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At American Apparel, the Federal Subpoena and SEC Probe Aren't Even the Worst Part

Fashion advertiser American Apparel (APP) finally filed its quarterly earnings report for Q1 2010 and it's a disaster on all fronts:
  • The company has received a subpoena from the Department of Justice and an "inquiry" from the SEC and over its dodgy accounting;
  • The company warned it "may not have sufficient liquidity necessary to sustain operations for the next twelve months";
  • Its losses expanded based on new impairment charges from non-performing stores;
  • CEO Dov Charney has personally guaranteed more than $2 million in "obligations" racked up by five of his flagship stores;
  • And Charney's father is on the payroll as a consultant.
The good news? AA's ad budget went up by $2 million!

The 10-Q was delayed over irregularities that triggered the resignation of AA's accounting firm. The SEC probe is not a surprise. The company has been dogged by the rumor that it is being eyed by the SEC for more than a year.

What is a surprise is the scale of the mess that AA is in. It's not just that AA, at base, is unprofitable and cashflow negative -- lots of companies jump in and out of the red. It's the fact that AA's finances are so bad that it may not be able to meet the terms of Lion Capital, the investment firm that gave it a rescue package recently. AA warns that if cannot meet its Lion obligations, then that triggers a Bank of America loan requirement which becomes due in full, immediately. AA has a $75 million revolving credit facility with BofA.

AA's revenues actually went up in the quarter, but as I've discussed previously this is actually bad news for the company: Sales have gone up because AA keeps opening more stores, and each store cannibalizes the sales of nearby stores and AA's Internet operations. As that happens, each store becomes increasingly less profitable, threatening the entire company.

The result of all that is that 19 of AA's stores -- about 8 percent of the entire chain -- had their carrying value written down as "impaired," creating more paper losses. Charney "has personally guaranteed" these property leases:

  • New York store at 712 Broadway, $820,000
  • New York store at 183 E. Houston St., $420,000
  • New York store at 1090 Third Ave., $202,000
  • Chicago store at 1563 N. Milwaukee Ave., $16,000
  • Los Angeles store at 6922 Hollywood Blvd., $1,800,000
In many ways, this is the worst part for AA. If there's a question that these stores, in the heart of hipdom, can't pay their debts without Charney bankrolling them from his own checking account, then the rest of the chain may not be far behind. New York and Los Angeles drive fashion in the U.S. What falls out of favor on the coasts will fall a few months later in the malls of the South and the Heartland.

There's no sign of common sense appearing at AA anytime soon. The report doesn't talk about closing stores or selling locations and leases, or raising prices on its web and trade business -- something AA needs to do in order to reduce its outsized footprint to its profitable core and increase profitability in its more marginal segments. Even the ad budget is going up, when it probably needs to start coming down.

And why, exactly, does Charney have his dad on the payroll? Morris Charney was paid $69,000 in "consulting" fees in Q1, the 10-Q says (reporting its numbers in the thousands):

Mr. [Morris] Charney does not perform any policy making functions for the Company or any of its subsidiaries. Instead, Mr. M. Charney only provides architectural consulting services primarily for stores located in Canada and, in limited cases, in the United States. Mr. M. Charney was paid architectural consulting fees amounting to $69 and $42 for the three months ended March 31, 2010 and 2009, respectively.
AA says has given no date as to when it feels it will be able to file its Q2 numbers by Sept. Nov. 15; they are already about a month late.

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