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
April 30, 2011, the Company operated in one reportable segment.
On March 5, 2010, the Company’s Board of Directors (the “Board”) approved management’s recommendation to proceed
with the closure of the M+O brand. The Company completed the closure of the M+O stores and
e-commerce operation during the second quarter of Fiscal 2010. These Consolidated Financial
Statements reflect the results of M+O as a discontinued operation for all periods presented.
The Company’s financial year is a 52/53 week year that ends on the Saturday nearest to January 31.
As used herein, “Fiscal 2012” and “Fiscal 2011” refer to the 53 and 52 week periods ending February
2, 2013 and January 28, 2012, respectively. “Fiscal 2010” and “Fiscal 2009” refer to the 52 week
periods ended January 29, 2011 and January 30, 2010, 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 December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards
Update (“ASU”) 2010-28, Intangibles — Goodwill and Other (Topic 350): When to Perform Step 2 of the
Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (“ASU
2010-28”). ASU 2010-28
amendments to Accounting Standards Codification (“ASC”)
350, Intangibles — Goodwill and Other (“ASC 350”) to modify Step 1 of the goodwill impairment test for reporting
units with zero or negative carrying amounts to clarify that, for those reporting units, an entity
is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a
goodwill impairment exists. In determining whether it is more likely than not that a goodwill
impairment exists, an entity should consider whether there are any adverse qualitative factors
indicating that an impairment may exist. For public entities, the amendments in this ASU are
effective for fiscal years, and interim periods within those years, beginning after December 15,
2010. Early adoption is not permitted. The adoption of ASU 2010-28 did not have an impact on the
Company’s Fiscal 2011 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 9 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 recognizes revenue generated from its franchise agreements based upon a percentage on
sales of merchandise by the franchisee. This revenue is recorded as a component of net sales when
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,
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, Net
Other income, net consists primarily of interest income/expense, foreign currency transaction
gain/loss and realized investment gain/loss.
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. Additionally, ASC 320 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 other-than-temporary impairment (“OTTI”) in the Consolidated
Statements of Operations, with an offsetting reduction for any non-credit loss impairment amount
recognized in other comprehensive income (“OCI”). There was no net impairment loss recognized in
earnings during either the 13 weeks ended April 30, 2011 or May 1, 2010.
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 April 30, 2011, short-term investments included commercial paper, corporate bonds, treasury
bills and short-term deposits purchased with a maturity of greater than three months, but less than
one year, and auction rate securities (“ARS”) classified as available for sale that the Company
expects to be redeemed at par within 12 months.
As of April 30, 2011, long-term investments included investments with remaining maturities of
greater than 12 months and consisted of ARS classified as available-for-sale. It also includes the
Company’s ARS Call Option related to investment sales during Fiscal 2010. The remaining contractual
maturities of our long-term ARS investments are approximately 14 months and the ARS Call Option
expires on October 29, 2013.
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 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
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
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 for a period of time sufficient to reach maturity. 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 recognized within selling, general and administrative expenses on the Consolidated
Statements of Operations.
No asset impairment charges were recorded in the 13 weeks ended April 30, 2011. During the 13
weeks ended May 1, 2010, the Company recorded asset impairment charges of $18.0 million related to
the impairment of 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. The asset impairment charges for the 13 weeks ended May 1, 2010 are recorded
within Loss from Discontinued Operations on the Consolidated Statements of Operations.
Refer to Note 13 to the Consolidated Financial Statements for additional information regarding the
discontinued operations of M+O.
As of April 30, 2011, the Company had approximately $11.7 million of goodwill compared to $11.5
million as of January 29, 2011. 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, the
Company evaluates goodwill for possible impairment on at least an annual basis and last performed
an annual impairment test as of January 29, 2011. As a result of the Company’s annual goodwill
impairment test, the Company concluded that its goodwill was not impaired.
Intangible assets are recorded on the basis of cost with amortization computed utilizing the
straight-line method over the assets’ estimated useful lives. The Company’s intangible assets,
which primarily include trademark assets, are amortized over 15 to 25 years.
Company evaluates intangible assets for impairment in accordance with
ASC 350 when events or circumstances indicate that
the carrying value of the asset may not be recoverable. Such an evaluation includes the estimation
of undiscounted future cash flows to be generated by those assets. If the sum of the estimated
future undiscounted cash flows is less than the carrying amounts of the assets the assets are
impaired and are adjusted to their estimated fair value. No asset impairment charges were recorded
in the 13 weeks ended April 30, 2011 or May 1, 2010.
Refer to Note 7 to the Consolidated Financial Statements for additional information regarding
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 April 30, 2011 and May 1, 2010, the Company recorded $1.1
million and $1.0 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 “AEO Visa Card”) and a private label credit card
(the “AEO Credit Card”) under the American Eagle, aerie and 77kids brands. 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 AEO Visa Card or the AEO Credit Card and the card is activated,
the customer is eligible to participate in the credit card 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, AEO Visa Card customers who make purchases at other retailers
where the card is accepted earn additional discounts. Savings certificates are valid for 90 days
Points earned under the credit card rewards program on purchases at AE, aerie and 77kids 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, aerie or 77kids 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.