10-Q 1 app0930201310q.htm 10-Q APP 09.30.2013 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2013
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 001-32697  
 
American Apparel, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 

Delaware
20-3200601
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
 
 
747 Warehouse Street, Los Angeles, California
90021
(Address of Principal Executive Offices)
(Zip Code)
Registrant's Telephone Number, Including area code: (213) 488-0226
 
 
Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x    No   o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer” and “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  
Large accelerated filer
o
Accelerated filer
o
 
 
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
Smaller reporting company
x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
The number of shares of the registrant's common stock issued and outstanding as of November 8, 2013 was approximately 113,442,430 and 110,449,569, respectively.



AMERICAN APPAREL, INC.
TABLE OF CONTENTS
 
Item 1.
 
 
 
 
Item 2.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Mine Safety Disclosures
Item 5.
Item 6.
 
 

 

2


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

3


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 Part II, Item IA and elsewhere in this report and in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 (filed with the United States Securities and Exchange Commission (the “SEC”) on March 5, 2013) as well as in other reports and documents we file with the SEC and include, without limitation, the following:
our ability to generate or obtain from external sources sufficient liquidity for operations and debt service;
changes in the level of consumer spending or preferences or demand for our products;
our financial condition, operating results and projected cash flows;
disruptions in the global financial markets;
consequences of our significant indebtedness, including our relationship with our lenders and our ability to comply with our debt agreements and generate cash flow to service our debt;
our ability to maintain compliance with the exchange rules of the NYSE MKT, LLC;
the highly competitive and evolving nature of our business in the U.S. and internationally;
our ability to effectively carry out and manage our strategy, including growth and expansion both in the U.S. and internationally;
loss of U.S. import protections or changes in duties, tariffs and quotas, and other risks associated with international business;
intensity of competition, both domestic and foreign;
technological changes in manufacturing, wholesaling, or retailing;
risks that our suppliers or distributors may not timely produce or deliver our products;
loss or reduction in sales to our wholesale or retail customers or financial nonperformance by our wholesale customers;
the adoption of new accounting standards or changes in interpretations of accounting principles;
our ability to pass on the added cost of raw materials to customers;
the availability of store locations at appropriate terms and our ability to identify locations and negotiate new store leases effectively and to open new stores and expand internationally;
our ability to renew leases at existing locations on economic terms;
our ability to attract customers to our stores;
seasonality and fluctuations in comparable store sales and margins;
our ability to successfully implement our strategic, operating, financial and personnel initiatives;
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 increases in the price of raw materials in the global market;
our ability to improve manufacturing efficiency at our production facilities;
our ability to improve efficiency and control costs at our distribution facility located in La Mirada, California;
location of our facilities in the same geographic area;
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;
adverse changes in our credit ratings and any related impact on financial costs and structure;
continued compliance with U.S. and foreign government regulations, legislation, and regulatory environments, including environmental, immigration, labor, and occupational health and safety laws and regulations;
the risk, including costs and timely delivery issues associated therewith, that information technology systems changes and the transition to our new distribution center in La Mirada, California (as described herein) may disrupt our supply chain or operations and could impact our cash flow and liquidity, and our ability to upgrade our information technology infrastructure and other risks associated with the systems that operate our online retail operations;
litigation and other inquiries and investigations, including the risks that we, or our officers in cases where indemnification applies, will not be successful in defending any proceedings, lawsuits, disputes, claims or audits, and that exposure could exceed expectations or insurance coverages;
our ability to effectively manage inventory levels;
changes in key personnel, our ability to hire and retain key personnel, and our relationship with our employees;
general economic conditions, including increases in interest rates, geopolitical events, other regulatory changes and inflation or deflation;
disruptions due to severe weather or climate change; and
disruptions due to earthquakes, flooding, tsunamis or other natural disasters.
All forward-looking statements included in this document are made as of the date hereof, based on information available to us as of the date hereof, and we assume no obligation to update any forward-looking statements.

4


PART I-FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
American Apparel, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(Amounts and shares in thousands, except per share amounts)
(unaudited)
 
 
September 30, 2013
 
December 31, 2012*
ASSETS
 
 
 
CURRENT ASSETS
 
 
 
Cash
$
4,913

 
$
12,853

Trade accounts receivable, net of allowances of $2,063 and $2,085 at September 30, 2013 and December 31, 2012, respectively
23,053

 
22,962

Restricted cash

 
3,733

Prepaid expenses and other current assets
12,712

 
9,589

Inventories, net
170,723

 
174,229

Income taxes receivable and prepaid income taxes
1,018

 
530

Deferred income taxes, net of valuation allowance
419

 
494

Total current assets
212,838

 
224,390

PROPERTY AND EQUIPMENT, net
71,515

 
67,778

DEFERRED INCOME TAXES, net of valuation allowance
1,229

 
1,261

OTHER ASSETS, net
47,351

 
34,783

TOTAL ASSETS
$
332,933

 
$
328,212

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
 

 
 

CURRENT LIABILITIES
 

 
 

Cash overdraft
$
2,812

 
$

Revolving credit facilities and current portion of long-term debt
33,014

 
60,556

Accounts payable
31,547

 
38,160

Accrued expenses and other current liabilities
51,925

 
41,516

Fair value of warrant liability
22,466

 
17,241

Income taxes payable
1,753

 
2,137

Deferred income tax liability, current
245

 
296

Current portion of capital lease obligations
1,692

 
1,703

Total current liabilities
145,454

 
161,609

LONG-TERM DEBT, net of unamortized discount of $5,926 and $27,929 at September 30, 2013 and December 31, 2012, respectively
207,237

 
110,012

CAPITAL LEASE OBLIGATIONS, net of current portion
4,991

 
2,844

DEFERRED TAX LIABILITY
261

 
262

DEFERRED RENT, net of current portion
18,936

 
20,706

OTHER LONG-TERM LIABILITIES
12,245

 
10,695

TOTAL LIABILITIES
389,124

 
306,128

COMMITMENTS AND CONTINGENCIES


 


STOCKHOLDERS' (DEFICIT) EQUITY
 

 
 

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

 

Common stock, $0.0001 par value per share, authorized 230,000 shares; 113,412 shares issued and 110,366 shares outstanding at September 30, 2013 and 110,111 shares issued and 107,181 shares outstanding at December 31, 2012
11

 
11

Additional paid-in capital
185,119

 
177,081

Accumulated other comprehensive loss
(3,510
)
 
(2,725
)
Accumulated deficit
(235,654
)
 
(150,126
)
Less: Treasury stock, 304 shares at cost
(2,157
)
 
(2,157
)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY
(56,191
)
 
22,084

TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
$
332,933

 
$
328,212

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

5


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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Net sales
$
164,543

 
$
162,160

 
$
464,839

 
$
444,282

Cost of sales
79,903

 
76,960

 
223,461

 
209,990

Gross profit
84,640

 
85,200

 
241,378

 
234,292

Selling expenses
63,982

 
58,017

 
177,235

 
168,258

General and administrative expenses (including related party charges of $181 and $332 for the three months ended September 30, 2013 and 2012, respectively, and $625 and $883 for the nine months ended September 30, 2013 and 2012, respectively)
24,918

 
22,566

 
80,716

 
71,792

Retail store impairment
233

 

 
311

 
129

 
 
 
 
 
 
 
 
(Loss) income from operations
(4,493
)
 
4,617

 
(16,884
)
 
(5,887
)
 
 
 
 
 
 
 
 
Interest expense
10,121

 
10,454

 
29,555

 
30,274

Foreign currency transaction (gain) loss
(449
)
 
(685
)
 
422

 
141

Unrealized (gain) loss on change in fair value of warrants
(12,922
)
 
13,312

 
5,225

 
15,340

Loss (gain) on extinguishment of debt

 

 
32,101

 
(11,588
)
Other expense
58

 
36

 
42

 
188

Loss before income taxes
(1,301
)
 
(18,500
)
 
(84,229
)
 
(40,242
)
Income tax provision
212

 
512

 
1,299

 
1,933

Net loss
$
(1,513
)
 
$
(19,012
)
 
$
(85,528
)
 
$
(42,175
)
 
 
 
 
 
 
 
 
Basic and diluted loss per share
$(0.01)
 
$(0.18)
 
$(0.78)
 
$(0.40)
Weighted average basic and diluted shares outstanding
110,354
 
106,248
 
110,172
 
105,960
 
 
 
 
 
 
 
 
Net loss (from above)
$
(1,513
)
 
$
(19,012
)
 
$
(85,528
)
 
$
(42,175
)
    Other comprehensive income (loss) item:
 
 
 
 
 
 
 
    Foreign currency translation loss (gain), net of tax
1,445

 
1,073

 
(785
)
 
622

        Other comprehensive loss (gain), net of tax
1,445

 
1,073

 
(785
)
 
622

Comprehensive loss
$
(68
)
 
$
(17,939
)
 
$
(86,313
)
 
$
(41,553
)

See accompanying notes to condensed consolidated financial statements.
 

6


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

 
Nine Months Ended September 30,
 
2013
 
2012
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Cash received from customers
$
465,468

 
$
439,634

Cash paid to suppliers, employees and others
(468,632
)
 
(431,915
)
Income taxes (paid) refunded
(2,082
)
 
646

Interest paid
(5,726
)
 
(6,635
)
Other
35

 
(160
)
Net cash (used in) provided by operating activities
(10,937
)
 
1,570

 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Capital expenditures
(18,907
)
 
(14,257
)
Proceeds from sale of fixed assets
30

 
70

Restricted cash
1,594

 
(5,926
)
Net cash used in investing activities
(17,283
)
 
(20,113
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash overdraft
2,812

 
704

Repayments of expired revolving credit facilities, net
(28,513
)
 
(48,324
)
Borrowings under current revolving credit facilities, net
28,713

 
39,337

(Repayments) borrowings of term loans and notes payable
(25,463
)
 
30,042

Repayment of Lion term loan
(144,149
)
 

Issuance of Senior Secured Notes
199,820

 

Payments of debt issuance costs
(11,880
)
 
(4,965
)
Repayments of capital lease obligations
(773
)
 
(810
)
Net cash provided by financing activities
20,567

 
15,984

 
 
 
 
EFFECT OF FOREIGN EXCHANGE RATE ON CASH
(287
)
 
(548
)
 
 
 
 
NET DECREASE IN CASH
(7,940
)
 
(3,107
)
CASH, beginning of period
12,853

 
10,293

CASH, end of period
$
4,913

 
$
7,186


See accompanying notes to condensed consolidated financial statements.

7



American Apparel, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (continued)
(Amounts in thousands)
(unaudited)
 
Nine Months Ended September 30,
 
2013
 
2012
RECONCILIATION OF NET LOSS TO NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES
 
 
 
Net loss
$
(85,528
)
 
$
(42,175
)
Depreciation and amortization of property and equipment, and other assets
19,155

 
17,040

Retail store impairment
311

 
129

Loss on disposal of property and equipment
77

 
28

Share-based compensation expense
8,044

 
7,333

Unrealized loss on change in fair value of warrants
5,225

 
15,340

Amortization of debt discount and deferred financing costs
3,717

 
7,655

Loss (gain) on extinguishment of debt
32,101

 
(11,588
)
Accrued interest paid-in-kind
6,875

 
15,984

Foreign currency transaction loss
422

 
141

Allowance for inventory shrinkage and obsolescence
964

 
(339
)
Bad debt expense
380

 
73

Deferred income taxes
(26
)
 
32

Deferred rent
(1,667
)
 
(649
)
Changes in cash due to changes in operating assets and liabilities:
 
 
 
Trade accounts receivables
249

 
(4,721
)
Inventories
1,741

 
6,238

Prepaid expenses and other current assets
(4,026
)
 
(3,343
)
Other assets
(4,274
)
 
(5,756
)
Accounts payable
(8,133
)
 
2,471

Accrued expenses and other liabilities
14,261

 
(4,750
)
Income taxes receivable / payable
(805
)
 
2,427

Net cash (used in) provided by operating activities
$
(10,937
)
 
$
1,570

 
 
 
 
NON-CASH INVESTING AND FINANCING ACTIVITIES
 
 
 
Property and equipment acquired, and included in accounts payable
$
5,270

 
$
98


See accompanying notes to condensed consolidated financial statements.


8



American Apparel, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements
For the Three and Nine Months Ended September 30, 2013 and 2012
(Amounts and shares in thousands, except per share amounts)
(unaudited)

Note 1. Organization and Business
American Apparel, Inc. and its subsidiaries (collectively the “Company”) is a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel products and designs, manufactures and sells clothing and accessories for women, men, children and babies. The Company sells its products through the wholesale distribution channel supplying t-shirts and other casual wear to distributors and screen printers, as well as direct to customers through its retail stores located in the United States, and internationally. In addition, the Company operates an online retail e-commerce website. At September 30, 2013, the Company operated a total of 247 retail stores in 20 countries: the United States, Canada and 18 other countries.
Liquidity and Management's Plan
As of September 30, 2013, the Company had approximately $4,913 in cash and $17,574 of availability for additional borrowings under the Capital One Credit Facility and Bank of Montreal Credit Agreement (as defined in Note 6). Additionally, the Company had $32,820 outstanding on a $50,000 asset-backed revolving credit facility (increased from $35,000 to $50,000 on July 5, 2013) under the Capital One Credit Facility and $106 outstanding on a C$11,000 (Canadian dollars) revolving credit facility under the Bank of Montreal Credit Agreement.
On April 4, 2013, the Company closed a private offering of $206,000 aggregate principal amount of its Senior Secured Notes due April 15, 2020 (the "Notes") at 97% of par and also entered into a new $35,000 asset-backed revolving credit facility with Capital One Leverage Finance Corp. maturing on April 4, 2018, subject to a January 15, 2018 maturity under certain circumstances. Subsequently, on July 5, 2013, the Company entered into an amendment to the credit agreement governing its credit facility with Capital One Leverage Finance Corp., pursuant to which the total commitment under the credit facility was raised to $50,000. The notes and the new credit facility are the Company's senior secured obligations and are guaranteed, on a senior secured basis, by the Company's domestic restricted subsidiaries, subject to some exceptions.
The Company used the net proceeds from the offering of the Notes, together with borrowings under the new credit facility, to repay and terminate its credit agreement with Crystal Financial LLC and its loan agreement with Lion Capital LLP.
As of September 30, 2013, the Company determined it is probable that a special interest trigger event under the indenture governing the Notes will occur as of December 31, 2013 and has accrued interest on the Notes at 15% retroactive to April 4, 2013, representing an additional 2% interest, which additional interest is payable in kind until April 15, 2018 and in cash on subsequent interest dates. The Company recorded $2,014 in additional interest expense for the special interest trigger event during the three months ended September 30, 2013.
On November 14, 2013, the Company entered into a third amendment to the Capital One Credit Facility, which among other things, waived the obligation to maintain a minimum fixed charge coverage ratio and a maximum leverage ratio for the twelve consecutive fiscal month period ending September 30, 2013. As a condition to the waiver, the Company agreed to a one percentage point increase in the interest rate to either LIBOR plus 4.5% or the bank's prime rate plus 3.5% (at the Company's option) and limitations on amounts available to be borrowed, consisting of the imposition of a reserve against the line that will gradually reduce the total borrowing capacity to $47,500 and certain amendments to the borrowing base calculation.  In addition, the Company paid a waiver fee of $75. The financial covenants under the Capital One Credit Facility will again be tested in the fourth quarter of 2013 and future quarterly periods and will use the Company's prior twelve-month operating results as a measurement. The Company is currently projecting non-compliance under the Capital One Credit Facility through the third quarter of 2014 and future waivers will be required in order to maintain compliance in the fourth quarter of 2013 and in the quarters ending in 2014.
An amendment that resets these covenants is an alternative to the need for obtaining waivers. The Company is in discussions with Capital One with respect to such an amendment. No assurance can be given that the Company will be successful in obtaining such an amendment or any further waivers or as to the cost of them. In addition, if an event of default occurs and is continuing and such event of default is not waived or the Capital One Credit Facility not amended, the terms of the credit agreement would allow Capital One to prevent the Company from making any additional borrowings, which it uses to access working capital, as the Company's cash is swept by Capital One, and accelerate maturity of the loan. If as a result of an event of default under the Capital One Credit Facility, Capital One accelerates the repayment of amounts the Company owes to them, there could also be an acceleration of debt repayments of the Notes and other credit agreements. In such an event, the

9


Company would be required to seek alternative sources of liquidity, and there can be no assurance that any alternative source of liquidity would be available on terms acceptable to the Company, or at all. See Notes 6 and 7.
The Company's transition to its new distribution center in La Mirada, California has had a significant negative impact on the Company's earnings and cash flow. For the three and nine months ended September 30, 2013, the Company incurred incremental distribution costs (primarily labor) associated with these transition activities of approximately $5,900 and $10,900, respectively. All such costs have been charged to cost of sales and operating expense in the accompanying statements of operations. The issues surrounding the transition primarily relate to improper system design and integration and inadequate training and staffing. These issues caused processing inefficiencies that required the Company to employ additional staffing in order to meet customer demand. At September 30, 2013, staffing levels were significantly above target levels at the distribution facility. The Company believes the system design and integration issues have been largely resolved and training and staffing efforts are ongoing. Further, as of November 1, 2013, the Company has begun reducing staffing levels and overtime and has targeted additional reductions in the fourth quarter. If there are any further transition issues associated with the new center, sales and financial results could be negatively impacted further.
The Company continues to execute its plan, which was commenced in late 2010, to improve its operating performance and financial position. Among other things, in 2013, the Company completed the installation of RFID tracking systems in all of its stores, plans to complete the transition of distribution operations to its new distribution facility in La Mirada, California, continues with expansion of its selling square footage in its stores, continues with its inventory productivity improvement program, plans to reduce operating expenses, and plans to improve online sales performance with the implementation of the Oracle ATG back-end online system for international store fronts. In addition, the Company continues to seek improvements in store labor productivity and workers' compensation exposure. The Company continues to develop other initiatives intended to either increase sales, reduce costs or improve liquidity.
There can be no assurance that plans to improve operating performance and financial position will be successful. If the Company is unable to achieve significant cost reductions at its La Mirada distribution facility and achieve its projected sales results, it will need to promptly seek additional liquidity and there can be no assurance that such efforts will be successful. The Company believes that it has sufficient financing commitments to meet funding requirements for the next twelve months, subject to the foregoing matters.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of American Apparel, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation. Certain reclassifications have been made to the prior year's condensed consolidated financial statements and related footnotes to conform them to the 2013 presentation.
The accompanying unaudited condensed consolidated financial statements of the Company and its wholly owned subsidiaries have been prepared by the Company, in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information, and are presented in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X, and have not been audited. Accordingly, these unaudited condensed consolidated financial statements do not include all of the information and notes required by GAAP for complete financial statements and should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended December 31, 2012 included in the Company's Annual Report on Form 10-K. In the opinion of management, the interim unaudited condensed consolidated financial statements included herein contain all adjustments, including normal recurring adjustments, considered necessary to present fairly the Company's financial position, the results of operations and cash flows for the periods presented.
The operating results and cash flows of the interim periods presented herein are not necessarily indicative of the results to be expected for any other interim period or the full year.

10


Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, disclosures of contingent assets and liabilities at the date of the financial statements, and reported amounts of revenues and expenses during the reporting period. Management bases its estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The most complex and subjective estimates include: self-insured liabilities; inventory valuation and obsolescence; valuation and recoverability of long-lived assets, including the values assigned to goodwill, and property and equipment; fair value calculations, including derivative liabilities such as the Lion warrants; contingencies, including accruals for the outcome of current litigation; and income taxes as well as other taxes and governmental assessments, including uncertain income tax positions and recoverability of deferred income taxes.
On a regular basis, management reviews its estimates utilizing currently available information, changes in facts and circumstances, historical experience, and reasonable assumptions. After such reviews, and if deemed appropriate, those estimates are adjusted accordingly. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments, which potentially subject the Company to credit risk consist primarily of cash (the amounts of which may, at times, exceed Federal Deposit Insurance Corporation limits on insurable amounts) and trade accounts receivable (including credit card receivables), relating substantially to the Company’s U.S. Wholesale segment. The Company mitigates its risk by maintaining accounts through major financial institutions. The Company had approximately $3,720 and $8,265 held in foreign banks at September 30, 2013 and December 31, 2012, respectively.
The Company mitigates its risks related to trade receivables by performing on-going credit evaluations of its customers and adjusts credit limits based upon payment history and the customer’s current credit worthiness, as determined by the review of their current credit information. The Company also maintains an insurance policy for certain customers based on a customer’s credit rating and established limits. Collections and payments from customers are continuously monitored. One customer in the Company's U.S. Wholesale segment accounted for 18.8% and 15.1% of the Company’s total accounts receivables as of September 30, 2013 and December 31, 2012, respectively. The Company maintains an allowance for doubtful accounts, which is based upon historical experience and specific customer collection issues that have been identified. While bad debt expenses have historically been within expectations and allowances established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past.
Fair Value Measurements
The Company’s financial instruments are primarily composed of cash, restricted cash, accounts receivable (including credit card receivables), accounts payable, revolving credit borrowings, its senior secured notes, term loan and warrants. The fair value of cash, restricted cash, accounts receivable and accounts payable closely approximates their carrying value due to their short maturities and variable rates. The fair value of fixed-rate borrowings are estimated using a discounted cash flow analysis.
The valuation techniques utilized are based upon observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect internal market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related asset or liabilities.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of assets or liabilities.
The Company utilizes observable market inputs (quoted market prices) when measuring fair value whenever possible.
For fair value measurements categorized within Level 3 of the fair value hierarchy, the Company's accounting and finance department determine its valuation policies and procedures. The development and determination of the unobservable inputs for Level 3 fair value measurements and fair value calculations are the responsibility of the Company's accounting and finance department and are approved by the Chief Financial Officer.
As of September 30, 2013, there were no transfers in or out of Level 3 from other levels.
The fair value of fixed rate borrowings are estimated using a projected discounted cash flow analysis based on unobservable inputs including interest payments, principal payments and discount rate, and is classified within Level 3 of the valuation

11


hierarchy. An increase or decrease in the discount rate assumption, in isolation, can significantly decrease or increase the fair value of the fixed rate borrowings. See Note 8.
The fair value of each warrant is estimated using the Binomial Lattice option valuation model. Significant observable and unobservable inputs include stock price, exercise price, annual risk free rate, term, and expected volatility, and are classified within Level 3 of the valuation hierarchy. An increase or decrease in volatility, in isolation, can significantly increase or decrease the fair value of the warrants. See Notes 8 and 11.
The fair value of indefinite-lived assets, which consists exclusively of goodwill, is measured in connection with the Company’s annual goodwill impairment test.  The fair value of the reporting unit to which goodwill has been assigned, is determined using a projected discounted cash flow analysis based on unobservable inputs including gross profit, discount rate, working capital requirements, capital expenditures, depreciation and terminal value assumptions, and are classified within Level 3 of the valuation hierarchy. An increase or decrease in the discount rate assumption and/or the terminal value assumption, in isolation, can have a significant effect on the fair value of the reporting unit.
Retail stores that have indicators of impairment and whose carrying value of assets are greater than their related projected undiscounted future cash flows, are measured for impairment by comparing the fair value of the assets against their carrying value. Fair value of the assets is estimated using a projected discounted cash flow analysis based on unobservable inputs including gross profit and discount rate, and is classified within Level 3 of the valuation hierarchy.  The key assumptions used in the estimates of projected cash flows were sales, gross margins, and payroll costs. These forecasts were based on historical trends and take into account recent developments, as well as the Company's plans and intentions. An increase or decrease in the discount rate assumption and/or projected cash flows, in isolation, can significantly decrease or increase the fair value of the assets, which would have an effect on the impairment recorded.
Income Taxes
The Company recognizes deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.  The Company estimates the degree to which tax assets and credit carryforwards will result in a benefit based on expected profitability by tax jurisdiction.  A valuation allowance for such tax assets and loss carryforwards is provided when it is determined that such amounts will more likely than not go unrealized.  If it becomes more likely than not that a tax asset will be realized, any related valuation allowance of such assets would be reversed.
During the three and nine months ended September 30, 2013, the Company incurred losses from operations.  During the three months ended September 30, 2012, the Company recorded income from operations and during the nine months ended September 30, 2012, the Company incurred loss from operations. Based upon these results, and trends in the Company's performance projected through 2013, it is more likely than not that the Company will not realize any benefit from the deferred tax assets recorded by the Company in previous periods.  The Company did not record income tax benefits in the condensed consolidated financial statements for the three and nine months ended September 30, 2013 and 2012 as the Company determined that it was more likely than not that sufficient taxable income in the future will not be generated in the respective jurisdictions to realize the deferred income tax assets. 
Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability.  In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions.  In management's opinion, adequate provisions for income taxes have been made for all years.  If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
The Company's foreign domiciled subsidiaries are subject to foreign income taxes on earnings in their respective jurisdictions. The Company elected to have its foreign subsidiaries, except for its subsidiaries in Brazil, Canada, China, Spain, Italy, Ireland and Korea, consolidated in the Company's U.S. federal income tax return.  The Company will generally be eligible to receive tax credits on its U.S. federal income tax return for most of the foreign taxes paid by the Company's entities included in the United States Federal income tax return.
The Company accounts for uncertain tax positions in accordance with ASC 740 - “Income Taxes”, and gross unrecognized tax benefits at September 30, 2013 and December 31, 2012 are included in current liabilities in the accompanying condensed consolidated balance sheets.  The Company accrues interest and penalties on unrecognized tax benefits as components of the income tax provision in the accompanying condensed consolidated statements of operations. In accordance with ASC 740, the Company evaluates whether a valuation allowance should be established against the net deferred tax assets based upon the consideration of all available evidence and using a “more likely than not” standard. Significant weight is given to evidence that can be objectively verified. The determination to record a valuation allowance is based on the recent history of cumulative losses and current operating performance. In conducting the analysis, the Company utilizes an approach, which considers the current year loss, including an assessment of the degree to which any losses are driven by items that are unusual in nature and

12


incurred to improve future profitability. In addition, the Company reviews changes in near-term market conditions and any other factors arising during the period, which may impact its future operating results.
Accounting Standards Updates
Recently issued accounting standards updates are not expected to have a material effect on the Company's condensed consolidated financial statements.
Subsequent Events
The Company has evaluated events that occurred subsequent to September 30, 2013 and through the date the financial statements were available to be issued. Management concluded that no additional subsequent events required disclosure in these financial statements other than those disclosed in these notes to these financial statements.
Note 3. Inventories
The components of inventories are as follows:  
 
September 30, 2013
 
December 31, 2012
Raw materials
$
24,445

 
$
22,301

Work in process
3,063

 
2,197

Finished goods
146,800

 
152,384

 
174,308

 
176,882

Less reserve for inventory shrinkage and obsolescence
(3,585
)
 
(2,653
)
Total, net of reserves
$
170,723

 
$
174,229

Inventories are stated at the lower of cost or market. Cost is primarily determined on the first-in, first-out (FIFO) method. The cost elements of inventories include materials, labor and overhead. For the three and nine months ended September 30, 2013 and 2012, no one supplier provided more than 10% of the Company’s raw material purchases.
The Company identifies potentially excess and slow-moving inventories by evaluating turn rates, inventory levels and other factors and provides reserves for lower of cost or market reserves for such identified excess and slow-moving inventories. At September 30, 2013 and December 31, 2012, the Company had a lower of cost or market reserve for excess and slow-moving inventories of $1,952 and $2,140, respectively.
The Company establishes a reserve for inventory shrinkage for each of its retail locations and its warehouse. The reserve is based on the historical results of physical inventory cycle counts. The Company had a reserve for inventory shrinkage in the amount of $1,633 and $513 at September 30, 2013 and December 31, 2012, respectively.
Note 4. Property and Equipment
Depreciation and amortization expense relating to property and equipment (including capitalized leases) is recorded in cost of sales and operating expenses. For the three and nine months ended September 30, 2013, depreciation and amortization expense was $6,738 and $19,155, respectively. For the three and nine months ended September 30, 2012, depreciation and amortization expense was $5,538 and $17,040, respectively.
Based upon the results of its retail store impairment analysis, for the three and nine months ended September 30, 2013, the Company recorded impairment charges of $233 and $311, respectively. For the nine months ended September 30, 2012, the Company incurred impairment charges of $129.

13


Note 5. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows:
 
September 30, 2013
 
December 31, 2012
Compensation, bonuses and related taxes
$
9,351

 
$
11,524

Accrued interest
13,238

 
520

Workers' compensation and other self-insurance reserves (Note 14)
5,851

 
5,288

Sales, value and property taxes
3,552

 
4,751

Gift cards and store credits
5,238

 
5,964

Loss contingencies
752

 
752

Accrued vacation
1,452

 
1,055

Deferred revenue
412

 
590

Deferred rent
3,039

 
2,997

Other
9,040

 
8,075

Total accrued expenses
$
51,925

 
$
41,516


Note 6. Revolving Credit Facilities and Current Portion of Long-Term Debt
The following table presents revolving credit facilities and current portion of long-term debt:
 
September 30, 2013
 
December 31, 2012
Revolving credit facility (Capital One), maturing April 2018
$
32,820

 
$

Revolving credit facility (Crystal), replaced in April 2013 (a)

 
26,113

Term loan (Crystal), replaced in April 2013 (a)

 
30,000

Revolving credit facility (Bank of Montreal), maturing December 2013
106

 
4,387

Current portion of long-term debt (Note 7)
88

 
56

Total revolving credit facilities and current portion of long-term debt
$
33,014

 
$
60,556

(a) All outstanding principal amounts and accrued and unpaid interest and fees under the Crystal revolving credit facility and term loan were repaid with the proceeds of the financing transactions that the Company closed on April 4, 2013.
The Company incurred interest charges of $10,121 and $29,555 for the three and nine months ended September 30, 2013, respectively, and $10,454 and $30,274 for the three and nine months ended September 30, 2012, respectively, for all outstanding borrowings.
Revolving Credit Facility - Capital One
On April 4, 2013, the Company and its domestic subsidiaries replaced the credit facility with Crystal with a new $35,000 asset-based revolving facility with Capital One Leverage Finance Corp. ("Capital One" and the credit facility, the "Capital One Credit Facility"). On July 5, 2013, the Company entered into an amendment to the credit agreement with Capital One, pursuant to which the total commitment under the credit facility was raised to $50,000. The additional commitment was made under substantially the same terms as the existing facility.
The Capital One Credit Facility matures on April 4, 2018, subject to a January 15, 2018 maturity if excess availability is less than $15,000 at the time of notice to Capital One of a determination by the Company that an Applicable High Yield Discount Obligation ("AHYDO") redemption will be required pursuant to Section 3.01(e) of the indenture governing the Notes. See Note 7. Borrowings under the Capital One Credit Facility bear interest equal to LIBOR plus 3.5% or the bank's prime rate plus 2.5% (at the Company's option) and are subject to maintenance of specified borrowing base requirements and covenants. The Capital One Credit Facility is secured by a lien on substantially all of the assets of the Company's domestic subsidiaries and equity interests in certain of the Company's foreign subsidiaries, subject to some exceptions. As of September 30, 2013, the Company had $1,880 of outstanding letters of credit secured against the Capital One Credit Facility. The amount available for additional borrowings on September 30, 2013 was $15,245.
The Company is required to maintain a minimum fixed charge coverage ratio of not less than 1.00 to 1.00 and is also required to not exceed certain maximum leverage ratio thresholds, both determined as at the end of each fiscal quarter. Additionally, the

14


Company's domestic subsidiaries are subject to an annual limitation of certain specified capital expenditure amounts as determined at the end of each fiscal year.
Among other provisions, the Capital One Credit Facility requires that the Company maintain a lockbox arrangement and contains certain subjective acceleration clauses. In addition, Capital One may at its discretion, adjust the advance restriction and criteria for eligible inventory and accounts receivable. The Capital One Credit Facility contains cross-default provisions whereby an event of default under the Bank of Montreal Credit Agreement, under the indenture governing the Notes or other indebtedness, in each case of an amount greater than a specified threshold, would cause an event of default under the Capital One Credit Facility.
On November 14, 2013, the Company entered into a third amendment to the Capital One Credit Facility, which among other things, waived the obligation to maintain a minimum fixed charge coverage ratio and a maximum leverage ratio for the twelve consecutive fiscal month period ending September 30, 2013. As a condition to the waiver, the Company agreed to a one percentage point increase in the interest rate to either LIBOR plus 4.5% or the bank's prime rate plus 3.5% (at the Company's option) and limitations on amounts available to be borrowed, consisting of the imposition of a reserve against the line that will gradually reduce the total borrowing capacity to $47,500 and certain amendments to the borrowing base calculation.  In addition, the Company paid a waiver fee of $75.
These financial covenants will again be tested in the fourth quarter of 2013 and future quarterly periods and will use as a measurement the Company’s prior twelve-month operating results as a measurement. The Company is currently projecting non-compliance with the covenants through the third quarter of 2014 and future waivers will be required in order to maintain compliance in the fourth quarter of 2013 and in the quarters ending in 2014.
An amendment that resets these covenants is an alternative to the need for obtaining waivers. The Company is in discussions with Capital One with respect to such an amendment. In addition, if an event of default occurs and is continuing and such event of default is not waived or the Capital One Credit Facility not amended, the terms of the credit agreement would allow Capital One to prevent the Company from making any additional borrowings, which it uses to access working capital, as the Company's cash is swept by Capital One, and accelerate maturity of the loan. If as a result of an event of default under the Capital One Credit Facility, Capital One accelerates the repayment of amounts the Company owes to them, there could also be an acceleration of debt repayments of the Notes and other credit agreements. In such an event, the Company would be required to seek alternative sources of liquidity, and there can be no assurance that any alternative source of liquidity would be available on terms acceptable to the Company, or at all.
Revolving Credit Facility - Bank of Montreal
The Company's wholly-owned subsidiaries, American Apparel Canada Wholesale, Inc. and American Apparel Canada Retail Inc. (collectively, the “CI Companies”), have a line of credit with Bank of Montreal (the "Bank of Montreal Credit Agreement") that provides for borrowings up to C$11,000 (Canadian dollars) with a fixed maturity date of December 31, 2013, bearing interest at 7.0% (the bank's prime rate at 3.0% as of September 30, 2013 plus 4.0% per annum) payable monthly. This line of credit is secured by a lien on the CI Companies' accounts receivable, inventory and certain other tangible assets. Available borrowing capacity at September 30, 2013 was $2,329.
The Bank of Montreal Credit Agreement contains a fixed charge coverage ratio and restricts the Company's Canadian subsidiaries from entering into operating leases above a specified threshold. Additionally, the Bank of Montreal Credit Agreement imposes a minimum excess availability covenant, which requires the Company's Canadian subsidiaries to maintain at all times minimum excess availability of 5.0% of the revolving credit commitment under the facility.
The Bank of Montreal Credit Agreement contains cross-default provisions with the Capital One Credit Facility and the Notes, whereby an event of default occurring thereunder would cause an event of default under the Bank of Montreal Credit Agreement.
As of September 30, 2013, the Company was in compliance with all required financial covenants of the Bank of Montreal Credit Agreement.
Revolving Credit Facility and Term Loan - Crystal
On April 4, 2013, the Company replaced its existing revolving credit facility and term loan with Crystal Financial LLC ("Crystal" and the "Crystal Credit Agreement", respectively), with a new asset-based revolving credit agreement with Capital One.
In connection with the termination of the Crystal Credit Agreement, the Company paid an early termination fee of $2,400. The difference between the net carrying amount of the Crystal loans of $60,533 (which includes the outstanding balance, accrued but unpaid interest, and unamortized financing cost immediately prior to the date of the extinguishment) and the cash paid to

15


Crystal of $66,411, which includes the early termination fee, was recorded as a $5,878 loss on early extinguishment of debt in the statement of operations for the nine months ended September 30, 2013.

Note 7. Long-Term Debt
Long-term debt consists of the following:
 
September 30, 2013
 
 
December 31, 2012
 
Senior Secured Notes due 2020
$
202,088

(a)
 
$

 
Long-term debt with Lion

 
 
109,680

(b)
Other
5,237

 
 
388

 
Total long-term debt
207,325

 
 
110,068

 
Current portion of debt
(88
)
 
 
(56
)
 
Long-term debt, net of current portion
$
207,237

 
 
$
110,012

 
(a) Net of unamortized discount of $5,926 at September 30, 2013.
(b) Including accrued interest paid-in-kind of $16,469 and net of unamortized discount of $27,929 at December 31, 2012.
      
Senior Secured Notes due 2020
On April 4, 2013, the Company issued the Notes in an aggregate principal amount of $206,000. The Notes mature on April 15, 2020. The Notes were issued at 97% of par value with an interest rate at issuance of 13% per annum, subject to adjustment. Interest on the Notes is payable semi-annually, in arrears, on April 15 and October 15 of each year, beginning on October 15, 2013.
A "special interest trigger event" is deemed to have occurred under the indenture governing the Notes (the "Senior Notes Indenture") if the Company's net leverage ratio for the year ended December 31, 2013 is greater than 4.50 to 1.00. Upon the occurrence of a special interest trigger event, interest on the Notes accrues at the rate of 15% per annum, retroactive to April 4, 2013, with the interest in excess of 13% per annum payable (i) in the case of any interest payment date prior to April 15, 2018, by adding such excess interest to the principal amount of the Notes on the interest payment date, and (ii) for any interest payment date on or after April 15, 2018, in cash.
As of September 30, 2013, the Company determined it is probable that a special interest trigger event under the indenture governing the Notes will occur as of December 31, 2013 and has accrued interest on the Notes at 15% retroactive to April 4, 2013 representing an additional 2% interest, which additional interest is payable in kind until April 15, 2018 and in cash on subsequent interest dates. The Company recorded $2,014 in additional interest expense for the special interest trigger event during the three months ended September 30, 2013.
On or after April 15, 2017, the Company may, at its option, redeem some or all of the Notes at a premium decreasing ratably to zero as specified in the indenture, plus accrued and unpaid interest to, but not including, the redemption date. Prior to April 15, 2017, the Company may, at its option, redeem up to 35% of the aggregate principal amount of the Notes with the net cash proceeds of certain equity offerings at a redemption price of 113% of the aggregate principal amount of the redeemed notes plus accrued and unpaid interest to, but not including, the redemption date. In addition, at any time prior to April 15, 2017 the Company may, at its option, redeem some or all of the Notes by paying a "make whole" premium, plus accrued and unpaid interest to, but not including, the redemption date. If the Company experiences certain change of control events, the holders of the Notes will have the right to require the Company to purchase all or a portion of the Notes at a price in cash equal to 101% of the principal amount of such Notes, plus accrued and unpaid interest to, but not including, the date of purchase. In addition, the Company is required to use the net proceeds of certain asset sales, if not used for specified purposes, to purchase some of the Notes at 100% of the principal amount, plus accrued and unpaid interest to, but not including, the date of purchase. On each interest payment date after April 4, 2018, the Company will be required to redeem, for cash, a portion of each Note then outstanding equal to the amount necessary to prevent such Note from being treated as an “applicable high yield discount obligation” within the meaning of the Internal Revenue Code. The redemption price will be 100% of the principal amount plus accrued and unpaid interest thereon on the date of redemption.
The Notes are guaranteed, jointly and severally, on a senior secured basis by the Company's existing and future domestic subsidiaries. The Notes and the related guarantees are secured by a first-priority lien on the Company's and its domestic subsidiaries' assets (other than the Credit Facility Priority Collateral, as defined below, subject to some exceptions and permitted liens). The Notes and the related guarantees also are secured by a second-priority lien on all of Company's and its domestic subsidiaries' accounts receivable, inventory, cash, and certain other assets (collectively, the "Credit Facility Priority Collateral"), subject to certain exceptions and permitted liens. The Notes and the guarantees, respectively, rank equal in right

16


of payment with the Company's and its domestic subsidiaries' senior indebtedness, including indebtedness under the Capital One Credit Facility, before giving effect to collateral arrangements.
The Notes impose certain limitations on the ability of the Company and its domestic subsidiaries to, among other things, and subject to a number of important qualifications and exceptions, incur additional indebtedness or issue disqualified capital stock or preferred stock (with respect to restricted subsidiaries), grant liens, make payments in respect of their capital stock or certain indebtedness, enter into transactions with affiliates, create dividend or other payment restrictions affecting subsidiaries, merge or consolidate with any other person, sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets or adopt a plan of liquidation. The Company must annually report to the trustee on compliance with such limitations. The Notes also contain cross-default provisions whereby a payment default or acceleration of any indebtedness in an aggregate amount greater than a specified threshold would cause an event of default with respect to the Notes.
In connection with the issuance of the Notes, the Company entered into a Registration Rights Agreement under which the Company has agreed to, among other things, conduct a registered exchange offer with respect to the Notes. If the Company fails to fulfill its obligations under the Registration Rights Agreement in a timely manner, it may be required to pay additional interest on the Notes.
As of September 30, 2013, the Company was in compliance with the required covenants of the Senior Notes Indenture.
Lion Loan Agreement
On April 4, 2013, the Company repaid and terminated its outstanding obligations with Lion Capital LLP ("Lion" and the "Lion Loan Agreement", respectively) with a portion of the proceeds of the financing transactions. There were no early termination penalties associated with the repayment of the Lion Loan. The difference between the net carrying amount of the Lion debt of $117,926 (which includes the principal, accrued but unpaid interest, unamortized discount and unamortized financing cost immediately prior to the date of extinguishment) and the cash paid to Lion of $144,149 was recorded in the statement of operations for the nine months ended September 30, 2013 as a $26,223 loss on the early extinguishment of debt. As of September 30, 2013, other long-term debt includes $4,797 related to an 20% paid-in-kind interest loan agreement with Lion maturing on October 4, 2018. The agreement governing this loan contains cross-acceleration provisions that could be triggered if the Company’s indebtedness under the Capital One Credit Facility is accelerated upon the occurrence of an event of default or if the maturity of the Notes is accelerated.
Note 8. Fair Value of Financial Instruments
The fair value of the Company's financial instruments are measured on a recurring basis. The carrying amount reported in the accompanying condensed consolidated balance sheets for cash, accounts receivable (including credit card receivables), accounts payable and accrued expenses approximates fair value because of the short-term maturity of those instruments. The carrying amount for borrowings from Capital One and the Bank of Montreal approximates fair value because of the variable market interest rate charged to the Company for these borrowings. The fair value of the Notes was estimated using a discounted cash flow analysis and a yield rate that was estimated using yield rates for publicly traded debt instruments of comparable companies with similar features. The fair value of warrants was estimated using Binomial Lattice option valuation model.  
The Company did not have any assets or liabilities categorized as Level 1 or 2 as of September 30, 2013.
The following table presents carrying amounts and fair values of the Company's financial instruments as of September 30, 2013:
 
Carrying Amount
 
Fair Value
Liabilities
 
 
 
Senior Secured Notes due 2020
$
202,088

 
$
200,074

Lion Warrant

(a)
22,466

SOF Warrant

(a)

 
$
202,088

 
$
222,540

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


17


The following table summarizes the activity of Level 3 inputs measured on a recurring basis:
Fair Value Measurements of Common Stock Warrants using Significant Unobservable Inputs (Level 3)
Nine Months Ended September 30,
 
2013
 
2012
Balance at January 1,
$
17,241

 
$
9,633

Adjustment resulting from change in value recognized in earnings (a)
5,225

 
15,340

Gain on extinguishment of debt

 
3,482

Balance at September 30,
$
22,466

 
$
28,455

(a) Adjustment resulting from change in fair value is the amount of total gains or losses for the period attributable to the change in unrealized gains or losses relating to liabilities held at the reporting date. The unrealized gain or loss is recorded in unrealized loss on change in fair value of warrants in the accompanying condensed consolidated statements of operations.
Note 9. Income Taxes
Income taxes for the three and nine months ended September 30, 2013 were computed using the effective tax rate estimated to be applicable for the full fiscal year, which is subject to ongoing review and evaluation by management.
The Company incurred a loss from operations for the three and nine months ended September 30, 2013. During the three months ended September 30, 2012, the Company recorded income from operations and during the nine months ended September 30, 2012, the Company incurred loss from operations. Based primarily upon recent history of cumulative losses and the results of operations for the three and nine months ended September 30, 2013 and 2012, the Company determined that it is more likely than not it will not realize benefits from the deferred tax assets in certain jurisdictions. The Company will not record income tax benefits in the condensed consolidated financial statements until it is determined that it is more likely than not that the Company will generate sufficient taxable income in the respective jurisdictions to realize the deferred income tax assets. As a result of the analysis, the Company determined that a full valuation allowance against the net deferred tax assets in certain jurisdictions, primarily in the U.S., and a partial valuation allowance in certain foreign jurisdictions, is required. Section 382 of the Internal Revenue Code in the United States limits the utilization of net operating losses when ownership changes, as defined by that section, occur. The Company has performed an analysis and determined it is more likely than not that an ownership change has not occurred through December 31, 2012 and, accordingly, the net operating loss carryforwards through such date are not subject to an annual Section 382 limitation.
Management makes judgments as to the interpretation of the tax laws that might be challenged upon an audit and cause changes to previous estimates of tax liability. In addition, the Company operates within multiple taxing jurisdictions and is subject to audit in these jurisdictions.
The Company is currently subject to audit under the statute of limitations by the Internal Revenue Service for the years ended December 31, 2011 through December 31, 2012. The Company and its subsidiaries' state and foreign tax returns are open to audit under similar statute of limitations for the years ended December 31, 2007 through December 31, 2012, depending on the particular jurisdiction. The Company concluded its audit with the Internal Revenue Service for the years ended December 31, 2008 through December 31, 2010 with no tax owed due to utilization of net operating losses. The Company agreed to a settlement with Canada Revenue Agency for audit of the years ended December 31, 2005 through December 31, 2007.  Amounts to be paid pursuant to the agreed settlement are recorded in current liabilities at September 30, 2013.
The Company is currently being audited by the Internal Revenue Service for the year ended December 31, 2011. In management's opinion, adequate provisions for income taxes have been made for all years. If actual taxable income by tax jurisdiction varies from estimates, additional allowances or reversals of reserves may be necessary.
Note 10. Related Party Transactions
See Note 7 for a description of loans made by Lion to the Company and Note 11 for a description of the warrants issued by the Company to Lion.
Personal Guarantees by the Company’s CEO
As of September 30, 2013, the CEO of the Company has personally guaranteed the obligations of American Apparel under four property leases aggregating $6,261 in obligations. Additionally, the CEO of the Company has personally guaranteed the obligations of the Company with two vendors aggregating $1,000.

18


Lease Agreement Between the Company and a Related Party
The Company is party to an operating lease, expiring in November 2016, for its knitting facility with a related company (“American Central Plaza, LLC”), which is partially owned by the CEO and the Chief Manufacturing Officer ("CMO") of the Company. The Company's CEO holds an 18.75% ownership interest in American Central Plaza, LLC, while the CMO holds a 6.25% interest. The remaining members of American Central Plaza, LLC are not affiliated with the Company. Rent expense (including property taxes and insurance payments) for the three and nine months ended September 30, 2013 was $155 and $465 and for the three and nine months ended September 30, 2012 was $272 and $675, respectively.
Payments to Morris Charney
Morris Charney, (“Mr. M. Charney”), is the father of the Company's CEO and serves as a director of American Apparel Canada Wholesale Inc. and a director of American Apparel Canada Retail Inc. Day to day operations of these two Canadian subsidiaries are handled by management and other employees of these subsidiaries, none of whom performs any policy making functions for the Company. Management of American Apparel sets the policies for American Apparel and its subsidiaries as a whole. Mr. M. Charney does not perform any policy making functions for the Company or any of its subsidiaries. Instead, Mr. M. Charney only provides architectural consulting services primarily for stores located in Canada and, in limited cases, in the U.S. Mr. M. Charney was paid architectural consulting and director fees amounting to $26 and $160 for the three and nine months ended September 30, 2013 and $60 and $208 for the three and nine months ended September 30, 2012, respectively.
Note 11. Stockholders' (Deficit) Equity
Common Stock Warrants
Lion Warrants
As of September 30, 2013, Lion held warrants (the "Lion Warrants") to purchase 21,606 shares of the Company's common stock, with an exercise price of $0.75 per share. These warrants expire on February 18, 2022.
As of September 30, 2013, the fair value of the 21,606 Lion Warrants, estimated using the Binomial Lattice option valuation model, was $22,466 and was recorded as a current liability in the accompanying condensed consolidated balance sheets. The calculation as of September 30, 2013 assumed a stock price of $1.30, exercise price of $0.75, volatility of 71.40%, annual risk free interest rate of 2.33%, a contractual remaining term of 8.51 years and no dividends.
SOF Warrants
As of September 30, 2013, SOF Investments, L.P. ("SOF") held warrants to purchase 1,000 shares of the Company's common stock, with an exercise price of $2.148 per share, subject to adjustment under certain circumstances. These warrants expire on December 19, 2013.
As of September 30, 2013, the fair value of the SOF warrants, estimated using the Binomial Lattice option valuation model, was $0. The calculation as of September 30, 2013 assumed a stock price of $1.30, exercise price of $2.148, volatility of 39.17%, annual risk free interest rate of 0.02%, a contractual remaining term of 0.22 years and no dividends.
The following table summarizes common stock warrants issued, forfeited, expired and outstanding (shares in thousands):
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Contractual Life (Years)
Outstanding - January 1, 2013
22,606

 
$
0.81

 
8.8

 
Issued

 

 

 
Forfeited

 

 

 
Expired

 

 

 
Outstanding - September 30, 2013
22,606

 
$
0.81

 
8.0

 
Fair value - September 30, 2013
$
22,466

 
 
 
 
 
Earnings Per Share
The Company presents earnings per share (“EPS”) utilizing a dual presentation of basic and diluted EPS. Basic EPS includes no dilution and is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
The Company had common stock under various options, warrants and other agreements at September 30, 2013 and 2012. The weighted average effects of 53,583 and 56,874 shares at September 30, 2013 and 2012, respectively, were excluded from the

19


calculations of net loss per share for the three and nine months ended September 30, 2013 and 2012, because their impact would have been anti-dilutive.
A summary of the potential stock issuances under various options, warrants and other agreements that could have a dilutive effect on the shares outstanding as of September 30, 2013 and 2012 are as follows:
 
2013
 
2012
SOF warrants
1,000

 
1,000

Lion warrants
21,606

 
21,606

Shares issuable to Mr. Charney based on market conditions (1)
20,416

 
20,416

Contingent shares issuable to Mr. Charney based on market conditions (2)
2,112

 
2,112

Contingent shares issuable to Mr. Charney based on performance factors (3)
5,000

 
7,500

Employee options & restricted shares
3,449

 
4,240

 
53,583

 
56,874

(1) Charney Anti-Dilution Rights pursuant to the April 26, 2011 Investor Purchase Agreement
(2) Pursuant to the March 24, 2011 conversion of debt to equity
(3) Pursuant to Mr. Charney's employment agreement commencing April 1, 2012
The table above does not include additional warrants that may be issuable to Lion pursuant to the anti-dilution provisions under the Lion Loan Agreement such as in the event anti-dilutive shares are issued to Mr. Charney pursuant to the Charney Anti-Dilution Rights.
Note 12. Share-Based Compensation
Plan Description - On June 21, 2011 the Company's Board of Directors and stockholders approved the American Apparel, Inc. 2011 Omnibus Stock Incentive Plan (the “2011 Plan”). The 2011 Plan authorizes the granting of a variety of incentive awards, the exercise or vesting of which would allow up to an aggregate of 10,000 shares of the Company's common stock to be acquired by the holders of such awards. On June 25, 2013, the Company's Board of Directors and stockholders approved amendments to the 2011 Plan to increase the maximum number of shares reserved under the 2011 Plan to 17,500 shares and increase the number of shares that may be awarded to any one participant during any calendar year to 3,000 shares. The purpose of the 2011 Plan is to provide an incentive to selected employees, directors, independent contractors, and consultants of the Company or its affiliates, and provides that the Company may grant options, stock appreciation rights, restricted stock, and other stock-based and cash-based awards. As of September 30, 2013, there were approximately 13,461 shares available for future grants under the 2011 Plan.
Restricted Share Awards - The following table summarizes shares of restricted stock that were granted, vested, forfeited and outstanding (shares in thousands):
 
Number of Restricted Shares
 
Weighted Average Grant Date Fair Value
 
Weighted Average Remaining Vesting Period (in years)
Non-vested - January 1, 2013
2,644

 
$
1.33

 
1.3
Granted
857

 
1.81

 
 
Vested
(685
)
 
1.31

 
 
Forfeited
(67
)
 
1.53

 
 
Non-vested - September 30, 2013
2,749

 
$
1.48

 
0.8
Vesting of the restricted share awards to employees may be either immediately upon grant or over a period of three to five years of continued service by the employee in equal annual installments. Vesting is immediate in the case of members of the Board of Directors. Share-based compensation is recognized over the vesting period based on the grant-date fair value.

20


Stock Option Awards - The following table summarizes stock options granted, forfeited, expired and outstanding (shares in thousands):
 
Number of Shares
 
Weighted Average Exercise Price
 
Weighted Average Contractual Remaining Life (Years)
 
Aggregate Intrinsic Value
Outstanding - January 1, 2013
700

 
$
0.82

 
8.8

 
 
Granted

 

 

 
 
Forfeited

 

 

 
 
Expired

 

 

 
 
Outstanding - September 30, 2013
700

 
$
0.82

 
8.0

 
 
Vested - September 30, 2013
525

 
$
0.82

 
8.0

 
$

Non-vested - September 30, 2013
175

 
$
0.82

 
8.0

 
$

Share-Based Compensation Expense - During the three and nine months ended September 30, 2013, the Company recorded share-based compensation expense of $1,228 and $8,044, respectively, related to its share-based compensation awards that are expected to vest. During the three and nine months ended September 30, 2012, the Company recorded share-based compensation expense of $2,949 and $7,333, respectively, related to its share-based compensation awards that are expected to vest. No amounts have been capitalized. As of September 30, 2013 unrecorded compensation cost related to non-vested awards was $6,532, which is expected to be recognized through 2016.
CEO Anti-Dilution Rights - During the three and nine months ended September 30, 2013, the Company recorded share-based compensation expense (included in the above) associated with Mr. Charney's certain anti-dilution rights of $1,628 and $5,770, respectively. During the three and nine months ended September 30, 2012, the Company recorded share-based compensation expense (included in the above) associated with Mr. Charney's certain anti-dilution rights of $1,105 and $3,599, respectively. As of September 30, 2013, unrecorded compensation cost was $2,674, which is expected to be recognized through 2015.
CEO Performance-Based Award - Pursuant to an employment agreement with Mr. Charney commencing on April 1, 2012, the Company provided to the CEO rights to 7,500 shares of the Company's stock. The shares vest in three equal installments, one per each measurement period, only upon the achievement of certain EBITDA targets for each of fiscal 2012, 2013 and 2014. For the fiscal 2012 measurement period, the Company achieved the target EBITDA and Mr. Charney received 2,500 shares on June 25, 2013.
The grant date fair value of the award is based on the share price of $0.75. The remaining share-based compensation expense will be recognized over the related service and amortization period in two probability-weighted terms of 2.1 and 3.1 years corresponding to the two remaining measurement periods. During the three months ended September 30, 2013, the Company determined it was probable that certain EBITDA targets related to 2013 would not be achieved. As a result, the Company recorded an adjustment of $1,406 to reverse previously recorded share-based compensation related to unvested shares. During the three and nine months ended September 30, 2013, the Company recorded share-based compensation benefit of $1,015 and expense of $235 (included in the above), respectively. During the three and nine months ended September 30, 2012, the Company recorded share-based compensation expense (included in the above) of $859 and $1,718, respectively. As of September 30, 2013, unrecorded compensation cost was $937, which is attributable to certain EBITDA targets related to 2014 and is expected to be recognized through 2015.
Non-Employee Directors
On October 1, 2013, July 1, 2013, April 1, 2013 and January 2, 2013 the Company issued a quarterly stock grant to each non-employee director for services performed of approximately 8, 5, 5 and 9 shares of the Company's common stock, based on grant date fair values of $1.28, $1.88, $2.10 and $1.13 per share, respectively.

21


Note 13. Commitments and Contingencies
Operating Leases
The Company conducts retail operations under operating leases, which expire at various dates through September 2022. The Company's primary manufacturing facilities and executive offices are currently under a long-term lease, which expires on July 31, 2019. Operating lease rent expense (including real estate taxes and common area maintenance costs) was approximately $19,790 and $59,154 for the three and nine months ended September 30, 2013, respectively. Operating lease rent expense (including real estate taxes and common area maintenance costs) was approximately $19,667 and $57,483 for the three and nine months ended September 30, 2012, respectively. The Company did not incur any significant contingent rent during these periods. Rent expense is allocated to cost of sales (for production-related activities), selling expenses (primarily for retail stores) and general and administrative expenses in the accompanying condensed consolidated statements of operations.
Sales Tax
The Company sells its products through its wholesale business, retail stores and the internet. The Company operates these channels separately and accounts for sales and use tax accordingly. The Company is periodically audited by state taxing authorities and it is possible they may disagree with the Company's method of assessing and remitting these taxes. The Company believes that it properly assesses and remits all applicable state sales taxes in the applicable jurisdictions and has accrued approximately $289 as of September 30, 2013 and December 31, 2012 for state sales tax contingencies.
Customs and duties
The Company is being audited by German customs authorities for the years ended December 31, 2009 through December 31, 2011. In connection with the audit, the German customs has issued retroactive assessments on the Company's imports totaling $4,913 at the September 30, 2013 exchange rates (assessment was issued in Euros). The size of the retroactive assessments are largely due to member countries of the European Union (“E.U.”) limited right to impose retaliatory duties on certain imports of U.S. origin goods into the E.U., based upon the World Trade Organization's (“WTO”) Dispute Settlement procedures and the related WTO arbitrator rulings brought into place as a result of EU complaint against the U.S. "Continued Dumping and Subsidy Offset Act of 2000" (the "CDSOA") usually referred to as "the Byrd Amendment." Consequently, the German customs authorities are attempting to impose a substantially higher tariff rate than the original rate that the Company had paid on the imports, approximately doubling the amount of the tariff that the Company would have to pay.
The Company believes that it has valid arguments to challenge the merit of the German customs assessment and has filed litigation in German courts to contest such assessment. However, as the case is still in its preliminary stages, the Company is unable to reasonably estimate the financial outcome of the matter at this time as it cannot predict whether the outcome will be favorable or unfavorable to the Company, or if the Company will be required to advance material amounts during the pendency of the litigation, and accordingly has not recorded a provision for this matter. No assurance can be made that this matter will not result in a material financial exposure in connection with the audit, which could have a material adverse effect on the Company's financial condition, results of operations or cash flows.
Advertising
At September 30, 2013 and December 31, 2012, the Company had approximately $1,302 and $4,456, respectively, in open advertising commitments, which primarily relate to print advertisements in various newspapers and magazines, as well as outdoor advertising. The majority of these commitments are expected to be paid during the remainder of 2013.
Note 14. Workers' Compensation and Other Self-Insurance Reserves
The Company uses a combination of third-party insurance and/or self-insurance for a number of risks including workers’ compensation, medical benefits provided to employees, and general liability claims. General liability costs relate primarily to litigation that arises from store operations. Self-insurance reserves include estimates of both filed claims carried at their expected ultimate settlement value and claims incurred but not yet reported. The Company’s estimated claim amounts are discounted using a rate of 1.03% with a duration that approximates the duration of the Company’s self-insurance reserve portfolio. As of September 30, 2013 the undiscounted liability amount was $15,646. The Company’s liability reflected on the accompanying condensed consolidated balance sheets represents an estimate of the ultimate cost of claims incurred as of the balance sheet dates. In estimating this liability, the Company utilizes loss development factors based on Company specific data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claim settlements and reported claims. These projections are subject to a high degree of variability based upon future inflation rates, litigation trends, legal interpretations, benefit level changes and claim settlement patterns. Although the Company does not expect the amounts ultimately paid to differ significantly from its estimates, self-insurance reserves could be affected if future claim experience differs significantly from the historical trends and the assumptions applied.

22


The workers' compensation liability is based on an estimate of losses for claims incurred, but not paid at the end of the period. Funding is made directly to the providers and/or claimants by the insurance company. To guarantee performance under the workers' compensation program, as of September 30, 2013 and December 31, 2012, the Company had issued standby letters of credit in the amount of $1,100, with insurance companies being the beneficiaries, through a bank, and cash deposits of $16,124 and $14,624, respectively, in favor of insurance company beneficiaries. At September 30, 2013, the Company recorded a total reserve of $15,198, of which $3,831 is included in accrued expenses and $11,367 is included in other long-term liabilities on the accompanying condensed consolidated balance sheets. At December 31, 2012, the Company recorded a total reserve of $14,472, of which $3,778 is included in accrued expenses and $10,694 is included in other long-term liabilities on the accompanying condensed consolidated balance sheets.
The Company self-insures its health insurance benefit obligations while the claims are administered through a third party administrator. The medical benefit liability is based on estimated losses for claims incurred, but not paid at the end of the period. Funding is made directly to the providers and/or claimants by the insurance company. At September 30, 2013 and December 31, 2012, the Company's total reserve of $2,020 and $1,510, respectively, was included in accrued expenses in the accompanying condensed consolidated balance sheets.
Note 15. Business Segment and Geographic Area Information
The Company reports the following four operating segments: U.S. Wholesale, U.S. Retail, Canada, and International. The Company believes this method of segment reporting reflects both the way its business segments are managed and the way the performance of each segment is evaluated. The U.S. Wholesale segment consists of the Company's wholesale operations of sales of undecorated apparel products to distributors and third party screen printers in the United States, as well as the Company's online consumer sales generated in the U.S.. The U.S. Retail segment consists of the Company's retail operations in the United States, which comprised 140 retail stores operating in the United States, as of September 30, 2013. Canada segment includes retail, wholesale and online consumer operations in Canada. As of September 30, 2013, the retail operations in the Canada segment comprised 33 retail stores. The International segment includes retail, wholesale and online consumer operations outside of the United States and Canada. As of September 30, 2013, the retail operations in the International segment comprised 74 retail stores operating in 18 countries outside the United States and Canada. All of the Company's retail stores sell the Company's apparel products directly to consumers.
The Company's management evaluates performance based on a number of factors; however, the primary measures of performance are net sales and income or loss from operations of each business segment, as these are the key performance indicators reviewed by management. Operating income or loss for each segment does not include unallocated corporate general and administrative expenses, interest expense and other miscellaneous income/expense items. Corporate general and administrative expenses include, but are not limited to: human resources, legal, finance, information technology, accounting, executive compensation and various other corporate level expenses.

23


The following tables represent key financial information of the Company's reportable segments before unallocated corporate expenses:
 
Three Months Ended September 30, 2013
 
U.S. Wholesale 
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
41,232

 
$

 
$
3,044

 
$
1,725

 
$
46,001

Retail net sales

 
54,303

 
11,321

 
39,278

 
104,902

Online consumer net sales
8,993

 

 
668

 
3,979

 
13,640

Total net sales to external customers
50,225

 
54,303

 
15,033

 
44,982

 
164,543

Gross profit
13,407

 
34,755

 
8,477

 
28,001

 
84,640

Income (loss) from segment operations
1,441

 
(317
)
 
1,091

 
2,953

 
5,168

Depreciation and amortization
1,934

 
3,172

 
507

 
1,125

 
6,738

Capital expenditures
1,360

 
2,387

 
540

 
983

 
5,270

Retail store impairment

 

 
145

 
88

 
233

Deferred rent expense (benefit)
5

 
(338
)
 
(66
)
 
(148
)
 
(547
)
 
 
 
 
 
Three Months Ended September 30, 2012
 
U.S. Wholesale
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
39,862

 
$

 
$
3,215

 
$
2,113

 
$
45,190

Retail net sales

 
52,714

 
13,086

 
39,256

 
105,056

Online consumer net sales
6,985

 

 
416
 
4,513

 
11,914

Total net sales to external customers
46,847

 
52,714

 
16,717

 
45,882

 
162,160

Gross profit
12,873

 
34,361

 
10,166

 
27,800

 
85,200

Income from segment operations
5,811

 
3,116

 
721

 
4,192

 
13,840

Depreciation and amortization
1,446

 
2,747

 
394

 
951

 
5,538

Capital expenditures
3,300

 
2,136

 
328

 
894

 
6,658

Deferred rent expense (benefit)
297

 
(349
)
 
(58
)
 
(122
)
 
(232
)

24


 
Nine Months Ended September 30, 2013
 
U.S. Wholesale 
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
119,159

 
$

 
$
9,236

 
$
6,297

 
$
134,692

Retail net sales

 
149,811

 
31,664

 
105,629

 
287,104

Online consumer net sales
26,869

 

 
1,942

 
14,232

 
43,043

Total net sales to external customers
146,028

 
149,811

 
42,842

 
126,158

 
464,839

Gross profit
39,421

 
97,248

 
25,244

 
79,465

 
241,378

Income (loss) from segment operations
12,156

 
(2,239
)
 
1,592

 
7,022

 
18,531

Depreciation and amortization
5,327

 
9,231

 
1,388

 
3,209

 
19,155

Capital expenditures
5,847

 
9,377

 
970

 
2,713

 
18,907

Retail store impairment

 
78

 
145

 
88

 
311

Deferred rent expense (benefit)
43

 
(1,114
)
 
(279
)
 
(317
)
 
(1,667
)
 
 
 
Nine Months Ended September 30, 2012
 
U.S. Wholesale
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
110,380

 
$

 
$
9,449

 
$
7,183

 
$
127,012

Retail net sales

 
143,444

 
34,181

 
102,859

 
280,484

Online consumer net sales
21,232

 

 
1,466

 
14,088

 
36,786

Total net sales to external customers
131,612

 
143,444

 
45,096

 
124,130

 
444,282

Gross profit
36,582

 
93,977

 
26,627

 
77,106

 
234,292

Income (loss) from segment operations
18,324

 
449

 
(1,888
)
 
8,339

 
25,224

Depreciation and amortization
4,795

 
8,074

 
1,107

 
3,064

 
17,040

Capital expenditures
6,502

 
3,990

 
1,144

 
2,621

 
14,257

Retail store impairment

 

 
129

 

 
129

Deferred rent expense (benefit)
393

 
(509
)
 
(156
)
 
(377
)
 
(649
)
Reconciliation of reportable segments combined income from operations for the three and nine months ended September 30, 2013 and 2012 to the consolidated loss before income taxes is as follows:  
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
Consolidated income from operations of reportable segments
$
5,168

 
$
13,840

 
$
18,531

 
$
25,224

Unallocated corporate expenses
(9,661
)
 
(9,223
)
 
(35,415
)
 
(31,111
)
Interest expense
(10,121
)
 
(10,454
)
 
(29,555
)
 
(30,274
)
Foreign currency transaction gain (loss)
449

 
685

 
(422
)
 
(141
)
Unrealized gain (loss) on change in fair value of warrants
12,922

 
(13,312
)
 
(5,225
)
 
(15,340
)
(Loss) gain on extinguishment of debt

 

 
(32,101
)
 
11,588

Other expense
(58
)
 
(36
)
 
(42
)
 
(188
)
Consolidated loss before income taxes
$
(1,301
)
 
$
(18,500
)
 
$
(84,229
)
 
$
(40,242
)
 

25


Net sales by geographic location of customers for the three and nine months ended September 30, 2013 and 2012, are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2013
 
2012
 
2013
 
2012
United States
$
104,528

 
$
99,562

 
$
295,839

 
$
275,056

Canada
15,033

 
16,717

 
42,842

 
45,096

Europe (excluding United Kingdom)
19,065

 
17,311

 
51,996

 
48,901

United Kingdom
11,552

 
12,060

 
31,735

 
32,811

South Korea
2,987

 
3,451

 
8,093

 
8,371

China
1,950

 
1,549

 
5,526

 
3,791

Japan
4,977

 
6,151

 
14,421

 
15,190

Australia
2,503

 
3,629

 
9,071

 
10,116

Other foreign countries
1,948

 
1,730

 
5,316

 
4,950

Total consolidated net sales
$
164,543

 
$
162,160

 
$
464,839

 
$
444,282


Note 16. Litigation
The Company is subject to various claims and contingencies in the ordinary course of business, including those related to litigation, business transactions, employee-related matters and taxes, and others. When the Company is aware of a claim or potential claim, it assesses the likelihood of any loss or exposure. If it is probable that a loss will result and the amount of the loss can be reasonably estimated, the Company will record a liability for the loss. In addition to the estimated loss, the recorded liability includes probable and estimable legal costs associated with the claim or potential claim. There is no assurance that such matters will not materially and adversely affect the Company's business, financial position, and results of operations or cash flows.
Individual Actions
On 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 the Company 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 August 2013 the parties entered into a Conciliation Agreement providing for an immaterial compensatory payment to Ms. Hsu and the Company's agreement to comply with the Company's Policy on Sexual Harassment and Sexual Discrimination, which Policy was reviewed by the EEOC, and take certain administrative measures relating thereto. The Conciliation Agreement remains in effect for three years.
On November 5, 2009, Guillermo Ruiz, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of all current and former non-exempt California employees (Guillermo Ruiz, on behalf of himself and all others similarly situated v. American Apparel, Inc., Case Number BC425487) in the Superior Court of the State of California for the County of Los Angeles, alleging the Company failed to pay certain wages due for hours worked, to provide meal and rest periods or compensation in lieu thereof and to pay wages due upon termination to certain of the Company's employees. The complaint further alleges that the Company failed to comply with certain itemized employee wage statement provisions and violations of unfair competition law.  The plaintiff is seeking compensatory damages and economic and/or special damages in an unspecified amount, premium pay, wages and penalties, injunctive relief and restitution, and reimbursement for attorneys' fees, interest and the costs of the suit. This matter is now proceeding in arbitration.
On June 21, 2010, Antonio Partida, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of current and former non-exempt California employees (Antonio Partida, on behalf of himself and all others similarly situated v. American Apparel (USA), LLC, Case No. 30-2010-00382719-CU-OE-CXC) in the Superior Court of the State of California for the County of Orange, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation. The complaint further alleges that the Company failed to timely pay wages, unlawfully deducted wages and failed to comply with certain itemized employee wage statement provisions and violations of unfair competition law. The plaintiff is seeking compensatory damages and

26


economic and/or special damages in an unspecified amount, premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit. This matter is now proceeding in arbitration.
On or about December 2, 2010, Emilie Truong, a former employee of American Apparel, filed suit against the Company on behalf of putative classes of current and former non-exempt California employees (Emilie Truong, individually and on behalf of all others similarly situated v. American Apparel, Inc. and American Apparel LLC, Case No. BC450505) in the Superior Court of the State of California for the County of Los Angeles, alleging the Company failed to timely provide final paychecks upon separation.  Plaintiff is seeking unspecified premium wages, attorneys' fees and costs, disgorgement of profits, and an injunction against the alleged unlawful practices. This matter is now proceeding in arbitration.
On or about February 9, 2011, Jessica Heupel, a former retail employee filed suit on behalf of putative classes of current and former non-exempt California employees (Jessica Heupel, individually and on behalf of all others similarly situated v. American Apparel Retail, Inc., Case No. 37-2011-00085578-CU-OE-CTL) in the Superior Court of the State of California for the County of San Diego, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation.  The plaintiff is seeking monetary damages as follows: (1) for alleged meal and rest period violations; (2) for alleged failure to timely pay final wages, as well as for punitive damages for the same; and (3) unspecified damages for unpaid minimum wage and overtime.  In addition, Plaintiff seeks premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit. This matter is now proceeding in arbitration. On or about September 9, 2011, Anthony Heupel, a former retail employee initiated arbitration proceedings on behalf of putative classes of current and former non-exempt California employees, alleging the Company failed to pay certain wages for hours worked, to provide meal and rest periods or compensation in lieu thereof, and to pay wages due upon separation.  The plaintiff is seeking monetary damages in an amount in excess of $3,600, as follows: (1) for alleged meal and rest period violations; (2) for alleged failure to timely pay final wages, as well as for punitive damages for the same; and (3) unspecified damages for unpaid minimum wage and overtime.  In addition, Plaintiff seeks premium pay, wages and penalties, injunctive relief and restitution, and reimbursement of attorneys' fees, interest and the costs of the suit. This matter is now proceeding in arbitration.
The Company does not have insurance coverage for the above matters. The Company has accrued an estimate for the loss contingency for each of the above matters (excluding the Hsu case as noted above) in the Company's accompanying condensed consolidated balance sheet as of September 30, 2013. The Company may have an exposure to loss in excess of the amounts accrued, however, an estimate of such potential loss cannot be made at this time. Moreover, 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, larger than the Company's estimate, which could have a material adverse effect upon the Company's financial condition, results of operations or cash flows.
Additionally, the Company is currently engaged in other employment-related claims and other matters incidental to the Company's business.  The Company believes that all such claims against the Company are without merit or not material, and the Company intends to vigorously dispute the validity of the plaintiffs' claims. While the ultimate resolution of such claims cannot be determined, based on information at this time, the Company believes, but the Company cannot provide assurance that, the amount, and ultimate liability, if any, with respect to these actions will not materially affect the Company's business, financial position, results of operations, or cash flows. Should any of these matters be decided against the Company, the Company could not only incur liability but also experience an increase in similar suits and suffer reputational harm.
Derivative Matters
Two shareholder derivative lawsuits (Case No. CV106576 GAF (JCx) and Case No. CV107518 RSWL (FFMx)) were filed in the United States District Court for the Central District of California which were subsequently consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. CV106576 (the “Federal Derivative Action”).  Plaintiffs in the Federal Derivative Action allege a cause of action for breach of fiduciary duty arising out of (i) the Company's alleged failure to maintain adequate accounting and internal control policies and procedures; (ii) the Company's alleged violation of state and federal immigration laws in connection with the previously disclosed termination of over 1,500 employees following an Immigration and Customs Enforcement inspection; and (iii) the Company's alleged failure to implement controls sufficient to prevent a sexually hostile and discriminatory work environment.  The Company does not maintain any direct exposure to loss in connection with these shareholder derivative lawsuits. The Company's status as a “Nominal Defendant” in the actions reflects the fact that the lawsuits are maintained by the named plaintiffs on behalf of American Apparel and that plaintiffs seek damages on the Company's behalf. The Company filed a motion to dismiss the Federal Derivative Action which was granted with leave to amend on July 31, 2012. Plaintiffs did not amend the complaint and subsequently filed a motion to dismiss each of their claims, with prejudice, for the stated purpose of taking an immediate appeal of the Court's July 31, 2012 order. On October 16, 2012, the Court granted the Plaintiffs' motion to dismiss and entered judgment accordingly. On November 12, 2012, Plaintiffs filed a Notice of Appeal to the Ninth Circuit Court of Appeals where the case is currently pending.

27


Four shareholder derivative lawsuits (Case No. BC 443763, Case No. BC 443902, Case No. BC 445094, and Case No. BC 447890) were filed in fall of 2010 in the Superior Court of the State of California for the County of Los Angeles which were subsequently consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Derivative Litigation, Lead Case No. BC 443763 (the "State Derivative Action"). 
Three of the matters comprising the State Derivative Action allege causes of action for breach of fiduciary duty arising out of (i) the Company's alleged failure to maintain adequate accounting and internal control policies and procedures; and (ii) the Company's alleged violation of state and federal immigration laws in connection with the previously disclosed termination of over 1,500 employees following an Immigration and Customs Enforcement inspection.  The fourth matter alleges seven causes of action for breach of fiduciary duty, unjust enrichment, abuse of control, gross mismanagement, and waste of corporate assets also arising out of the same allegations.  On April 12, 2011, the Court issued an order granting a stay (which currently remains in place) of the State Derivative Action on the grounds that the case is duplicative of the Federal Derivative Action, as well as the Federal Securities Action currently pending in the United States District Court for the Central District of California (see below).
Both the Federal Derivative Action and State Derivative Actions are covered under the Company's Directors and Officers Liability insurance policy, subject to a deductible and a reservation of rights.
Other Proceedings
Four putative class action lawsuits, (Case No. CV106352 MMM (RCx), Case No. CV106513 MMM (RCx), Case No. CV106516 MMM (RCx), and Case No. CV106680 GW (JCGx)) were filed in the United States District Court for the Central District of California in the Fall of 2010 against American Apparel and certain of the Company's officers and executives on behalf of American Apparel shareholders. On December 3, 2010, the four lawsuits were consolidated for all purposes into a case entitled In re American Apparel, Inc. Shareholder Litigation, Lead Case No. CV106352 MMM (JCGx) (the “Federal Securities Action”). The lead plaintiff filed a consolidated class action complaint on April 29, 2011 on behalf of shareholders who purchased the Company's common stock between November 28, 2007 and August 17, 2010. The lead plaintiff alleges two causes of action for violations of Section 10(b) and 20(a) of the 1934 Act, and Rule 10b-5 promulgated under Section 10(b), arising out of alleged misrepresentations contained in the Company's press releases, public filings with the SEC, and other public statements relating to (i) the adequacy of the Company's internal and financial control policies and procedures; (ii) the Company's employment practices; and (iii) the effect that the dismissal of over 1,500 employees following an Immigration and Customs Enforcement inspection would have on the Company. Plaintiff seeks damages in an unspecified amount, reasonable attorneys' fees and costs, and equitable relief as the Court may deem proper.  The Company filed two motions to dismiss the Federal Securities Action which the court granted with leave to amend. Plaintiffs filed a Second Amended Complaint on February 15, 2013. The Company filed a motion to dismiss the complaint on March 15, 2013. The hearing on the motion was held on June 3, 2013, at which time, the Court took the matter under submission. On August 8, 2013, the court issued its final order granting the motion to dismiss in regards to certain claims. Defendants answered the complaint's remaining claims on September 27, 2013. Discovery in the federal class action has not yet begun. The Federal Securities Action is covered under the Company's Directors and Officers Liability insurance policy, subject to a deductible and a reservation of rights.
Should any of the above matters (i.e., the Federal Derivative Action, the State Derivative Action, or the Federal Securities Action) be decided against the Company in an amount that exceeds the Company's insurance coverage, or if liability is imposed on grounds which fall outside the scope of the Company's insurance coverage, the Company could not only incur a substantial liability, but also experience an increase in similar suits and suffer reputational harm.  The Company is unable to predict the financial outcome of these matters at this time, and any views formed as to the viability of these claims or the financial exposure which could result may change from time to time as the matters proceed through their course. However, no assurance can be made that these matters, either individually or together with the potential for similar suits and reputational harm, will not result in a material financial exposure, which could have a material adverse effect upon the Company's financial condition, results of operations, or cash flows.
The Company has previously disclosed an arbitration filed by the Company on February 17, 2011, related to cases filed in the Supreme Court of New York, County of Kings (Case No. 5018-1) and Superior Court of the State of California for the County of Los Angeles (Case Nos. BC457920 and BC460331) against American Apparel, Dov Charney and certain members of the Board of Directors asserting claims of sexual harassment, assault and battery, impersonation through the internet, defamation and other related claims.  The Company recently settled one of these cases with no monetary liability to the Company.  The Company recently prevailed on the sexual harassment claims in another of these cases.  While the ultimate resolution of the remaining claims cannot be determined, in light of the favorable ruling in one of these cases, the amount of settlement in the other of these cases, and based on information available at this time regarding the remaining cases, the Company believes, but the Company cannot provide assurances that, the amount and ultimate liability, if any, with respect to these remaining actions will not materially affect the Company's business, financial position, results of operations, or cash flows. 

28


Note 17. Condensed Consolidating Financial Information
The Notes (see Note 7), which constitute debt obligations of American Apparel Inc. (the "Parent") are fully and unconditionally guaranteed, jointly and severally, and on a senior secured basis, by the Company's existing and future 100% owned direct and indirect domestic subsidiaries. The following presents the condensed consolidating balance sheets as of September 30, 2013 and December 31, 2012, the condensed consolidating statements of operations for the three and nine months ended September 30, 2013 and 2012, and the condensed consolidating statements of cash flows for the nine months ended September 30, 2013 and 2012 of the Parent, the Company's material guarantor subsidiaries and the non-guarantor subsidiaries, and the elimination entries necessary to present the Company's financial statements on a consolidated basis. These condensed consolidating financial information should be read in conjunction with the accompanying condensed consolidated financial statements of the Company.

Condensed Consolidating Balance Sheets
September 30, 2013
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$

 
$
535

 
$
4,378

 
$

 
$
4,913

Trade accounts receivable, net

 
17,076

 
5,977

 

 
23,053

Intercompany accounts receivable, net
256,481

 
(239,205
)
 
(17,276
)
 

 

Inventories, net

 
133,250

 
37,572

 
(99
)
 
170,723

Other current assets
193

 
8,749

 
5,207

 

 
14,149

Total current assets
256,674

 
(79,595
)
 
35,858

 
(99
)
 
212,838

PROPERTY AND EQUIPMENT, net

 
55,505

 
16,010

 

 
71,515

INVESTMENTS IN SUBSIDIARIES
(80,014
)
 
22,596

 

 
57,418

 

OTHER ASSETS, net
9,659

 
26,982

 
11,939

 

 
48,580

TOTAL ASSETS
$
186,319

 
$
25,488

 
$
63,807

 
$
57,319

 
$
332,933

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

 
$
32,895

 
$
119

 
$

 
$
33,014

Accounts payable

 
28,237

 
3,310

 

 
31,547

Accrued expenses and other current liabilities
13,159

 
24,836

 
13,930

 

 
51,925

Fair value of warrant liability
22,466

 

 

 

 
22,466

Other current liabilities

 
4,515

 
1,987

 

 
6,502

Total current liabilities
35,625

 
90,483

 
19,346

 

 
145,454

LONG-TERM DEBT, net
206,885

 
47

 
305

 

 
207,237

OTHER LONG-TERM LIABILITIES

 
30,862

 
5,571

 

 
36,433

TOTAL LIABILITIES
242,510

 
121,392

 
25,222

 

 
389,124

STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
Common stock
11

 
100

 
492

 
(592
)
 
11

Additional paid-in capital
185,119

 
6,726

 
7,563

 
(14,289
)
 
185,119

Accumulated other comprehensive loss
(3,510
)
 
(663
)
 
(111
)
 
774

 
(3,510
)
(Accumulated deficit) retained earnings
(235,654
)
 
(102,067
)
 
30,641

 
71,426

 
(235,654
)
Less: Treasury stock
(2,157
)
 

 

 

 
(2,157
)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY
(56,191
)
 
(95,904
)
 
38,585

 
57,319

 
(56,191
)
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
$
186,319

 
$
25,488

 
$
63,807

 
$
57,319

 
$
332,933


29



Condensed Consolidating Balance Sheets
December 31, 2012
(Amounts in thousands)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$

 
$
3,796

 
$
9,057

 
$

 
$
12,853

Trade accounts receivable, net

 
15,697

 
7,265

 

 
22,962

Intercompany accounts receivable, net
200,529

 
(172,170
)
 
(28,359
)
 

 

Inventories, net

 
125,988

 
49,493

 
(1,252
)
 
174,229

Other current assets
438

 
8,200

 
5,708

 

 
14,346

Total current assets
200,967

 
(18,489
)
 
43,164

 
(1,252
)
 
224,390

PROPERTY AND EQUIPMENT, net

 
50,551

 
17,227

 

 
67,778

INVESTMENTS IN SUBSIDIARIES
(50,773
)
 
20,118

 

 
30,655

 

OTHER ASSETS, net
204

 
25,607

 
10,233

 

 
36,044

TOTAL ASSETS
$
150,398

 
$
77,787

 
$
70,624

 
$
29,403

 
$
328,212

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

 
$
56,156

 
$
4,400

 
$

 
$
60,556

Accounts payable

 
34,120

 
4,040

 

 
38,160

Accrued expenses and other current liabilities
1,679

 
24,137

 
15,700

 

 
41,516

Fair value of warrant liability
17,241

 

 

 

 
17,241

Other current liabilities
(286
)
 
1,778

 
2,644

 

 
4,136

Total current liabilities
18,634

 
116,191

 
26,784

 

 
161,609

LONG-TERM DEBT, net
109,680

 
6

 
326

 

 
110,012

OTHER LONG-TERM LIABILITIES

 
28,230

 
6,277

 

 
34,507

TOTAL LIABILITIES
128,314

 
144,427

 
33,387

 

 
306,128

STOCKHOLDERS' EQUITY (DEFICIT)
 
 
 
 
 
 
 
 
 
Common stock
11

 
100

 
492

 
(592
)
 
11

Additional paid-in capital
177,081

 
6,726

 
7,223

 
(13,949
)
 
177,081

Accumulated other comprehensive (loss) income
(2,725
)
 
(381
)
 
736

 
(355
)
 
(2,725
)
(Accumulated deficit) retained earnings
(150,126
)
 
(73,085
)
 
28,786

 
44,299

 
(150,126
)
Less: Treasury stock
(2,157
)
 

 

 

 
(2,157
)
TOTAL STOCKHOLDERS' EQUITY (DEFICIT)
22,084

 
(66,640
)
 
37,237

 
29,403

 
22,084

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY(DEFICIT)
$
150,398

 
$
77,787

 
$
70,624

 
$
29,403

 
$
328,212








30


Condensed Consolidating Statement of Operations and Comprehensive (Loss) Income
For the Three Months Ended September 30, 2013
(Amounts in thousands)
(Unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
Net sales
$

 
$
121,352

 
$
60,015

 
$
(16,824
)
 
$
164,543

Cost of sales

 
71,878

 
24,876

 
(16,851
)
 
79,903

Gross profit

 
49,474

 
35,139

 
27

 
84,640

Selling expenses

 
39,747

 
24,235

 

 
63,982

General and administrative expenses
(195
)
 
14,959

 
10,140

 
14

 
24,918

Retail store impairment

 

 
233

 

 
233