BUSI 710: Financial Reporting and Analysis

Professor: Thomas Nickles

Case study: 2
American apparel. Drowning in Debt?

Dear Mr, Charney,

Firstly, I would like to express my appreciation for the opportunity to serve you in evaluating the
financial situation of American apparel and providing you with perspective strategies that can be
applied to come out of the current situation. As per the brief analysis of the situation provided by you
including the financial statement, income statement, the stock price and the cash flow statement, I am
confident that my recommendations would be able to help you in reaching the goal that you desire.
According to the report given there are two main objectives that I would be focusing on:
1. First, analyze the financial statement of the past five years to understand the reason for the
insolvent situation and prepare financial ratios to analyze the situation.
2. Provide recommendations to prevent the company from falling further into debt.

American Apparel Situations from 2009-13:

American Apparel was a vertically integrated manufacturer, distributer and retailer of branded basic
fashion apparel and accessories for women, men, children and babies. From being the top trend
setting brand to being a debt-ridden company, the journey or American apparel had been very
difficult. The aggressive expansion of the company, sexually provocating advertisements and r high
quality product has been profitable for the company. From 2006 to 2008 it was able to grow from 147
stores to 206 stores both domestically and internationally, along with massive increase in sale of 40%
compared to other years.
After the crises with the workers the company’s graph started the downfall journey. In 2009 the
operating profits decrease from $36 million to $3 million that is a direct downfall of 92% in a year.
Furthermore, the decrease in human capital of 2000 workers lead to the company’s inability to
complete orders and meet the demands. This led to decline in the company’s sales (figure1: from
$558 million in 2009 to $532 million in 2010). Along with this the company incurred a loss in
operating income from $24 million in 2009 to -$50 million in 2010 leading to a net loss of $86
million in 2010.
Moving on with the current situation the company was deep under debt and lack of liquidity and the
situation worsened till 2011. However, from on the verge of filing for bankruptcy the CEO was able
to bring in some investors along with their continuous expansion in assets let them to be in a better
situation in 2011 by reducing their debt to $39 million from $86 million in the previous years. The
year 2013 was the worst hit that American apparel took, with the sales growth of marginal 3% and the
cost of sales increase by 2.9% with respect to the revenue earned each year. The company was in huge
debt with high interest rates and high operating expenses. After analyzing the current situation, the
comprehensive case structured below delivers the analysis in the financial discrepancies along with
the ratios, comprehensive statement followed by my interpretation and observations.
American apparel five years’ comparative Financial analysis
In figure 1: Common size Income statement for year 2009- 2010 : In this graph I would like to bring your
attention the interest expense which slightly increase from 2009 to 2010 because of loan taken on 18% interest
but spikes to 6.06% in 2011 and reaches 6.20% in 2013, one can incur that the long term debts are affecting the
company in the longer run. Along with this the cost of sales spiked from 43% in year 2019 to 47.48 % in 2010,
along with this it shows a steady rise till 2012 but spikes again in 2013 reaching 49.38%of the net sales. This
increase in cost of sales led to decrease in gross profit, this can also be because of the US apparel industry
situation at that point of time. The common size statement brings into light the revenue they were earning vs the
cost and expenses and these areas are the opportunity areas where American apparel could change the structure
of working and create a sustainable future.
Figure 2: Balance Sheet of American apparel 2008-2013: In this particular data I would like to bring
your attention to the long term debts as they load on a huge interest rate of 18% and even after the
discount of $5,779 and $27,929 one could see a massive rise of 65% in 2010 and that kept on
increasing. This was majorly because of their investing in opening up more store and expanding
though they reduced certain amount of stores in 2013 from 243 in march to 238 in December they
were not able to clear their liabilities. One can see this in the net properties and equipment. Along
with this the operating expenses dropped to negative in 2013 that led to decrease in their cash from
$11, 368 in 2009 to $8,676 in 2013. This clearly shows their disruption in asset management because
of the fixed asset that couldn’t service the debts.
Figure3 : Debt ratio: Debt ratio is also called debt to asset ratio depicting the percentage of
companies assets financed bt debts. According to the analysing the debt raio incresed from 80% in
2010 to 90% in 2012. The debt ratio of 1.2 means that the entity's total assets is unable to meet its
total debts obligations. This incures that american apparel is using large amount of financial
leverages, which increases its financial risk in interest-bearing and principal requirements of the debts.
This analysis also idicated the disruption in asset management, as their continous expantion of stores
led to debt to asset ratio increase dramaticaly.

Debt Ratio
1.4

1.2

1.0

0.8
Ratio

Debt Ratio
0.6

0.4

0.2

0.0
2008 2009 2010 2011 2012 2013
Years

Figure 4 Quick ratio: The quick ratio measure how easy it would be to pay off short-term debt
without waiting to sell inventory. The expectation of a quick ratio is to be above 1. Prepaid expenses
are excluded from liquid assets as they cannot be converted into cash within a few days of time. The
quick ratio was lowest at 0.114 in 2010 that means that means that American Apparel could only
convert 11.4% of the liabilities with cash in hand. It gradually increases during the year 2011 and
2012 from 21.8% to 22.2%, but again saw a dip in 2013 to 18.1%. The expansion in stores and buying
equipment’s and increase in investing and operating expense led to reduced amount of cash in hand.
 Quick Ratio (Quick assets/ Current Liabilities)
0.45

0.4

0.35

0.3

0.25

0.2

0.15

0.1

0.05

0
2009 2010 2011 2012 2013

Figure 5: inventories turnover ratio: high rate means that the inventory is sold at a faster rate,
signaling good inventory management system. Moreover, excess inventory means high expenses,
storage spaces, property tax and other related expenses. Comparing the balance sheet as well as the
ratio one can see that it slows down in 2011 by starts to increase till 2013. This could be related to the
coming getting hit by the layoff of 2000 workers because of the ID issues. Also, this means that in
2013 thy could only replenish their inventories 1.8 times a year.
 Inventories turnover ratio
2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0
2009 2010 2011 2012 2013

Inventories turnover ratio

Figure 6: Return on assets: Return on assets measures the profitability of total assets, without
considering how the assets are financed. In other words, this rate is not affected by the portion of
assets financed by creditors or stockholders. As one can see through the graph that even after
expanding their stores the return decreases from 7.18% in 2009 to – 20.25% in 2013. This shows
clearly that they have an asset management issue where they couldn’t incur profits with the assets
they were acquiring.

Throughout the analysis of common size statement, balance sheet and financial ratios there
were some point that were constantly coming into notice.
1. Generation of cash
From 2009 one could see that the American apparel was not able to generate enough liquidity
from its operations. Even though there were massive expansion in terms of the number of
stores being open, the company is not able to gain revenue from these assets and incurring
more interest from loan and hence increase their debt. Also with the recession in the starting
period it made it more difficult for the company to sustain in the market with its competitors.
The total liabilities are observed to increase greatly in year 2010 due to increase in total
current liabilities from revolving credit facilities. Looking on the quick ratio as well, as the
inventories are excluded the drop from 0.4 to 0.18 is due to decrease in cash and increase in
liabilities.
Recommendation: To keep operating, American Apparel should generate cash from
investing or financing activities or used some of the cash on hand at the beginning of the
reporting period. They should have incurred loans at a lower rate or sold some of its assets for
cash to maintain the steady flow in demand. Also as mentioned in the case about the launch
of e commerce this should have taken place in 2010 when they were hit as that would have
led to spending on creating warehouses and making the inventory system function better
rather than opening more stores without considering the revenue output.
2. Increasing its hand
Looking at the current situation American apparel is not able to cover its liabilities. Along
with this due to the market crash and it identity the shares also drop to 0.50 cents. Apart from
improving the financial activities and the management systems the company could also look
for other opportunities where they can grow with another existing companies help.
Recommendation: The apparel industry is constantly changing and the trends are moving
and shifting paces at a much faster rate. Collaborating with other brands could have given
American apparel the investment it required to sustain through which it could maintain it
quick ratio and increase its liquidity as well. Not just with apparel brand but it could have
focused on collaborating with other industries to overcome its current situation.

Thank you for your time and confidence in me for providing financial strategies to American
apparel. I am confident that these strategies could help the company is sustaining through this
tough times.
Best regards
Ojas Gupta