Shares of American Eagle Outfitters (NYSE: AEO) rose 2% on Wednesday after the apparel retailer posted its third-quarter earnings. That rally was surprising, since AEO's numbers were fairly mixed.

The company's revenue rose 2% annually to $960.4 million, which met analyst expectations. Its adjusted earnings dropped 10% to $0.37 per share, missing estimates by a penny a share. However, that figure was impacted by a discrete charge of $0.05. Excluding that charge, its adjusted EPS would have been up 2%.

The key numbers

AEO reported 3% comps growth during the quarter, beating expectations of 2% growth. Its smaller, higher-growth Aerie lingerie and activewear brand posted 19% comps growth, and its namesake brand reported 1% growth.

However, much of that growth came on the back of promotions and markdowns, which caused gross margin to fall 120 basis points year over year to 39%. The growth of its digital business, which entails higher shipping costs, also contributed to that margin decline. AEO's adjusted operating margin also decline 70 basis points to 11.9%.

Unfortunately, those markdowns didn't lead to a meaningful reduction in its inventories, which rose 8.4% annually to $534.02 million. Nonetheless, AEO added a single store, bring its total store count to 1,058 locations.

The holiday outlook

For the holiday quarter, AEO expects its comps to rise in the mid-single digit percentages, and for its EPS to grow by 8% to 13%. That outlook indicates that it's expecting margin pressures will ease, and that it isn't stuck in a negative cycle of slashing prices to boost its top line growth.

AEO's Q3 numbers weren't spectacular, but they indicate that the retailer isn't about to be obliterated by fast-fashion retailers or e-commerce rivals. That's definitely a positive sign for traditional U.S. apparel retailers, which have fallen out of favor over the past few years.

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The author(s) may have a position in any stocks mentioned.


Leo Sun owns shares of American Eagle Outfitters.

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