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American Eagle Outfitters Inc.'s (AEO - Analyst Report) adjusted earnings of 41 cents per share for the third quarter of fiscal 2012 (ending October 27, 2012) surged nearly 37% from the prior-year quarter’s adjusted earnings of 30 cents. The year-over-year growth in earnings was driven by a double-digit rise in the top line, coupled with improved margins. Moreover, quarterly adjusted earnings were above the Zacks Consensus Estimate of 39 cents.

Adjusted figures do not include income generated from 77Kids business, since the company exited from children's business in August this year. On a reported basis, including loss from discontinued business, the company earned 39 cents per share compared with 27 cents in the year-ago period.

Quarter in detail

During the quarter, American Eagle's adjusted net sales went up 11% year over year to $910 million, beating the Zacks Consensus Estimate of $873 million. Growth in revenue was driven by a 10% increase in comparable store sales compared with a rise of 7% registered in the year-ago quarter. The online sales for the company jumped 27% year over year from 21% rise in the prior year.

The company's AE Brand, aerie and AEO Direct segments reported a growth of 8%, 5% and 27%, respectively, in comparable store sales.

Adjusted gross profit increased 21% to $379 million, while gross margin improved 350 basis points (bps) to 41.6%. The year-over-year increase in gross profit and margin was primarily driven by strong top-line performance along with lower cost of goods sold and a benefit of 60 bps, rising from leveraged buying, occupancy and warehousing expenses.

Adjusted selling, general and administrative (SG&A) expense increased 18% to $219 million. Moreover, as a percentage of sales, it expanded 140 bps to 24.1% compared with 22.7% in the prior-year quarter. The rise in expenses is primarily attributable to higher incentive compensation along with variable selling and advertising expenses.

Further, the company’s adjusted operating income soared 39% to $129 million. Moreover, adjusted operating margin expanded 290 bps to 14.1%, primarily due to increased sales along with improved margins.

Financial Position

American Eagle ended the quarter with cash and short-term investments of $545 million compared with $481 million in the year-ago period. During the first nine months of fiscal 2012, the company generated $210.8 million cash from operating activities, while it deployed $71 million toward capital expenditure.

The company’s total inventory was $481 million at the end of the third quarter of 2012 compared with $555 million in the comparable quarter last year. Cost per square foot fell 11% from the year-ago quarter.

Guidance

Looking ahead into fiscal 2012, the company once again raised its earnings guidance range to $1.38–$1.40 per share from $1.33–$1.36 forecasted earlier. The Zacks Consensus estimate for the fiscal 2012 stands at $1.37 per share. Moreover, the company still anticipates incurring a capital expenditure of $100 million in fiscal 2012.

For the fourth quarter of fiscal 2012, American Eagle expects to earn in the range of 54–56 cents per share compared with 39 cents in the prior-year period. The guidance for the fourth quarter is based on the company’s anticipation of mid-single digit growth in comparable store sales. The Zacks Consensus Estimate for the quarter is 55 cents a share.

In addition, the company is anticipating a decline in the range of high-single-digit in inventory cost per square foot.

Our Viewpoint

American Eagle now plans to focus more on merchandise assortments, adding more compelling brands, managing inventory level much diligently and augmenting e-commerce business. Further, in order to emphasize more on the core business, while generating the best possible return for shareholders, the company has exited its children’s brand – 77Kids.

We remain impressed with the company’s continued momentum in denim along with improved merchandise assortments in the women’s business segment, which will likely augment its top-line performance as well as enhance the gross margin.

Moreover, we believe that American Eagle’s cost-saving initiatives and long-term growth strategy will not only provide financial flexibility, but will also help driving value proposition. In an effort to boost its bottom line, the company is relentlessly focusing on initiatives to cut down costs through supply chain efficiencies and updated product allocation system.

American Eagle, a peer of Gap Inc. (GPS - Analyst Report) carries a Zacks #2 Rank, translating into short-term Buy rating for the next 1-3 months. Moreover, we maintain our long-term ‘Outperform’ recommendation on the stock.

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