2. Summary of Significant Accounting Policies
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company and its wholly owned
subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. At
July 31, 2010, the Company operated in one reportable segment.
On March 5, 2010, the Company’s Board of Directors approved management’s recommendation to proceed
with the closure of the M+O brand. The Company notified employees and issued a press release
announcing this decision on March 9, 2010. The decision to take this action resulted from an
extensive evaluation of the brand and review of strategic alternatives, which revealed that it was
not achieving performance levels that warranted further investment. The Company completed the
closure of the M+O stores and e-commerce operation during the 13 weeks ended July 31, 2010 and the
Consolidated Financial Statements reflect the presentation of M+O as a discontinued operation.
Refer to Note 12 to the Consolidated Financial Statements for additional information regarding the
discontinued operations for M+O.
The Company’s financial year is a 52/53 week year that ends on the Saturday nearest to January 31.
As used herein, “Fiscal 2011” and “Fiscal 2010” refer to the 52 week periods ending January 28,
2012 and January 29, 2011, respectively. “Fiscal 2009” and “Fiscal 2008” refer to the 52 week
periods ended January 30, 2010 and January 31, 2009, respectively.
The preparation of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure
of our contingent assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual results could differ from
those estimates. On an ongoing basis, our management reviews its estimates based on currently
available information. Changes in facts and circumstances may result in revised estimates.
Recent Accounting Pronouncements
In September 2009, the Financial Accounting Standards Board (“FASB”) approved the consensus on
Emerging Issues Task Force (“EITF”) 08-1, Revenue Arrangements with Multiple Deliverables,
primarily codified under Accounting Standards Codification (“ASC”) 605, Revenue Recognition, as
Accounting Standards Update (“ASU”) 2009-13, Revenue Recognition
(Topic 605): Multiple-Deliverable Revenue Arrangements (“ASU 2009-13”). ASU 2009-13 requires
entities to allocate revenue in an arrangement using estimated selling prices of the delivered
goods and services based on a selling price hierarchy. The amendments eliminate the residual method
of revenue allocation and require revenue to be allocated among the various deliverables in a
multi-element transaction using the relative selling price method. This guidance is effective for
revenue arrangements entered into or materially modified in fiscal years beginning after June 15,
2010. The Company is currently evaluating the impact that the adoption of ASU 2009-13 will have on
its Consolidated Financial Statements.
In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures Topic 820:
Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 requires new
disclosures regarding transfers in and out of the Level 1 and 2 and activity within Level 3 fair
value measurements and clarifies existing disclosures of inputs and valuation techniques for Level
2 and 3 fair value measurements. The new disclosures and clarifications of existing disclosures
are effective for interim and annual reporting periods beginning after December 15, 2009, except
for the disclosure of activity within Level 3 fair value measurements, which is effective for
fiscal years beginning after December 15, 2010, and for interim reporting periods within those
years. The Company adopted the new disclosures effective January 31, 2010, except for the
disclosure of activity within Level 3 fair value measurements. The Level 3 disclosures are
effective for the Company at the beginning of Fiscal 2011. The adoption of ASU 2010-06 did not have
a material impact, and is not expected to have a material impact, on the disclosures within the
Company’s Consolidated Financial Statements.
Foreign Currency Translation
The Canadian dollar is the functional currency for the Canadian business. In accordance with ASC
830, Foreign Currency Matters, assets and liabilities denominated in foreign currencies were
translated into U.S. dollars (the reporting currency) at the exchange rate prevailing at the
balance sheet date. Revenues and expenses denominated in foreign currencies were translated into
U.S. dollars at the monthly average exchange rate for the period. Gains or losses resulting from
foreign currency transactions are included in the results of operations, whereas, related
translation adjustments are reported as an element of other comprehensive income in accordance with
ASC 220, Comprehensive Income (refer to Note 8 to the Consolidated Financial Statements).
Revenue is recorded for store sales upon the purchase of merchandise by customers. The Company’s
e-commerce operation records revenue upon the estimated customer receipt date of the merchandise.
Shipping and handling revenues are included in net sales. Sales tax collected from customers is
excluded from revenue and is included as part of accrued income and other taxes on the Company’s
Consolidated Balance Sheets.
Revenue is recorded net of estimated and actual sales returns and deductions for coupon
redemptions and other promotions. The Company records the impact of adjustments to its sales return
reserve quarterly within net sales and cost of sales. The sales return reserve reflects an estimate
of sales returns based on projected merchandise returns determined through the use of historical
average return percentages.
Revenue is not recorded on the purchase of gift cards. A current liability is recorded upon
purchase, and revenue is recognized when the gift card is redeemed for merchandise. Additionally,
the Company recognizes revenue on unredeemed gift cards based on an estimate of the amounts that
will not be redeemed (“gift card breakage”), determined through historical redemption trends. Gift
card breakage revenue is recognized in proportion to actual gift card redemptions as a component of
net sales. For further information on the Company’s gift card program, refer to the Gift Cards
The Company sells off end-of-season, overstock, and irregular merchandise to a third-party. The
proceeds from these sales are presented on a gross basis, with proceeds and cost of sell-offs
recorded in net sales and cost of sales, respectively.
Cost of Sales, Including Certain Buying, Occupancy and Warehousing Expenses
Cost of sales consists of merchandise costs, including design, sourcing, importing and inbound
freight costs, as well as markdowns, shrinkage and certain promotional costs (collectively
“merchandise costs”) and buying, occupancy, and warehousing costs. Buying, occupancy and
warehousing costs consist of compensation, employee benefit expenses and travel for our buyers and
certain senior merchandising executives; rent and utilities related to our stores, corporate
headquarters, distribution centers and other office space; freight from our distribution centers to
the stores; compensation and supplies for our distribution centers, including purchasing, receiving
and inspection costs; and shipping and handling costs related to our e-commerce operation.
Merchandise margin is the difference between net sales and merchandise costs. Gross profit is the
difference between net sales and cost of sales.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist of compensation and employee benefit expenses,
including salaries, incentives and related benefits associated with our stores and corporate
headquarters. Selling, general and administrative expenses also include advertising costs, supplies
for our stores and home office, communication costs, travel and entertainment, leasing costs and
services purchased. Selling, general and administrative expenses do not include compensation,
employee benefit expenses and travel for our design, sourcing and importing teams, our buyers and
our distribution centers as these amounts are recorded in cost of sales.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income/expense, foreign currency
transaction gain/loss and realized investment losses.
The Company evaluates its investments for impairment in accordance with ASC 320, Investments – Debt
and Equity Securities (“ASC 320”). ASC 320 provides guidance for determining when an investment is
considered impaired, whether impairment is other-than-temporary, and measurement of an impairment
loss. An investment is considered impaired if the fair value of the investment is less than its
cost. If, after consideration of all available evidence to evaluate the realizable value of its
investment, impairment is determined to be other-than-temporary, then an impairment loss is
recognized in the Consolidated Statement of Operations equal to the difference between the
investment’s cost and its fair value. As of May 3, 2009, the Company adopted ASC 320-10-65,
Transition Related to FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of
Other-Than-Temporary-Impairments (“ASC 320-10-65”), which modifies the requirements for recognizing
other-than-temporary impairment (“OTTI”) and changes the impairment model for debt securities. In
addition, ASC 320-10-65 requires additional disclosures relating to debt and equity securities both
in the interim and annual periods as well as requires the Company to present total OTTI in the
Consolidated Statements of Operations, with an offsetting reduction for any non-credit loss
impairment amount recognized in other comprehensive income (“OCI”). During the 13 and 26 weeks
ended July 31, 2010, the Company recorded net impairment loss recognized in earnings related to credit losses on its
investment securities of $1.2 million. There was $0.2 million of net impairment loss recognized in
earnings during the 13 and 26 weeks ended August 1, 2009.
Refer to Notes 3 and 4 to the Consolidated Financial Statements for additional information
regarding net impairment losses recognized in earnings.
Cash and Cash Equivalents, Short-term Investments and Long-term Investments
Cash includes cash equivalents. The Company considers all highly liquid investments purchased with
a maturity of three months or less to be cash equivalents.
As of July 31, 2010, short-term investments included auction rate securities (“ARS”) classified as
available for sale that the Company expects to be redeemed at par within 12 months, based on notice
from the issuer.
As of July 31, 2010, long-term investments included investments with remaining maturities of
greater than 12 months and consisted of ARS classified as available-for-sale that have experienced
failed auctions or have long-term auction resets. The remaining contractual maturities of our
long-term investments are 14 months to 38 years. The weighted average contractual maturity for our
long-term investments is approximately 26 years.
Unrealized gains and losses on the Company’s available-for-sale securities are excluded from
earnings and are reported as a separate component of stockholders’ equity, within accumulated other
comprehensive income, until realized. The components of OTTI losses related to credit losses, as
defined by ASC 320, are considered by the Company to be realized losses. When available-for-sale
securities are sold, the cost of the securities is specifically identified and is used to determine
any realized gain or loss.
Refer to Note 3 to the Consolidated Financial Statements for information regarding cash and cash
equivalents, short-term investments and long-term investments.
Merchandise inventory is valued at the lower of average cost or market, utilizing the retail
method. Average cost includes merchandise design and sourcing costs and related expenses. The
Company records merchandise receipts at the time
merchandise is delivered to the foreign shipping port by the manufacturer (FOB port). This is the
point at which title and risk of loss transfer to the Company.
The Company reviews its inventory levels to identify slow-moving merchandise and generally uses
markdowns to clear merchandise. Additionally, the Company estimates a markdown reserve for future
planned permanent markdowns related to current inventory. Markdowns may occur when inventory
exceeds customer demand for reasons of style, seasonal adaptation, changes in customer preference,
lack of consumer acceptance of fashion items, competition, or if it is determined that the
inventory in stock will not sell at its currently ticketed price. Such markdowns may have a
material adverse impact on earnings, depending on the extent and amount of inventory affected. The
Company also estimates a shrinkage reserve for the period between the last physical count and the
balance sheet date. The estimate for the shrinkage reserve, based on historical results, can be
affected by changes in merchandise mix and changes in actual shrinkage trends.
The Company calculates income taxes in accordance with ASC 740, Income Taxes (“ASC 740”), which
requires the use of the asset and liability method. Under this method, deferred tax assets and
liabilities are recognized based on the difference between the Consolidated Financial Statement
carrying amounts of existing assets and liabilities and their respective tax bases as computed
pursuant to ASC 740. Deferred tax assets and liabilities are measured using the tax rates, based on
certain judgments regarding enacted tax laws and published guidance, in effect in the years when
those temporary differences are expected to reverse. A valuation allowance is established against
the deferred tax assets when it is more likely than not that some portion or all of the deferred
taxes may not be realized. Changes in the Company’s level and composition of earnings, tax laws or
the deferred tax valuation allowance, as well as the results of tax audits may materially impact
our effective tax rate.
The Company evaluates its income tax positions in accordance with ASC 740 which prescribes a
comprehensive model for recognizing, measuring, presenting and disclosing in the financial
statements tax positions taken or expected to be taken on a tax return, including a decision
whether to file or not to file in a particular jurisdiction. Under ASC 740, a tax benefit from an
uncertain position may be recognized only if it is “more likely than not” that the position is
sustainable based on its technical merits.
The calculation of the deferred tax assets and liabilities, as well as the decision to recognize a
tax benefit from an uncertain position and to establish a valuation allowance require management to
make estimates and assumptions. The Company believes that its assumptions and estimates are
reasonable, although actual results may have a positive or negative material impact on the balances
of deferred tax assets and liabilities, valuation allowances, or net income.
Property and Equipment
Property and equipment is recorded on the basis of cost with depreciation computed utilizing the
straight-line method over the assets’ estimated useful lives. The useful lives of our major classes
of assets are as follows:
||Lesser of 10 years or the term of the lease
Fixtures and equipment
In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), the Company’s management
evaluates the value of leasehold improvements and store fixtures associated with retail stores,
which have been open longer than one year. The Company evaluates long-lived assets for impairment
at the individual store level, which is the lowest level at which individual cash flows can be
identified. Impairment losses are recorded on long-lived assets used in operations when events and
circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated
to be generated by those assets are less than the carrying amounts of the assets. When events such
as these occur, the impaired assets are adjusted to their estimated fair value and an impairment
loss is recorded separately as a component of operating income under loss on impairment of assets.
During the 26 weeks ended July 31, 2010, the Company recorded asset impairment charges of $18.0
million related to the impairment of MARTIN+OSA (“M+O”) stores. Based on the Company’s decision to
close all M+O stores in Fiscal 2010, the Company determined that the stores not previously impaired
would not be able to generate sufficient cash flow over the life of the related leases to recover
the Company’s initial investment in them.
Refer to Note 12 to the Consolidated Financial Statements for additional information regarding the
discontinued operations for M+O.
As of July 31, 2010, the Company had approximately $11.4 million of goodwill compared to $11.2
million as of January 30, 2010. The Company’s goodwill is primarily related to the acquisition of
its importing operations on January 31, 2000, as well as the acquisition of its Canadian business
on November 29, 2000. The increase in goodwill is due to the fluctuation in the foreign exchange
spot rate at which the Canadian goodwill is translated. In accordance with ASC 350, Intangibles-
Goodwill and Other, the Company evaluates goodwill for possible impairment on at least an annual
basis and last performed an annual impairment test as of January 30, 2010. As a result of the
Company’s annual goodwill impairment test, the Company concluded that its goodwill was not
The value of a gift card is recorded as a current liability upon purchase, and revenue is
recognized when the gift card is redeemed for merchandise. The Company estimates gift card
breakage and recognizes revenue in proportion to actual gift card redemptions as a component of net
sales. The Company determines an estimated gift card breakage rate by continuously evaluating
historical redemption data and the time when there is a remote likelihood that a gift card will be
redeemed. During the 13 weeks ended July 31, 2010 and August 1, 2009, the Company recorded $0.7
million and $1.5 million, respectively, of revenue related to gift card breakage. During the 26
weeks ended July 31, 2010 and August 1, 2009, the Company recorded $1.7 million and $3.2 million,
respectively, of revenue related to gift card breakage.
Deferred Lease Credits
Deferred lease credits represent the unamortized portion of construction allowances received from
landlords related to the Company’s retail stores. Construction allowances are generally comprised
of cash amounts received by the Company from its landlords as part of the negotiated lease terms.
The Company records a receivable and a deferred lease credit liability at the lease commencement
date (date of initial possession of the store). The deferred lease credit is amortized on a
straight-line basis as a reduction of rent expense over the term of the original lease (including
the pre-opening build-out period) and any subsequent renewal terms. The receivable is reduced as
amounts are received from the landlord.
Co-Branded Credit Card and Customer Loyalty Program
The Company offers a co-branded credit card (the “AE Visa Card”) and a private label credit card
(the “AE Credit Card”) under both the American Eagle and aerie brands. Both of these credit cards
are issued by a third-party bank (the “Bank”), and the Company has no liability to the Bank for bad
debt expense, provided that purchases are made in accordance with the Bank’s procedures. Once a
customer is approved to receive the AE Visa Card and the card is activated, the customer is
eligible to participate in the Company’s credit card rewards program. On January 1, 2010, the
Company modified the benefits on the AE Visa and AE Credit Card programs to make both credit cards
a part of the rewards program. Customers who make purchases at AE, aerie and 77kids earn discounts
in the form of savings certificates when certain purchase levels are reached. Also, AE Visa Card
customers, who make purchases at other retailers where the card is accepted, earn additional
discounts. Savings certificates are valid for 90 days from issuance.
Points earned under the credit card rewards program on purchases at AE and aerie are accounted for
by analogy to ASC 605-25, Revenue Recognition, Multiple Element Arrangements (“ASC 605-25”). The
Company believes that points earned under its point and loyalty programs represent deliverables in
a multiple element arrangement rather than a rebate or refund of cash. Accordingly, the portion of
the sales revenue attributed to the award points is deferred and recognized when the award is
redeemed or when the points expire. Additionally, credit card reward points earned on non-AE or
aerie purchases are accounted for in accordance with ASC 605-25. As the points are earned, a
current liability is recorded for the estimated cost of the award, and the impact of adjustments is
recorded in cost of sales.
Through December 31, 2009, the Company offered its customers the AE All-Access Pass (the “Pass”), a
customer loyalty program. On January 1, 2010, the Company replaced the Pass, with the
AEREWARD$sm Loyalty Program (the “Program”). Under either loyalty program, customers
accumulate points based on purchase activity and earn rewards by reaching certain point thresholds
during three-month earning periods. Rewards earned during these periods are valid through the
stated expiration date, which is approximately one month from the mailing date. These rewards can
be redeemed for a discount on a purchase of merchandise. Rewards not redeemed during the one-month
redemption period are forfeited. The Company determined that rewards earned using the Pass and the
Program should be accounted for in accordance with ASC 605-25. Accordingly, the portion of the
sales revenue attributed to the award credits is deferred and recognized when the awards are
redeemed or expire.
During Fiscal 2007, the Company’s Board authorized a total of 60.0 million shares of our common
stock for repurchase under our share repurchase program with expiration dates extending into Fiscal
2010. The Company repurchased 18.7 million shares during Fiscal 2007 and the authorization related
to 11.3 million shares expired in Fiscal 2009. The Company repurchased 14.0 million shares as part
of our publicly announced repurchase programs during the 26 weeks ended July 31, 2010 for
approximately $192.3 million, at a weighted average price of $13.73 per share. As of July 31, 2010,
the Company had 16.0 million shares remaining authorized for repurchase. These shares will be
repurchased at the Company’s discretion. The authorization relating to the 16.0 million shares
remaining under the program expires at the end of Fiscal 2010.
During the 26 weeks ended July 31, 2010 and August 1, 2009, the Company repurchased approximately
1.0 million and 14,000 shares, respectively, from certain employees at market prices totaling $18.0
million and $0.2 million, respectively. These shares were repurchased for the payment of taxes in
connection with the vesting of share-based payments, as permitted under the 2005 Stock Award and
Incentive Plan (the “2005 Plan”).
The aforementioned share repurchases have been recorded as treasury stock.
In accordance with ASC 280, Segment Reporting (“ASC 280”), the Company has identified three
operating segments (American Eagle Brand US and Canadian stores, aerie by American Eagle retail
stores and AEO Direct) that reflect the basis used internally to review performance and allocate
resources. All of the operating segments have been aggregated and are presented as one reportable
segment, as permitted by ASC 280.
Certain reclassifications have been made to the Consolidated Financial Statements for prior periods
in order to conform to the current period presentation.