American Eagle Outfitters, Inc. (AEO - Free Report) declined nearly 5% on Dec 11 as investors remain cautious of the company’s holiday quarter (fourth-quarter fiscal 2018) guidance, which lagged analysts’ expectations. Further, lower-than-expected sales numbers for third-quarter fiscal 2018 hurt sentiments. Nonetheless, top line grew year over year, backed by strength in both American Eagle (“AE”) and Aerie brands, as well as across stores and digital channels, with lesser promotions.

Additionally, the company delivered solid bottom line results, which beat estimates and improved year over year. This marked the third consecutive quarter of an earnings beat. Despite recording a miss in the fiscal third quarter, sales have topped estimates in three of the last four quarters.

Overall, this Zacks Rank #3 (Hold) stock descended 27.8% in the last three months, wider than the industry’s 17.2% decline. This was mostly due to soft projections for the fiscal third quarter, which were announced during fiscal second-quarter results.

Q3 Highlights

Quarterly earnings of 48 cents per share rose 29.7% from adjusted earnings of 37 cents recorded in the prior-year quarter and beat the Zacks Consensus Estimate of 47 cents. Earnings also surged 33.3% year over year from GAAP earnings of 36 cents per share in the year-ago quarter.

American Eagle Outfitters, Inc. Price, Consensus and EPS Surprise

Net revenues increased 4.5% year over year to $1,003.7 million, marking record sales and the company’s first $1-billion quarter. However, top line lagged the Zacks Consensus Estimate of $1,036 million. Year-over-year growth was driven by well-executed fall season for both American Eagle (“AE”) and Aerie brands. This led to robust sales across stores and digital channels, with less promotional activity.

Nonetheless, a shift of the 2018 retail calendar (moving of back-to-school week to the second quarter in fiscal 2018) resulted in $40 million lesser sales in the fiscal third quarter. This shift in revenues unfavorably impacted operating income in the fiscal third quarter.

Consolidated comps increased 8%, attributed to gains from initiatives, and ability to boost market share through strong brands and compelling merchandise. This marked the company’s 15th straight quarter of positive comps, with both AE and Aerie brands reporting positive results across stores as well as e-commerce.

Brand-wise, comps rose 32% for the Aerie brand while it improved 5% for the AE brand. This marked Aerie brand’s 16th straight quarter (nearly four years) of double-digit sales growth, reflecting a significant momentum in all areas of the business. The AE brand is gaining from its leadership position in bottoms, with jeans business recording 21st consecutive quarter of comps growth.

The company’s digital business continued to exhibit solid growth, contributing about 27% to net sales. In fact, this was the company’s 15th straight quarter of double-digit e-commerce growth. Moreover, trends in brick-and-mortar stores continued to improve as both AE and Aerie stores reported positive in-store comps. Consequently, in-store comps improved 6%, marking the fourth consecutive quarter of positive in-store comps.

Evidently, the company witnessed a healthy quality of sales during the reported quarter with positive store conversion, average unit retail price and transaction value in the number of transactions. Further, both AE and Aerie brands outpaced mall traffic.

Quarter in Detail

Gross profit increased 7% to $399.5 million in the reported quarter, with gross margin expansion of 80 basis points (bps) to 39.8%, primarily due to lower markdowns and lesser rent, offset by higher delivery costs.
 
SG&A expenses increased nearly 14% to $248.4 million and deleveraged 220 bps to 24.8% as a percentage of sales. The increase is mainly attributed to higher investments brands and customer experience as well as higher store payroll, wages, and increased incentive expenses and advertising.

Operating income of $108.6 million declined 2.1% from $110.9 million recorded in the prior-year quarter. Operating margin contracted 70 bps to 10.8%, owing to the aforementioned unfavorable impact on sales due to the calendar shift as well as SG&A deleverage.

Financial Position

American Eagle ended the fiscal third quarter with cash and cash equivalents of $279.9 million compared with $257.5 million in the prior-year quarter. Further, total shareholders’ equity as of Nov 3 was $1,295.4 million.

Moreover, the company spent $43 million as capital expenditure in third-quarter fiscal 2018. More than half of this spending was allocated to store openings and refurbishment while the remaining was invested in omni-channel and digital projects as well as general corporate maintenance. For fiscal 2018, management reiterated its capital expenditure forecast of $180-$190 million.

As of Nov 3, American Eagle’s merchandise inventory at cost was roughly $592 million, up 11% from the comparable year-ago period. It expects mid to high-single-digit increase in inventory at the end of fourth-quarter fiscal 2018.

During the fiscal third quarter, the company returned nearly $50 million to shareholders through cash dividends and share buybacks. The company bought back nearly one million shares for about $25 million.

Store Update

American Eagle inaugurated five AE stores and two Aerie stand-alone stores while it closed three AE and one stand-alone Aerie location in the fiscal second quarter.

As of Nov 3, the company operated 1,057 stores, comprising 941 AE (including 142 Aerie side-by-side locations), 110 stand-alone Aerie, five Tailgate and one Todd Synder stores. Additionally, it operated 223 international licensed outlets.

In fiscal 2018, management intends to open 15-20 AE outlets, including 5-10 Aerie side-by-side stores. Additionally, it plans to inaugurate 10-15 Aerie stand-alone stores and one each for Tailgate Clothing Company and Todd Snyder. Further, American Eagle expects to shut down 10-15 AE stores and 5-10 Aerie stores.

The company remains focused on strengthening its Aerie stores, targeting to open nearly 40 stores in fiscal 2018. It also plans to open five AE stores (net of closures) in the fiscal year. In fiscal 2019, the company expects to open 60-70 Aerie stores, alongside 15-20 AE locations.

Looking Ahead

Management remains impressed with the company’s quarterly performance, particularly record sales growth. Further, the company noted that it had a positive start to the holiday season, delivering record volumes over Thanksgiving and Cyber Week shopping periods. The company expects to maintain the momentum and brand strength to drive growth in the future while delivering solid returns to shareholders. Considering these and other factors, American Eagle outlined its outlook for fourth-quarter fiscal 2018.

American Eagle anticipates comps for fourth-quarter fiscal 2018 to increase in a mid-single digit, with low-single-digit revenue growth. This is likely to result in adjusted earnings per share of 40-42 cents compared with adjusted earnings of 44 cents in the prior-year quarter. The guidance includes impacts related to the additional 53rd week in fiscal 2017. This should result in revenue loss of about $60 million and it should reduce earnings by 7 cents per share from the prior year. Further, the company’s EPS guidance stands significantly lower than the current Zacks Consensus Estimate of 46 cents, which probably has hurt investors’ sentiment.

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