American Apparel Shorts Triple as Sales Growth Stalls

Shorting American Apparel Inc. is back in style.

After a period of steady sales growth and a rising stock price, the maker and seller of clothes worn by hipsters worldwide has hit turbulence. The retailer has posted three straight quarterly losses, and preliminary results it released show revenue fell in the most recent quarter. American Apparel, led by Chief Executive Officer and founder Dov Charney, has disclosed that it amended debt terms, paid interest penalties and borrowed money at 18 percent interest while also laying the groundwork for selling stock.

The recent upheaval is hurting the shares, which fell below $1 last week for the first time in more than a year. Bearish equity bets against the Los Angeles-based clothing chain have tripled since June to the highest level since 2011, a period when the company said it may not have sufficient cash to sustain its operations.

“American Apparel faces challenges on the operating side and on the capital-structure side,” Charlie O’Shea, a credit analyst at Moody’s Investors Service in New York, said in a telephone interview. “This is one of the lowest-rated retailers we have at Moody’s.”

After a November downgrade, American Apparel’s bonds are the second-lowest of the retailers, apparel manufacturers and restaurants Moody’s covers. Only closely held pizza chain Sbarro Inc. has a lower debt rating than American Apparel’s Caa2, and the retailer’s SGL-4 liquidity rating is the firm’s lowest grade.

Charney and Chief Financial Officer John Luttrell both declined to comment for this story, saying American Apparel is in a quiet period before reporting earnings. Charney said in a January statement detailing December sales that the company’s management is energized and excited about its prospects for the spring and summer of 2014. The company hasn’t disclosed when it plans to report fourth-quarter results.

No Strangers

American Apparel and Charney, who’s also chairman and the chain’s largest shareholder with 43 percent of the stock, are no strangers to tumult. The chain for years has grabbed headlines for everything from using nudity in its advertising to a legal battle with director Woody Allen over the use of his image on billboards that the company paid $5 million to settle. Most recently, one of the company’s New York stores gained attention by featuring mannequins with pubic hair.

The company, which had 248 stores at the end of December, has attributed most of its recent struggles to the introduction of a new distribution center that began shipping in February 2013. The chain disclosed costs of $5.9 million in the third quarter associated with transitioning to the new center, and Luttrell said in a statement that the problems with the facility were “substantially behind” the company.

December Sales

Then after sales fell 6 percent in December, Charney again pointed to the center, saying in a company statement that it caused so much distraction that executives failed to buy enough of its best-selling items. The chain yesterday said revenue continued to decline in January, falling 1 percent.

To make matters worse, American Apparel’s brand has been losing cachet with teens and 20-somethings who are shifting from its jeans, T-shirts, underwear and other basics to offerings from chains such as Forever 21, Hennes & Mauritz AB and Uniqlo, which are known for rapidly changing their assortments to catch current trends, said Craig Johnson, president of Customer Growth Partners, a New Canaan, Connecticut-based consulting firm.

“American Apparel hasn’t done a whole lot of innovation, and in the meantime” a lot of retailers have incorporated the clean, simple look it became known for, Johnson said. “Time has marched on.”

Fourth-quarter sales declined 2 percent, snapping more than two years of gains, according to a company statement last month.

Short Interest

Shares sold short now account for 16 percent of the stock, up from 4.7 percent in June, according to Markit, a London-based provider of financial information services. The average for the Russell 2000 Index, which includes American Apparel, is 3.7 percent. Shorting refers to the practice of selling borrowed shares in hopes of profiting by buying them back later at a lower price and keeping the difference.

American Apparel rose 7 percent to $1 at 9:40 a.m. in New York. The shares had declined 24 percent this year through yesterday’s close at 93 cents.

American Apparel, which started trading publicly in 2007, has confronted occasional cash shortfalls since 2009. It survived them by privately selling shares to Charney and other investors, convincing lenders to amend credit agreements to avoid breaching covenants and more recently by ramping up borrowing.

Net Losses

Despite posting net losses totaling $248.4 million since the beginning of 2010, the company found some solid ground in the first half of last year with sales increasing 6.4 percent to $300.3 million. The company also forecast annual adjusted earnings before interest, taxes, depreciation and amortization to be the highest since 2008.

The chain moved to put to rest its liquidity issues too. In April, it issued $206 million of bonds paying 13 percent and entered a new $35 million asset-backed credit revolver to pay off higher-interest debt. In July, it boosted the revolver’s capacity to $50 million as it tried to fix the distribution center. Charney has said the implementation of the center gummed up the supply chain, which then slowed shipments.

The difficulty slowed sales, causing the company to cut its forecast for 2013 Ebitda. Same-store sales in September fell 6 percent for the first drop in 28 months, the company said.

American Apparel in the following months worked to raise more capital and amend existing debt agreements to avoid violating their terms.

Higher Interest

In November, it amended the credit facility to waive some provisions in exchange for a higher interest rate, and said it would need more waivers in the future. The company also disclosed that it borrowed an additional $5 million under a previous loan agreement at 18 percent interest.

The chain also said it didn’t meet required debt ratios on its bonds and paid $2 million in extra interest expenses in the third quarter. It said it won’t meet those requirements in the fourth quarter either.

Not everyone is sour on the company’s prospects. While 2013 turned out to be “a frustrating year” for its investors, American Apparel has now fixed its distribution center and remained fashionable, Eric Beder, an analyst for Brean Capital LLC in New York, wrote in a note to clients on Jan. 9. Beder recommends buying the retailer’s shares.

There may be more capital-raising to come. In December, the company filed a registration with the Securities and Exchange Commission to sell as much as $50 million of common stock, preferred stock or warrants at undetermined times and prices.

Balance Sheet

That money would help shore up a balance sheet that has been strained after three straight quarters of negative free cash flow that left it entering the third quarter with $4.9 million in cash, the lowest since 2007.

“I’m not surprised at all” at the chain’s current woes, Johnson said. “It’s not a well-managed company, and it’s not a well-governed company.”

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