What happened

Shares of American Eagle Outfitters (AEO 1.37%) were pulling back today after the apparel retailer issued a disappointing second-quarter earnings report. Like other retailers, American Eagle was hurt by a slowdown in consumer spending and bloated inventory levels that forced it to mark down more merchandise than normal.

As of 10:36 a.m. ET on Thursday, the stock was down 9.1%.

So what

Revenue in the quarter was flat at $1.2 billion, which matched the analyst consensus. But comparable-store sales fell for both of its brands. At American Eagle, comps were down 10%; at Aerie, the fast-growing brand focused on intimates for young women and teen girls, comps were down 6%.

Aerie's revenue still rose 11% in the quarter as the company has aggressively expanded its store footprint.

The challenges facing the company were more noticeable further down the income statement. Gross margin plunged from 42.1% to 30.9% as inventory rose 36%, leading to higher markdowns to clear spring and summer merchandise. 

The retailer finished with an adjusted per-share profit of $0.04, well below the $0.60 it generated in the quarter a year ago. That missed analyst estimates of $0.13.

Management also said it was pausing its dividend to give it additional financial flexibility. Prior to the earnings report, it had offered a sizable dividend yield of 6.2%.

CEO Jay Schottenstein said:

This an unprecedented time in retail. As we cycle exceptional demand from last year, a tougher macro environment is impacting consumer spending behavior. Second quarter performance reflected these challenges, constraining revenue and amplifying margin pressure as we fully cleared through excess spring and summer goods.

Now what

Guidance indicated that management expects the challenges to persist. Quarter to date, retail revenue is down in the high single digits, and the company forecast gross margins in the mid-30% range for the third quarter and low 30% range in the fourth quarter, since it typically has more clearance sales in that quarter. The company is stepping up cost-cutting, increasing its target from $60 million in annual expenses to $100 million.

The recent growth of Aerie makes American Eagle stock more attractive than the typical brick-and-mortar retailer, but the outlook and the dividend pause show that the stock is likely to struggle until macro conditions improve.