Even though Abercrombie & Fitch Co. swung to a second-quarter profit, the teen retailer’s shares descended 6.9 percent to close at $35.05 in trading Tuesday as worries over softening margins, rising inventories and newly announced store closures preoccupied Wall Street.

This story first appeared in the August 18, 2010 issue of WWD. Subscribe Today.

A&F unveiled plans to chop up to 110 stores over the next 18 months, mainly because of natural lease expirations. The apparel firm anticipates closing 60 stores domestically during the year and 50 more stores in 2011. The majority of closures will be in the kids’ division and in the Abercrombie chain, executives said in a call to Wall Street analysts. On the international front, the retailer said it would open 20 mall-based Hollister stores in fiscal 2010, down from its previous estimate of 25 stores.

At the end of the second quarter, the company operated 1,098 doors, which included 345 A&F stores, 206 children’s stores, 530 Hollister stores and 17 Gilly Hicks stores.

Forced to play hardball with lower-priced rivals like Aéropostale Inc. and American Eagle Outfitters Inc., the company reduced average unit retail by 15 percent in the quarter, and built second-quarter inventories up 47 percent over last year, to compensate for what it called “significantly under-inventoried” year-ago levels.

Chairman and chief executive officer Mike Jeffries said on the call that the company is carrying more inventory to back up some “trends” that are gaining “traction.”

But the ceo was mindful of the price-sensitive climate, adding: “We are prepared and plan for an aggressive promotional environment and ready to deal with that if that is how things end up.”

That willingness may be a necessity, as the “inflated inventory position will likely require significant markdowns to clear, pressuring third-quarter EPS,” said Stifel Nicolaus analyst Richard Jaffe. “While we believe the merchandise has improved, there is still work to be done, as we believe a significant portion of the merchandise remains uninspiring and lackluster. It appears the consumer agrees with us, as it required deep markdowns”

“Inventory concerns, while valid in an uncertain top-line period, I think are overdone,” said Weeden & Co. analyst Amy Noblin, who explained the company expects a midsingle-digit comp gain in the fall based on the inventory build.

“Most retailers are waiting for a macroeconomic recovery,” Noblin said, but Abercrombie “is one of the few out there vis-à-vis 12 months ago that can do a lot” to positively “impact” the brand.

The New Albany, Ohio-based firm has already begun making strides, as it posted net income of $19.5 million, or 22 cents a diluted share for the second quarter ended July 31, compared with a year-ago loss of $26.7 million, or 30 cents a share. Income for the quarter includes a non-cash asset impairment charge of 2 cents a diluted share in connection with expected store closures. Sales expanded 17 percent to $745.8 million from $637.2 million. Analysts projected EPS of 16 cents on sales of $727.7 million, according to Yahoo Finance.

Including direct sales, international revenue soared 85 percent to $133.2 million, while domestic sales increased 8 percent to $612.6 million. Comparable-store sales for the quarter rose 5 percent, led by an 8 percent comp jump at Abercrombie’s namesake chain. Abercrombie kids and Hollister & Co. reported comp increases of 3 percent and 2 percent, respectively. Quarterly gross margin slid to 65.1 as a percent of sales, versus 66.6 percent a year ago.

In first half, the retailer turned in a $7.7 million profit, or 9 cents a diluted share, versus a net loss of $86 million, or 98 cents in 2009.

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