American Apparel's Financial Disaster: Retailer Faces Credit Default

In the highly competitive clothing industry, business fortunes hang by threads. Economics, employment, and competition continually entangle the competitive web clothing manufacturers and retailers face, complicating life in an already unstable and complex operational environment.

One clothing retailer that has recently found itself struggling to stay afloat is the casual clothing chain American Apparel. This morning, after announcing a steep slump in first quarter sales - as well as persistent manufacturing and supply chain issues - the retailer's leadership warned that the risk of a credit default had risen. Moreover, the Los Angeles-based maker and seller of "Made in U.S.A" T-shirts and other basic fashion clothing, noted that it may not have the liquidity or consumer support to stay in business for the next year.

In its recent earnings release, American Apparel (APP), which operates 279 stores in 20 countries, said it expects same-store sales to tumble 16% in its second quarter. The clothing retailer expects to post a loss from operations of between $5 million to $7 million in the quarter; a loss, that many expect will continue into the third quarter.

While the company remains in discussion with creditors, hoping to restructure its debt, the company is also facing a financial reporting controversy. Deloitte & Touche, its former accounting firm which officially resigned from American Apparel on July 22, has begun investigating the "reliability" of the company's 2009 consolidated financial statements. Deloitte is also investigating the company's financial results for the first quarter of 2010, as well as its projected financial results for the remainder of 2010.

Yet, despite the uncertainty, many remain hopeful that this retailer - who has dealt with crisis before - can market itself out of trouble? Can the firm's leadership build a plan that will enable it to fight through the uncertainty? Or, does the company face a financial future from which recovery will be impossible?

American Apparel is no stranger to controversy. The company's founder and CEO Dov Charney has faced numerous sexual harassment suits, allegedly conducting interviews and company meetings in his underwear.

Late last year, the company paid $5 million to settle a controversial lawsuit with actor-director Woody Allen after the actor-director sued American Apparel for unauthorized use of his image on billboards. Ironically, while the lawsuit threatened to derail the brand, the company's founder used the hype to develop an aggressive social media following using controversial, and often highly sexualized marketing. In fact, rather than hurting the brand, the lawsuit ended up turning American Apparel into an iconic fashion name-stay that now maintains a cult-like status with teens and young adults.

Additionally, the founder took a number of risks, putting American Apparel stores into unexpected locations and growing its retail presence while the market contracted. Unfortunately, while these moves held promise, the expansion has yet to bring the company the revenues that it company needs to develop a sustainable operating cash flow.

Moreover, many now recognize that - in the clothing industry particularly - retailers can no longer rely on their marketing and imagery to drive product sales. This fact was accentuated through the global recession, where consumers in nearly every income bracket were faced with shrinking wallets; often, choosing to trade down to cheaper fashion alternatives.

Unfortunately, it is precisely this downshift that has left American Apparel struggling to stay afloat. As many of its customers are choosing to get their basic clothing from low-cost retailers such as Target and H&M, American Apparel has been left scrambling. Only time will tell whether the next few months will be American Apparel's last; or, if this iconic retailer has one more trick up its sleeve.

Photo Credit: American Apparel