promenade
 
California (cont’d.)
Studio City
Ventura
 
Colorado (2)
Boulder
Denver
 
Connecticut (2)
New Haven
South Norwalk
 
District of Columbia (2)
Georgetown
Lincoln Square
 
Florida (11)
Boca Raton
Coconut Grove
Gainesville*
Miami Beach—
  Lincoln Road
  Ocean Drive*
  Sunset Drive
  Washington Ave.
Orlando
St. Augustine
Sunrise
Wellington
 
Georgia (2)
Atlanta—
  Lenox Mall
  Little Five Points
 
Hawaii (2)
Honolulu
  Ala Moana
  Kalakaua Road*
 
Illinois (8)
Chicago—
  Belmont & Clark
  Gold Coast
  Lincoln Park
  State St.
  Wicker Park
Evanston
Oak Brook
Schaumburg
 
 
 
Louisiana (1)
New Orleans
 
Maryland (4)
Annapolis
Baltimore
Bethesda
Silver Spring
 
Massachusetts (4)
Boston—
  Back Bay
  Newbury Street
Cambridge
Wrentham
 
Michigan (3)
Ann Arbor
East Lansing
Royal Oak
 
Minnesota (2)
Bloomington
Minneapolis
 
Missouri (1)
Kansas City
 
Nebraska (1)
Omaha
 
Nevada (4)
Las Vegas—
  Boca Park
  Caesars Palace*
  Miracle Mile
  Premium Outlets
 
New Jersey (5)
Cherry Hill
Edison
Hoboken
Paramus
Short Hills
 
New York (24)
Bleecker Street
Brooklyn—
  Carroll Gardens
  Court Street
  Park Slope
  Williamsburg
Central Valley
Garden City
 
New York (cont’d.)
Manhattan—
  Chelsea
  Columbia University
  Columbus Circle
  FIT
  Flatiron
  Gramercy Park
  Harlem
  Hell’s Kitchen
  Lower Broadway
  Lower East Side
  Noho
  Soho
  Tribeca
  Upper East Side
  Upper West Side
Riverhead
White Plains
 
North Carolina (2)
Charlotte—
  Camden Road
  SouthPark Mall
 
Ohio (3)
Cincinnati
Cleveland
Columbus
 
Oregon (4)
Eugene
Portland—
  Hawthorne Blvd.
  Stark Street
  Tigard
 
Pennsylvania (5)
King of Prussia
Philadelphia—
  Sansom Common
  Walnut Street
Pittsburgh—
  Shadyside
  Univ. of Pittsburgh
 
Rhode Island (1)
Providence
 
South Carolina (2)
Charleston
Columbia*
 
 
Tennessee (2)
Memphis
Nashville
 
Texas (8)
Austin—
  Congress Ave
  Guadalupe Street
Dallas—
  Mockingbird
  NorthPark Center
Houston
Round Rock
San Antonio—
  La Cantera
  North Star Mall
 
Utah (1)
Salt Lake City
 
Vermont (1)
Burlington
 
Virginia (1)
Richmond
 
Washington (4)
Lynnwood
Seattle—
  Capitol Hill
  Downtown Seattle
  University Way
 
Wisconsin (2)
Madison
Milwaukee
 
*    Scheduled to be closed in 2011
 

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Canada (40)
 
Alberta (4)
Calgary—
  17thAvenue
  Market Mall
Edmonton—
  82ndAvenue
  West Edmonton
  Mall
 
British Columbia (8)
Burnaby
Kelowna
Vancouver—
  Granville
  Park Royal
  Robson Street
  South Granville
  West 4th Street
  Victoria
 
Manitoba (1)
Winnipeg
 
Newfoundland (1)
St. John's
 
Nova Scotia (1)
Halifax
 
Ontario (14)
Kingston
London
Ottawa—
  Rideau Centre
  Westboro
Thornhill
Toronto—
  Bloor Street
  College Street*
  Queen Street
  Sherway Gardens
  Yonge & Dundas
  Yonge & Eglington
  Yorkdale Shopping Centre
  Vaughan
  Waterloo
 
Quebec (10)
Laval
Montreal—
  Cours Mont-Royal
  Mont-Royal Est
  St-Denis
  Ste-Catherine West
  Ste-Catherine Est*
  Pointe-Claire
Quebec—
  Place Laurier
  Rue St-Jean
  Westmount
 
Saskatchewan (1)
Saskatoon
 
*    Scheduled to be closed in 2011
 

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International Locations (76)
 
Europe (50)
Austria (1)
Vienna
 
Belgium (1)
Antwerp
 
France (11)
Aix-en-Provence
Paris—
  Marais
  Vielle du Temple
  Beaurepaire
  Avenue Victor Hugo
  Saint-Germain
  Saint-Honore (2)
  Galeries Lafayette
  La Defense
Toulouse
 
Italy (3)
Florence
Milan
Rome
 
Netherlands (2)
Amsterdam—
  Westerstraat
  Utrechtsestraat
 
  
Germany (11)
Berlin—
  Alte Schönhauser Strasse
  Bayreuther Strasse
  Münzstrasse
Dresden
Düsseldorf
Frankfurt
Hamburg—
  Jungfernstieg
  Schanzenstrasse
Mannheim
Munich—
  Sendlinger Strasse
Stuttgart
 
Spain (1)
Barcelona
 
Sweden (2)
Stockholm—
  Götgatan
  Kungsgatan
 
  
Switzerland (2)
Zurich—
  Josefstrasse
  Rennweg
 
United Kingdom (15)
Brighton
Bristol
Glasgow
Leeds
Liverpool
London—
  Camden High Street
  Carnaby Street
  Covent Garden
  Kensington High Street
  Oxford Street
  Portobello Road
  Selfridges
  Shoreditch
Manchester
Nottingham
 
Ireland (1)
Dublin
 
Israel (2)
Jerusalem*
Tel Aviv
 
Mexico (2)
Mexico City—
  Polanco
Monterrey
 
Brazil (1)
São Paulo
 
Australia (3)
Adelaide
Melbourne
Sydney
  
 
Asia (18)
China (3)
Beijing—
  Nali Mall
  World Trade Center
Shanghai
 
Japan (8)
Fukuoka
Osaka—
  Chayamachi*
  Shinsaibashi
Tokyo—
  Daikanyama
  Jiyugaoka
  Shibuya (2)
Yokohama*
  
 
South Korea (7)
Busan
Daegu
Seongnam
Seoul—
  Chungdam
  Hong Dae
  Kangnam
  Myung-dong
 
*    Scheduled to be closed in 2011
 
 

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Item 3.    Legal Proceedings
 
We are subject to various claims and contingencies in the ordinary course of our business, including those related to litigation, business transactions, employee-related matters and taxes, and others. When we are aware of a claim or potential claim, we assess 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, we 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 our business, financial position, and results of operations or cash flows.
 
On or about September 19, 2005, Ms. Mary Nelson, an independent contractor in the sales department at American Apparel, commenced a lawsuit (Mary Nelson v. American Apparel, Inc., et al., Case No. BC333028 filed in Superior Court of the State of California for the County of Los Angeles, Central District) (the “Nelson Action”) wherein she alleges she was wrongfully terminated, was subjected to harassment and discrimination based upon her gender and other claims related to her tenure at America Apparel. The parties are engaged in ongoing arbitration of this suit. Until arbitration proceedings are final, the ultimate costs could change. The insurance carrier for American Apparel has asserted that it is not obligated to provide coverage for this proceeding. We have accrued an estimate for this loss contingency in our consolidated balance sheet as of December 31, 2010.
 
On February 7, 2006, Sylvia Hsu, a former employee of American Apparel, filed a Charge of Discrimination with the Los Angeles District Office of the Equal Employment Opportunity Commission (“EEOC”) (Hsu v. American Apparel: Charge No. 480- 2006-00418), alleging that she was subjected to sexual harassment by a co-worker and constructively discharged as a result of the sexual harassment and a hostile working environment. On March 9, 2007, the EEOC expanded the scope of its investigation to other employees of American Apparel who may have been sexually harassed. On August 9, 2010, the EEOC issued a written determination finding that reasonable cause exists to believe we discriminated against Ms. Hsu and women, as a class, on the basis of their female gender, by subjecting them to sexual harassment. No finding was made on the issue of Ms. Hsu's alleged constructive discharge. In its August 19, 2010 written determination, the EEOC has invited the parties to engage in informal conciliation. If the parties are unable to reach a settlement which is acceptable to the EEOC, the EEOC will advise the parties of the court enforcement alternatives available to Ms. Hsu, aggrieved persons, and the EEOC. The insurance carrier for American Apparel has asserted that it is not obligated to provide coverage for this proceeding. The Company has not recorded a provision for this matter and intends to work cooperatively with the EEOC to resolve the claim in a manner acceptable to all parties. We do not at this time believe that any settlement will involve the payment of damages in an amount that would be material to and adversely affect our business, financial position, and results of operations and cash flows.
 
On November 5, 2009, Guillermo Ruiz, a former employee of American Apparel, filed suit against us 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 we 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 our employees. The complaint further alleges that we failed to comply with certain itemized employee wage statement provisions and 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. The parties are engaged in ongoing settlement discussions jointly with Antonio Partida (the case described below) in an effort to reach a global settlement of all claims asserted in both of these actions. No assurances can be made that a settlement can be reached. In accordance with an agreement between the parties', this matter will now proceed to binding arbitration. We do not have insurance coverage for this matter. Should the matter be decided against us, we could not only incur substantial liability but also experience an increase in similar suits and suffer reputational harm. We have accrued an estimate for this loss contingency in our consolidated balance sheet as of December 31, 2010. However, no assurance can be made that this matter either individually or together with the potential for similar suits and reputational harm, will not result in a material financial exposure, larger than our estimate, which could have a material adverse effect upon our financial condition and results of operations.
 
On June 21, 2010, Antonio Partida, a former employee of American Apparel, filed suit against us 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 we failed to timely pay wages, unlawfully deducted wages and failed to comply with certain itemized employee wage statement provisions and 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'

34


fees, interest and the costs of the suit. In December 2010, the Court granted American Apparel's Petition to Compel Arbitration. This matter will now proceed in arbitration. The parties are engaged in ongoing settlement discussions jointly with Guillermo Ruiz (the case described above) in an effort to reach a global settlement of all claims asserted in both of these actions. No assurances can be made that a settlement can be reached. There is no known insurance coverage for this matter. Should the matter be decided against us, we could not only incur substantial liability but also experience an increase in similar suits and suffer reputational harm. We have accrued an estimate for this loss contingency in our consolidated balance sheet as of December 31, 2010. However, no assurance can be made that this matter either individually or together with the potential for similar suits and reputational harm, will not result in a material financial exposure, larger than our estimate, which could have a material adverse effect upon our financial condition and results of operations.
 
On or about December 2, 2010, Emilie Truong, a former employee of American Apparel, filed suit against us 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 we 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. In February 2011, the Court granted American Apparel's Petition to Compel Arbitration. This matter will now proceed in arbitration. There is no known insurance coverage for this matter. Should the matter be decided against us, we could not only incur substantial liability, but also experience an increase in similar suits and suffer reputational harm. We are 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 our financial condition and results of operations.
 
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 San Diego Superior Court of the State of California, alleging we 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. We will soon be filing a Petition to Compel this matter into arbitration, pursuant to a written agreement between Plaintiff and the Company to submit all disputes into confidential binding arbitration. There is no known insurance coverage for this matter. Should the matter be decided against us, we could not only incur substantial liability, but also experience an increase in similar suits and suffer reputational harm. We are 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 our financial condition and results of operations.
 
Two shareholder derivative lawsuits, entitled Nikolai Grigoriev v. Dov Charney, et al., Case No. CV106576 GAF (JCx) (the “Grigoriev Action”) and Andrew Smukler v. Dov Charney, et al., Case No. CV107518 RSWL (FFMx) (the “Smukler Action”), were filed in the United States District Court for the Central District of California on September 2, 2010 and October 7, 2010, respectively, and four shareholder derivative lawsuits, entitled John L. Smith v. Dov Charney, et al., Case No. BC 443763 (the "Smith Action"), Lisa Kim v. Dov Charney, et al., Case No. BC 443902 (the "Kim Action"), Teresa Lankford v. Dov Charney, et al., Case No. BC 445094 (the "Lankford Action"), and Wesley Norris v. Dov Charney, et al., Case No. BC 447890 (the "Norris Action") were filed in the Superior Court of the State of California, County of Los Angeles on August 16, 2010, September 3, 2010, September 7, 2010, and October 21, 2010, respectively, by persons identifying themselves as American Apparel shareholders and purporting to act on behalf of American Apparel, naming American Apparel as a nominal defendant and certain current and former officers, directors, and executives of American Apparel as defendants. Plaintiffs in the Grigoriev Action, Smukler Action, Smith Action, Kim Action, and Norris Action allege causes of action for breach of fiduciary duty arising out of (i) our alleged failure to maintain adequate accounting and internal control policies and procedures; and (ii) our 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 Lankford Action 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 (i) our alleged failure to maintain adequate accounting and internal control policies and procedures; and (ii) our 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. On November 4, 2010, the four lawsuits

35


filed in the Superior Court of the State of California were consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. BC 443763. On November 12, 2010, the two lawsuits filed in the United States District Court for the Central District of California were consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. CV106576 (the “Federal Derivative Action”). On February 17, 2011, we filed a motion to stay the State Derivative Action pending resolution of the Federal Derivative Action. Although the Superior Court stayed the State Derivative Action pending its decision on the motion to stay, plaintiffs in the State Derivative Action purported to file a Consolidated Amended Shareholder Derivative Complaint on March 18, 2011, which contains substantially the same allegations as the complaints filed in the Smith, Kim, Lankford, and Norris Actions. The court will hear our motion to stay on April 12, 2011. Plaintiffs in each of the derivative cases seek damages on behalf of us in an unspecified amount, as well as equitable and injunctive relief. No damages against us are sought in the lawsuits.
 
Four putative class action lawsuits, entitled Anthony Andrade v. American Apparel, et al., Case No. CV106352 MMM (RCx), Douglas Ormsby v. American Apparel, et al., Case No. CV106513 MMM (RCx), James Costa v. American Apparel, et al., Case No. CV106516 MMM (RCx), and Wesley Childs v. American Apparel, et al., Case No. CV106680 GW (JCGx), were filed in the United States District Court for the Central District of California on August 25, 2010, August 31, 2010, August 31, 2010, and September 8, 2010, respectively, against us and certain of our officers and executives on behalf of American Apparel shareholders who purchased American Apparel's common stock between December 19, 2006 and August 17, 2010. Plaintiffs allege three causes of action for violations of Sections 10(b), 20(a), and 14(a) of the 1934 Act, and Rules 10b-5 and 14a-9 promulgated thereunder, arising out of alleged misrepresentations contained in our press releases, public filings with the SEC, and other public statements relating to (i) the adequacy of our internal and financial control policies and procedures; (ii) our hiring practices; and (iii) the effect that the dismissal of over 1,500 employees following an Immigration and Customs Enforcement inspection would have on us. 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 (the “Federal Securities Action”). On March 14, 2011, the United States District Court appointed the firm of Barroway Topaz, LLP to serve as lead counsel and Mr. Charles Rendelman to serve as lead plaintiff. Mr. Rendelman must file an amended class action complaint within 45 days of the court’s ruling. Discovery is stayed in the Federal Securities Action, as well as in the Federal Derivative Action, pending resolution of any forthcoming motions to dismiss the Federal Securities Action. Plaintiffs seek damages in an unspecified amount, reasonable attorneys fees and costs, and equitable relief as the Court may deem proper. We are 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 our financial condition and results of operations.
 
In August 2010, we received a subpoena from the United States Attorney's Office for the Central District of California for documents relating to an official criminal investigation being conducted by the Federal Bureau of Investigation into the change in our registered independent accounting firm and our financial reporting and internal controls. We have also received a subpoena from the SEC for documents relating to its investigation surrounding the change in the Company's registered independent accounting firm and our financial reporting and internal controls. We intend to cooperate fully with these subpoenas and investigations.
 
On February 17, 2011, American Apparel filed complaints in arbitration against five former employees seeking: (1) declaratory relief that the arbitration, confidentiality, severance and bonus agreements signed by the former employees are valid and enforceable; (2) damages in the event the former employees or anyone of them breaches their confidentiality agreements, as threatened; (3) attorneys' fees and costs incurred to compel the suit into arbitration; (4) declaratory relief that the former employees' claims of sexual harassment and sexual assault are false and without merit; and (5) declaratory relief that the former employees have attempted to engage in abuse of process for the purpose of extorting from American Apparel and Dov Charney money solely to avoid public shame and economic loss.  On March 4, 2011, one such former employee filed suit against American Apparel, Dov Charney, and the current members of the Board of Directors of American Apparel in the Supreme Court of New York, County of Kings, Case No. 5018-11.  The suit alleges sexual harassment, gender discrimination, retaliation, negligent hiring and supervision, intentional and negligent infliction of emotional distress, fraud and unpaid wages, and seeks, among other things, an award of compensatory damages, exemplary damages, attorneys' fees and costs, all in an amount of at least $250.0 million. On March 23, 2011, three of the other former employees filed a consolidated suit against American Apparel and Dov Charney in the Los Angeles Superior Court for the State of California, Case No. BC457920. Such action alleges sexual harassment, failure to prevent harassment and discrimination, intentional infliction of emotional distress, assault and battery, and a declaratory judgment that the confidentiality and arbitration agreements signed by plaintiffs are unenforceable. Such action seeks monetary damages, various forms of injunctive relief, and attorneys' fees and costs. The remaining plaintiffs seek only a declaratory judgment that the confidentiality and arbitration agreements they signed are unenforceable. We believe that each of the above described actions are covered by insurance, subject to a deductible, and we

36


are awaiting confirmation of coverage from our carriers. We do not believe that any of these claims will exceed the amount of our available insurance, although the 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.
 
We are currently engaged in other employment-related claims and other matters incidental to our business. Management believes that all such claims against American Apparel are without merit or not material, and we intend 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, we believe the amount, and ultimate liability, if any, with respect to these actions will not materially affect our business, financial position, results of operations, or cash flows. We cannot assure you, however, that such actions will not have a material adverse effect on our consolidated results of operations, financial position or cash flows.
 
 
 

37


Item 4.    Reserved
 
 
PART II
 
Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
The principal market on which our common stock is traded is the NYSE Amex. Our common stock is traded under the symbol APP.
The following table sets forth the range of high and low sales prices for our common stock and for the periods indicated.
 
 
Common Stock
 
High
 
Low
2009
 
 
 
Fourth Quarter
$
3.55
 
 
$
2.42
 
Third Quarter
4.20
 
 
2.80
 
Second Quarter
6.97
 
 
2.66
 
First Quarter
3.70
 
 
1.20
 
2010
 
 
 
Fourth Quarter
$
1.90
 
 
$
0.86
 
Third Quarter
1.88
 
 
0.66
 
Second Quarter
3.62
 
 
1.14
 
First Quarter
3.88
 
 
2.56
 
Holders
On March 31, 2011 there were 1,281 recordholders and approximately 8,068 beneficial holders of our common stock.
Dividends
As a public company, we have not paid any cash dividends. Certain cash dividends and distributions were paid by Old American Apparel to its principal stockholders prior to becoming a public company. We intend to continue to retain earnings for use in the operation and expansion of our business and, therefore, do not anticipate paying any cash dividends in the foreseeable future. In addition, restrictions imposed by our debt instruments significantly restrict us from making dividends or distributions to shareholders.
Warrants
On December 19, 2008, in connection with an extension of the SOF Credit Agreement, we issued the SOF Warrants. On March 13, 2009, in connection with the Lion financing, we issued the Lion Warrants and on March 24, 2011 . The warrants were issued to SOF and Lion in private placements exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended.
In connection with the amendment to the Lion Financing and the New Lion Warrant, on March 24, 2011, we entered into, and closed the transactions under, a purchase agreement pursuant to which (i) Dov Charney purchased an aggregate of 1,801,802 shares of our common stock at a price of $1.11 per share, for aggregate cash consideration of approximately $2.0 million in cash and (ii) the three promissory notes issued by two subsidiaries of the Company to Mr. Charney, which as of March 24, 2011 had an aggregate of approximately $4.7 million, including principal and accrued and unpaid interest (to but not including March 24, 2011) outstanding were canceled in exchange for an issuance of an aggregate of 4,223,194 shares of our common stock to Mr. Charney at a price of $1.11 per share with 50% of such shares issuable to Mr. Charney only if prior to March 24, 2014, (x) the closing sale price of our common stock on the NYSE Amex exceeds $3.50 for 30 consecutive trading days or (y) there is a change of control of the Company.
On December 1, 2010, we sold 1,129,576 treasury shares of our common stock to Dov Charney at approximately $1.48 per share, for a total cost of $1.65 million.

38


The warrants that were issued to SOF and Lion, and the shares sold to Mr. Charney on December 1, 2010 and March 24, 2011, were issued in private placements exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act").
The 4,223,194 shares that were issued or are issuable to Mr. Charney in exchange for the three promissory notes owed to Mr. Charney were issued or are issuable pursuant to the exemption under Section 3(a)(9) of the Securities Act.
For further discussion, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources”.
Stock Price Performance Graph
The graph below compares the cumulative total return of our common stock from March 7, 2006 through December 31, 2010 with the cumulative total return of companies comprising the Dow Jones Industrial Average, the S&P Retail Index, and the S&P500. The graph plots the growth in value of an initial investment of $100 in each of our common stock, the Dow Jones Industrial Average, the S&P Retail Index, and the S&P500 over the indicated time periods, assuming reinvestment of all dividends, if any, paid on the securities. We have not paid any cash dividends and, therefore, the cumulative total return calculation for us is based solely upon stock price appreciation and not upon reinvestment of cash dividends. The stock price performance shown on the graph is not necessarily indicative of future price performance.
Dates
American Apparel
 
S&P Retail
 
S&P 500
 
Dow
March 7, 2006
100.00
 
 
100.00
 
 
100.00
 
 
100.00
 
December 31, 2006
126.76
 
 
107.30
 
 
110.96
 
 
113.73
 
December 31, 2007
206.90
 
 
88.11
 
 
114.87
 
 
121.04
 
December 31, 2008
27.45
 
 
60.02
 
 
70.66
 
 
80.09
 
December 31, 2009
42.76
 
 
88.37
 
 
87.24
 
 
95.16
 
December 31, 2010
22.90
 
 
110.77
 
 
98.87
 
 
105.44
 
 

39


Item 6.    Selected Financial Data
The selected historical financial data presented below under the heading “Selected Statement of Operations Data” and “Per Share Data” for the years ended December 31, 2010, 2009 and 2008 and the selected historical financial data presented below under the heading “Balance Sheet Data” as of December 31, 2010 and 2009 have been derived from, and are qualified by reference to, the audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The selected historical financial data presented below under the heading “Selected Statement of Operations Data” and “Per Share Data” for the years ended December 31, 2007 and 2006 and the selected historical financial data presented below under the heading “Balance Sheet Data” as of December 31, 2008, 2007 and 2006 have been derived from, and are qualified by reference to, our audited consolidated financial statements which are not included in this Annual Report on Form 10-K.
On December 21, 2005, Endeavor Acquisition Corp. consummated its initial public offering, and on December 18, 2006, entered into an Agreement and Plan of Reorganization, amended November 7, 2007, with American Apparel, Inc., a California corporation (“Old American Apparel”), and its affiliated companies. Endeavor Acquisition Corp. consummated the acquisition of Old American Apparel and its affiliated companies on December 12, 2007 (the “Acquisition”) and changed its name to American Apparel, Inc. The Acquisition was accounted for as a reverse merger (“Merger”) and recapitalization for financial reporting purposes. Accordingly, for accounting and financial purposes, Endeavor Acquisition Corp. was treated as the acquired company, and Old American Apparel was treated as the acquiring company. Accordingly, the historical financial information for periods and dates prior to December 12, 2007, is that of Old American Apparel, and its affiliated companies.
The data set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and notes included elsewhere in this Annual Report on Form 10-K.
 
 
Year Ended December 31,
 
2010
 
2009
 
2008
 
2007
 
2006
 
(In Thousands Except Per Share Data)
Selected Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Net sales
$
532,989
 
 
$
558,775
 
 
$
545,050
 
 
$
387,044
 
 
$
284,966
 
Gross profit
$
279,909
 
 
$
319,912
 
 
$
294,421
 
 
$
213,368
 
 
$
145,636
 
(Loss) Income from Operations
$
(50,053
)
 
$
24,415
 
 
$
36,064
 
 
$
31,122
 
 
$
10,572
 
Net (Loss) Income
$
(86,315
)
 
$
1,112
 
 
$
14,112
 
 
$
15,478
 
 
$
(1,606
)
Pro forma Net Income—conversion to C Corporation for tax purposes (unaudited) (1)
 
 
 
 
$
 
 
$
9,457
 
 
$
257
 
Cash Distributions/Dividends Paid (2)
$
 
 
$
 
 
$
 
 
$
22,147
 
 
$
696
 
Per Share Data (3)
 
 
 
 
 
 
 
 
 
Net (Loss) Earnings per share—basic
$
(1.21
)
 
$
0.02
 
 
$
0.20
 
 
$
0.32
 
 
$
(0.03
)
Net (Loss) Earnings per share—diluted
$
(1.21
)
 
$
0.01
 
 
$
0.20
 
 
$
0.31
 
 
$
(0.03
)
Pro forma Net Earnings per share—conversion to C Corporation for tax purposes (unaudited)—basic (1)
$
 
 
$
 
 
$
 
 
$
0.19
 
 
$
0.01
 
Pro forma Net Earnings per share—conversion to C Corporation for tax (unaudited) purposes—diluted (1)
$
 
 
$
 
 
$
 
 
$
0.19
 
 
$
0.01
 
Weighted—average number of shares—basic
71,626
 
 
71,026
 
 
69,490
 
 
48,890
 
 
48,390
 
Weighted—average number of shares—diluted
71,626
 
 
76,864
 
 
70,317
 
 
49,414
 
 
48,390
 
Dividends Paid (2)
$
 
 
$
 
 
$
 
 
$
0.45
 
 
$
0.01
 
Balance Sheet Data (3)
 
 
 
 
 
 
 
 
 
Total Assets
$
327,950
 
 
$
327,579
 
 
$
333,609
 
 
$
233,350
 
 
$
163,056
 
Working Capital
$
3,379
 
 
$
121,423
 
 
$
83,069
 
 
$
2,120
 
 
$
38,559
 
Total Long Term Debt Less Current Maturities
$
5,597
 
 
$
71,372
 
 
$
72,328
 
 
$
10,744
 
 
$
75,546
 
Stockholders’ Equity
$
75,024
 
 
$
157,341
 
 
$
136,412
 
 
$
61,821
 
 
$
12,973
 
___________________________

40


(1)    
As a result of the Merger, Old American Apparel was required to convert from a Subchapter S Corporation to a C Corporation as of the Closing on December 12, 2007. As a Subchapter S Corporation, U.S. federal and certain state income taxes were the responsibility of the entity’s stockholders. Accordingly, the income taxes were not reflected in the entity’s financial statements. The result of this conversion was to recognize deferred tax assets and liabilities from the expected tax consequences of temporary differences between the book and tax basis of the entity’s assets and liabilities at the date of conversion into a taxable entity. This resulted in a deferred tax benefit of $6,205 being recognized and included in the 2007 tax (benefit).
 
The unaudited pro forma computation of income tax, represents the tax effects that would have been reported had Old American Apparel been subject to U.S. federal and state income taxes as a corporation for the year ended December 31, 2007. Pro forma taxes are based upon the statutory income tax rates and adjustments to income for estimated permanent differences occurring during each period. Actual rates and expenses could have differed had Old American Apparel actually been subject to U.S. federal and state income taxes for all periods presented. Therefore, the unaudited pro forma amounts for net earnings per share are for informational purposes only and are intended to be indicative of the results of operations had Old American Apparel been subject to U.S. federal and state income taxes as a corporation for the year ended December 31, 2007.
 
(2)    
Dividends paid represent cash dividends paid by Old American Apparel to its stockholders prior to becoming a public company. We do not anticipate paying any cash dividends in the foreseeable future.
 
(3)    
The effect of the Merger has been given retroactive application in the earnings per share (“EPS”) calculation. The common stock issued and outstanding with respect to the pre-Merger stockholders of American Apparel, Inc. has been included in the EPS calculation since the Closing date of the Merger. All of American Apparel, Inc.’s outstanding warrants (the “Endeavor Warrants”) which were issued in the initial public offering of Endeavor Acquisition Corp. and underwriter’s purchase option are reflected in the diluted EPS calculation, using the treasury stock method, commencing with the Closing date of the Merger.
 
(4)    
Dov Charney, a 50% owner of Old American Apparel’s common stock and 100% owner of American Apparel Canada Wholesale, Inc. and American Apparel Canada Retail, Inc.’s (collectively, the “CI Companies”) common stock and current Chief Executive Office of the Company received from American Apparel, Inc. 37,258 shares of its common stock in exchange for his ownership interest in Old American Apparel and CI Companies. The other 50% owner of Old American Apparel’s Common Stock, Sang Ho Lim, received $67,903 for his ownership interest, the equivalent of 11,132 shares of common stock.
 
Immediately prior to the closing of the Merger, American Apparel, Inc. had 19,933 shares of Common stock outstanding with a net tangible book value of $121,589, net of $5,494 of transaction costs. The net tangible book value consisted of cash of $123,000, a tax liability of $1,406 and accrued expenses of $5. The net cash proceeds were used as follows: $67,903 was paid to Sang Ho Lim, $15,764 was paid to Dov Charney and Sang Ho Lim as a Company distribution to settle their estimated personal income tax liabilities as a result of Old American Apparel’s subchapter S Corporation status, $13,323 was used to repay related party and third party debt, and $26,010 was available for working capital.
 

41


Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion together with Part II, Item 6 “Selected Financial Data” and our audited consolidated financial statements and the related notes thereto included in Item 8 “Financial Statements and Supplementary Data.” In addition to historical consolidated financial information, this discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Actual results could differ from these expectations as a result of factors including those described under Item 1A, “Risk Factors,” “Special Note Regarding Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K.
Overview
We are a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel. We design, manufacture and sell clothing, accessories and personal care products for women, men, children and babies through retail, wholesale and online distribution channels. As of December 31, 2010, we operated 273 retail stores in United States, Canada and 18 other countries. Our wholesale business is a leading supplier of T-shirts and other casual wear to screen printers and distributors. In addition, we operate an online retail e-commerce website at www.americanapparel.com where we sell our clothing and accessories directly to consumers.
We conduct our primary manufacturing operations out of an 800,000 square foot facility in the warehouse district of downtown Los Angeles, California. The facility houses our executive offices, as well as cutting, sewing, warehousing, and distribution operations. We conduct knitting operations in Los Angeles and Garden Grove, California, which produce a majority of the fabric we use in our products. We also operate dye houses that provide dyeing and finishing services for nearly all of the raw fabric used in production. We operate a dyeing and finishing facility in Hawthorne, California, which provides fabric dyeing and finishing services. We operate a garment dyeing and finishing facility, acquired in December 2007 and located in South Gate, California, which is used in cutting, sewing, dyeing and finishing garments. We operate a fabric dyeing and finishing facility, acquired in May 2008 and located in Garden Grove, California, which has been expanded to including knitting, cutting and sewing operations. Because we manufacture domestically and are vertically integrated, we believe this enables us to more quickly respond to customer demand and to changing fashion trends and to closely monitor product quality. Our products are recognized for their quality and fit, and together with our distinctive branding these attributes have differentiated our products in the marketplace.
We report the following four operating segments: U.S. Wholesale, U.S. Retail, Canada, and International. We believe this method of segment reporting reflects both the way our business segments are managed and the way the performance of each segment is evaluated. The U.S. Wholesale segment consists of our wholesale operations and our online consumer operations in the U.S. The U.S. Retail segment consists of our retail store operations in the United States, which were comprised of 157 retail stores as of December 31, 2010. The Canada segment consists of our retail, wholesale and online consumer operations in Canada. As of December 31, 2010, the retail operations in the Canada segment were comprised of 40 retail stores. The International segment consists of our retail, wholesale and online consumer operations outside of the United States and Canada. As of December 31, 2010, the retail operations in the International segment comprised of 76 retail stores in the following 18 countries: the United Kingdom, Ireland, Austria, Belgium, France, Germany, Italy, the Netherlands, Spain, Sweden, Switzerland, Israel, Australia, Brazil, Mexico, Japan, South Korea, and China.
The results of the respective business segments exclude unallocated corporate expenses, which consist of our shared overhead costs. These costs are presented separately and generally include corporate costs such as human resources, legal, finance, information technology, accounting, and executive compensation.
During the period from January 1, 2008 through December 31, 2010, we increased the net number of retail stores in the U.S. Retail segment from 105 to 157, increased the number of retail stores in the Canada segment from 30 to 40 and increased the number of retail stores in the International segment from 47 to 76. The following table details, by segment, the growth in retail store count during the years ended December 31, 2010, 2009 and 2008.
 

42


Stores Opened by Year
 
 
United States
 
Canada
 
International
 
Total
Stores open as of December 31, 2007
105
 
 
30
 
 
47
 
 
182
 
2008
 
 
 
 
 
 
 
Opened
44
 
 
8
 
 
29
 
 
81
 
Closed
(2
)
 
(1
)
 
(1
)
 
(4
)
Stores open as of December 31, 2008
147
 
 
37
 
 
75
 
 
259
 
2009
 
 
 
 
 
 
 
Opened
15
 
 
4
 
 
8
 
 
27
 
Closed
(2
)
 
(1
)
 
(2
)
 
(5
)
Stores open as of December 31, 2009
160
 
 
40
 
 
81
 
 
281
 
2010
 
 
 
 
 
 
 
Opened
1
 
 
2
 
 
3
 
 
6
 
Closed
(4
)
 
(2
)
 
(8
)
 
(14
)
Stores open of December 31, 2010
157
 
 
40
 
 
76
 
 
273
 
Comparable Store Sales
The table below shows the (decrease) increase in comparable store sales for our retail stores, by quarter for the years ended December 31, 2010, 2009 and 2008, including the number of retail stores included in the comparison at the end of each period. Comparable store sales are defined as the percentage change in sales for stores that have been open for more than twelve full months. Remodeled and expanded stores are excluded from the determination of comparable stores for the following twelve month period if the remodel or expansion results in a change of greater than 20% of selling square footage. Closed stores are excluded from the base of comparable stores following their last full month of operation.
In calculating constant currency amounts, we convert the results of our foreign operations both in the current period and the prior year comparable period using the weighted-average foreign exchange rate for the prior comparable period to achieve a consistent basis for comparison.
 
 
For the Quarter Ended
 
March 31
 
June 30
 
September 30
 
December 31
 
Full year
2010
(10
)%
 
(16
)%
 
(16
)%
 
(12
)%
 
(13
)%
Number of Stores
249
 
 
257
 
 
260
 
 
260
 
 
 
2009
(7
)%
 
(10
)%
 
(16
)%
 
(7
)%
 
(10
)%
Number of Stores
169
 
 
175
 
 
200
 
 
235
 
 
 
2008
36
 %
 
23
 %
 
24
 %
 
11
 %
 
22
 %
Number of Stores
140
 
 
145
 
 
150
 
 
162
 
 
 
Executive Summary
For the year ended December 31, 2010, we reported net sales of $533.0 million, a decrease of $25.8 million, or 4.6% over the $558.8 million reported for the year ended December 31, 2009. Gross margin decreased to 52.5% for the year ended December 31, 2010 compared to 57.3% for the year ended December 31, 2009. The decrease in gross margin was primarily due to an increase in production costs caused by increases in yarn and fabric prices and manufacturing labor inefficiencies associated with training of newly added sewing operators, and a continued shift in production mix towards more complex retail styles. In addition, the decrease reflects a shift in sales mix from retail to wholesale sales as wholesale sales generate lower gross margin. Additionally, the net impact of inventory reserve for obsolescence and shrinkage to cost of goods sold was approximately $1.1 million for the year ended December 31, 2010 as compared to $1.2 million for the year ended December 31, 2009. Operating expenses, which include all selling, general and administrative costs and retail store impairment charges, increased $34.5 million, or 11.7%, to $330 million for the year ended December 31, 2010 as compared to $295.5 million for the year ended December 31, 2009. Fixed asset impairment expenses increased $5.3 million, or 160.6%, to $8.6 million for the year ended December 31, 2010 as compared to $3.3 million for the year ended December 31, 2009. Interest expense increased $1.2 million, or 5.3% to $23.8 million for the year ended December 31, 2010, as compared to $22.6 million the year ended December 31, 2009. Net loss for the year ended December 31, 2010 was $86.3 million compared to net income

43


of $1.1 million for the year ended December 31, 2009.
 
As of December 31, 2010, the Company had approximately (i) $7.7 million in cash, (ii) $4.9 million of availability for additional borrowings and $53.4 million outstanding on a $75.0 million revolving credit facility under the BofA Credit Agreement (as defined in Note 8 to our consolidated financial statements under Item 8-Financial Statements and Supplementary Data), (iii) C$5.0 million of availability for additional borrowings and C$3.8 million outstanding on a C$11.0 million revolving credit facility under the Bank of Montreal Credit Agreement (as defined in Note 8 to our consolidated financial statements under Item 8-Financial Statements and Supplementary Data) and (iv) $81.2 million (including paid-in-kind interest of $17.2 million and net of discount $16.0 million) of term loans outstanding under the Lion Credit Agreement (as defined in Note 9 to our consolidated financial statements under Item 8-Financial Statements and Supplementary Data). As of February 28, 2011 (the latest date as of which such information was available), the Company had approximately $5.3 million in cash, while as of March 30, 2011 the Company had $1.9 million of availability for additional borrowings and $58.2 million outstanding on the credit facility under the BofA Credit Agreement and C$1.2 million of availability for additional borrowings and C$3.9 million outstanding on the credit facility under the Bank of Montreal Credit Agreement.
We incurred a substantial loss from operations and had negative cash flows from operating activities for the year ended December 31, 2010. Our current operating plan indicates that we will incur a loss from operations for fiscal 2011 and generate negative cash flows from operating activities (if non-cash charges, such as depreciation expense and paid-in-kind interest that increase cash flows but do not have an effect on the Company's liquidity are not taken into account). As a result of these factors and the negative comparative store sales achieved in 2010, together with world-wide economic conditions and significant increases in yarn and fabric prices, among others, there exists substantial doubt that we will be able to continue as a going concern. In addition, for these reasons, and due to the effect on our ability to borrow under our revolving credit agreements as a result of the “going concern” qualification with respect to our 2010 financial statement described below, we may not have sufficient liquidity or minimum cash levels to operate the business.
Our consolidated financial statements for the year ended December 31, 2010 included herein contains a “going concern” explanatory paragraph. These financial statements do not include any adjustments to reflect the possible future effects on the recoverability of assets or the amounts of liabilities that may result should we be unable to continue as a going concern.
 
The BofA Credit Agreement and Bank of Montreal Credit Agreement contain covenants which require us to furnish our audited financial statements and audited financial statements of our Canadian operations, respectively, within 120 days after the fiscal year end without a going concern or like qualification. Our consolidated financial statements for the year ended December 31, 2010 included herein contain a “going concern” explanatory paragraph. Absent a waiver, non-compliance with such covenants could constitute a default under the BofA Credit Agreement and will constitute an event of default under the BoA Credit Agreement within 15 days following notice given from the administrative agent after April 30, 2011. Noncompliance with such covenants could also, absent a waiver, allow the banks prevent us from making borrowings under the BofA Credit Agreement and the Bank of Montreal Credit Agreement. In addition, all indebtedness under the BofA Credit Agreement and the Bank of Montreal Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. All cash proceeds received by us and the guarantors under the BofA Credit Agreement must be applied to our outstanding obligations under the BofA Credit Agreement. Our daily cash needs are funded through borrowings under the BofA Credit Agreement. If we are unable to borrow under the BofA Credit Agreement, we will be unable to fund our operations. We have made a formal request to BofA and Lion for waivers, however there can be no assurances that we will be successful in obtaining waivers from our lenders.
 
In addition, the BofA Credit Agreement matures in July 2012, and the Bank of Montreal Credit Agreement matures in December 2012, and there can be no assurances that we will be able to negotiate a renewal or extension of these credit agreements with our existing lenders or enter into a replacement credit agreement with new lenders or commercially reasonably terms or at all. If we are not able to enter into a renewal, extension or replacement of the BofA Credit Agreement or the Bank of Montreal Credit Agreement prior to their respective maturities, we would no longer have access to liquidity from such revolving credit facility after its maturity date. As a result, our access to working capital would be limited and this could adversely affect our ability to finance and continue our operations.
 
The Lion Credit Agreement also requires us to furnish our audited financial statements within 120 days after the fiscal year end without a going concern or like qualification. The requirement that such financials statements be delivered without a going concern qualification has been waived for financial statements relating to the 2010 fiscal year; however, such waiver ceases to be in effect if an event of default occurs under the BofA Credit Agreement as a result of a going concern qualification with respect to such financial statements. The Lion Credit Agreement also contains cross-default provisions by which noncompliance with covenants under the BofA Credit Agreement could also constitute an event of default under the Lion Credit Agreement. In addition, all indebtedness under the Lion Credit Agreement could be declared immediately due and

44


payable upon the occurrence and during the continuance of an event of default. Based upon the foregoing, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
Results of Operations
Year Ended December 31, 2010 compared to Year Ended December 31, 2009
(Dollars in thousands)
 
 
For the Years Ended December 30,
 
2010
 
% of net sales
 
2009
 
% of net sales
U.S. Wholesale
$
148,997
 
 
28.0
 %
 
$
141,521
 
 
25.3
 %
U.S. Retail
177,610
 
 
33.3
 %
 
191,325
 
 
34.2
 %
Canada
65,638
 
 
12.3
 %
 
68,983
 
 
12.3
 %
International
140,744
 
 
26.4
 %
 
156,946
 
 
28.1
 %
Total net sales
532,989
 
 
100.0
 %
 
558,775
 
 
100.0
 %
Cost of sales
253,080
 
 
47.5
 %
 
238,863
 
 
42.7
 %
Gross profit
279,909
 
 
52.5
 %
 
319,912
 
 
57.3
 %
 
 
 
 
 
 
 
 
 
 
Selling expenses
218,198
 
 
40.9
 %
 
198,518
 
 
35.5
 %
General and administrative expenses
103,167
 
 
19.4
 %
 
93,636
 
 
16.8
 %
Retail store impairment
8,597
 
 
1.6
 %
 
3,343
 
 
0.6
 %
(Loss) income from operations
(50,053
)
 
(9.4
)%
 
24,415
 
 
4.4
 %
 
 
 
 
 
 
 
 
Interest expense
23,752
 
 
4.5
 %
 
22,627
 
 
4.0
 %
Foreign currency transaction gain
(686
)
 
(0.1
)%
 
(2,920
)
 
(0.5
)%
Unrealized loss on change in fair value of warrants
993
 
 
0.2
 %
 
 
 
 %
Other expense (income)
39
 
 
0.0
 %
 
(220
)
 
(0.0
)%
(Loss) income before income tax
(74,151
)
 
(13.9
)%
 
4,928
 
 
0.9
 %
Income tax provision
12,164
 
 
2.3
 %
 
3,816
 
 
0.7
 %
Net (loss) income
$
(86,315
)
 
(16.2
)%
 
$
1,112
 
 
0.2
 %
 
U.S. Wholesale: Total net sales for the U.S. Wholesale segment increased $7.4 million, or 5.2%, to $148.9 million for the year ended December 31, 2010 as compared to $141.5 million for the year ended December 31, 2009. Wholesale net sales, excluding online consumer net sales, increased $9.5 million, or 8.0%, to $127.7 million for the year ended December 31, 2010 as compared to $118.2 million for the year ended December 31, 2009, primarily due to an increase in sales to distributors and a slight increase in sale price per unit.
Online consumer net sales decreased $2.1 million, or 9.0%, to $21.2 million for the year ended December 31, 2010 as compared to $23.3 million for the year ended December 31, 2009.
U.S. Retail: Net sales for the U.S. Retail segment decreased $13.7 million, or 7.2%, to $177.6 million for the year ended December 31, 2010 as compared to $191.3 million for the year ended December 31, 2009. The decrease was primarily caused by a decrease in price per units sold combined with a slight decrease number of units sold. Comparable store sales for the year ended December 31, 2010 decreased by 10.0%, or $18.0 million as compared to the comparable period in 2009. Declines in 2010 were partially offset by an increase of approximately $4.3 million relating to the incremental sales of a key store opening in 2010 and existing store sales that were not in operation for the full comparable year. Since December 31, 2009, the number of U.S. Retail segment stores in operation decreased from 160 to 157.
Canada: Total net sales for the Canada segment decreased $3.4 million, or 4.9%, to $65.6 million for the year ended December 31, 2010 as compared to $69.0 million for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $59.3 million, or $9.7 million lower when compared to the same period last year.
 
 

45


Retail net sales decreased $4.0 million, or 7.1%, to $52.0 million for the year ended December 31, 2010 as compared to $56.0 million for the year ended December 31, 2009. The decrease was primarily caused by a decrease in number of units sold, which was partially offset by an increase in price per units sold. Comparable store sales for the year ended December 31, 2010 decreased by 22.5%, or $13.2 million as compared to the comparable period in 2009. Declines in 2010 were partially offset by an increase of approximately $9.2 million relating to incremental sales of two stores opening in 2010 and existing store sales that were not in operation for the full comparable year. As of both December 31, 2010 and 2009, the number of retail stores in operation in the Canada segment remain unchanged at 40. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $46.9 million, or $9.1 million lower when compared to the same period last year.
Wholesale net sales increased $0.5 million, or 4.4%, to $11.9 million for the year ended December 31, 2010 as compared to $11.4 million for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $10.8 million, or $0.7 million lower when compared to the same period last year.
Online consumer net sales slightly increased to $0.2 million, or 12.5%, to $1.8 million for the year ended December 31, 2010 as compared to $1.6 million for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $1.6 million, or unchanged when compared to the same period last year.
International: Total net sales for the International segment decreased $16.2 million, or 10.3%, to $140.7 million for the year ended December 31, 2010 as compared to $157.0 million for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $141.2 million, or $15.7 million lower when compared to the same period last year.
Retail net sales decreased $15.3 million, or 11.6%, to $116.8 million for the year ended December 31, 2010 as compared to $132.1 million for the year ended December 31, 2009. The decrease was primarily caused by a decrease in number of units sold combined with a slight decrease in price per units sold. Comparable store sales for the year ended December 31, 2010 decreased by 15.0%, or $17.8 million as compared to the comparable period in 2009. Declines in 2010 were offset by an increase of approximately $2.5 million relating to incremental sales of three new stores opening in 2010 and existing store sales that were not in operation for the full comparable year. Since December 31, 2009, the number of International retail segment stores in operation decreased from 81 to 76. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $117.0 million, or $15.1 million lower when compared to the same period last year.
Wholesale net sales decreased $0.9 million, or 7.3%, to $11.5 million for the year ended December 31, 2010 as compared to $12.4 million for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $11.9 million, or $0.2 million lower when compared to the same period last year.
Online consumer net sales for both the year ended December 31, 2010 and 2009 was $12.5 million. Holding foreign currency exchange rates constant to those prevailing in fiscal 2009, total revenue for the current year would have been approximately $12.3 million, or $0.4 million lower when compared to the same period last year.
Cost of sales: Cost of goods sold as a percentage of net sales was 47.5% and 42.7% for the years ended December 31, 2010 and December 31, 2009, respectively. On a comparative basis, cost of goods sold was impacted by an increase in yarn and fabric prices, labor inefficiencies associated with training of newly added sewers, and continued shift in production mix towards more complex retail styles that have a higher cost of production. Cost of goods sold was also impacted by a shift in mix from retail to wholesale net sales, for which the wholesale segment generates lower margins. The increase in cost of sales in 2010 compared to 2009 was partially offset by $1.9 million, due to a decline in the value of the U.S. Dollar relative to foreign currencies primarily with the Canadian dollar. Additionally, the net impact of inventory reserve for obsolescence and shrinkage to cost of goods sold was approximately $1.1 million for the year ended December 31, 2010 as compared to $1.2 million for the year ended December 31, 2009.
Selling expenses: Selling expenses increased $19.7 million, or 9.9%, to $218.2 million for the year ended December 31, 2010 as compared to $198.5 million million for the year ended December 31, 2009. As a percentage of sales, selling expenses increased to 40.9% in the year ended December 31, 2010 from 35.5% in the year ended December 31, 2009. The increase was mainly attributable to the impact of full year 2009 store openings of $7.2 million, advertising and marketing expenses of $3.8 million, salaries, wages and benefits of $2.7 million, impact of new stores and closures in 2010 of $2.2 million, facility related expenses of $1.1 million, travel and entertainment expenses of $0.9 million, rent termination cost of $0.8 million, stock compensation expense of $0.6 million, and supplies expense in the International segment of $0.4 million.

46


General and administrative expenses: General and administrative expenses increased $9.6 million, or 10.3%, to $103.2 million for the year ended December 31, 2010 as compared to $93.6 million for the year ended December 31, 2009. As a percentage of sales, general and administrative expenses increased to 19.4% in the year ended December 31, 2010 from 16.8% in the year ended December 31, 2009. The increase was primarily due to stock compensation expense of $4.2 million, worker's compensation expense of $1.7 million, payroll related expense of $1.5 million, bad debt expense of $0.9 million and facilities and equipment of $1.3 million.
Retail store impairment charges: At December 31, 2010, we performed a recoverability test and an impairment test of our long lived assets at our retail stores and determined that the fair value of the assets at eighteen retail stores was less than their carrying value at December 31, 2010 based on sales performance through the date of issuance of these financial statements, and projected future cash flows over the respective remaining lease terms for these retail stores. We recorded impairment charges relating primarily to certain retail store leasehold improvements in the U.S. Retail, Canada and International segments of $8.6 million and $3.3 million for the year ended December 31, 2010 and 2009, respectively, to reduce the assets' carrying value to their estimated fair value.
Interest expense: The major components of interest expense, for the year ended December 31, 2010, consisted of interest on the BofA Credit Agreement, the Bank of Montreal Credit Agreement, loans from our CEO and unrelated parties and the Lion Credit Agreement. Interest rates on our various debt facilities and capital leases ranged from 3.4% to 18.0% during the year ended December 31, 2010 and 4.8% to 16.0% during the year ended December 31, 2009. Interest expense increased $1.2 million, or 5.3%, to $23.8 million for the year ended December 31, 2010 as compared to $22.6 million for the year ended December 31, 2009. Interest expense for the year ended December 31, 2010 primarily consisted of deferred financing cost of approximately $3.7 million and Lion Credit Agreement related interest of approximately $17.5 million, of which $14.3 million was paid in kind. For the year ended December 31, 2009, interest expense primarily consisted of BofA related fees and interest of $3.9 million, Lion Credit Agreement fees and interest of $13.8 million and SOF Credit Agreement related fees and interest of $4.8 million.
Foreign currency transaction gain: Foreign currency transaction gain was $0.7 million for the year ended December 31, 2010, as compared to a gain of $2.9 million for the year ended December 31, 2009. The unfavorable change related to lower exchange gains of the U.S. Dollar relative to foreign currencies used by our international subsidiaries for December 31, 2010 compared to the same periods in the prior year
Unrealized loss on change in fair value of warrants: The change in fair value of warrants was a loss of $1.0 million for the year ended December 31, 2010. No change in fair value of warrants was recorded for the year ended December 31, 2009.
Other expense (income): There was relatively no changes to other expense (income) for the year ended December 31, 2010 as compared to the year ended December 31, 2009.
Income tax provision: The income tax provision changed $8.4 million, to $12.2 million for the year ended December 31, 2010 as compared to $3.8 million for the year ended December 31, 2009. The change was primarily due to an increase in valuation allowance charges for the year ended December 31, 2010. The effective income tax rate for the year ended December 31, 2010 was 16.4% (a provision expense against book loss before income tax), as compared to 77.4% for the year ended December 31, 2009 (a net income year). The effective rates for both years differed from the statutory rate due to valuation allowances charges and changes in liabilities for uncertain tax positions. For the year ended December 31, 2010, we recorded valuation allowances against a majority of our deferred tax assets, including 100% of the U.S. deferred tax assets and certain foreign deferred tax assets, and recorded a return to provision adjustment for state tax credits. These charges were offset slightly by a benefit recorded for reversal of uncertain tax positions related to U.S. federal and state filing positions.  For the year ended December 31, 2009, we recorded valuation allowances against certain foreign net operating losses and established certain liabilities related to uncertain tax positions as a result of a Canadian income tax audit.   
See Note 13-Income Taxes to the consolidated financial statements included in Part II, Item 8, Financial Statements, of this Annual Report on Form 10-K.
 
 
 

47


Year Ended December 31, 2009 compared to Year Ended December 31, 2008
(Dollars in thousands)
 
 
For the Years Ended December 30,
 
2009
 
% of net sales
 
2008
 
% of net sales
U.S. Wholesale
$
141,521
 
 
25.3
 %
 
$
162,668
 
 
29.8
%
U.S. Retail
191,325
 
 
34.2
 %
 
168,653
 
 
30.9
%
Canada
68,983
 
 
12.3
 %
 
67,280
 
 
12.3
%
International
156,946
 
 
28.1
 %
 
146,449
 
 
26.9
%
Total net sales
558,775
 
 
100.0
 %
 
545,050
 
 
100.0
%
Cost of sales
238,863
 
 
42.7
 %
 
250,629
 
 
46.0
%
Gross profit
319,912
 
 
57.3
 %
 
294,421
 
 
54.0
%
 
 
 
 
 
 
 
 
 
 
Selling expenses
198,518
 
 
35.5
 %
 
184,122
 
 
33.8
%
General and administrative expenses
93,636
 
 
16.8
 %
 
73,591
 
 
13.5
%
Retail store impairment
3,343
 
 
0.6
 %
 
644
 
 
0.1
%
Income from operations
24,415
 
 
4.4
 %
 
36,064
 
 
6.6
%
 
 
 
 
 
 
 
 
Interest expense
22,627
 
 
4.0
 %
 
13,921
 
 
2.6
%
Foreign currency transaction (gain) loss
(2,920
)
 
(0.5
)%
 
621
 
 
0.1
%
Other (income) expense
(220
)
 
(0.0
)%
 
155
 
 
0.0
%
Income before income taxes
4,928
 
 
0.9
 %
 
21,367
 
 
3.9
%
Income tax provision
3,816
 
 
0.7
 %
 
7,255
 
 
1.3
%
Net income
$
1,112
 
 
0.2
 %
 
$
14,112
 
 
2.6
%
 
 
 
 
 
 
 
 
U.S. Wholesale: Total net sales for our U.S. Wholesale segment decreased $21.2 million, or 13.0%, to $141.5 million for the year ended December 31, 2009 as compared to $162.7 million for the year ended December 31, 2008. Net sales to wholesale customers (excluding online consumer sales) decreased $19.0 million, or 13.8%, to $118.2 million for the year ended December 31, 2009 as compared to $137.2 million for the year ended December 31, 2008. This decrease was primarily caused by difficult economic conditions for our wholesale customers, especially for private label and manufacturer customers, who significantly reduced their order volumes. Online consumer sales decreased $2.2 million, or 8.6%, to $23.3 million for the year ended December 31, 2009, as compared to $25.5 million for the year ended December 31, 2008. The decrease in online consumer sales was primarily due to a significant reduction in online advertising and the cannibalization of online sales as a result of operating additional retail locations.
U.S. Retail: Net sales for the U.S. Retail segment increased $22.6 million, or 13.4%, to $191.3 million for the year ended December 31, 2009 as compared to $168.7 million for the year ended December 31, 2008. The increase was primarily due to $14.5 million of incremental net sales contributed by 15 new retail stores opened in key markets within the U.S. during 2009, and $33.0 million of incremental net sales from the 44 new stores opened within the U.S. during 2008, for the period before their first full year of operation. The increase was partially offset by a $24.8 million decline in comparable store sales for retail stores in the U.S. Retail segment for the year ended December 31, 2009. Since December 31, 2008, we opened 15 new retail stores in the U.S. Retail segment, while closing two and the number of stores in operation increased from 147 to 160.
Canada: Total net sales for our Canada segment increased $1.7 million, or 2.5%, to $69.0 million for the year ended December 31, 2009 as compared to $67.3 million for the year ended December 31, 2008. Net sales to retail customers increased $3.1 million, or 5.9% to $56.0 million for the year ended December 31, 2009 compared to $52.9 million for the year ended December 31, 2008. The increase was primarily caused by $3.3 million of incremental net sales contributed by the four new retail stores opened in key markets within Canada during 2009. The increase was partially offset by a $2.4 million, or 5%, decline in same store sales for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008, total revenue for 2009 would have been approximately $73.9 million, or $6.6 million higher when compared to 2008. Since December 31, 2008 we opened 4 new retail stores, while closing one and the number of stores in operation increased from 37 to 40.
 
 

48


Net sales to wholesale customers decreased $1.3 million, or 10.2% to $11.4 million for the year ended December 31, 2009 as compared to $12.7 million for the year ended December 31, 2008. This decrease was primarily caused by difficult economic conditions for our wholesale customers, especially for private label and manufacturer customers, who significantly reduced their order volumes. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008 total revenue for the current year would have been approximately $72.2 million, or $6.6 million higher when compared to 2008.
Online sales decreased $0.1 million, or 5.9%, to $1.6 million for the year ended December 31, 2009 as compared to $1.7 million for the year ended December 31, 2008. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008, total revenue for 2009 would have been approximately $1.7 million, resulting in no change when compared to 2008.
International: Total net sales for the International segment increased $10.5 million, or 7.2%, to $156.9 million for the year ended December 31, 2009 as compared to $146.4 million for the year ended December 31, 2008. Net sales to retail customers increased $12.4 million, or 10.4% to $132.1 million for the year ended December 31, 2009 as compared to $119.7 million for the year ended December 31, 2008. The increase was primarily caused by $6.0 million of incremental net sales contributed by the eight new retail stores opened in key markets during 2009. The increase was partially offset by a 4% decline in same store sales for the year ended December 31, 2009. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008, total revenue for 2009 would have been approximately $167.6 million, or $21.2 million higher when compared to 2008. Since December 31, 2008, we opened 8 new retail stores, while closing two and the number of stores in operation increased from 75 to 81.
Net sales to wholesale customers decreased $2.1 million, or 14.5%, to $12.4 for the year ended December 31, 2009 as compared to $14.5 million for the year ended December 31, 2008. This decrease was primarily caused by difficult economic conditions for our wholesale customers, especially for private label and manufacturer customers, who significantly reduced their order volumes. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008, total revenue for the current year would have been approximately $13.1 million, or $1.4 million lower when compared to the same period last year.
Online net sales increased $0.3 million, or 2.5% to $12.5 million for the year ended December 31, 2009 as compared to $12.2 million for the year ended December 31, 2008. Holding foreign currency exchange rates constant to those prevailing in fiscal 2008, total revenue for 2009 would have been approximately $13.6 million, or $1.4 million higher when compared to 2008.
Cost of sales: Cost of sales as a percentage of net sales was 42.7% and 46.0% for the years ended December 31, 2009 and 2008, respectively. Cost of sales for 2008 was impacted by $13.2 million, or 2.4%, as a percentage of sales, in stock based compensation expense relating to the award of approximately 1.9 million shares of common stock to our manufacturing employees (the “2008 Grant”) during the third quarter of 2008. On a comparative basis, excluding the impact of the 2008 Grant, our cost of sales as a percentage of net sales decreased from 43.6% for the year ended December 31, 2008 to 42.7% for the year ended December 31, 2009. Cost of sales was impacted by a shift in mix from wholesale to retail sales, as retail increased from 62.6% of total net sales in 2008 to 67.9% of total net sales in 2009. The favorable impact from the shift in mix was partially offset by the negative impact of the appreciation of the U.S. dollar versus foreign currencies for the full year 2009 relative to the full year 2008. Cost of sales was also negatively impacted by lower capacity utilization of our manufacturing facilities in the first half of 2009 due to the hiring of additional sewing operators to expand production capacity in 2010 and to replace sewing operators dismissed following the ICE inspection. These lower capacity utilization resulted in lower amount of fixed overhead loss allocation to units of inventory produced.
 
Selling expenses: Selling expenses together with unallocated corporate selling, advertising and promotion expenses, for the year ended December 31, 2009, increased $14.4 million, or 7.8%, to $198.5 million for the year ended December 31, 2009 as compared to $184.1 million for the year ended December 31, 2008. Specifically, rent and occupancy costs increased $18.3 million and payroll and benefit costs increased $5.5 million. The increase in payroll costs was a result of higher staffing costs required to support the increased number of stores in operation compared to in the prior year.
Increases in rent and occupancy costs and payroll and benefit costs were partially offset by decreases in advertising, trade show and catalog expenses. Advertising, trade show and catalog costs included in selling expenses for the year ended December 31, 2009 were $15.4 million, or 2.8% of net sales, as compared with $25.0 million, or 4.5% of net sales, for the year ended December 31, 2008. The decrease of $9.6 million was mainly due to a reduction in discretionary expenses to promote new store openings and to promote our products through print publications, magazines, trade shows, catalogs and online media.
Pre-opening expenses for the U.S. Retail segment totaled $2.3 million for the year ended December 31, 2009, associated with the opening of 15 new retail stores, as compared with $5.8 million for the year ended December 31, 2008. Pre-opening expenses in the Canada and International segments totaled $1.6 million for the year ended December 31, 2009, associated with the opening of 12 new retail stores, as compared with $4.5 million for the year ended December 31, 2008. Pre-opening

49


expenses include costs related to opening new stores such as materials, pre-opening labor and training; utilities, travel, and IT labor costs. The decrease in pre-opening expenses from the prior year was due to the larger number of stores in the process of being opened in prior year.
General and administrative expenses: General and administrative (“G&A”) expenses increased $20.4 million, or 27.7%, to $94.0 million for the year ended December 31, 2009, as compared to $73.6 million for the year ended December 31, 2008. G&A expenses represented 16.8% and 13.5% of total net sales for the years ended December 31, 2009 and 2008, respectively. G&A expenses increased by $7.5 million due to higher depreciation charges, and $4.1 million due to an increase in salaries, wages and benefits, primarily associated with an increased number of retail stores in operation during the year ended December 31, 2009 as compared to year ended December 31, 2008. An additional $5.1 million of the increase in G&A was due to higher professional fees related to accounting and legal services, and $1.6 million related to bonuses and director stock grants.
Retail store impairment charges: At December 31, 2009, we performed a recoverability test and an impairment test of our long lived assets at our retail stores and determined that the fair value of the assets at eighteen retail stores was less than their carrying value at December 31, 2009 based on sales performance through the date of issuance of these financial statements, and projected future cash flows over the respective remaining lease terms for these retail stores. We recorded impairment charges relating primarily to certain retail store leasehold improvements in the U.S. Retail, Canada and International segments of $3.3 million and $0.6 million for the years ended December 31, 2009 and 2008, respectively, to reduce the assets' carrying value to their estimated fair value.
Interest expense: The major components of interest expense for the year ended December 31, 2009 consisted of interest on our revolving line of credit, loans from our CEO and unrelated parties, capital leases and our term loans. Interest rates on our various debt facilities and capital leases ranged from 4.8% to 16.0% during the year ended December 31, 2009 and 6.2% to 21.0% during the year ended December 31, 2008. Interest expense increased $8.7 million to $22.6 million for the year ended December 31, 2009, as compared to $13.9 million for the year ended December 31, 2008. Interest expense represented 4.0% and 2.6% of the total net sales for the years ended December 31, 2009 and 2008, respectively. For the year ended December 31, 2009, interest expense primarily consisted of BofA related fees and interest of $3.9 million, Lion Credit Agreement fees and interest of $13.8 million and SOF Credit Agreement related fees and interest of $4.8 million. For the year ended December 31, 2008, interest expense primarily consisted of BofA Credit Agreement related fees and interest of $2.7 million and SOF Credit Agreement related fees and interest of approximately $10.2 million.
Foreign currency transaction gain: Foreign currency transaction gain was $2.9 million for the year ended December 31, 2009, as compared to a loss of $0.6 million for the year ended December 31, 2008, mainly due to an appreciation of the U.S. Dollar relative to foreign currencies used by our international subsidiaries during the year ended December 31, 2009, compared to prior periods.
Unrealized (gain) loss on change in fair value of warrants: No change in fair value of warrants was recorded for the year ended December 31, 2009.
Other (income) expense: Other income was $0.2 million for the year ended December 31, 2009 as compared to other expense of $0.2 million for the year ended December 31, 2008.
Income tax provision: Income taxes decreased $3.5 million to a $3.8 million income tax provision for the year ended December 31, 2009, as compared to a $7.3 million income tax provision for the year ended December 31, 2008. The decrease was due to the decline in income before taxes for the year ended December 31, 2009 as compared to the year ended December 31, 2008. The effective income tax rate for the year ended December 31, 2009 was 77.4% as compared to 34% for the year ended December 31, 2008. The significant increase in the effective income tax rate for the year ended December 31, 2009 compared to prior year was primarily due to the establishment of valuation allowances against certain foreign net operating losses and the establishment of certain liabilities related to uncertain tax positions raised in connection with certain income tax audits. We are forecasting a pre-tax loss in 2011 so it will be difficult again to gauge if the tax rate will return to percentage consistent with prior years
We file income tax returns for various states and foreign jurisdictions. Where applicable, we provide for state and foreign taxes at the applicable statutory state and country rates multiplied by pre-tax income.
 
 
 

50


Liquidity and Capital Resources
As of December 31, 2010, we had (i) approximately $7.7 million in cash, (ii) $4.9 million of availability for additional borrowing and $53.4 million outstanding on a $75.0 million revolving credit facility under the BofA Credit Agreement, (iii) $5.0 million of availability for additional borrowings and $3.8 million outstanding on a C$11.0 million revolving credit facility under the Bank of Montreal Credit Agreement, and (iv) $81.2 million of borrowings outstanding under the Lion Credit Agreement, net of discount, and including accrued paid-in-kind interest of $17.2 million. See “Debt Agreements” below for an overview of the BofA Credit Agreement, the Lion Credit Agreement and our other debt agreements. As of February 28, 2011 (the latest date as of which such information was available), we had approximately $5.3 million in cash, while as of March 30, 2011, we had $1.9 million of availability for additional borrowings and $58.2 million outstanding on the credit facility under the BofA Credit Agreement and C$1.2 million of availability for additional borrowings and C$3.9 million outstanding on the credit facility under the Bank of Montreal Credit Agreement.
 
Over the past years, our growth has been funded through a combination of borrowings from related and unrelated parties, bank debt and lease financing, and proceeds from the exercise of warrants. Our principal liquidity requirements are for working capital and capital expenditures and in 2010 to fund operating losses. We fund our liquidity requirements primarily through cash on hand, cash flow from operations, if any, borrowings from revolving credit facilities and term loans under the Lion Credit Agreement. We also in the past have funded liquidity needs with related party loans from our CEO, all of which were canceled in exchange for shares of common stock in March 2011, and cash investments by our CEO, who purchased 1,129,576 treasury shares of common stock at a total cost of $1.675 million in December 2010 and 1,801,802 shares of common stock at a total cost of approximately $2.0 million in March 2011. We generate cash primarily through the sale of our products manufactured by us at our retail stores and through our wholesale operations. Primary uses of cash are for the purchase of raw materials, payment to our manufacturing employees and retail employees, retail store opening costs and the payment of rent for retail stores.
 
We incurred a substantial loss from operations and had negative cash flows from operating activities for the year ended December 31, 2010. Our current operating plan indicates that we will incur a loss from operations for fiscal 2011 and generate negative cash flows from operating activities. As a result of these factors and the negative comparative store sales achieved in 2010, together with world-wide economic conditions and significant increases in yarn and fabric prices, among others, there exists substantial doubt that we will be able to continue as a going concern. In addition, for these reasons, and due to the effect on our ability to borrow under our revolving credit agreements as a result of the “going concern” qualification with respect to our 2010 financial statement described below, we may not have sufficient liquidity or minimum cash levels to operate the business.
 
We are currently exploring alternatives for other sources of capital for ongoing cash needs, and we have engaged a financial advisory firm. We are working to develop and implement a plan to improve our operating performance and our cash, liquidity and financial position. This plan includes reduction of seasonal volatility in production levels at our manufacturing facilities in order to reduce direct labor costs and increase production efficiency; streamlining the our logistics operations; merchandise price rationalization in our wholesale and retail channels; renegotiating the terms of a number of our retail real estate leases, including possible store closures; lengthening the cycle of payables to certain vendors and landlords; improving merchandise allocation procedures; and rationalizing staffing levels at our retail stores. In addition, we continue to develop other initiatives intended to increase sales, reduce costs and/or improve liquidity. If we cannot meet our capital needs from these actions, we may be required to take additional steps such as further modifying our business plan to close additional stores, further reducing production or reducing or delaying capital expenditures or seeking to restructure our existing indebtedness. We also are in the process of seeking additional financing, to the extent available.
 
However, there can be no assurance that our plan to improve our operating performance and financial position will be successful or that we will be able to obtain additional financing on commercially reasonable terms or at all. As a result, our liquidity and ability to timely pay our obligations when due could be adversely affected. In addition, any equity financing or warrants that we may be required to issue in connection with any financing may be substantially dilutive to existing stockholders and may require reductions in exercise prices or other adjustments of our existing warrants. Furthermore, our vendors and landlords may resist renegotiation or lengthening of payment and other terms through legal action or otherwise. If we are not able to timely, successfully or efficiently implement the strategies that we are pursuing to improve our operating performance and financial position, obtain alternative sources of capital or otherwise meet our liquidity needs, we may need to voluntarily seek protection under Chapter 11 of the U.S. Bankruptcy Code.
 
The BofA Credit Agreement and the Bank of Montreal Credit Agreement contain covenants which require us to furnish our audited financial statements and audited financial statements of our Canadian operations, respectively, within 120 days after the fiscal year end without a going concern or like qualification. Our consolidated financial statements for the year ended

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December 31, 2010 included herein contain a “going concern” explanatory paragraph. Absent a waiver, non-compliance with such covenants could constitute a default under the BofA Credit Agreement and will constitute an event of default under the BoA Credit Agreement within 15 days following notice given from the administrative agent after April 30, 2011. Noncompliance with such covenants will also, absent a waiver, prevent us from making borrowings under the BofA Credit Agreement and the Bank of Montreal Credit Agreement. In addition, all indebtedness under the BofA Credit Agreement and the Bank of Montreal Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. All cash proceeds received by us and the guarantors under the BofA Credit Agreement must be applied to our outstanding obligations under the BofA Credit Agreement. Our daily cash needs are funded through borrowings under the BofA Credit Agreement. If we are unable to borrow under the BofA Credit Agreement, we will be unable to fund our operations.
 
In addition, the BofA Credit Agreement matures in July 2012, and the Bank of Montreal Credit Agreement matures in December 2012, and there can be no assurances that we will be able to negotiate a renewal or extension of these credit agreements with our existing lenders or enter into a replacement credit agreement with new lenders or commercially reasonably terms or at all. If we are not able to enter into a renewal, extension or replacement of the BofA Credit Agreement or the Bank of Montreal Credit Agreement prior to their respective maturities, we would no longer have access to liquidity from such revolving credit facility after its maturity date. As a result, our access to working capital would be limited and this could adversely affect our ability to finance and continue our operations.
 
The Lion Credit Agreement also requires us to furnish our audited financial statements within 120 days after the fiscal year end without a going concern or like qualification. The requirement that such financials statements be delivered without a going concern qualification has been waived for financial statements relating to the 2010 fiscal year; however, such waiver ceases to be in effect if an event of default occurs under the BofA Credit Agreement as a result of a going concern qualification with respect to such financial statements. The Lion Credit Agreement also contains cross-default provisions by which noncompliance with covenants under the BofA Credit Agreement could also constitute an event of default under the Lion Credit Agreement. In addition, all indebtedness under the Lion Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. Based upon the foregoing, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
On January 11, 2011, we entered an agreement to sell and simultaneously lease back all of our unencumbered manufacturing equipment, for a term of 48 months. The sale price of the manufacturing equipment was $3.1 million. We have an option, exercisable during the fourth year of the lease term, to repurchase the manufacturing equipment for $0.3 million. The transaction is accounted for as a financing transaction in the first quarter of 2011.
Cash Flow Overview
Cash Flow Overview for the years ended December 31, 2010, 2009 and 2008 is as follows (dollars in thousands):
 
 
2010
 
2009
 
2008
Net cash (used in) provided by:
 
 
 
 
 
Operating activities
$
(32,370
)
 
$
45,203
 
 
$
18,886
 
Investing activities
(15,662
)
 
(20,889
)
 
(69,865
)
Financing activities
48,172
 
 
(25,471
)
 
41,171
 
Effect of foreign exchange rate changes on cash
(1,530
)
 
(1,165
)
 
1,884
 
Net decrease in cash
$
(1,390
)
 
$
(2,322
)
 
$
(7,924
)
Year Ended December 31, 2010
For the year ended December 31, 2010, cash used in operations was $32.4 million. This was a result of net losses of $86.3 million, non-cash expenses of of $78.4 million, including depreciation, amortization, loss on disposal of property and equipment, foreign exchange transaction gain, allowance for inventory shrinkage and obsolescence, change in fair value of warrant liability, accrued interest-in-kind, impairment charges, stock based compensation, bad debt expense, deferred income taxes, and deferred rent and cash used of $24.5 million. Changes in cash related uses were due to an increase in trade receivables of $1.7 million, increases in inventory of $37.2 million, a decreases in prepaid expenses and other current assets of $0.6 million, increase in other long-term assets of $0.6 million, an increase in accounts payable and accrued expenses and other liabilities of $13.7 million and an increase in income taxes of $0.8 million. The increase in inventory was due to higher levels of production during fiscal 2010, increased manufacturing costs, and introduction of new product styles.

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For the year ended December 31, 2010, we used $15.7 million of cash in investing activities. This consisted of increased net investment in property and equipment of $4.8 million for the U.S. Wholesale segment, $7.6 million for the U.S. Retail segment, $1.5 million for the Canada segment and $1.9 million for the International segment. During this period, one new retail store was opened in the United States, two new retail store were opened in Canada, and three new retail stores were opened in the International segment. Investments in the U.S. Wholesale segment consisted mostly of expenditures for manufacturing equipment, computer hardware and software. Investments in the U.S. Retail segment were primarily to upgrade and remodel certain existing stores.
 
For the year ended December 31, 2010, cash provided by financing activities was $48.2 million. This consisted primarily from net borrowings of $50.9 million under our revolving credit facilities, offset by net cash overdraft, stock-based compensation expense and the repayments of capital lease obligations. Borrowings were used primarily to fund our working capital needs required for higher production levels.
 
Year Ended December 31, 2009
For the year ended December 31, 2009, cash provided by operations was $45.2 million. This was a result of net income of $1.1 million, non-cash expenses of $47.3 million, including depreciation, amortization, loss on disposal of property and equipment, foreign exchange transaction gain, allowance for inventory shrinkage and obsolescence, accrued interest-in-kind, impairment charges, stock based compensation, bad debt expense, deferred income taxes, and deferred rent, and cash of $3.2 million provided by changes in operating assets and liabilities were due to an increase in accounts payable and accrued expenses and other liabilities of $3.6 million, a decrease in inventory of $9.5 million, and a decrease in income tax payable of $9.9 million. The decrease in inventory levels during 2009 included a reduction in raw material purchases and moderated production in order to maintain lower levels of inventory in response to the declining economic environment and a projected decrease in demand from wholesale customers.
For the year ended December 31, 2009, we used $20.9 million of cash in investing activities. This was primarily a result of investment in property and equipment of $4.6 million for the U.S. Wholesale segment, $11.2 million for the U.S. Retail segment, $1.4 million in the Canada segment and $3.8 million in the International segment.
For year ended December 31, 2009, cash used in financing activities was $25.5 million. This was primarily the result of using available cash and our new financing received from Lion to pay down our revolving credit facility and our previous term note and notes payable.
 
Year Ended December 31, 2008
For the year ended December 31, 2008, cash provided by operations was $18.9 million. This was a result of net income of $14.1 million, non-cash expenses of $39.6 million, including depreciation, amortization, loss on disposal of property and equipment, foreign exchange transaction loss, allowance for inventory shrinkage and obsolescence, accrued interest-in-kind, impairment charges, stock based compensation, bad debt expense, deferred income taxes, and deferred rent, and cash of $34.9 million provided by changes in operating assets and liabilities were due to an increase in accounts payable and accrued expenses of $21.4 million, an increase in income taxes payable of $2.1 million, an increase in inventory of $48.1 million, an increase in trade and other receivables of $0.8 million, an increase in prepaid expenses and other current assets of $0.4 million and an increase to other assets of $9.1 million. The increase in inventory levels during 2008 included raw material purchases and production of product to support our growth in the U.S. Wholesale segment and continued expansion of the retail business in U.S. Retail, Canada and International segments.
For the year ended December 31, 2008, we used $69.9 million of cash in investing activities. This was primarily a result of increased investment in property and equipment for the U.S. wholesale segment by approximately $13.9 million and an investment in property and equipment of $29.5 million for the U.S. Retail, $4.7 million in the Canada segment and $18.3 million in the International segment. In addition, we acquired all of the assets of a fabric dyeing and finishing plant for $3.5 million.
For year ended December 31, 2008, cash provided by financing activities was $41.2 million. This was primarily the result of our principal capital requirements to fund working capital needs and to finance opening of new retail stores, as well as to finance purchase of new manufacturing and information systems equipment to support higher production levels and growth in online operations. Proceeds from exercise of warrants amounted to $65.6 million offset by the $10.0 million repurchase of treasury shares and $5.2 million to satisfy the applicable income tax withholding obligations in connection with the net share settlement of some of the Endeavor Warrants which is deemed to be a repurchase by our Company of its common stock. Other financing activities included receipt of a $2.5 million loan from Dov Charney, offset by debt repayments and financing costs.
 

53


Debt Agreements
Revolving Credit Facilities:
On July 2, 2007, we replaced our, then existing, credit facility with an increased revolving credit facility (the “BofA Credit Agreement”) of $75.0 million from Bank of America, N.A (the “Bank”). Availability under the BofA Credit Agreement, which is secured by substantially all of our assets, is calculated by a formula referencing the amounts of accounts receivable and inventory that we maintain at any given time. The BofA Credit Agreement also imposes certain restrictions on us regarding capital expenditures and limits our ability to, among other things, incur additional indebtedness, dispose of assets, make repayments of indebtedness or amendments of debt instruments, pay distributions, create liens on assets and enter into sale and leaseback transactions, investments, loans or advances and acquisitions.
Borrowings under the BofA Credit Agreement are subject to certain advance provisions established by the Bank and are collateralized by substantially all of our assets. Interest under the agreement is at LIBOR (0.30% at December 31, 2010) plus 4.5% or the Bank’s prime rate (which rate can in no event be lower than LIBOR plus 4.5% per annum) (3.25% at December 31, 2010) plus 2.5%, at our option. In addition, the BofA Credit Agreement requires us to maintain certain amounts of unused availability under the revolving credit facility. The BofA Credit Agreement will mature on July 2, 2012. Net available borrowing capacity, reflecting outstanding letters of credit of approximately $8.6 million and outstanding borrowings of $53.4 million at December 31, 2010, was approximately $4.9 million as determined based on our levels of inventory and amount of account receivables.
On December 30, 2009, our Canadian Companies replaced their secured revolving credit facility of C$4.0 million from Toronto Dominion Bank, with an increased revolving credit facility (the “Bank of Montreal Credit Agreement”) of C$11.0 million from Bank of Montreal (the “Canadian Bank”). The revolving credit facility is secured by liens on personal property, on all present and future movable property of our Canadian Companies. Borrowings under the Bank of Montreal Credit Agreement are subject to certain advance provisions established by the Canadian Bank. Interest under the agreement is at the Bank’s prime rate (3..25% at December 31, 2010) plus 2.0%. The credit facility matures on December 30, 2012, and our available borrowing capacity at December 31, 2010 was $5.0 million.
Long-term debt and capital lease obligations:
On March 13, 2009, we entered into agreement with Lion Capital, LLC (“Lion” and the “Lion Credit Agreement”, respectively), who provided us with term loans in an aggregate principal amount equal to $80.0 million, of which $5.0 million constituted a fee paid by us to Lion in accordance with the Lion Credit Agreement. The term loans under the Lion Credit Agreement mature on December 31, 2013 and bear interest at a rate of 15% per annum, payable quarterly in arrears. The Lion Credit Agreement is subordinated to the BofA Credit Agreement and contains customary representations and warranties, events of default, affirmative covenants and negative covenants (which impose restrictions and limitations on, among other things, dividends, investments, asset sales, capital expenditures and the ability of us to incur additional debt and liens) and a total leverage ratio financial maintenance covenant. We are permitted to prepay the loans in whole or in part at any time at our option, with no prepayment penalty.
Approximately $51.3 million of the proceeds of the loans made under the Lion Credit Agreement were used by us to repay in full all outstanding principal and interest due under the SOF Credit Agreement. The remaining proceeds were used to repay $3.3 million of loans we owed to our CEO (see Note 11 to the consolidated financial statements contained elsewhere herein), to pay fees and expenses of $4.3 million that were capitalized as deferred financing costs and included in other assets in the consolidated balance sheet as of December 31, 2009, and to reduce the outstanding revolver balance under the BofA Credit Agreement by $16.0 million.
In connection with the loans under the Lion Credit Agreement, we issued the Existing Lion Warrant, which was subsequently amended by the Existing Lion Warrant Amendment. We allocated the cash received from the Lion Credit Agreement between debt and warrants based on their relative fair values. The relative fair value of the debt under the Lion Credit Agreement was approximately $56.0 million, based on a net present value of future cash flows using a discount rate of 21.6% determined by comparable financial instruments. The Existing Lion Warrant was recorded as a debt discount and a credit to stockholders’ equity at its relative fair value of approximately $18.7 million. At December 31, 2010, the debt, net of unamortized discount and excluding interest paid-in-kind of $17.2 million, totaled approximately $64.0 million, and will be accreted up to the $80.0 million par value of the loan using the effective interest method over the term of the Lion Credit Agreement. The Existing Lion Warrant may be exercised by Lion by paying the exercise price in cash, pursuant to “cashless exercise” of the warrant or by a combination of the two methods. The Existing Lion Warrant contains 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 Existing Lion Warrant, in connection with, among other things, stock dividends, subdivisions and combinations and the issuance of additional equity securities of the

54


Company at less than fair market value.
As of December 31, 2010, we had outstanding approximately $81.2 million of second lien debt, net of discount and including accrued paid-in-kind interest, payable to Lion. The Lion Credit Agreement contains certain cross-default provisions by which noncompliance with covenants under the BofA Credit Agreement also constitutes an event of default under the Lion Credit Agreement. In addition, all indebtedness under the Lion Credit Agreement could be declared immediately due and payable. Based upon our anticipated noncompliance with certain covenants of the BofA Credit Agreement, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
On January 11, 2011, we entered an agreement to sell and simultaneously lease back substantially all of our unencumbered manufacturing equipment, for a term of 48 months. The sale price of the manufacturing equipment was $3,100. We have an option, exercisable during the fourth year of the lease term, to repurchase the manufacturing equipment for $310. The transaction is accounted for as a financing transaction.
On January 31, 2011, we entered into a waiver to the Lion Credit Agreement, which among other things, waived for the period from January 31, 2011 to but excluding February 11, 2011, our obligation to maintain a minimum Consolidated EBITDA (as defined in the Lion Credit Agreement) for the twelve consecutive fiscal month period ending January 31, 2011. This period was subsequently extended to February 18, 2011.
On February 18, 2011, we entered into a fifth amendment to the Lion Credit Agreement, which among other things, (i) redefined the monthly minimum Consolidated EBITDA financial covenant calculation to include limited fees and charges of professional services, (ii) established new monthly minimum Consolidated EBITDA amounts, (iii) adjusted the Total Debt to Consolidated EBITDA ratios, and (iv) added a covenant for the Total Debt to Consolidated EBITDA ratio that increases the interest rate payable from 17% to 18% if the ratio is greater than 4.00:1.00 for any four consecutive Fiscal Quarters or if Consolidated EBITDA for any twelve consecutive Fiscal Month period is negative. Furthermore, the fifth amendment calls for the previously issued Existing Lion Warrant (see Note 15 to the consolidated financial statements contained elsewhere herein) to be adjusted upon any issuance and sale of Common Stock or Preferred Stock below $1.11, to that of the lowest issuance price of such transaction. This provision expires in August 2011. In connection with the fifth amendment, we paid Lion a fee of approximately $1.0 million, of which was recorded as paid in kind and added to the outstanding indebtness and capitalized as a deferred financing cost to be amortize over the remaining term of the loan.
On March 24, 2011, in accordance with the fifth amendment to the Lion Credit Agreement, American Apparel and Lion entered into the Existing Lion Warrant Amendment, which, among other things, extended the term of the Existing Lion Warrant to February 18, 2018 and reduced the exercise price of the Existing Lion Warrant to $1.11, as such price may be adjusted from time to time pursuant to the adjustments specified in the Existing Lion Warrant or the Lion Credit Agreement. In addition, we issued the New Lion Warrant to Lion, which expires in 2018 and is exercisable at any time during its term, to purchase an aggregate of 759,809 shares of common stock at an exercise price of $1.11 per share, as such price may be adjusted from time to time pursuant to the adjustments specified in the New Lion Warrant or the Lion Credit Agreement.
Related-party Debt: As of December 31, 2010, we had outstanding approximately $4.6 million of related party long-term debt payable to our CEO, Dov Charney. The notes provide for interest at an annual rate of 6%, payable in kind, and are due in December 2012 and January 2013. Notes are subordinated to the Canadian revolving credit facility, BofA Credit Agreement and Lion Credit Agreement.
On March 24, 2011, American Apparel and Mr. Charney entered into an agreement, pursuant to which the accrued promissory notes payable by the Company to Mr. Charney were canceled in exchange for an issuance by the Company of an aggregate of 4,223,194 shares of our common stock at a price of $1.11 per share, with 50% of such shares being issued at closing and the remaining shares issuable to Mr. Charney only if prior to the third anniversary of the closing date (x) the closing sale price of the Common Stock on the NYSE Amex exceeds $3.50 for 30 consecutive trading days or (y) there is a change of control of American Apparel.
 
 
 
 
 
 

55


The following is an overview of our total debt as of December 31, 2010 (dollars in thousands).
 
Description of Debt
Lender Name
 
Stated
Interest Rate
 
December 31, 2010
 
Covenant
Violations
Revolving credit facility
Bank of America, N.A.
 
(LIBOR + 4.5%)
 
 
$
53,414
 
 
No
Revolving credit facility (Canada)
Bank of Montreal
 
5
%
 
3,799
 
 
Yes
Term loan from private investment firm, net of discount and including interest paid-in-kind
Lion Capital LLP
 
17
%
 
81,206
 
 
No
Other
 
 
 
 
444
 
 
N/A
Capital lease obligations
30 individual leases ranging between $1-$633
 
From 3.4% to 16.7%
 
 
1,102
 
 
N/A
Subordinated notes payable to related parties
 
 
6
%
 
4,611
 
 
N/A
Cash overdraft
 
 
 
 
3,328
 
 
N/A
Total debt including cash overdraft
 
 
 
 
$
147,904
 
 
 
Financial Covenants
 
Our credit agreements impose certain restrictions regarding capital expenditures and limit our ability to: incur additional indebtedness, dispose of assets, make repayment of indebtedness or amendments of debt instruments, pay distributions, create liens on assets and enter into sale and leaseback transactions, investments, loans or advances and acquisitions.
 
The BofA Credit Agreement limits our domestic subsidiaries from incurring capital expenditures of more than $25.0 million, and the Lion Credit Agreement limits us from incurring capital expenditures of more than $27.5 million, for the year ended December 31, 2010. Our actual capital expenditures for the combined U.S. Wholesale and U.S. Retail segments, which consist of our domestic subsidiaries, were $12.3 million for the year ended December 31, 2010. Our total actual capital expenditures were $15.7 million for the year ended December 31, 2010, respectively. The BofA Credit Agreement also imposes a minimum excess availability covenant, which requires us to maintain minimum excess availability of 10% of our net availability under the BofA Credit Agreement. At December 31, 2010 our net availability under the credit agreement was $74.3 million, minimum excess availability was $7.4 million, and our excess availability was $12.4 million.
 
The BofA Credit Agreement and Bank of Montreal Credit Agreement contain covenants which require us to furnish our audited financial statements and audited financial statements of our Canadian operations, respectively, within 120 days after the fiscal year end without a going concern or like qualification. Our consolidated financial statements for the year ended December 31, 2010 included herein contain a “going concern” explanatory paragraph. Absent a waiver, non-compliance with such covenants could constitute a default under the BoA Credit Agreement and will constitute an event of default under the BoA Credit Agreement within 15 days following notice given from the administrative agent after April 30, 2011. Noncompliance with such covenants could also, absent a waiver, allow the banks prevent us from making borrowings under the BofA Credit Agreement and the Bank of Montreal Credit Agreement. In addition, all indebtedness under the BofA Credit Agreement and the Bank of Montreal Credit Agreement could be declared immediately due and payable upon the occurrence and during the continuance of an event of default. All cash proceeds received by us and the guarantors under the BofA Credit Agreement must be applied to our outstanding obligations under the BofA Credit Agreement. Our daily cash needs are funded through borrowings under the BofA Credit Agreement. If we are unable to borrow under the BofA Credit Agreement, we will be unable to fund our operations. We have made a formal request to BofA and Lion for waivers, however there can be no assurances that we will be successful in obtaining waivers from our lenders.
 
On March 31, 2010, we entered into a second amendment to the Lion Credit Agreement, which among other things, increased the maximum permitted ratio Total Debt to Consolidated EBITDA (as defined in the Lion Credit Agreement) for the four quarter period ending June 30, 2010 from 1.70:1.00 to 1.90:1.00.
 
On June 23, 2010, we entered into a third amendment to the Lion Credit Agreement, which among other things, (i) replaced the Total Debt to Consolidated EBITDA financial covenant with a minimum Consolidated EBITDA financial covenant, tested on a quarterly basis, and (ii) increased the interest rate payable under the Lion Credit Agreement from 15% to 17% per annum for the period from June 21, 2010 through the date that we deliver financial statements to Lion for the three months ended September 30, 2010, and thereafter from the time financial statements for any Fiscal Quarters (as defined in the Lion Credit Agreement) demonstrate that the ratio of Total Debt to Consolidated EBITDA as at the end of such Fiscal Quarter exceeds certain specified ratios until we deliver financial statements to Lion for the next Fiscal Quarter. As of December 31, 2010, we

56


were not within range and therefore the interest rate payable increased from 15% to 17%.
 
The minimum Consolidated EBITDA financial covenant requires that we maintained Consolidated EBITDA at a level of no less than $20.0 million for the four quarter periods ending on June 30, 2010, September 30, 2010, and December 31, 2010 and $22.0 million for the four quarter period ending on March 31, 2011. As of September 30, 2010, this covenant was waived for the quarters ended September 30, 2010 and December 31, 2010 and also amended to provide for a monthly covenant as described below.
 
On September 30, 2010, we entered into a fourth amendment to the Lion Credit Agreement, which among other things, (i) waived the minimum Consolidated EBITDA financial covenant for the quarters ended September 30, 2010 and December 31, 2010, and (ii) replaced the quarterly minimum Consolidated EBITDA financial covenant, with a monthly minimum Consolidated EBITDA financial covenant (as defined in the fourth amendment to the Lion Credit Agreement) beginning January 31, 2011.
 
On January 31, 2011 we entered into a waiver to the Lion Credit Agreement, which among other things, waived for the period from January 31, 2011 to but excluding February 11, 2011, our obligation to maintain a minimum Consolidated EBITDA (as defined in the Lion Credit Agreement) for the twelve consecutive fiscal month period ending January 31, 2011. This period was subsequently extended to February 18, 2011.
 
On February 18, 2011, we entered into a fifth amendment to the Lion Credit Agreement, which among other things, (i) redefined the monthly minimum Consolidated EBITDA financial covenant calculation to include limited fees and charges for professional services, (ii) established new monthly minimum Consolidated EBITDA amounts, (iii) adjusted the Total Debt to Consolidated EBITDA ratios, and (iv) added a covenant for the Total Debt to Consolidated EBITDA ratio that increases the interest rate payable from 17% to 18% if the ratio is greater than 4.00:1.00 for any four consecutive Fiscal Quarters or if Consolidated EBITDA for any twelve consecutive Fiscal Month period is negative. In connection with the fifth amendment, we paid Lion a fee of approximately $1.0 million, which was capitalized as a deferred financing cost and will amortize over the remaining term of the loan.
 
Additionally, the BofA Credit Agreement and the Lion Credit Agreement contain cross-default provisions, whereby an event of default occurring under one of the credit agreements could cause an event of default under the other credit agreement. Consequently, all indebtedness under the Lion Credit Agreement could be declared immediately due and payable. Based upon the foregoing, we have classified our obligations outstanding under the Lion Credit Agreement as current liabilities in the accompanying consolidated balance sheets as of December 31, 2010.
 
The Bank of Montreal Credit Agreement contains a fixed charge coverage ratio, tested at the end of each month, which measures the ratio of EBITDA less cash income taxes paid, dividends paid and unfinanced capital expenditures divided by interest expense plus scheduled principal payments of long term debt, debt under capital leases, dividends, and shareholder loans and advances, for our Canadian subsidiaries, of not less than 1.25:1.00. The Bank of Montreal Credit Agreement also restricts our Canadian subsidiaries from entering into operating leases which would lead to payments under such leases totaling more than C$8.5 million in any fiscal year, and imposes a minimum excess availability covenant which requires our Canadian subsidiaries to maintain at all times minimum excess availability of 5% of the revolving credit commitment under the credit facility. The Bank of Montreal Credit Agreement also contains covenants which require us to furnish audited financial statements of our Canadian subsidiaries within 120 days after the fiscal year end without a going concern or like qualification. As of December 31, 2010, we were not in compliance with the covenant which required furnishing audited financial statements of our Canadian subsidiaries to Bank of Montreal within 120 days after December 31, 2009. Noncompliance with such covenant constitutes and event of default under the credit agreements, which, if not waived, could block us from making borrowings under the Bank of Montreal Credit Agreement. In addition, all indebtedness under the Bank of Montreal Credit Agreement could be declared immediately due and payable.
Future Capital Requirements
As of December 31, 2010, we had (i) approximately $7.7 million in cash, (ii) $4.9 million of availability for additional borrowings and $53.4 million outstanding under the BofA Credit Agreement, (iii) $5.0 of availability for additional borrowings and $3.8 million outstanding on a C$11.0 million revolving credit facility under the Bank of Montreal Credit Agreement. We are pending approval on capital expenditures limits for fiscal 2011 for our U.S. operations, as set by restrictions in the BofA Credit Agreement and the Lion Credit Agreement. Capital expenditures are primarily necessary to fund the opening of new stores and the remodeling of existing stores, and the purchase of manufacturing equipment, distribution center equipment and computer hardware and software.
 

57


Off-Balance Sheet Arrangements and Contractual Obligations
Our material off-balance sheet contractual commitments are operating lease obligations and letters of credit. These items were excluded from the balance sheet in accordance with GAAP.
Operating lease commitments consist principally of leases for our retail stores, manufacturing facilities, main distribution center and corporate office. These leases frequently include options which permit us to extend the terms beyond the initial fixed lease term. With respect to most of those leases, we intend to renegotiate the leases as they expire. Issued and outstanding letters of credit were $8.6 million at December 31, 2010, and were related primarily to workers’ compensation insurance and rent deposits. We also have capital lease obligations which consist principally of leases for our manufacturing equipment.
Contractual Obligations Summary
The following table summarizes our contractual commitments as of December 31, 2010, which relate to future minimum payments due under non-cancelable licenses, leases, revolving credit facility, long-term debt and advertising commitments. Future minimum rental payment on operating lease obligations presented below do not include any related property insurance, taxes, maintenance or other related costs required by operating leases. Operating lease rent expenses, including the related real estate taxes and maintenance costs, are included in the cost of sales and general and administrative expenses in our consolidated financial statements and amounted to approximately $86.7 million for the year ended December 31, 2010.
 
 
Total
 
Payments due by period
Contractual Obligations
Less than
1 year
 
1-3 years
 
4-5 years
 
More than
5 years
Long term debt, including interest
$
190,144
 
 
$
183,096
 
 
$
6,684
 
 
$
62
 
 
$
302
 
Current debt, including interest
361
 
 
361
 
 
 
 
 
 
 
Capital lease obligations, including interest
1,188
 
 
619
 
 
569
 
 
 
 
 
Operating lease obligations
417,426
 
 
67,696
 
 
125,336
 
 
108,359
 
 
116,035
 
Advertising commitments
3,764
 
 
3,764
 
 
 
 
 
 
 
Self insurance reserves
10,938
 
 
4,254
 
 
3,471
 
 
1,738
 
 
1,475
 
Total contractual obligations
$
623,821
 
 
$
259,790
 
 
$
136,060
 
 
$
110,159
 
 
$
117,812
 
We had approximately $1.3 million of total gross unrecognized tax benefits, including interest at December 31, 2010. The timing of any payments which could result from these unrecognized tax benefits will depend on a number of factors, and accordingly the amount and timing of any future payments cannot be reasonably estimated. We do not expect a significant tax payment related to these benefits within the next year. Therefore, these amounts are not included in the table above.
Seasonality
We experience seasonality in our operations. Historically, sales during the third and fourth fiscal quarters have generally been the highest, with sales during the first fiscal quarter the lowest. This reflects the combined impact of the seasonality of our wholesale and retail sales channels. Generally, our retail sales channel has not experienced the same pronounced sales seasonality as other retailers.
Inflation
Inflation affects the cost of raw materials, goods and services used in our operations. In 2010, the price of yarn and the cost of certain related fabrics began to increase as a result of the compounding effect of added demand, and supply shortages primarily from the effect of severe weather conditions in certain cotton producing countries, and a ban on cotton exports imposed by the government of India. Prices continued to increase throughout 2010 and thus far through the first quarter of 2011. As of March 31, 2011, our per pound cost is approximately two times what it was immediately prior to when cotton prices began to rise in 2010. Although to date we have not experienced any meaningful shortages in the supply of yarn and fabrics we cannot predict if any future shortages will occur and if such shortages do occur they could have a material effect on our financial condition and results of operations. In addition, high oil costs can affect the cost of all raw materials and components. The competitive environment limits the ability of American Apparel to recover higher costs resulting from inflation by raising prices.
Although, we cannot precisely determine the effects of inflation on our business, we believe that the effects on revenues and operating results have not been significant. We seek to mitigate the adverse effects of inflation primarily through improved productivity and strategic buying initiatives. We do not believe that inflation has had a material impact on our results of operations for the periods presented, except with respect to payroll-related costs and other costs arising from or related to

58


government imposed regulations. Further, in response to increases in our raw material costs we have implemented only modest price increases of certain products in our Wholesale and U.S. Retail segments. We are unable to predict if we will be able to successfully pass on the added cost of raw materials by further increasing the price of our products to our wholesale and retail customers.
Critical Accounting Estimates and Policies
Complete descriptions of our significant accounting policies are outlined in Note 3 to our consolidated financial statements under Item 8—Financial Statements and Supplementary Data. The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and 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 other 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.
Our critical accounting estimates and policies include:
 
•    
revenue recognition
 
•    
sales returns and other allowances;
 
•    
allowance for doubtful accounts;
 
•    
inventory valuation, obsolescence;
 
•    
valuation and recoverability of long-lived intangible assets including the values assigned to acquired intangible assets, goodwill, and property and equipment;
 
•    
income taxes;
 
•    
foreign currency;
 
•    
accruals for the outcome of current litigation.
 
•    
self insurance liabilities
In general, estimates are based on historical experience, on information from third party professionals and on various other sources and assumptions that are believed to be reasonable under the facts and circumstances at the time such estimates are made. On a continual 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 may vary from these estimates and assumptions under different and/or future circumstances. Our management considers an accounting estimate to be critical if:
 
•    
it requires assumptions to be made that were uncertain at the time the estimate was made; and
 
•    
changes in the estimate, or the use of different estimating methods that could have been selected, could have a material impact on our consolidated results of operations or financial condition.
Revenue Recognition
We recognize product sales when title and risk of loss have transferred to the customer, there is persuasive evidence of an arrangement, the sales price is fixed or determinable and collectability is reasonably assured. Wholesale product sales are recorded at the time the product is either picked up by or shipped to the customer. Online product sales are recorded at the time the products are received by the customers. Retail store sales are recorded as revenue upon the sale of product to retail customers. Our net sales represent gross sales invoiced to customers, less certain related charges for discounts, returns, and other promotional allowances and are recorded net of sales or value added tax. Allowances provided for these items are presented in the consolidated financial statements primarily as reductions to sales and cost of sales (see “Sales Returns and Allowances” discussed below for further information).
We recognize revenues from gift cards, gift certificates and store credits as they are redeemed for product. Prior to redemption, we maintain an unearned revenue liability for gift cards, gift certificates and store credits until we are released from such liability, as we do not currently have sufficient historical evidence to recognize gift card breakage. Our gift cards, gift certificates and store credits do not have expiration dates.
 

59


Sales Returns and Allowances
We analyze sales returns in order to make reasonable and reliable estimates of product returns for our wholesale, online product sales and retail store sales based upon historical experience. We also monitor the buying patterns of the end-users of our products based on sales data received by our retail outlets. Estimates for sales returns are based on a variety of factors including actual returns based on expected return data communicated to it by customers. Accordingly, we believe that our historical returns analysis is an accurate basis for our allowance for sales returns. As with any set of assumptions and estimates, there is a range of reasonably likely amounts that may be calculated for our allowance for sales returns above. However, we believe that there would be no significant difference in the amounts reported using other reasonable assumptions than what was used to arrive at the allowance. We regularly review the factors that influence our estimates and, if necessary, make adjustments when we believe that actual product returns and credits may differ from established reserves. Actual experience may be significantly different than our estimates due to various factors, including, but not limited to, changes in sales volume based on consumer demand and competitive conditions. If actual or expected future returns and claims are significantly greater or lower than the allowance for sales returns established, we would record a reduction or increase to net revenues in the period in which it made such determination.
Trade Receivables and Allowance for Doubtful Accounts
Accounts receivable primarily consists of trade receivables, including amounts due from credit card companies, net of allowances. On a periodic basis, we evaluate our trade receivables and establish an allowance for doubtful accounts based on our history of past bad debt expense, collections and current credit conditions.
We perform on-going credit evaluations of our customers and adjust credit limits based upon payment history and the customer’s current credit worthiness, as determined by our review of their current credit information. Collections and payments from customers are continuously monitored. We maintain an allowance for doubtful accounts, which is based upon historical experience as well as specific customer collection issues that have been identified. While such bad debt expenses have historically been within expectations and allowances established, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. If the financial condition of customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Inventories
Inventories are stated at the lower of cost or market. Cost is primarily determined on the first-in, first-out (“FIFO”) method. We identify potential excess and slow-moving inventories by evaluating turn rates, inventory levels and other factors. Excess quantities are identified through evaluation of inventory aging, review of inventory turns and historical sales experiences. At times however, we will purposefully engage in inventory build up at a rate that outpaces sales. This is typically done during the first and second quarters in anticipation of the peak selling season which occurs during the summer months of the third and fourth quarters each year. At such times, we will consider the timing of inventory buildup in order to determine whether the buildup warrants additional reserves for inventory obsolescence. If the inventory buildup occurs in advance of the selling season, management maintains the existing reserve for excess and slow-moving inventory until the peak selling season has passed and the accumulated sales data provides a better basis for an update of our management’s estimate of this provision.
 
We have evaluated the current level of inventories considering historical sales and other factors and, based on this evaluation, have recorded adjustments to cost of goods sold to adjust inventories to net realizable value. These adjustments are estimates, which could vary significantly, either favorably or unfavorably, from actual requirements if future economic conditions, customer demand or competition differ from expectations. Other significant estimates include the allocation of variable and fixed production overheads. While variable production overheads are allocated to each unit of production on the basis of actual use of production facilities, the allocation of fixed production overhead to the costs of conversion is based on the normal capacity of our production facilities, and recognizes abnormal idle facility expenses as current period charges. Certain costs, including categories of indirect materials, indirect labor and other indirect manufacturing costs which are included in the overhead pools are estimated. We determine our normal capacity based upon the amount of direct labor minutes in a reporting period.
Long-Lived Assets
We follow the provisions of ASC 360 “Property, Plant and Equipment”, which requires evaluation of the need for an impairment charge relating to long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The estimated future undiscounted cash flows associated with the asset would be compared to the asset’s carrying amount to determine if a write down to a new depreciable basis is required. If required, an impairment charge is recorded based on an estimate of future discounted cash flows.
 

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We consider the following to be some examples of important indicators that may trigger an impairment review: (i) significant under-performance or losses of retail stores relative to expected historical or projected future operating results; (ii) significant changes in the manner or use of the assets or in our overall strategy with respect to the manner or use of the acquired assets or changes in our overall business strategy; (iii) significant negative industry or economic trends; (iv) increased competitive pressures; (v) a significant decline in American Apparel’s stock price for a sustained period of time; and (vi) regulatory changes.
We evaluate acquired assets and our retail stores for potential impairment indicators at least annually and more frequently upon the occurrence of certain events. Judgment regarding the existence of impairment indicators is based on market conditions and operational performance of the acquired businesses. Future events could cause us to conclude that impairment indicators exist, and therefore long lived assets could be impaired. Such evaluations are significantly impacted by estimates of future revenues, costs and expenses and other factors. A significant change in cash flows in the future could result in an impairment of long lived assets. During the years ended December 31, 2010, 2009 and 2008 we recorded an impairment charge in the amount of $8.6 million, $3.3 million and $0.6 million related to underperforming retail stores located in each of the U.S. Retail, Canada and International segments.
Income Taxes
We record the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in our accompanying consolidated balance sheets, as well as tax credit carrybacks and carryforwards. We periodically review the recoverability of deferred tax assets recorded on our balance sheet and provide valuation allowances as management deems necessary. Based upon the results of fiscal 2010, trends in our performance during the year and projected through 2011 it is more likely than not that we will not realize any benefit from the deferred tax assets recorded by us in previous periods. We did not record income tax benefits in the consolidated financial statements for the year ending December 31, 2010 as we 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. During the years ended December 31, 2010 and 2009, we recorded a valuation allowance against deferred tax assets of $52.0 million and $20.5 million. 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, we operate within multiple taxing jurisdictions and are 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.
Foreign Currency
In preparing our consolidated financial statements, the financial statements of the foreign subsidiaries are translated from the functional currency, generally the local currency, into U.S. Dollars. This process results in exchange rate gains and losses, which, under the relevant accounting guidance, are included as a separate component of stockholders’ equity under the caption “Accumulated other Comprehensive Income.”
Under the relevant accounting guidance, the functional currency of each foreign subsidiary is determined based on management’s judgment and involves consideration of all relevant economic facts and circumstances affecting the subsidiary. Generally, the currency in which the subsidiary transacts a majority of its transactions, including billings, financing, payroll and other expenditures, would be considered the functional currency, but any dependency upon the parent and the nature of the subsidiary’s operations must also be considered.
If a subsidiary’s functional currency is deemed to be the local currency, then any gain or loss associated with the translation of that subsidiary’s financial statements is included in accumulated other comprehensive income. However, if the functional currency is deemed to be the U.S. Dollar, then any gain or loss associated with the re-measurement of these financial statements from the local currency to the functional currency would be included within the statement of operations. If we dispose of subsidiaries, then any cumulative translation gains or losses would be recorded into our statement of operations. If we determine that there has been a change in the functional currency of a subsidiary to the U.S. Dollar, any translation gains or losses arising after the date of change would be included within the statement of operations.
Based on an assessment of the factors discussed above, we consider the relevant subsidiary’s local currency to be the functional currency for each of our foreign subsidiaries.
Contingencies
We are subject to proceedings, lawsuits and other claims related to various matters. We assess the likelihood of any adverse judgments or outcomes to these matters as well as potential ranges of probable losses. Management determines the amount of reserves needed, if any, for each individual issue based on its knowledge and experience and discussions with legal counsel.

61


The required reserves may change in the future due to new developments in each matter, the ultimate resolution of each matter or changes in approach, such as a change in settlement strategy, in dealing with these matters. We currently do not believe, based upon information available at this time, that these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows. However, 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. See Note 16 and 19 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
 
Self insurance liabilities
We maintain self-insurance programs for our estimated commercial general liability risk and our estimated workers’ compensation liability risk related to our manufacturing and retail operations in the United States. In addition, starting in October 2008, we have a self-insurance program for a portion of our employee medical benefits covering all employees in the United States. Under these programs, we maintain insurance coverage for losses in excess of specified per-occurrence amounts. Estimated costs under the workers’ compensation program, including incurred but not reported claims, are recorded as expense based upon historical experience, trends of paid and incurred claims, and other actuarial assumptions. If actual claims trends under these programs, including the severity or frequency of claims, differ from our estimates, our financial results may be significantly impacted. Our estimated self-insurance liabilities are classified in our balance sheet as accrued expenses or other long-term liabilities based upon whether they are expected to be paid during or beyond our normal operating cycle of 12 months from the date of our consolidated financial statements. As of December 31, 2010 and 2009, our self-insurance liabilities totaled $10.9 million and $11.7 million, respectively.
Accounting Pronouncements-Newly Issued
See Note 3 to our consolidated financial statements under Item 8—Financial Statements and Supplementary Data.
 
 
 

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Item 7A.    Quantitative and Qualitative Disclosures about Market Risks (amounts in thousands)
Our exposure to market risk is limited to interest rate risk associated with our credit facilities and foreign currency exchange risk associated with our foreign operations.
Interest Rate Risk
Based on our interest rate exposure on variable rate borrowings at December 31, 2010, a 1% increase in average interest rates on our borrowings would increase future interest expense by approximately $48 per month. We determined this amount based on approximately $57.2 million of variable rate borrowings at December 31, 2010. We are currently not using any interest rate collars or hedges to manage or reduce interest rate risk. As a result, any increase in interest rates on the variable rate borrowings would increase interest expense and reduce net income.
Foreign Currency Risk
The majority of our operating activities are conducted in U.S. dollars. Approximately 38.7% of our net sales for the year ended December 31, 2010 were denominated in other currencies such as Euros, British Pounds Sterling or Canadian Dollars. Nearly all of our production costs and material costs are denominated in U.S. dollars although the majority of the yarn is sourced from outside the United States. If the U.S. dollar were to appreciate by 10% against other currencies it could have a significant adverse impact on our earnings. Since an appreciated U.S. dollar makes goods produced in the United States relatively more expensive to overseas customers, other things being equal, we would have to lower our retail margin in order to maintain sales volume overseas. A lower retail margin overseas would adversely affect net income assuming sales volume remains the same. The functional currencies of our foreign operations consist of the Canadian dollar for Canadian subsidiaries, the pound Sterling for U.K. subsidiaries, the Euro for subsidiaries in Continental Europe, the Yen for the Japanese subsidiary, the Won for the South Korea subsidiary, and local currencies for any of the foreign subsidiaries not mentioned.
 

63


American Apparel, Inc.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
 
 
 

64


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 
To the Audit Committee of the
Board of Directors and Stockholders of
American Apparel, Inc.
 
We have audited the accompanying consolidated balance sheets of American Apparel, Inc. and Subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss) and cash flows for the years ended December 31, 2010, 2009 and 2008. Our audits also included the financial statement schedule as of and for the years listed in the index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Apparel, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years ended December 31, 2010, 2009 and 2008 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole presents fairly, in all material respects, the information set forth therein.
 
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated, March 31, 2011, expressed an adverse opinion on the effectiveness of the Company's internal control over financial reporting because of the existence of material weaknesses.
 
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has incurred a substantial loss from operations and had negative cash flow from operations for the year ended December 31, 2010. As a result of noncompliance with certain loan covenants, debt with carrying value of approximately $138.0 million at December 31, 2010, could be declared immediately due and payable. Notwithstanding the foregoing, the Company has minimal availability for additional borrowings from its existing credit facilities, which could result in the Company not having sufficient liquidity or minimum cash levels to operate its business. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plan in regard to these matters is also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.
 
 
/s/ Marcum LLP
Marcum LLP
New York, NY
March 31, 2011
 

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Item 8. Financial Statements and Supplementary Data
 
 
American Apparel, Inc. and Subsidiaries
Consolidated Balance Sheets
(Amounts in thousands)
 
December 31,
 
2010
 
2009
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash
$
7,656
 
 
$
9,046
 
Trade accounts receivable, net of allowances of $2,630 and $1,763 at December 31, 2010 and 2009, respectively
16,688
 
 
16,907
 
Prepaid expenses and other current assets
9,401
 
 
9,994
 
Inventories, net
178,052
 
 
141,235
 
Income taxes receivable and prepaid income taxes
4,114
 
 
4,494
 
Deferred income taxes, net of valuation allowance of $9,661 and $5,342 at December 31, 2010 and 2009, respectively
626
 
 
4,627
 
Total current assets
216,537
 
 
186,303
 
PROPERTY AND EQUIPMENT, net
85,400
 
 
103,310
 
DEFERRED INCOME TAXES, net of valuation allowance of $42,318 and $15,115 at December 31, 2010 and 2009, respectively
1,695
 
 
12,033
 
OTHER ASSETS, net
24,318
 
 
25,933
 
TOTAL ASSETS
$
327,950
 
 
$
327,579