APP 06.30.2014 10Q
Table of Contents

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 quarter ended June 30, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File No. 001-32697  
 
American Apparel, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 

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

At August 1, 2014, the Registrant had issued and outstanding 175,533,788 and 174,161,765 shares of its common stock, respectively.

Table of Contents

AMERICAN APPAREL, INC.
TABLE OF CONTENTS
 
 
 
Page
Item 1.
 
Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013
 
Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended June 30, 2014 and 2013
 
Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013
 
Condensed Notes to Consolidated Financial Statements
Item 2.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Mine Safety Disclosures
Item 5.
Item 6.
 
 
 
 
 

 

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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 100% 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," "expect," "believe," "plan," "estimate," "potential," "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," "comfortable," "anticipate," "current," "intention," "position," "assume," "outlook," "remain," "maintain," "sustain," "seek," "achieve," and similar expressions.
Any statements that refer to projections of our future financial performance, 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:
•
consequences of the suspension of our chief executive officer, including the pending internal investigation related thereto, any litigation or regulatory investigations or any impact on our sales or brand, and any future determinations that may be made with respect thereto;
•
ability to hire and/or retain qualified employees, including at the chief executive officer and other executive levels;
•
future financial condition, results of operations, plans and prospects, expectations, goals and strategies for future growth, operating improvements and cost savings, and the timing of any of the foregoing;
•
growth, expansion and acquisition prospects and strategies, the success of such strategies, and the benefits we believe can be derived from such strategies; 
•
ability to make debt service payments and remain in compliance with financial covenants under financing arrangements and obtain appropriate waivers or amendments with respect to any noncompliance;
•
liquidity and projected cash flows;
•
plans to make continued investments in advertising and marketing; 
•
the outcome of investigations, enforcement actions and litigation matters, including exposure, which could exceed expectations;
•
intellectual property rights and those of others, including actual or potential competitors, our personnel, consultants, and collaborators; 
•
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; 
•
operations outside the U.S.; 
•
the impact of accounting pronouncements; 
•
ability to maintain compliance with the listing requirements of NYSE MKT LLC;
•
ability to improve manufacturing efficiency at our production facilities;
•
ability to improve efficiency and control costs at our distribution facility located in La Mirada, California; and
•
other assumptions described in this Quarterly Report on Form 10-Q underlying or relating to any forward-looking statements.
The forward-looking statements in this report speak only as of the date of this report and caution should be taken not to place undue reliance on any such forward-looking statements, which are qualified in their entirety by this cautionary statement. Forward-looking statements are subject to numerous assumptions, events, risks, uncertainties and other factors, including those that may be outside of our control and that change over time. As a result, actual results and/or the timing of events could differ materially from those expressed in or implied by the forward-looking statements and future results could differ materially from historical

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performance and those expressed in or implied by the forward-looking statements. Such assumptions, events, risks, uncertainties and other factors are found in Item IA. Risk Factors in Part II and elsewhere in this Quarterly Report on Form 10-Q, and the Annual Report on Form 10-K for the year ended December 31, 2013, and other reports and documents we file with the Securities and Exchange Commission (the "SEC") and include, without limitation, the following:
•
suspension and possible termination of our chief executive officer and consequences related thereto, including the pending internal investigation related thereto, any litigation or regulatory investigations or any impact on our sales or brand, and any future determinations that may be made with respect thereto;
•
changes in key personnel, our ability to hire and retain key personnel, and our relationship with our employees;
•
voting control by our executive officers, directors, lenders and other affiliates;
•
ability to successfully implement our strategic, operating, financial and personnel initiatives;
•
ability to effectively carry out and manage our strategy including growth and expansion in the U.S. and internationally;
•
ability to maintain the value and image of our brand and protect our intellectual property rights;
•
general economic conditions, geopolitical events, other regulatory changes, and inflation or deflation;
•
disruptions in the global financial markets;
•
the highly competitive and evolving nature of our business in the U.S. and internationally;
•
risks associated with the recent downturn in apparel spending in the U.S.;
•
loss or reduction in sales to wholesale or retail customers or financial nonperformance by our wholesale customers;
•
seasonality and fluctuations in comparable store sales and wholesale net sales and associated margins;
•
ability to improve manufacturing efficiency at our production facilities;
•
ability to pass on the added cost of raw materials and labor to customers;
•
changes in the price of raw materials in the global market and labor costs including increases in minimum wages;
•
ability to effectively manage inventory levels;
•
ability to operate our distribution facility located in La Mirada, California without further unanticipated costs or, negative sales impacts, including the ability to achieve, as and when planned, labor cost reductions;
•
risks that our suppliers or distributors may not timely produce or deliver products;
•
ability to renew leases on economic terms;
•
ability to identify store locations and negotiate new leases effectively; ability to open new stores and expand internationally; and the availability of store locations at appropriate terms;
•
ability to generate or obtain from external sources sufficient liquidity for operations and debt service;
•
consequences of our significant indebtedness including relationship with lenders; ability to comply with debt agreements; ability to generate cash flow to serve our debt; and the risk of acceleration of borrowings thereunder as a result of noncompliance;
•
adverse changes in our credit ratings and any related impact on financial costs and structure;
•
continued compliance with U.S. and foreign government regulations and legislation; and regulatory environments including environmental, immigration, labor, and occupational health and safety laws and regulations;
•
loss of U.S. import protections; changes in duties, tariffs and quotas; other risks associated with our foreign operations and supply sources under market disruption; changes in import and export laws; currency restrictions and exchange rate fluctuations;
•
litigation and other inquiries and investigations, including the risks that we, our officers, or directors in cases where indemnification applies, will not be successful in defending any proceedings, lawsuits, disputes, claims or audits, and that exposure could exceed expectations or insurance coverage;
•
tax assessments by domestic or foreign governmental authorities, including import or export duties on our products and the applicable rates for any such taxes or duties;
•
ability to maintain compliance with the exchange rules of the NYSE MKT LLC;
•
the adoption of new accounting standards or changes in interpretations of accounting principles;
•
adverse weather conditions or natural disaster, including those which may be related to climate change;
•
technological changes in manufacturing, wholesaling, or retailing;
•
the risk, including costs and timely delivery issues associated therewith, that information technology systems changes may disrupt our supply chain or operations and could impact cash flow and liquidity, and ability to upgrade information technology infrastructure and other risks associated with the systems that operate our online retail operations; and

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•
the risk of failure to protect the integrity and security of our information systems and our customers' information.
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.

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PART I-FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
American Apparel, Inc. and Subsidiaries
Consolidated Balance Sheets
(in thousands, except per-share amounts)
(unaudited)
 
 
June 30, 2014
 
December 31, 2013
ASSETS
 
 
 
Current assets:
 
 
 
     Cash
$
10,160

 
$
8,676

     Trade accounts receivable (net of allowances $2,592; $2,229)
26,214

 
20,701

     Prepaid expenses and other current assets
15,832

 
15,636

     Inventories, net
150,751

 
169,378

     Income taxes receivable and prepaid income taxes
476

 
306

     Deferred income taxes, net of valuation allowance
620

 
599

     Total current assets
204,053

 
215,296

Property and equipment, net
61,659

 
69,303

Deferred income taxes, net of valuation allowance
2,317

 
2,426

Other assets, net
46,336

 
46,727

TOTAL ASSETS
$
314,365

 
$
333,752

LIABILITIES AND STOCKHOLDERS' DEFICIT
 

 
 

Current liabilities:
 

 
 

     Cash overdraft
$
0

 
$
3,993

     Revolving credit facilities and current portion of long-term debt
30,568

 
44,042

     Accounts payable
34,818

 
38,290

Accrued expenses and other current liabilities
47,364

 
50,018

Fair value of warrant liability
16,489

 
20,954

Income taxes payable
1,897

 
1,742

Deferred income tax liability, current
1,233

 
1,241

Current portion of capital lease obligations
1,186

 
1,709

Total current liabilities
133,555

 
161,989

Long-term debt (net of unamortized discount $5,475; $5,779)
215,797

 
213,468

Capital lease obligations, net of current portion
4,172

 
5,453

Deferred tax liability
546

 
536

Deferred rent, net of current portion
15,137

 
18,225

Other long-term liabilities
12,760

 
11,485

TOTAL LIABILITIES
381,967

 
411,156

COMMITMENTS AND CONTINGENCIES


 


STOCKHOLDERS' DEFICIT
 

 
 

Preferred stock, $0.0001 par value per-share: authorized 1,000 shares; none issued
0

 
0

Common stock, $0.0001 par value per-share: authorized 230,000 shares;
Issued 175,537; 113,469, Outstanding 174,052; 111,330

17

 
11

Additional paid-in capital
216,537

 
185,472

Accumulated other comprehensive loss
(3,904
)
 
(4,306
)
Accumulated deficit
(278,095
)
 
(256,424
)
Less: Treasury stock, 304 shares at cost
(2,157
)
 
(2,157
)
TOTAL STOCKHOLDERS' DEFICIT
(67,602
)
 
(77,404
)
TOTAL LIABILITIES AND STOCKHOLDERS' DEFICIT
$
314,365

 
$
333,752



See accompanying condensed notes to consolidated financial statements.

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Net sales
$
162,397

 
$
162,236

 
$
299,493

 
$
300,296

Cost of sales
80,010

 
78,366

 
145,132

 
143,558

Gross profit
82,387

 
83,870

 
154,361

 
156,738

Selling expenses
52,443

 
57,790

 
106,505

 
113,253

General and administrative expenses (including related party charges of
$222; $227, $382; $444)
27,135

 
27,994

 
52,044

 
55,798

Retail store impairment
229

 
0

 
728

 
78

Income (loss) from operations
2,580

 
(1,914
)
 
(4,916
)
 
(12,391
)
Interest expense
10,019

 
8,220

 
20,058

 
19,434

Foreign currency transaction loss
0

 
158

 
132

 
871

Unrealized loss (gain) on change in fair value of warrants
8,202

 
(5,498
)
 
(4,465
)
 
18,147

Loss on extinguishment of debt
0

 
32,101

 
0

 
32,101

Other expense (income)
60

 
(11
)
 
52

 
(16
)
Loss before income taxes
(15,701
)
 
(36,884
)
 
(20,693
)
 
(82,928
)
Income tax provision
504

 
620

 
978

 
1,087

Net loss
$
(16,205
)
 
$
(37,504
)
 
$
(21,671
)
 
$
(84,015
)
 
 
 
 
 
 
 
 
Basic and diluted loss per-share
$
(0.09
)
 
$
(0.34
)
 
$
(0.14
)
 
$
(0.76
)
Weighted-average basic and diluted shares outstanding
173,643

 
110,241

 
152,987

 
110,080

 
 
 
 
 
 
 
 
Net loss (from above)
$
(16,205
)
 
$
(37,504
)
 
$
(21,671
)
 
$
(84,015
)
    Other comprehensive income (loss) items:
 
 
 
 
 
 
 
    Foreign currency translation
873

 
(726
)
 
402

 
(2,230
)
        Other comprehensive income (loss), net of tax
873

 
(726
)
 
402

 
(2,230
)
Comprehensive loss
$
(15,332
)
 
$
(38,230
)
 
$
(21,269
)
 
$
(86,245
)

See accompanying condensed notes to consolidated financial statements.
 

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

 
Six Months Ended June 30,
 
2014
 
2013
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Cash received from customers
$
295,135

 
$
297,293

Cash paid to suppliers, employees and others
(276,024
)
 
(305,435
)
Income taxes paid
(902
)
 
(724
)
Interest paid
(16,938
)
 
(5,067
)
Other
32

 
30

Net cash provided by (used in) operating activities
1,303

 
(13,903
)
 
 
 
 
CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Capital expenditures
(7,087
)
 
(13,637
)
Proceeds from sale of fixed assets
29

 
30

Restricted cash
178

 
1,756

Net cash used in investing activities
(6,880
)
 
(11,851
)
 
 
 
 
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Cash overdraft
(3,993
)
 
4,117

Repayments of expired revolving credit facilities, net
0

 
(28,513
)
(Repayments) borrowings under current revolving credit facilities, net
(13,457
)
 
29,830

Repayments of term loans and notes payable
(53
)
 
(25,507
)
Repayment of Lion term loan
0

 
(144,149
)
Issuance of Senior Secured Notes
0

 
199,820

Payments of debt issuance costs
(699
)
 
(11,651
)
Net proceeds from issuance of common stock
28,446

 
0

Payment of payroll statutory tax withholding on share-based compensation associated with issuance of common stock
(301
)
 
(2,119
)
Repayments of capital lease obligations
(1,828
)
 
(1,081
)
Net cash provided by financing activities
8,115

 
20,747

 
 
 
 
Effect of foreign exchange rate on cash
(1,054
)
 
(502
)
Net increase (decrease) in cash
1,484

 
(5,509
)
CASH, beginning of period
8,676

 
12,853

CASH, end of period
$
10,160

 
$
7,344


See accompanying condensed notes to consolidated financial statements.

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American Apparel, Inc. and Subsidiaries
Consolidated Statements of Cash Flows (continued)
(in thousands)
(unaudited)
 
Six Months Ended June 30,
 
2014
 
2013
RECONCILIATION OF NET LOSS TO NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES
 
 
 
Net loss
$
(21,671
)
 
$
(84,015
)
Depreciation and amortization of property and equipment, and other assets
13,418

 
12,417

Retail store impairment
728

 
78

Loss on disposal of property and equipment
76

 
15

Share-based compensation expense
2,658

 
6,816

Unrealized (gain) loss on change in fair value of warrants
(4,465
)
 
18,147

Amortization of debt discount and deferred financing costs
1,264

 
3,126

Loss on extinguishment of debt
0

 
32,101

Accrued interest paid-in-kind
2,078

 
4,653

Foreign currency transaction loss
132

 
871

Allowance for inventory shrinkage and obsolescence
818

 
1,346

Bad debt expense
517

 
301

Deferred income taxes
108

 
39

Deferred rent
(3,141
)
 
(1,120
)
Changes in cash due to changes in operating assets and liabilities:
 
 
 
Trade accounts receivables
(4,876
)
 
(3,304
)
Prepaid expenses and other current assets
(107
)
 
(4,040
)
Inventories
18,118

 
(1,809
)
Other assets
(157
)
 
(3,737
)
Accounts payable
(2,560
)
 
(5,562
)
Accrued expenses and other liabilities
(1,603
)
 
9,483

Income taxes receivable / payable
(32
)
 
291

Net cash provided by (used in) operating activities
$
1,303

 
$
(13,903
)
 
 
 
 
NON-CASH INVESTING AND FINANCING ACTIVITIES
 
 
 
Property and equipment acquired, and included in accounts payable
$
628

 
$
2,767


See accompanying condensed notes to consolidated financial statements.


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American Apparel, Inc. and Subsidiaries
Condensed Notes to Consolidated Financial Statements
(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. The Company 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 U.S. and internationally. In addition, the Company operates an online retail e-commerce website. At June 30, 2014, the Company operated a total of 247 retail stores in 20 countries; the U.S., Canada, and 18 other countries.
The Company Highlights
Recent Developments - On June 18, 2014, the Board of Directors suspended Dov Charney as President and Chief Executive Officer ("CEO") as well as Chairman of the Board of Directors.
In connection with the suspension of Mr. Charney, the Company might be deemed to have triggered an event of default under the loan agreement (the "Lion Loan Agreement") with Lion Capital LLP ("Lion"). On July 16, 2014, Lion assigned its rights and obligations as a lender under the Lion Loan Agreement to an entity affiliated with Standard General Group ("Standard General").
Standard General has waived any default under the Lion Loan Agreement that may have resulted or which might result from Mr. Charney not being the CEO of the Company and has agreed to amend the Lion Loan Agreement (the "Standard General Amendment").
In connection with a Nomination, Standstill and Support Agreement with Standard General and Mr. Charney dated July 9, 2014, five directors, including Mr. Charney, resigned from the Company's Board of Directors (the "Board"), effective as of August 2, 2014, and five new directors were appointed to the Board, three of which were designated by Standard General and two of which were appointed by the mutual agreement of Standard General and the Company.
Liquidity - As of June 30, 2014, the Company had $10,160 in cash, $30,554 outstanding on a $50,000 asset-backed revolving credit facility with Capital One Business Credit Corp. ("Capital One" and such facility, the "Capital One Credit Facility") and $16,891 of availability for additional borrowings.
In March 2014, the Company entered into the Fifth Amendment to the Capital One Credit Facility (the "Fifth Amendment") and waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three months ended December 31, 2013 and March 31, 2014. Based on the Fifth Amendment, the interest rates on borrowings under the Capital One Credit Facility equal to LIBOR plus 5.0% or the bank's prime rate plus 4.0% at the Company's option and are subject to specified borrowing requirements and covenants. In addition, the Fifth Amendment reset a minimum fixed charge coverage ratio, a maximum leverage ratio, and a maximum capital expenditures allowed, and added a minimum EBITDA covenant. For the three months ended June 30, 2014, the Company was required to maintain a minimum fixed charge coverage ratio of not less than 0.85 to 1.00 and achieve a minimum EBITDA of $9,000. The Company was in compliance with the covenant at June 30, 2014.
Management's Plan - The Company continues to develop initiatives intended to increase sales, reduce costs or improve liquidity. Beginning with the fourth quarter of 2013, the Company instituted various programs to reduce costs such as payroll and related costs associated with manufacturing and administrative overhead. The Company also limited capital expenditures starting the first quarter of 2014. In addition, the Company continues to drive productivity improvements from its new distribution center, inventory reductions, other labor cost reductions, and consolidation of administrative and manufacturing functions. Efforts to identify additional ways to reduce costs and improve productivity are ongoing.
Although the Company has made significant improvements under these programs, the Company operates in a rapidly evolving and often unpredictable business environment that may change the timing or amount of expected future cash receipts and expenditures. The Company's cash flows are dependent upon meeting future sales growth projections and reducing certain expenses. Accordingly, there can be no assurance that the Company's planned improvements will be successful.

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Note 2. Summary of Significant Accounting Policies
Principles of Consolidation and Basis of Presentation
The condensed consolidated financial statements include the accounts of American Apparel, Inc. and its 100% owned subsidiaries. The condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("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.
The financial data of the Company included herein is unaudited. The condensed consolidated financial statements do not contain certain information that was included in the annual financial statements included in the Company's Annual Report on Form 10-K for the year ended December 13, 2013. Readers are urged to review the Company's Annual Report on Form 10-K for the year ended December 31, 2013 as well as other publicly filed documents for more complete descriptions and discussions. In the opinion of management, the 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.
All intercompany balances and transactions have been eliminated upon consolidation. Certain prior year amounts have been reclassified to conform to the current year presentation.
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 and disclosures of contingent assets and liabilities at the date of the financial statements, and the 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 significant estimates include: inventory valuation and obsolescence; valuation and recoverability of long-lived assets, including the values assigned to goodwill and property and equipment; fair value calculations, including derivative liabilities; contingencies, including accruals for the outcome of current litigation and assessments and self-insurance; income taxes, including uncertain income tax positions and recoverability of deferred income taxes and any limitations as to net operating losses ("NOL"); and cash flow projections in assessing future performance related to financial standards requiring a prospective analysis in valuing and classifying assets and liabilities. Actual results could differ from those estimates.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentration of 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. Cash is managed within established guidelines, and the Company mitigates its risk by investing through major financial institutions. The Company had approximately $7,843 and $7,374 held in foreign banks at June 30, 2014 and December 31, 2013, respectively.
Concentration of credit risk with respect to trade accounts receivable is limited by performing on-going credit evaluations of its customers and adjusting credit limits based upon payment history and the customer's current credit worthiness. 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. As of June 30, 2014, two customers in the Company's U.S. Wholesale segment accounted for 18.5% and 10.3% of the Company's total trade accounts receivable. As of December 31, 2013, one customer accounted for 14.2% of the Company’s total trade accounts receivable. 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 financial instruments recorded in the consolidated balance sheets include cash, trade accounts receivable (including credit card receivables), accounts payable, revolving credit facilities, senior secured notes, term loans and warrants. Due to their short-term maturity, the carrying values of cash, trade accounts receivables, accounts payable and accrued expenses approximate their fair market values. In addition, the carrying amount of the revolving credit facility from Capital One approximates its fair value because of the variable market interest rate charged to the Company.
The Company employs a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date using the exit price. Accordingly, when market observable data is not readily available, the Company's own assumptions are used to reflect those that market participants would be presumed to

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use in pricing the asset or liability at the measurement date. Assets and liabilities recorded on the consolidated balance sheets at fair value are categorized based on the level of judgment associated with inputs used to measure their fair value and the level of market price observability, as follows:
Level 1 – Unadjusted quoted prices are available in active markets for identical assets or liabilities as of the reporting date.
Level 2 – Pricing inputs are other than unadjusted quoted prices in active markets, which are based on the following:
•Quoted prices for similar assets or liabilities in active markets;
•Quoted prices for identical or similar assets or liabilities in non-active markets; or
•Either directly or indirectly observable inputs as of the reporting date.
Level 3 – Pricing inputs are unobservable and significant to the overall fair value measurement, and the determination of fair value requires significant management judgment or estimation. The valuation policies and procedures underlying are determined by the Company's accounting and finance team and are approved by the Chief Financial Officer.
In certain cases, inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Thus, a Level 3 fair value measurement may include inputs that are observable (Level 1 or Level 2) and unobservable (Level 3). The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and consideration of factors specific to the asset or liability.
The Company uses prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the ability to observe prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2, or from Level 2 to Level 3. The Company recognizes transfers between levels at either the actual date of the event or a change in circumstances that caused the transfer.
As of June 30, 2014, there were no transfers between Levels 1, 2, and 3 of the fair value hierarchy.
Summary of Significant Valuation Techniques
Level 2 Measurements:
Senior secured notes: Estimated based on quoted prices for identical senior secured notes in non-active market.
Level 3 Measurements:
Term notes (Lion Loan Agreement): Estimated using a projected discounted cash flow analysis based on unobservable inputs including principal and interest payments and discount rate. A yield rate was estimated using yields rates for publicly traded debt instruments of comparable companies with similar features. See Note 8.
Warrants: 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. See Notes 8 and 11.
Indefinite-lived assets - goodwill: Estimated 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.
Retail stores: Estimated using a projected discounted cash flow analysis based on unobservable inputs including gross profit and discount rate. 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.
Income Taxes
Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial reporting basis and the respective tax basis of its assets and liabilities, and are measured 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. 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 and includes an assessment of the degree to which any losses are driven by items that are unusual in nature or 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

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results. If it becomes more likely than not that a tax asset will be realized, any related valuation allowance of such assets would be reversed.
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. Management believes that adequate provisions have been made for all years, but the outcome of tax audits cannot be predicted with certainty. If any issues addressed in the Company's tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution occurs.
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, Ireland, Italy, South Korea, and Spain, consolidated in the Company's U.S. federal income tax return. The Company is generally eligible to receive tax credits on its U.S. federal income tax return for most of the foreign taxes paid by the Company's subsidiaries included in the U.S. federal income tax return.
For financial statement purposes, the Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. Once this threshold has been met, the Company's measurement of its expected tax benefits is recognized in its financial statements. Gross unrecognized tax benefits are included in current liabilities in the consolidated balance sheets, and interest and penalties on unrecognized tax benefits are recorded in the income tax provision in the consolidated statements of operations.
Accounting Standards Updates
In June 2014, the Financial Accounting Standards Board ("FASB") issued a new standard on accounting for share-based payments. The new standard clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. As such, the performance target should not be reflected in estimating the grant date fair value of the award. The new standard also clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period for which the requisite service has already been rendered. The new standard will be effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. The Company is in the process of evaluating the impact of adoption on the Company's condensed consolidated financial statements.
In May 2014, the FASB issued a new standard on recognizing revenue in contracts with customers. The new standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance. The new standard creates a five-step process to recognize revenue that requires entities to exercise judgment when considering contract terms and relevant facts and circumstances. The new standard also requires expanded disclosures surrounding revenue recognition. The new standard will be effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2016. The Company is in the process of evaluating the impact of adoption on the Company's condensed consolidated financial statements.
Other recently issued accounting standards are not expected to have a material effect on the Company's condensed consolidated financial statements.
Note 3. Inventories
The components of inventories are as follows:  
 
June 30, 2014
 
December 31, 2013
Raw materials
$
18,580

 
$
23,199

Work in process
3,084

 
2,596

Finished goods
132,693

 
146,361

 
154,357

 
172,156

Less reserve for inventory shrinkage and obsolescence
(3,606
)
 
(2,778
)
Total, net of reserves
$
150,751

 
$
169,378

Inventories consist of material, labor, and overhead, and are stated at the lower of cost or market. Cost is primarily determined on the first-in, first-out (FIFO) method. For the three and six months ended June 30, 2014 and 2013, no 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 records lower of cost or market reserves for such identified excess and slow-moving inventories. The Company had a lower of cost or market reserve for excess and slow-moving inventories of $1,928 and $1,951 at June 30, 2014 and December 31, 2013, respectively.
The Company establishes a reserve for inventory shrinkage for each of its retail locations and warehouse based on the historical results of physical inventory cycle counts. Inventory shrinkage reserves were $1,678 and $827 as of June 30, 2014 and December 31, 2013, respectively.

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Note 4. Property and Equipment
Depreciation and amortization expense relating to property and equipment (including capitalized leases) is recorded in cost of sales and general and administrative expenses in the consolidated statements of operations. Depreciation and amortization expenses were $6,703 and $6,386 for the three months ended June 30, 2014 and 2013, respectively, and $13,418 and $12,417 for the six months ended June 30, 2014 and 2013, respectively.
Based on the Company's retail store impairment analysis, it recorded impairment charges of $229 and $0 for the three months ended June 30, 2014 and 2013, respectively, and $728 and $78 for the six months ended June 30, 2014 and 2013, respectively.
Note 5. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows:
 
June 30, 2014
 
December 31, 2013
Compensation, bonuses and related taxes
$
8,865

 
$
11,773

Accrued interest
5,842

 
6,064

Workers' compensation and other self-insurance reserves (Note 14)
6,623

 
6,383

Sales, value and property taxes
2,002

 
3,868

Gift cards and store credits
6,600

 
7,391

Loss contingencies
2,479

 
1,177

Deferred revenue
578

 
1,258

Deferred rent
3,385

 
3,363

Other
10,990

 
8,741

Total accrued expenses and other current liabilities
$
47,364

 
$
50,018

Note 6. Revolving Credit Facilities and Current Portion of Long-Term Debt
The following table presents revolving credit facilities and current portion of long-term debt:
 
Lender
 
Expiration
 
June 30, 2014
 
December 31, 2013
Revolving credit facility
Capital One
 
April 14, 2018
 
$
30,554

 
$
43,526

Revolving credit facility
Bank of Montreal
 
March 31, 2014
 
0

 
443

Current portion of long-term debt
 
 
 
 
14

 
73

Total
 
 
 
 
$
30,568

 
$
44,042

The Company incurred interest charges of $10,019 and $8,220 for the three months ended June 30, 2014 and 2013, respectively, and $20,058 and $19,434 for the six months ended June 30, 2014 and 2013, respectively, for all outstanding borrowings. The interest charges subject to capitalization were not significant for the three and six months ended June 30, 2014 and 2013.
Revolving Credit Facility - Capital One
In March 2014, the Company entered into the Fifth Amendment to the Capital One Credit Facility which waived the obligation to maintain the minimum fixed charge coverage and maximum leverage ratios for the three months ended December 31, 2013 and March 31, 2014. Based on the Fifth Amendment, the interest rates on borrowings under the Capital One Credit Facility equal to LIBOR plus 5.0% or the bank's prime rate plus 4.0% at the Company's option and are subject to specified borrowing requirements and covenants. In addition, the Fifth Amendment reset a minimum fixed charge coverage ratio, a maximum leverage ratio, and a maximum capital expenditures allowed and added a minimum EBITDA covenant. For the three months ended June 30, 2014, the Company was required to maintain a minimum fixed charge coverage ratio of not less than 0.85 to 1.00 and achieve a minimum EBITDA of $9,000. The Company was in compliance with the covenants at June 30, 2014.
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 restrictions. It requires that the Company maintain a lockbox arrangement and contains certain subjective acceleration clauses. In addition, Capital One may adjust the advance restriction and criteria for eligible inventory and accounts receivable at its discretion. The Capital One Credit Facility contains cross-default provisions whereby an event of default under the Senior Notes Indenture (the "Indenture") 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. As of June 30, 2014, the Company had $1,230 of outstanding letters of credit secured against the Capital One Credit Facility.

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The Company had $30,554 and $43,526 outstanding on a $50,000 asset-backed revolving credit facility with Capital One as of June 30, 2014 and December 31, 2013, respectively. The amount available for additional borrowings on June 30, 2014 was $16,891. The Capital One Credit Facility matures on April 14, 2018 and is subject to a January 15, 2018 maturity if excess availability is less than $15,000 at the time of notice to Capital One that an Applicable High Yield Discount Obligation redemption will be required pursuant to Section 3.01(e) of the Indenture governing the Notes (as defined in Note 7).
Revolving Credit Facility - Bank of Montreal
The Company's 100% owned Canadian subsidiaries had a revolving credit facility with Bank of Montreal. Outstanding amounts under this credit facility were repaid, and the agreement expired on March 31, 2014.
Note 7. Long-Term Debt
Long-term debt consists of the following:
 
June 30, 2014
 
December 31, 2013
Senior Secured Notes due 2020 (a)
$
205,647

 
$
203,265

Lion Loan Agreement (b)
9,865

 
9,865

Other
299

 
411

Total long-term debt
215,811

 
213,541

Current portion of debt
(14
)
 
(73
)
Long-term debt, net of current portion
$
215,797

 
$
213,468

(a) Includes accrued interest paid in-kind of $5,122 and $3,044 and net of unamortized discount of $5,475 and $5,779 at June 30, 2014 and December 31, 2013, respectively.
(b) Includes accrued interest paid in-kind of $365 at both June 30, 2014 and December 31, 2013.
      
Senior Secured Notes due 2020
On April 4, 2013, the Company issued the senior secured notes (the "Notes") in an aggregate principal amount of $206,000 at 97% of par value. The Notes mature on April 15, 2020 and bear interest at 15% per annum, of which 2% is payable in-kind until April 14, 2018 and in cash on subsequent interest dates. Interest on the Notes of approximately $13,500 per payment period in 2014 is payable semi-annually, in arrears, on April 15 and October 15 of each year, beginning on October 15, 2013. On April 14, 2014, the Company paid $13,390 in interest on the Notes.
On or after April 15, 2017, the Company may, at its option, redeem some or all of the Notes at a premium, decreasing ratably over time to zero as specified in the Indenture, plus accrued and unpaid interest to 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 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 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, 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' cash, trade accounts receivable, inventory 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 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

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or preferred stock (with respect to restricted subsidiaries), grant liens, make payments in respect of their capital stock or certain indebtedness, enter into transactions with affiliates, create dividend or other payment restrictions affecting subsidiaries, merge or consolidate with any other person, sell, assign, transfer, lease, convey or otherwise dispose of all or substantially all of its assets or adopt a plan of liquidation. The Company must annually report to the trustee on compliance with such limitations. The Notes also contain cross-default provisions whereby a payment default or acceleration of any indebtedness in an aggregate amount greater than a specified threshold would cause an event of default with respect to the Notes.
As of June 30, 2014, the Company was in compliance with the required covenants of the Indenture.
Lion Loan Agreement
The term loans under the Lion Loan Agreement are scheduled to mature on October 4, 2018 and bear interest at 20% per annum. Interest under the Lion Loan Agreement is payable in cash or in-kind. The interest was being paid in cash.
On July 7, 2014, Lion issued a notice of acceleration to the Company under the Lion Loan Agreement as a result of the Board of Directors' decision to suspend Mr. Charney as CEO of the Company (see Note 1). The notice accelerated and declared the amounts outstanding under the Lion Loan Agreement and any accrued interest immediately due and payable. On July 14, 2014, Lion issued a notice rescinding the notice of accelerations.
In connection with the suspension of Mr. Charney, the Company might be deemed to have triggered an event of default under the loan agreement (the "Lion Loan Agreement") with Lion Capital LLP ("Lion"). On July 16, 2014, Lion assigned its rights and obligations as a lender under the Lion Loan Agreement to an entity affiliated with Standard General Group ("Standard General"). Standard General has waived any default under the Lion Loan Agreement that may have resulted or which might result from Mr. Charney not being the CEO of the Company and has agreed to amend the Lion Loan Agreement.
.
Note 8. Fair Value of Financial Instruments
The Company's financial instruments at fair value are measured on a recurring basis. Related unrealized gains or losses are recognized in unrealized loss (gain) on change in fair value of warrants in the consolidated statements of operations. For additional disclosures regarding methods and assumptions used in estimating fair values of these financial instruments, see Note 2.
The following tables present carrying amounts and fair values of the Company's financial instruments as of June 30, 2014 and December 31, 2013, and indicate the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value. The Company did not have any assets or liabilities categorized as Level 1 as of June 30, 2014.
 
 
June 30, 2014
 
 
Carrying Amount
 
Fair Value
Senior Secured Notes due 2020
Level 2 Liability
$
205,647

 
$
198,018

Lion Loan Agreement
Level 3 Liability
9,865

 
9,372

Lion Warrant
Level 3 Liability
(a)

 
16,489

 
 
$
215,512

 
$
223,879

 
 
 
 
 
 
 
December 31, 2013
 
 
Carrying Amount
 
Fair Value
Senior Secured Notes due 2020
Level 2 Liability
$
203,265

 
$
191,065

Lion Loan Agreement
Level 3 Liability
9,865

 
9,773

Lion Warrant
Level 3 Liability
(a)

 
20,954

 
 
$
213,130

 
$
221,792

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


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The following table presents the activity of Level 3 inputs measured on a recurring basis:
 
Three Months Ended June 30,
 
Six Months Ended June 30, 2014
 
2014
 
2013
 
2014
 
2013
Beginning balance
$
8,287

 
$
40,886

 
$
20,954

 
$
17,241

Adjustments included in earnings (a)
8,202

 
(5,498
)
 
(4,465
)
 
18,147

Balance at June 30,
$
16,489

 
$
35,388

 
$
16,489

 
$
35,388

(a) 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 gains or losses are recorded in unrealized loss (gain) on change in fair value of warrants in the consolidated statements of operations.
At June 30, 2014, the Company did not have any nonrecurring fair value measurements of nonfinancial assets or nonfinancial liabilities.
Note 9. Income Taxes
Income taxes for the three and six months ended June 30, 2014 and 2013 were computed using an 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 losses from operations for the three and six months ended June 30, 2014 and 2013. Based upon these results and the recent history of cumulative losses for the prior three years, as well as trends in the Company's performance projected through 2014, the Company's management believes that it is more likely than not deferred tax assets in certain jurisdictions are not fully realizable. Accordingly, the Company will not record any income tax benefits in the condensed consolidated financial statements until it is determined that the Company will generate sufficient taxable income in the respective jurisdictions to realize the deferred income tax assets. As a result of the analysis, the Company determined that a full valuation allowance against the net deferred tax assets in certain jurisdictions, primarily in the U.S., and partial valuation allowances in certain foreign jurisdictions, is required.
The Internal Revenue Code, Section 382, as amended, imposes annual limitation on the utilization of NOL carryforwards, other tax carryforwards, and certain built-in losses upon an ownership change. The Company performed an analysis determining it was more likely than not that an ownership change had not occurred through December 31, 2013, and accordingly, NOL carryforwards through such date are not subject to an annual Section 382 limitation. On March 31, 2014, the Company completed a public offering of 61,645 shares of its common stock. On June 25, 2014 Standard General entered into an agreement with Mr. Charney to purchase shares of the Company's common stock and then loan Mr. Charney the funds necessary to acquire those shares from Standard General. On June 27, 2014, Standard General sold 27,351 shares of the Company's common stock to Mr. Charney. As of June 30, 2014, the Company has not completed an analysis whether an ownership change occurred under Section 382, which, if it did occur, could substantially limit its ability in the future to utilize its NOLs and other tax carryforwards.
The Internal Revenue Service completed its audit on the Company's tax year 2011, and there was no assessment. Tax years that remain subject to audits by the Internal Revenue Service are 2012 through 2013. The Company's state and foreign tax returns are open to audit under similar statute of limitations for the calendar years 2008 through 2013.
Note 10. Related Party Transactions
Personal Guarantees by Mr. Charney
As of June 30, 2014, Mr. Charney had personally guaranteed the obligations of the Company under three property leases aggregating $10,130 in obligations. Additionally, Mr. Charney had personally guaranteed the obligations of the Company with three vendors aggregating $1,970. The personal guarantees will expire on December 31, 2014.
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 American Central Plaza LLC, which is partially owned by Mr. Charney and Marty Bailey, the Company's Chief Manufacturing Officer ("CMO"). Mr. Charney 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 expenses (including property taxes and insurance payments) related to this lease were $207 and $155 for the three months ended June 30, 2014 and 2013, respectively, and $311 and $310 for the six months ended June 30, 2014 and 2013, respectively.

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Payments to Morris Charney
Morris Charney ("Mr. M. Charney") is the father of Mr. Charney and served as a director of American Apparel Canada Wholesale Inc. and a director of American Apparel Canada Retail Inc until June 28, 2014. Day to day operations of these two Canadian subsidiaries are handled by their management and employees, 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 did not perform any policy making functions for the Company or any of its subsidiaries. Instead, Mr. M. Charney only provided architectural consulting services primarily for stores located in Canada. Mr. M. Charney was paid architectural consulting and director fees amounting to $15 and $72 for the three months ended June 30, 2014 and 2013, respectively, and $71 and $134 for the six months ended June 30, 2014 and 2013, respectively.
See Note 7 for a description of loans made by Lion to the Company and Note 11 for a description of warrants issued by the Company to Lion.
Note 11. Stockholders' Deficit
Public Offering
On March 31, 2014, the Company completed a public offering of approximately 61,645 shares of its common stock at $0.50 per share for net proceeds of $28,446.
Common Stock Warrants
As a result of the public offering in March 2014, Lion received the right to purchase an additional 2,905 shares of the Company's common stock, and the exercise price of all of Lion held warrants (the "Lion Warrants") was adjusted from $0.75 per share to $0.66 per share. Such adjustments were required by the terms of the existing Lion Warrants. As of June 30, 2014, Lion held warrants to purchase 24,511 shares of the Company's common stock, with an exercise price of $0.66 per share. These warrants will expire on February 18, 2022.
The Lion Warrants, as amended, contain certain anti-dilution protections in favor of Lion providing for proportional adjustment of the warrant price and, under certain circumstances, the number of shares of the Company's common stock issuable upon exercise of the Lion Warrant, in connection with, among other things, stock dividends, subdivisions and combinations and the issuance of additional equity securities at less than fair market value, as well as providing for the issuance of additional warrants to Lion in the event of certain equity sales or debt for equity exchanges.
As of June 30, 2014, the fair value of the 24,511 Lion Warrants, estimated using the Binomial Lattice option valuation model, was $16,489 and was recorded as a current liability in the consolidated balance sheets. The calculation assumed a stock price of $0.90, exercise price of $0.66, volatility of 71.55%, annual risk free interest rate of 2.23%, a contractual remaining term of 7.8 years and no dividends.
The following table presents a summary of common stock warrants activity as of June 30, 2014:
 
Shares
(in thousands)
 
Weighted-Average Exercise Price
 
Weighted-Average Contractual Life
(in years)
Outstanding - January 1, 2014
21,606

 
$
0.75

 
8.2
 
Issued (a)
24,511

 
$
0.66

 
8.0
 
Forfeited (a)
(21,606
)
 
$
0.75

 
0.0
 
Expired
0

 
$
0.00

 
0.0
 
Outstanding - June 30, 2014
24,511

 
$
0.66

 
7.8
 
Fair value - June 30, 2014
$
16,489

 
 
 
 
 
(a) Issued and forfeited warrants represents repriced shares.
Earnings Per Share
The Company presents earnings per share ("EPS") utilizing a dual presentation of basic and diluted EPS. Basic EPS excludes dilution and reflects net loss divided by the weighted-average shares of common stock outstanding for the period presented. 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 June 30, 2014 and December 31, 2013. The weighted-average effects of 40,018 and 53,451 shares at June 30, 2014 and 2013, respectively, were excluded from the calculations of net loss per share for the three and six months ended June 30, 2014 and 2013 because their impact would have been anti-dilutive.

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A summary of the potential stock issuances under various options, warrants and other agreements that could have a dilutive effect on the shares outstanding are as follows:
 
June 30,
 
2014
 
2013
SOF warrants
0

 
1,000

Lion warrants
24,511

 
21,606

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

 
20,416

Contingent shares issuable to Mr. Charney based on market conditions (b)
0

 
2,112

Contingent shares issuable to Mr. Charney based on performance conditions (c)
0

 
5,000

Employee options and restricted shares
1,896

 
3,317

 
40,018

 
53,451

(a) Charney Anti-Dilution Rights pursuant to the April 26, 2011 Investor Purchase Agreement, of which 6,805 expired unexercised on April 15, 2014.
(b) Pursuant to the March 24, 2011 conversion of debt to equity, which expired unexercised on March 24, 2014.
(c) Pursuant to Mr. Charney's employment agreement commenced April 1, 2012 (Note 12).
Note 12. Share-Based Compensation
The American Apparel, Inc. 2011 Omnibus Stock Incentive Plan (the "2011 Plan") authorizes the granting of a variety of incentive awards, the exercise or vesting of which would allow up to an aggregate of 17,500 shares of the Company's common stock to be acquired by the holders of such awards and authorizes up to 3,000 shares that may be awarded to any one participant during any calendar year. The purpose of the 2011 Plan is to provide an incentive to selected employees, directors, independent contractors, and consultants of the Company or its affiliates, and provides that the Company may grant options, stock appreciation rights, restricted stock, and other stock-based and cash-based awards. As of June 30, 2014, there were approximately 12,993 shares available for future grants under the 2011 Plan.
Restricted Share Awards - The following table presents a summary of the restricted share awards activity as of June 30, 2014:
 
Shares
(in thousands)
 
Weighted-Average Grant Date Fair Value Per-Share
 
Weighted-Average Remaining Vesting Period (in years)
Non-vested - January 1, 2014
1,850

 
$
1.46

 
0.9
Granted
704

 
$
0.68

 
 
Vested
(1,077
)
 
$
0.93

 
 
Forfeited
(281
)
 
$
1.65

 
 
Non-vested - June 30, 2014
1,196

 
$
1.43

 
0.6
Vesting of the restricted share awards to employees are generally either immediately upon grant or over a period of three to five years of continued service by the employee in equal annual installments. Vesting is immediate in the case of members of the Board of Directors. Share-based compensation is recognized over the vesting period based on the grant-date fair value.
Stock Option Awards - The following table presents a summary of the stock option activity as of June 30, 2014:
 
Shares
(in thousands)
 
Weighted-Average Exercise Price
 
Weighted-Average Contractual Remaining Life
(in years)
 
Aggregate Intrinsic Value
Outstanding - January 1, 2014
700

 
$
0.82

 
7.8
 
 
Granted
0

 
 
 
 
 
 
Forfeited
0

 
 
 
 
 
 
Expired
0

 
 
 
 
 
 
Outstanding - June 30, 2014
700

 
$
0.82

 
7.3
 
$
56

Vested - June 30, 2014
700

 
$
0.82

 
7.3
 
$
56

Non-vested - June 30, 2014
0

 
$
0.00

 
 
 
 

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Share-Based Compensation Expense - The Company recorded share-based compensation expenses of $1,543 and $3,263 for the three months ended June 30, 2014 and 2013, respectively, and $2,658 and $6,816 for the six months ended June 30, 2014 and 2013, respectively, related to its share-based compensation awards that are expected to vest. No amounts have been capitalized. As of June 30, 2014, unrecorded compensation cost related to non-vested awards was $2,218, which is expected to be recognized through 2017.
Mr. Charney Anti-Dilution Rights - The Company recorded share-based compensation expense (included in the above) associated with Mr. Charney's certain anti-dilution rights of $687 and $2,071 for the three months ended June 30, 2014 and 2013, respectively, and $1,376 and $4,142 for the six months ended June 30, 2014 and 2013, respectively. As of June 30, 2014, unrecorded compensation cost related to non-vested awards was $608, which is expected to be recognized through 2015. On April 15, 2014, the last day of the first measurement period, the Company determined that the vesting requirements for such period were not met, and as a result, 6,805 of the 20,416 anti-dilution rights expired unexercised.
Mr. Charney Performance-Based Award - Effective April 1, 2012, the Company provided Mr. Charney the rights to 7,500 shares of the Company's stock which were issuable three equal installments, one per each measurement period, only upon the achievement of certain EBITDA targets for each of fiscal 2012, 2013 and 2014. The fair value of the award was based on the grant-date share price of $0.75 per share. For 2012, the Company achieved the target EBITDA and Mr. Charney received 2,500 shares, but did not achieve the target EBITDA for 2013. For 2014, the achievement of the performance condition was not considered probable as of June 30, 2014. As of June 30, 2014, there was no unrecorded compensation cost related to this EBITDA award. The Company recorded share-based compensation expense of $0 and $391 for the three months ended June 30, 2014 and 2013, respectively, and $0 and $1,250 for the six months ended June 30, 2014 and 2013, respectively.
Non-Employee Directors - On July 1, April 1 and January 2, 2014, the Company issued a quarterly stock grant to each non-employee director for services performed of approximately 11, 20 and 8 shares of the Company's common stock, based on grant date fair values of $0.87, $0.50 and $1.21 per share, respectively.
Note 13. Commitments and Contingencies
Operating Leases
The Company conducts retail operations under operating leases that expire at various dates through November 2023. The Company's primary manufacturing facilities and executive offices are currently under a long-term lease that expires on July 31, 2019. The rent expenses (including real estate taxes and common area maintenance costs) were $18,328 and $19,462 for the three months ended June 30, 2014 and 2013, respectively, and $37,340 and $39,364 for the six months ended June 30, 2014 and 2013, respectively. The Company did not incur any significant contingent rent during these periods. Rent expense is allocated to cost of sales for production-related activities, selling expenses for retail stores, and general and administrative expenses in the consolidated statements of operations.
Customs and Duties
The Company is currently under audit by German customs for years 2009 through 2011. The German customs issued retroactive assessments on the Company's imports of $4,958 at the June 30, 2014 exchange rates (assessment was issued in Euros). The size of the retroactive assessments are largely due to member countries of the European Union who have limited rights to impose retaliatory duties on U.S. origin goods, based upon the World Trade Organization's dispute settlement procedures and the related arbitrator rulings. Consequently, the German customs 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. Despite the ongoing appeals of the German customs assessment, German customs has indicated it will begin collection enforcement proceedings if the Company does not soon reach acceptable payment terms for the amounts assessed. Negotiations as to payment terms are ongoing.
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. At this time, the outcome of legal proceedings against the Company is subject to significant uncertainty. No assurance can be made that this matter will not result in a material financial exposure, which could have a material effect on the Company's financial condition, results of operations, and cash flows.
Charney Investigation
In connection with the June 18, 2014 suspension of the Company's CEO, Dov Charney, a committee of the Board of Directors is charged with investigating potential misconduct by Mr. Charney. As the investigation is ongoing, no assurance can be made regarding the outcome of the investigation.
Tuan Phan OSHA Matter
In 2011, an industrial accident at the Company's facility in Orange County, California resulted in the fatality of a Company employee. In accordance with law, a mandatory criminal investigation into the matter was initiated. In August 2014, the Company and the district attorney's office began to negotiate a resolution of potential claims related to the accident. Based upon these

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discussions, the Company has accrued $1,000 in costs representing its best estimate of the cost to settle this matter. As the negotiations are ongoing, no assurances can be given as to their ultimate outcome or as to the impact on the Company, which could be material.
NYSE MKT LLC Compliance
In February 2014, the Company received a letter from NYSE MKT LLC indicating that it was not in compliance with listing guidance set forth in Section 1003(a)(iv). The Company submitted a remediation plan, and on April 15, 2014, the NYSE MKT LLC issued a letter to the Company indicating it regained compliance with the NYSE MKT LLC. The Company's common stock is currently traded on the NYSE MKT LLC.
Advertising
The Company had approximately $1,711 in open advertising commitments at June 30, 2014, which were primarily allocated among print advertisements in newspapers or magazines and outdoor advertising. The majority of these commitments are expected to be paid during the remainder of 2014.
Note 14. Workers' Compensation and Other Self-Insurance Reserves
The Company uses a combination of third-party insurance and self-insurance for a number of risks including workers' compensation, medical benefits provided to employees, and general liability claims. General liability primarily relates 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.
Estimating liability is a difficult process as many factors can ultimately affect the final settlement of a claim and, therefore, the reserve required. Changes in future inflation rates, litigation trends, legal interpretations, benefit levels, and settlement patterns, among other factors, can impact ultimate claim costs. The Company estimates liability by utilizing loss development factors based on its specific data to project the future development of incurred losses. Loss estimates are adjusted based upon actual claim settlements and reported claims. Although the Company does not expect the amounts ultimately paid to differ significantly from its estimates, self-insurance reserves could be affected if future claim experience differs significantly from the historical trends and the assumptions applied. The Company's estimated claims are discounted using a rate of 1.54% with a duration that approximates the duration of its self-insurance reserve portfolio. The undiscounted liabilities were $18,342 and $15,809 as of June 30, 2014 and December 31, 2013, respectively.
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, the Company issued standby letters of credit in the amount of $450 with insurance companies being the beneficiaries and cash deposits of $16,124 in favor of insurance company beneficiaries as of both June 30, 2014 and December 31, 2013. At June 30, 2014, the Company recorded a total reserve of $17,565, of which $4,876 is included in accrued expenses and $12,689 is included in other long-term liabilities on the consolidated balance sheets. At December 31, 2013, the Company recorded a total reserve of $15,356, of which $3,871 is included in accrued expenses and $11,485 is included in other long-term liabilities on the 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. The Company's total reserve of $1,747 and $2,512 was included in accrued expenses in the consolidated balance sheets at June 30, 2014 and December 31, 2013, respectively.
Note 15. Business Segment and Geographic Area Information
The Company reports the following four operating segments based on the management approach: U.S. Wholesale, U.S. Retail, Canada, and International. The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company's reportable segments.
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 U.S. as well as its online consumer sales in the U.S. The U.S. Retail segment consists of the Company's retail operations in the U.S., which comprised 137 retail stores as of June 30, 2014. The Canada segment includes wholesale, retail and online consumer operations in Canada. As of June 30, 2014, the retail operations in the Canada segment comprised 31 retail stores. The International segment includes wholesale, retail, and online consumer operations outside of the U.S. and Canada. As of June 30, 2014, the retail operations in the International segment comprised 79 retail stores operating in 18 countries outside the U.S. and Canada. All of the Company's retail stores sell its apparel products directly to consumers.
The Company evaluates the performance of its operating segments primarily based on net sales and operating income or loss from operations. 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,

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but are not limited to: human resources, legal, finance, information technology, accounting, executive compensation and various other corporate level expenses.
The following tables present key financial information of the Company's reportable segments before unallocated corporate expenses:
 
Three Months Ended June 30, 2014
 
U.S. Wholesale 
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
48,945

 
$
0

 
$
2,826

 
$
2,200

 
$
53,971

Retail net sales
0

 
48,970

 
9,421

 
35,534

 
93,925

Online consumer net sales
9,309

 
0

 
770

 
4,422

 
14,501

Total net sales to external customers
58,254

 
48,970

 
13,017

 
42,156

 
162,397

Gross profit
16,056

 
32,033

 
7,051

 
27,247

 
82,387

Income from segment operations
9,147

 
1,919

 
941

 
3,550

 
15,557

Depreciation and amortization
2,187

 
3,051

 
454

 
1,011

 
6,703

Capital expenditures
952

 
1,333

 
81

 
763

 
3,129

Retail store impairment
0

 
66

 
0

 
163

 
229

Deferred rent expense (benefit)
47

 
(720
)
 
(51
)
 
(195
)
 
(919
)
 
 
 
 
 
Three Months Ended June 30, 2013
 
U.S.
 Wholesale
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
43,219

 
$
0

 
$
3,613

 
$
2,631

 
$
49,463

Retail net sales
0

 
51,164

 
11,231

 
35,899

 
98,294

Online consumer net sales
9,522

 
0

 
608
 
4,349

 
14,479

Total net sales to external customers
52,741

 
51,164

 
15,452

 
42,879

 
162,236

Gross profit
14,634

 
33,302

 
9,347

 
26,587

 
83,870

Income from segment operations
6,097

 
525

 
1,153

 
2,491

 
10,266

Depreciation and amortization
1,790

 
3,089

 
448

 
1,059

 
6,386

Capital expenditures
1,411

 
4,090

 
247

 
535

 
6,283

Deferred rent expense (benefit)
18

 
(564
)
 
(82
)
 
(44
)
 
(672
)

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Six Months Ended June 30, 2014
 
U.S. Wholesale 
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
87,182

 
$
0

 
$
4,735

 
$
4,000

 
$
95,917

Retail net sales
0

 
91,435

 
17,180

 
65,212

 
173,827

Online consumer net sales
19,809

 
0

 
1,562

 
8,378

 
29,749

Total net sales to external customers
106,991

 
91,435

 
23,477

 
77,590

 
299,493

Gross profit
33,361

 
58,799

 
12,660

 
49,541

 
154,361

Income (loss) from segment operations
18,867

 
(2,795
)
 
596

 
2,651

 
19,319

Depreciation and amortization
4,365

 
6,165

 
855

 
2,033

 
13,418

Capital expenditures
2,157

 
2,472

 
193

 
2,265

 
7,087

Retail store impairment
0

 
115

 
0

 
613

 
728

Deferred rent benefit
(400
)
 
(2,352
)
 
(99
)
 
(290
)
 
(3,141
)
 
 
 
Six Months Ended June 30, 2013
 
U.S.
Wholesale
 
U.S. Retail
 
Canada
 
International
 
Consolidated
Wholesale net sales
$
77,927

 
$
0

 
$
6,192

 
$
4,572

 
$
88,691

Retail net sales
0

 
95,508

 
20,343

 
66,351

 
182,202

Online consumer net sales
19,236

 
0

 
1,274

 
8,893

 
29,403

Total net sales to external customers
97,163

 
95,508

 
27,809

 
79,816

 
300,296

Gross profit
26,969

 
62,493

 
16,767

 
50,509

 
156,738

Income (loss) from segment operations
11,480

 
(1,922
)
 
501

 
3,304

 
13,363

Depreciation and amortization
3,393

 
6,059

 
881

 
2,084

 
12,417

Capital expenditures
4,487

 
6,990

 
430

 
1,730

 
13,637

Retail store impairment
0

 
78

 
0

 
0

 
78

Deferred rent expense (benefit)
38

 
(776
)
 
(213
)
 
(169
)
 
(1,120
)
Reconciliation of reportable segments combined income from operations for the three and six months ended June 30, 2014 and 2013 to the consolidated loss before income taxes is as follows:  
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Consolidated income from operations of reportable segments
$
15,557

 
$
10,266

 
$
19,319

 
$
13,363

Unallocated corporate expenses
(12,977
)
 
(12,180
)
 
(24,235
)
 
(25,754
)
Interest expense
(10,019
)
 
(8,220
)
 
(20,058
)
 
(19,434
)
Foreign currency transaction loss
0

 
(158
)
 
(132
)
 
(871
)
Unrealized (loss) gain on change in fair value of warrants
(8,202
)
 
5,498

 
4,465

 
(18,147
)
Loss on extinguishment of debt
0

 
(32,101
)
 
0

 
(32,101
)
Other (expense) income
(60
)
 
11

 
(52
)
 
16

Consolidated loss before income taxes
$
(15,701
)
 
$
(36,884
)
 
$
(20,693
)
 
$
(82,928
)







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Net sales by geographic location of customers for the three and six months ended June 30, 2014 and 2013, are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
United States
$
107,224

 
$
103,901

 
$
198,426

 
$
192,671

Canada
13,017

 
15,452

 
23,477

 
27,809

Europe (excluding United Kingdom)
17,644

 
17,862

 
32,665

 
32,931

United Kingdom
10,908

 
10,588

 
20,369

 
20,183

South Korea
3,249

 
2,937

 
5,580

 
5,106

China
2,212

 
2,082

 
3,740

 
3,576

Japan
3,726

 
5,006

 
7,063

 
9,444

Australia
2,493

 
2,637

 
4,585

 
5,208

Other foreign countries
1,924

 
1,771

 
3,588

 
3,368

Total consolidated net sales
$
162,397

 
$
162,236

 
$
299,493

 
$
300,296

Note 16. Litigation
The Company is subject to various claims and contingencies in the normal course of business that arise from litigation, business transactions, employee-related matters, or taxes. The Company establishes reserves when it believes a loss is probable and is able to estimate its potential exposure. For loss contingencies believed to be reasonably possible, the Company also discloses the nature of the loss contingency and an estimate of the possible loss, range of loss, or a statement that such an estimate cannot be made. While actual losses may differ from the amounts recorded and the ultimate outcome of our pending actions is generally not yet determinable, the Company does not believe the ultimate resolution of currently pending legal proceedings, either individually or in the aggregate, will have a material adverse effect on its business, financial position, results of operations, or cash flows. In all cases, the Company vigorously defends itself unless a reasonable settlement appears appropriate.
Wage and Hour Actions
In April 2014, the five former employees' wage and hour cases including Guillermo Ruiz, Antonio Partida, Emily Truong, Jessica Heupel, and Anthony Heupel have been settled on an aggregate and class-wide basis for $850, and a final approval was granted by the presiding arbitrator. The parties are now seeking final court approval in September 2014 in order to have binding claim preclusion on future similar claims. There is no guarantee that such approvals will be obtained. The Company does not have insurance coverage for this matter.
Derivative Matters
Two shareholder derivative lawsuits were filed in the United States District Court for the Central District of California (the "Court") 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 alleged 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.
Four shareholder derivative lawsuits were filed in fall of 2010 in the Superior Court of the State of California for the County of Los Angeles (the "Superior Court") 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 alleged 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

24
Table of Contents

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 Superior 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 Court (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.
In July 2014, two shareholder derivative lawsuits were filed in the Court and alleged similar causes of action for breach of fiduciary duty by failing to (i) maintain adequate internal control and exercise proper oversight over Mr. Charney, whose alleged misconduct and mismanagement has purportedly harmed the Company's operations and financial condition, (ii) ensure Mr. Charney's suspension as CEO did not trigger material defaults under two of the Company's credit agreements, and (iii) prevent Mr. Charney from increasing his ownership percentage of the Company. The lawsuits primarily seek to recover damages and reform corporate governance and internal procedures. The Company has tendered these matters to its insurance carriers and is awaiting coverage positions.
Should the above matters (i.e., the Federal Derivative Action or the State Derivative 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.
Federal Securities Action
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 fall of 2010 in the United States District Court for the Central District of California ("USDC") which were subsequently 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 appointed by the USDC 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 USDC may deem proper. On November 6, 2013, the USDC issued an order staying the case pending ongoing settlement discussions between the parties. Plaintiff filed an unopposed motion of preliminary approval which was granted on April 16, 2014 without oral argument. On July 28, 2014, the USDC approved the settlement, and final judgment was entered on July 30, 2014. The settlement will result in a payment by the Company's insurance carrier of $4,800.
Should the above matters (i.e., 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.
Employment Matters
The Company has previously disclosed arbitrations filed by the Company on or about February 17, 2011, related to cases filed in the Supreme Court of New York, County of Kings (Case No. 5018-1) and Superior Court of the State of California for the County of Los Angeles (Case Nos. BC457920 and BC460331) against American Apparel, Mr. Charney and certain members of the Board of Directors asserting claims of sexual harassment, assault and battery, impersonation through the internet, defamation and other related claims. The Company settled one of these cases with no monetary liability to the Company. In another case, the Company prevailed on its argument that certain claims had been released by the plaintiff, and the remaining claims were recently settled. In another case, the arbitrator rejected the Company’s argument that certain claims had been released, and a hearing will be held in the future on the merits of the parties' claims. In another case, the arbitrator ruled that both American Apparel and the

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plaintiff had established certain claims and damages against one another resulting in a net inconsequential amount awarded to the plaintiff and in June 2014, the arbitrator awarded attorneys' fees and costs to the plaintiff. The Company and its insurance carrier are currently in dispute about insurance coverage of the attorney's fees and costs. In a different case, the arbitrator has held an evidentiary hearing on the parties’ respective claims and the Company is waiting for the arbitrator's ruling. The Company cannot provide assurance that, the amount and ultimate liability, if any, with respect to these remaining cases will not materially affect the Company's business, financial position, results of operations, or cash flows. 
In addition, 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 are without merit or not material and intends to vigorously dispute the validity of the plaintiffs’ claims. While the final resolution of such claims cannot be determined based on information at this time, the Company believes, but cannot provide assurance that, the amount and ultimate liability, if any, with respect to these actions will not materially affect its business, financial position, results of operations, or cash flows. Should any of these matters be decided against the Company, it could not only incur liability but also experience an increase in similar suits and suffer reputational harm.
Note 17. Condensed Consolidating Financial Information
The Notes which constitute debt obligations of American Apparel Inc. (the "Parent") are fully and unconditionally guaranteed, jointly and severally, and on a senior secured basis, by the Company's existing and future 100% owned direct and indirect domestic subsidiaries, subject to customary automatic release provisions, including the satisfaction and discharge, or defeasance, or payment in full of the principal of, premium, if any, accrued and unpaid interest on the Notes, or, in certain circumstances, the sale or other disposition of substantially all of the assets of the subsidiary guarantor. No guarantor subsidiaries are less than 100% owned, directly or indirectly, by the Company.
The following presents the Parent's consolidating balance sheets as of June 30, 2014 and December 31, 2013 and its consolidating statements of operations for the three and six months ended June 30, 2014 and 2013, consolidating statements of cash flows for the six months ended June 30, 2014 and 2013, 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 Company's consolidated financial statement.


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Condensed Consolidating Balance Sheets
June 30, 2014
(in thousands)
(unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$
0

 
$
1,676

 
$
8,484

 
$
0

 
$
10,160

Trade accounts receivable, net
0

 
21,840

 
4,374

 
0

 
26,214

Intercompany accounts receivable, net
262,292

 
(242,289
)
 
(20,003
)
 
0

 
0

Inventories, net
0

 
115,102

 
35,655

 
(6
)
 
150,751

Other current assets
665

 
10,175

 
6,088

 
0

 
16,928

Total current assets
262,957

 
(93,496
)
 
34,598

 
(6
)
 
204,053

Property and equipment, net
0

 
46,985

 
14,674

 
0

 
61,659

Investments in subsidiaries
(101,268
)
 
18,806

 
0

 
82,462

 
0

Other assets, net
8,905

 
28,449

 
11,299

 
0

 
48,653

TOTAL ASSETS
$
170,594

 
$
744

 
$
60,571

 
$
82,456

 
$
314,365

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
 
 
 
 
 
 
Revolving credit facilities and current portion of long-term debt
$
0

 
$
30,555

 
$
13

 
$
0

 
$
30,568

Accounts payable
0

 
31,553

 
3,265

 
0

 
34,818

Accrued expenses and other current liabilities
6,194

 
28,464

 
12,706

 
0

 
47,364

Fair value of warrant liability
16,489

 
0

 
0

 
0

 
16,489

Other current liabilities
0

 
2,404

 
1,912

 
0

 
4,316

Total current liabilities
22,683

 
92,976

 
17,896

 
0

 
133,555

Long-term debt, net
215,513

 
0

 
284

 
0

 
215,797

Other long-term liabilities
0

 
27,051

 
5,564

 
0

 
32,615

TOTAL LIABILITIES
238,196

 
120,027

 
23,744

 
0

 
381,967

STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
Common stock
17

 
100

 
492

 
(592
)
 
17

Additional paid-in capital
216,537

 
6,726

 
7,746

 
(14,472
)
 
216,537

Accumulated other comprehensive (loss) income
(3,904
)
 
(203
)
 
(290
)
 
493

 
(3,904
)
(Accumulated deficit) retained earnings
(278,095
)
 
(125,906
)
 
28,879

 
97,027

 
(278,095
)
Less: Treasury stock
(2,157
)
 
0

 
0

 
0

 
(2,157
)
TOTAL STOCKHOLDERS' (DEFICIT) EQUITY
(67,602
)
 
(119,283
)
 
36,827

 
82,456

 
(67,602
)
TOTAL LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
$
170,594

 
$
744

 
$
60,571

 
$
82,456

 
$
314,365


27
Table of Contents


Condensed Consolidating Balance Sheets
December 31, 2013
(in thousands)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
CURRENT ASSETS
 
 
 
 
 
 
 
 
 
Cash
$
0

 
$
512

 
$
8,164

 
$
0

 
$
8,676

Trade accounts receivable, net
0

 
15,109

 
5,592

 
0

 
20,701

Intercompany accounts receivable, net
247,414

 
(224,181
)
 
(23,233
)
 
0

 
0

Inventories, net
0

 
129,716

 
39,736

 
(74
)
 
169,378

Other current assets
97

 
10,442

 
6,002

 
0

 
16,541

Total current assets
247,511

 
(68,402
)
 
36,261

 
(74
)
 
215,296

Property and equipment, net
0

 
53,424

 
15,879

 
0

 
69,303

Investments in subsidiaries
(94,161
)
 
18,158

 
0

 
76,003

 
0

Other assets, net
9,282

 
27,934

 
11,937

 
0

 
49,153

TOTAL ASSETS
$
162,632

 
$
31,114

 
$
64,077

 
$
75,929

 
$
333,752

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
CURRENT LIABILITIES
 
 
 
 
 
 
 
 
 
Revolving credit facilities and current portion of long-term debt
$
0

 
$
43,586

 
$
456

 
$
0

 
$
44,042

Accounts payable
0

 
34,738

 
3,552

 
0

 
38,290

Accrued expenses and other current liabilities
5,952

 
28,344

 
15,722

 
0

 
50,018

Fair value of warrant liability
20,954

 
0

 
0

 
0

 
20,954

Other current liabilities
0

 
6,830

 
1,855

 
0

 
8,685

Total current liabilities
26,906

 
113,498

 
21,585

 
0

 
161,989

Long-term debt, net
213,130

 
47

 
291

 
0

 
213,468

Other long-term liabilities
0

 
29,711

 
5,988

 
0

 
35,699

TOTAL LIABILITIES
240,036

 
143,256

 
27,864

 
0

 
411,156

STOCKHOLDERS' (DEFICIT) EQUITY
 
 
 
 
 
 
 
 
 
Common stock
11

 
100

 
492

 
(592
)
 
11

Additional paid-in capital
185,472

 
6,726

 
7,685

 
(14,411
)
 
185,472

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

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

 
89,718

 
(256,424
)
Less: Treasury stock
(2,157
)
 
0

 
0

 
0

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

 
75,929

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

 
$
31,114

 
$
64,077

 
$
75,929

 
$
333,752








28
Table of Contents

Condensed Consolidating Statement of Operations and Comprehensive (Loss) Income
For the Three Months Ended June 30, 2014
(in thousands)
(unaudited)
 
Parent
 
Combined Guarantor Subsidiaries
 
Combined Non-Guarantor Subsidiaries
 
Elimination Entries
 
Consolidated
Net sales
$
0

 
$
122,758

 
$
55,169

 
$
(15,530
)
 
$
162,397

Cost of sales
0

 
72,824

 
22,703

 
(15,517
)
 
80,010

Gross profit
0

 
49,934

 
32,466

 
(13
)
 
82,387

Selling expenses
0

 
29,577

 
22,866

 
0

 
52,443

General and administrative expenses
648

 
17,991