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American Apparel's Unhip Finances


"Hipster is over" says Dov Charney, who, as the founder and chief executive officer of American Apparel (APP), rode the trend as far as anyone. Starting the company in a dorm at Tufts University in Medford, Mass., he built a worldwide empire of 280 stores by boldly leaping out ahead of mainstream fashion. Over and over again he remade the hipster wardrobe, sensing the demand for neon nylon bike shorts and lace-thong leotards long before the competition. For better and for worse, he personified the racy, risk-taking aesthetics of his business and is now facing the consequences—skittish lenders and investors who doubt his ability to oversee his own creation. American Apparel shares trade at less than $2, down from a high of $16.80 in December 2007. The company teeters on the verge of being delisted from the New York Stock Exchange (NYX) Amex because it has been late filing quarterly reports, and last week its accountant, Deloitte & Touche, quit, saying American Apparel's 2009 numbers may not be reliable. The mounting problems suggest the company may now need more sophisticated management than its controversial founder can muster.

Charney, 41, admits the recent troubles have tested him—"It's been a major sweat, a real hard job"—but insists he will stick it out and that there will be no dialing back of ambition. His plan is to plunge straight into the storm, doubling the sales of the 11,500-employee company over the next six years by improving productivity and implementing better technology to more quickly move product from the company's Los Angeles factory into stores. Down the road, American Apparel, which owns and operates its own stores, might also sell its products through other retailers.

The biggest challenge of all may be stylistic. After outfitting the world of 18- to 30-year-olds in all manner of T-shirts and leggings, which still rank among the company's best-sellers, American Apparel is going preppy, diving into more sophisticated garments such as blazers, pleated pants, button-down shirts, and more formal lace tops. "Kids are moving away from piercings," Charney says. "We want to grow old with our customer. We want to be a traditional American clothier."

Even as American Apparel has grown, Charney, who owns 53 percent of the company and dresses exclusively in his own product, down to socks and underwear, has kept management small and personal. He makes it a priority to walk through his factory most days, talking to employees, handling fabrics, and seeing garments being made, a process he says takes more than two hours of his day. His mobile number is available to all employees, he says, and he prides himself on returning all calls. He spends much of his time with a circle of about 15 people who help him look at fabric and evaluate new designs.

Lately, though, the business is much less about fabric than finance. The NYSE Amex threat to delist American Apparel could become reality if it fails to file its most recent quarterly report by Aug. 16, the second delay in little more than a year. The delay stemmed from renegotiations on its second-lien loan with Lion Capital. That has since been settled, but another problem burst into public view when Deloitte notified American Apparel that certain information had come to its attention, that, if investigated, could impact the reliability of the company's 2009 financial statements. Charney says he's confident the accounting issues will be straightened out by the deadline.

Lion Capital, a London-based private equity firm, agreed in March 2009 to loan American Apparel $80 million maturing Dec. 31, 2013. As part of the agreement, Lion received detachable warrants amounting to 16 million shares of the company's common stock, equal to about 18 percent ownership.

Charney prematurely told investors on a conference call that the company had reached a new agreement with Lion, which was followed by a press release from American Apparel admitting it was at risk of breaching loan covenants. The two parties came to an agreement last month requiring American Apparel to meet trailing 12-month profit targets. The agreement would also raise the loan's interest rate by 2 percentage points, to 17 percent, if certain debt-to-earnings ratios aren't met, according to a regulatory filing.

Before the financial problems intensified, Charney had been contending with damaging sexual harassment allegations followed by a devastating immigration bust. Fifteen-hundred workers at the Los Angeles factory had to be let go owing to lack of documentation and another 1,000 quit for fear of being swept up for immigration violations. For a company that is proud of its insistence on domestic manufacturing, it was a costly blow. The recession has also taken a toll; the company posted same-store sales declines from February to December of 2009 and has not reported comparable store sales results since then.

"Those are troubling issues for the board and for the investors in the company," says Charles M. Elson, a University of Delaware professor who specializes in corporate governance. "It raises questions about controls within the company. It raises questions about the efficacy of oversight."

Yet American Apparel is not without admirers. Edward Yruma, an analyst at KeyBanc Capital Markets (KEY) in New York, calls the brand "edgy and provocative." And Charney says all the controversy won't stand in his way. "That stuff's not going to matter," he says. "In the end that will all dissipate, because scandals disappear faster than you think."

Charney, who grew up in Montreal, started selling Hanes T-shirts in his last year of boarding school at Choate Rosemary Hall in Connecticut in 1986. He'd buy them at bulk prices in the U.S. and sell them for a profit in Canada. At 17 he was arrested for selling T-shirts at a Madonna concert in Montreal, and his dad had to go to court on his behalf because he was back at Choate. He ended up being fined C$25.

Charney started American Apparel in his freshman year at Tufts and got so absorbed in it that he never graduated. He got in his car one night to drive to South Carolina and never went back. In 1987, Charney manufactured a few thousand T-shirts in Ninety Six, S.C., employing 20 women who worked in a barn with no air conditioning. Ten years later he moved the company to Los Angeles, where there was greater manufacturing capacity.

In 2003, riding in a taxi in Manhattan, Charney saw a retail space for rent and had an epiphany about where he could take his business. He promptly opened three stores—in New York, Los Angeles, and Montreal—and by 2006 he had 100 more. "Everybody along the journey thought I was crazy," he says.

Since it went public in 2007 through a special-purpose acquisition company, Endeavor Acquisition, American Apparel has doubled its store base, to more than 280 in 20 countries, a rate of expansion that has concerned some analysts. "They have overexpanded in recent years and had assumed that their past demand growth would continue at its earlier torrid pace, which it hasn't," says Craig Johnson, president of Customer Growth Partners, a consulting firm in New Canaan, Conn. "What was once a fresh new look is now seen by many as neither as fresh nor as new."

Charney says the rapid expansion was necessary to boost awareness of the brand. "Maybe there were a dozen stores we shouldn't have opened," he says. "Maybe we could have structured things differently, but then if it wasn't all about expansion, would we be a brand of any importance? Would the company have survived if we hadn't opened 100 stores in our first three years? Would we have captured the imagination of the public? Would it have been big enough to have been noticed?"

Moving too quickly isn't the only knock against Charney. He has been sued by three former employees for sexual harassment (one suit was dismissed, one was settled, and a third remains in arbitration), and in 2004, Jane magazine reported that he masturbated in front of a reporter while being interviewed. More recently, Gawker.com reported that American Apparel makes managers photograph its female store employees so Charney can ensure they fit his aesthetic tastes, which include full eyebrows and long, natural hair. Charney says there is no official doctrine, and that they look for people who understand the brand, know how to present themselves, and can communicate the brand's style to its customers. Still, Charney's record makes some wonder whether he has the judgment and credibility to oversee a large company. "The travails of their senior management, all well-known, will make fixing the brand very difficult until a management change occurs," says Johnson of Customer Growth Partners.

Charney insists he is willing to make major changes to how the company is managed, including the possibility of hiring three chief operating officers to run manufacturing, distribution, and retail separately. The company has recently added new senior staff and will continue to make key appointments, including a director of quality control, Charney says. He also says he is open to relinquishing his CEO role when he has built a management team he feels confident can take over. Charney does have his supporters, including Yruma, who praises his "hands-on" management style. Allan Mayer, who has served on American Apparel's board since 2007, calls Charney a brilliant marketer with an incredible work ethic. "This is a guy who works seven days a week, 52 weeks a year," says Mayer, a partner at Los Angeles public-relations firm 42West. "You don't build a $600 million-a-year vertically integrated manufacturing and retailing business on an edgy image and sexy ads alone."

Charney admits there are things he could have done differently: not opening quite as many stores; taking the company public through a normal initial public offering instead of through a shell company; moving manufacturing offshore while he resolved his worker problems.

"A lot of assumptions that I grew up with are no longer reality," he says. "Those were things that we could rely on: that lenders will always be there, that they'll behave ethically and they'll always have money, that you can trust that as the sun comes up the consumer will be healthy, that we'll always be close to full employment in developed nations. Now there are no certainties."

George Whalin, president of Retail Management Consultants in Carlsbad, Calif., says the brand is strong but the company needs a management overhaul. "Volatile people running retail businesses are scary people," Whalin says in an interview. "But I think [American Apparel's] concept is still viable."

That concept, however, is in flux. As Charney reorients the company to more grown-up styles, he goes up against the likes of J.Crew, Gap, and even Brooks Brothers, retailers who have been cultivating the preppy look for years. Charney says he isn't worried because his clothes are basics without the frills, and that nobody else can serve that market as well as he can.

As for his other troubles, Charney says he is used to people underestimating him, recalling a loan officer at the Bank of Nova Scotia (BNS) who waffled about extending a line of credit back when American Apparel was making $1 million a year. The hipster may be dead, but Charney lives on. "Over time, I will improve my ability to perform," he says. "Keep watching the movie and I'll prove you wrong."

Abell Schwartz is a reporter for Bloomberg News.

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