American Apparel Tumbles on Risk of Covenant Breach

American Apparel Inc., the operator of more than 280 clothing stores, plunged 41 percent in New York trading after posting a record loss and informing investors it may breach covenants on its second-lien loan.

American Apparel will attempt to amend its $80 million loan agreement with Lion Capital LLP by June 30 to avoid default, the Los Angeles-based retailer said today in a statement. The covenant relates to the company’s total debt to earnings before interest, taxes, depreciation, and amortization.

The company said in a preliminary report that its first-quarter loss from operations widened to $17.6 million, the most since selling shares to the public in 2006. A default could prevent American Apparel from borrowing under its revolving credit facility and force the company to immediately pay down the balances on both loans, according to the statement.

“We still think they will get resolution before default,” Edward Yruma, an analyst at Keybanc Capital Markets Inc. in New York, said in a telephone interview.

Lion Capital is a debt provider and equity holder through detachable warrants they own, “which we think incents them for a non-default resolution to a potential covenant breach,” Yruma said. He has a buy rating on American Apparel shares.

American Apparel dropped $1.11 to $1.63 at 4:01 p.m. New York time on the NYSE Amex, its largest one-day percentage drop, according to data compiled by Bloomberg. The shares have lost 67 percent in the last 12 months.

‘Made Some Mistakes’

The retailer, which dismissed 1,500 employees last year after an inspection by the U.S. government found the workers weren’t authorized to work in the country, said it expects the reduced manufacturing efficiency that began in the fourth quarter to remain through the end of 2010.

“We didn’t focus enough on building the strength and the speed of the factory,” Chief Executive Officer Dov Charney said today on a conference call. “We should have been hiring more people. We got blindsided. We made some mistakes.”

The company can’t provide more detail on the covenant negotiations, Chief Financial Officer Adrian Kowalewski said today on the call.

Sales in the quarter rose 6.6 percent to $121.8 million. The retailer said the first-quarter report is preliminary and it will file final results no later than the end of June upon completion of the review of certain items.

The retailer entered into an $80 million private financing agreement with London-based Lion Capital in March 2009. Proceeds to American Apparel amounted to $75 million, according to the original filing.

Total debt in the quarter rose 10 percent to $91.4 million, the company said in the statement. American Apparel said it had about $36 million and $4 million available under its U.S. and Canadian revolving credit facilities as of March 31.

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