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1. Interim Financial Statements
The accompanying Consolidated Financial Statements of American Eagle Outfitters, Inc. (the “Company”) at August 1, 2015 and August 2, 2014 and for the 13 and 26 week periods ended August 1, 2015 and August 2, 2014 have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Certain notes and other information have been condensed or omitted from the interim Consolidated Financial Statements presented in this Quarterly Report on Form 10-Q. Therefore, these Consolidated Financial Statements should be read in conjunction with the Company’s Fiscal 2014 Annual Report. In the opinion of the Company’s management, all adjustments (consisting of normal recurring adjustments and those described in the footnotes that follow) considered necessary for a fair presentation have been included.
As used in this report, all references to “we,” “our” and the “Company” refer to American Eagle Outfitters, Inc. and its wholly owned subsidiaries. “American Eagle Outfitters,” “American Eagle,” “AEO” and the “AE Brand” refer to our American Eagle Outfitters stores. “aerie” refers to our aerie® by American Eagle® stores. “AEO Direct” refers to our e-commerce operations, ae.com and aerie.com.
The Company’s business is affected by the pattern of seasonality common to most retail apparel businesses. The results for the current and prior periods are not necessarily indicative of future financial results.
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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 August 1, 2015, the Company operated in one reportable segment.
Fiscal Year
The Company’s financial year is a 52/53 week year that ends on the Saturday nearest to January 31. As used herein, “Fiscal 2015” refers to the 52 week period ending January 30, 2016. “Fiscal 2014” refers to the 52 week period ended January 31, 2015.
Estimates
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 the Company’s estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 is a comprehensive new revenue recognition model that expands disclosure requirements and requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. Originally, ASU 2014-09 was effective for annual reporting periods beginning after December 15, 2016 and early adoption was not permitted. In July 2015, the FASB voted to approve amendments that deferred the effective date by one year to be effective for annual reporting periods beginning after December 15, 2017. The amendment allows early adoption, but not before the original effective date of December 15, 2016. Accordingly, the Company will adopt ASU 2014-09 on February 4, 2018. The Company does not expect a material impact of the adoption of this guidance on the Company’s consolidated financial condition, results of operations and cash flows.
Foreign Currency Translation
In accordance with Accounting Standards Codification (“ASC”) 830, Foreign Currency Matters, assets and liabilities denominated in foreign currencies were translated into United States dollars (“USD”) (the reporting currency) at the exchange rates prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies were translated into USD at the monthly average exchange rates 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.
Revenue Recognition
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 total net revenue. 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 total net revenue 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 issuance of gift cards. A current liability is recorded upon issuance, 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 total net revenue. For further information on the Company’s gift card program, refer to the Gift Cards caption below.
The Company recognizes royalty revenue generated from its license agreements based on a percentage of merchandise sales by the licensee. This revenue is recorded as a component of total net revenue when earned.
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.
Design costs are related to the Company’s Design Center operations and include compensation, travel, supplies and samples for our design teams, as well as rent and depreciation for our Design Center. These costs are included in cost of sales as the respective inventory is sold.
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. Gross profit is the difference between total net revenue 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 (Expense) Income, Net
Other (expense) income, net consists primarily of foreign currency transaction gain/loss and interest income/expense.
Other-than-Temporary Impairment
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. There was no net impairment loss for investment securities recognized in earnings during the 13 and 26 weeks ended August 1, 2015 or August 2, 2014.
Cash and Cash Equivalents and Short-term Investments
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
As of August 1, 2015 and August 2, 2014, the Company held no short-term investments.
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. 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 and short-term investments.
Merchandise Inventory
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 when both title and risk of loss for the merchandise have transferred 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.
Income Taxes
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 the Company’s effective income 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.
Refer to Note 10 to the Consolidated Financial Statements for additional information regarding income taxes.
Property and Equipment
Property and equipment is recorded on the basis of cost, including costs to prepare the asset for use, 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:
Buildings | 25 years | |
Leasehold improvements | Lesser of 10 years or the term of the lease | |
Fixtures and equipment | 5 years |
In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), 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, for stores that have been open for a period of time sufficient to reach maturity. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets are impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded.
Refer to Note 6 to the Consolidated Financial Statements for additional information regarding property and equipment.
Goodwill
The Company’s goodwill is primarily related to the acquisition of its importing operations, Canadian business and businesses in Hong Kong and China. In accordance with ASC 350, Intangibles – Goodwill and Other (“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 31, 2015. As a result of the Company’s annual goodwill impairment test, the Company concluded that its goodwill was not impaired.
Intangible Assets
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 generally amortized over 15 to 25 years.
The 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 are less than the carrying amounts of the assets, then the assets are impaired and are adjusted to their estimated fair value. No intangible asset impairment charges were recorded during the 13 or 26 weeks ended August 1, 2015 or August 2, 2014.
Refer to Note 7 to the Consolidated Financial Statements for additional information regarding intangible assets.
Gift Cards
The value of a gift card is recorded as a current liability upon issuance, 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 total net revenue. 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. The Company recorded $1.5 million and $1.3 million of revenue related to gift card breakage during both the 13 weeks ended August 1, 2015 and August 2, 2014, respectively. During the 26 weeks ended August 1, 2015 and August 2, 2014, the Company recorded $3.2 million and $2.9 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). 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”). 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 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 from issuance.
Points earned under the credit card rewards program on purchases 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.
The Company offers its customers the AEREWARD$sm loyalty program (the “Program”). Under the 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 of the reward. 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 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.
Segment Information
In accordance with ASC 280, Segment Reporting (“ASC 280”), the Company has identified three operating segments (American Eagle Brand retail stores, aerie 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.
Reclassification
Certain reclassifications have been made to the Consolidated Financial Statements for prior periods in order to conform to the current period presentation.
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3. Cash and Cash Equivalents and Short-term Investments
The following table summarizes the fair market values for the Company’s cash and marketable securities, which are recorded on the Consolidated Balance Sheets:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Cash and cash equivalents: |
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Cash |
$ | 248,824 | $ | 370,692 | $ | 186,840 | ||||||
Money-market |
78,466 | 40,005 | 53,606 | |||||||||
Treasury bills |
— | — | 22,182 | |||||||||
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Total cash and cash equivalents |
$ | 327,290 | $ | 410,697 | $ | 262,628 | ||||||
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Total |
$ | 327,290 | $ | 410,697 | $ | 262,628 | ||||||
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Proceeds from the sale of investments were $10.0 million for the 26 weeks August 2, 2014. There were no sales or purchases of investments for the 26 weeks ended August 1, 2015.
There were no unrecognized gains or losses for the Company’s available-for-sale securities for the 13 or 26 weeks ended August 1, 2015 or August 2, 2014.
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4. Fair Value Measurements
ASC 820, Fair Value Measurement Disclosures (“ASC 820”), defines fair value, establishes a framework for measuring fair value in accordance with GAAP, and expands disclosures about fair value measurements. Fair value is defined under ASC 820 as the exit price associated with the sale of an asset or transfer of a liability in an orderly transaction between market participants at the measurement date.
Financial Instruments
Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. In addition, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:
• | Level 1 — Quoted prices in active markets for identical assets or liabilities. |
• | Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
• | Level 3 — Unobservable inputs (i.e., projections, estimates, interpretations, etc.) that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
As of August 1, 2015 and August 2, 2014, the Company held certain assets that are required to be measured at fair value on a recurring basis. These include cash and cash equivalents.
In accordance with ASC 820, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents) measured at fair value on a recurring basis at August 1, 2015 and August 2, 2014:
Fair Value Measurements at August 1, 2015 | ||||||||||||||||
(In thousands) | Carrying Amount |
Quoted Market Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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Cash and cash equivalents: |
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Cash |
$ | 248,824 | $ | 248,824 | — | — | ||||||||||
Money-market |
78,466 | 78,466 | — | — | ||||||||||||
Total cash and cash equivalents |
$ | 327,290 | $ | 327,290 | — | — | ||||||||||
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Total |
$ | 327,290 | $ | 327,290 | — | — | ||||||||||
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Fair Value Measurements at August 2, 2014 | ||||||||||||||||
(In thousands) | Carrying Amount |
Quoted Market Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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Cash and cash equivalents: |
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Cash |
$ | 186,840 | $ | 186,840 | — | — | ||||||||||
Money-market |
53,606 | 53,606 | — | — | ||||||||||||
Treasury bills |
22,182 | 22,182 | — | — | ||||||||||||
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Total cash and cash equivalents |
$ | 262,628 | $ | 262,628 | — | — | ||||||||||
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Total |
$ | 262,628 | $ | 262,628 | — | — | ||||||||||
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In the event the Company holds Level 3 investments, a discounted cash flow model is used to value those investments. There were no Level 3 investments at August 1, 2015 or August 2, 2014.
Non-Financial Assets
The Company’s non-financial assets, which include goodwill, intangible assets and property and equipment, are not required to be measured at fair value on a recurring basis. However, if certain triggering events occur, or if an annual impairment test is required, and the Company is required to evaluate the non-financial instrument for impairment, a resulting asset impairment would require that the non-financial asset be recorded at the estimated fair value.
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6. Property and Equipment
Property and equipment consists of the following:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Property and equipment, at cost |
$ | 1,752,491 | $ | 1,684,709 | $ | 1,731,661 | ||||||
Less: Accumulated depreciation |
(1,040,212 | ) | (989,853 | ) | (1,002,198 | ) | ||||||
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Property and equipment, net |
$ | 712,279 | $ | 694,856 | $ | 729,463 | ||||||
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7. Intangible Assets
Intangible assets consist of the following:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Trademarks and other intangibles, at cost |
$ | 61,065 | $ | 59,385 | $ | 59,015 | ||||||
Less: Accumulated amortization |
(13,911 | ) | (12,179 | ) | (10,505 | ) | ||||||
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Intangible assets, net |
$ | 47,154 | $ | 47,206 | $ | 48,510 | ||||||
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8. Other Credit Arrangements
In Fiscal 2014, the Company entered into a Credit Agreement (“Credit Agreement”) for five-year, syndicated, asset-based revolving credit facilities (the “Credit Facilities”). The Credit Agreement provides senior secured revolving credit for loans and letters of credit up to $400 million, subject to customary borrowing base limitations. The Credit Facilities provide increased financial flexibility and take advantage of a favorable credit environment.
All obligations under the Credit Facilities are unconditionally guaranteed by certain subsidiaries. The obligations under the Credit Agreement are secured by a first-priority security interest in certain working capital assets of the borrowers and guarantors, consisting primarily of cash, receivables, inventory and certain other assets and have been further secured by first-priority mortgages on certain real property.
As of August 1, 2015, the Company was in compliance with the terms of the Credit Agreement and had $8.1 million outstanding in stand-by letters of credit. No loans were outstanding under the Credit Agreement as of August 1, 2015.
Additionally, the Company has borrowing agreements with two separate financial institutions under which it may borrow an aggregate of $155.0 million USD for the purposes of trade letter of credit issuances. The availability of any future borrowings under the trade letter of credit facilities is subject to acceptance by the respective financial institutions.
As of August 1, 2015, the Company had outstanding trade letters of credit of $20.6 million
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10. Income Taxes
The provision for income taxes is based on the current estimate of the annual effective income tax rate and is adjusted as necessary for discrete quarterly events. The effective income tax rate based on actual operating results for the 13 weeks ended August 1, 2015 was 34.7% compared to 54.9% for the 13 weeks ended August 2, 2014. The effective income tax rate based on actual operating results for the 26 weeks ended August 1, 2015 was 37.0% compared to 56.0% for the 26 weeks ended August 2, 2014. The decrease in the effective income tax rate for the 13 weeks and 26 weeks ended August 1, 2015 was primarily due to a decrease in the amount of valuation allowance recorded as a result of reduced foreign losses as well as increased worldwide earnings in addition to income tax settlements and other changes in income tax reserves.
The Company records accrued interest and penalties related to unrecognized tax benefits in income tax expense. The Company recognizes income tax liabilities related to unrecognized tax benefits in accordance with ASC 740 and adjusts these liabilities when its judgment changes as the result of the evaluation of new information not previously available. Unrecognized tax benefits decreased by approximately $5.7 million during the 13 weeks ended August 1, 2015. The decrease was primarily due to income tax settlements and other changes in income tax reserves. Over the next twelve months, the Company believes that it is reasonably possible that unrecognized tax benefits may decrease by approximately $3.8 million due to settlements, expiration of statute of limitations or other changes in unrecognized tax benefits.
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11. Legal Proceedings
The Company is subject to certain legal proceedings and claims arising out of the conduct of its business. In accordance with ASC 450, Contingencies (“ASC 450”), management records a reserve for estimated losses when the loss is probable and the amount can be reasonably estimated. If a range of possible loss exists and no anticipated loss within the range is more likely than any other anticipated loss, the Company records the accrual at the low end of the range, in accordance with ASC 450. As the Company believes that it has provided adequate reserves, it anticipates that the ultimate outcome of any matter currently pending against the Company will not materially affect the consolidated financial position or results of operations of the Company.
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12. Discontinued Operations
In Fiscal 2012, the Company exited the 77kids business. In connection with the exit of the 77kids business, the Company became secondarily liable for obligations under lease agreements for 21 store leases assumed by the third party purchaser. In Fiscal 2014, the third party purchaser did not fulfill its obligations under the leases, resulting in the Company becoming primarily liable. The Company was required to make rental and lease termination payments and received reimbursement from the $11.5 million stand-by letter of credit provided by the third party purchaser. The cash outflow for the remaining lease termination costs is expected to be paid in Fiscal 2015.
In accordance with ASC 460, Guarantees (“ASC 460”), as the Company became primarily liable under the leases upon the third party purchaser’s default, the estimated remaining amounts to terminate the lease agreements have been accrued in our Consolidated Financial Statements related to these guarantees.
During the 26 weeks ended August 1, 2015 and August 2, 2014, there were no costs associated with discontinued operations incurred on the Consolidated Statement of Operations.
A rollforward of the liabilities recognized in the Consolidated Balance Sheets is as follows:
(In thousands) | ||||
Accrued liability as of January 31, 2015 |
$ | 14,636 | ||
Add: Costs incurred |
— | |||
Less: Cash payments |
(1,542 | ) | ||
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Accrued liability as of August 1, 2015 |
$ | 13,094 | ||
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13. Restructuring Charges
During Fiscal 2014, the Company undertook restructuring aimed at strengthening the store portfolio and reducing corporate overhead, including severance and office space consolidation. These changes are aimed at driving efficiencies and aligning investments in areas that help fuel the business.
Costs associated with restructuring activities are recorded when incurred. During the 26 weeks ended August 1, 2015 and August 2, 2014, there were no costs associated with restructuring incurred on the Consolidated Statement of Operations.
A rollforward of the liabilities recognized in the Consolidated Balance Sheets is as follows:
(In thousands) | ||||
Accrued liability as of January 31, 2015 |
$ | 12,456 | ||
Add: Costs incurred |
— | |||
Less: Cash payments |
(7,933 | ) | ||
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Accrued liability as of August 1, 2015 |
$ | 4,523 | ||
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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 August 1, 2015, the Company operated in one reportable segment.
Fiscal Year
The Company’s financial year is a 52/53 week year that ends on the Saturday nearest to January 31. As used herein, “Fiscal 2015” refers to the 52 week period ending January 30, 2016. “Fiscal 2014” refers to the 52 week period ended January 31, 2015.
Estimates
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 the Company’s estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”). ASU 2014-09 is a comprehensive new revenue recognition model that expands disclosure requirements and requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. Originally, ASU 2014-09 was effective for annual reporting periods beginning after December 15, 2016 and early adoption was not permitted. In July 2015, the FASB voted to approve amendments that deferred the effective date by one year to be effective for annual reporting periods beginning after December 15, 2017. The amendment allows early adoption, but not before the original effective date of December 15, 2016. Accordingly, the Company will adopt ASU 2014-09 on February 4, 2018. The Company does not expect a material impact of the adoption of this guidance on the Company’s consolidated financial condition, results of operations and cash flows.
Foreign Currency Translation
In accordance with Accounting Standards Codification (“ASC”) 830, Foreign Currency Matters, assets and liabilities denominated in foreign currencies were translated into United States dollars (“USD”) (the reporting currency) at the exchange rates prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies were translated into USD at the monthly average exchange rates 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.
Revenue Recognition
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 total net revenue. 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 total net revenue 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 issuance of gift cards. A current liability is recorded upon issuance, 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 total net revenue. For further information on the Company’s gift card program, refer to the Gift Cards caption below.
The Company recognizes royalty revenue generated from its license agreements based on a percentage of merchandise sales by the licensee. This revenue is recorded as a component of total net revenue when earned.
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.
Design costs are related to the Company’s Design Center operations and include compensation, travel, supplies and samples for our design teams, as well as rent and depreciation for our Design Center. These costs are included in cost of sales as the respective inventory is sold.
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. Gross profit is the difference between total net revenue 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 (Expense) Income, Net
Other (expense) income, net consists primarily of foreign currency transaction gain/loss and interest income/expense.
Other-than-Temporary Impairment
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. There was no net impairment loss for investment securities recognized in earnings during the 13 and 26 weeks ended August 1, 2015 or August 2, 2014.
Cash and Cash Equivalents and Short-term Investments
The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.
As of August 1, 2015 and August 2, 2014, the Company held no short-term investments.
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. 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 and short-term investments.
Merchandise Inventory
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 when both title and risk of loss for the merchandise have transferred 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.
Income Taxes
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 the Company’s effective income 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.
Refer to Note 10 to the Consolidated Financial Statements for additional information regarding income taxes.
Property and Equipment
Property and equipment is recorded on the basis of cost, including costs to prepare the asset for use, 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:
Buildings | 25 years | |
Leasehold improvements | Lesser of 10 years or the term of the lease | |
Fixtures and equipment | 5 years |
In accordance with ASC 360, Property, Plant, and Equipment (“ASC 360”), 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, for stores that have been open for a period of time sufficient to reach maturity. Impairment losses are recorded on long-lived assets used in operations when events and circumstances indicate that the assets are impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. When events such as these occur, the impaired assets are adjusted to their estimated fair value and an impairment loss is recorded.
Refer to Note 6 to the Consolidated Financial Statements for additional information regarding property and equipment.
Goodwill
The Company’s goodwill is primarily related to the acquisition of its importing operations, Canadian business and businesses in Hong Kong and China. In accordance with ASC 350, Intangibles – Goodwill and Other (“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 31, 2015. As a result of the Company’s annual goodwill impairment test, the Company concluded that its goodwill was not impaired.
Intangible Assets
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 generally amortized over 15 to 25 years.
The 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 are less than the carrying amounts of the assets, then the assets are impaired and are adjusted to their estimated fair value. No intangible asset impairment charges were recorded during the 13 or 26 weeks ended August 1, 2015 or August 2, 2014.
Refer to Note 7 to the Consolidated Financial Statements for additional information regarding intangible assets.
Gift Cards
The value of a gift card is recorded as a current liability upon issuance, 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 total net revenue. 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. The Company recorded $1.5 million and $1.3 million of revenue related to gift card breakage during both the 13 weeks ended August 1, 2015 and August 2, 2014, respectively. During the 26 weeks ended August 1, 2015 and August 2, 2014, the Company recorded $3.2 million and $2.9 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). 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”). 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 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 from issuance.
Points earned under the credit card rewards program on purchases 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.
The Company offers its customers the AEREWARD$sm loyalty program (the “Program”). Under the 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 of the reward. 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 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.
Segment Information
In accordance with ASC 280, Segment Reporting (“ASC 280”), the Company has identified three operating segments (American Eagle Brand retail stores, aerie 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.
Reclassification
Certain reclassifications have been made to the Consolidated Financial Statements for prior periods in order to conform to the current period presentation.
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The useful lives of our major classes of assets are as follows:
Buildings | 25 years | |
Leasehold improvements | Lesser of 10 years or the term of the lease | |
Fixtures and equipment | 5 years |
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The following table summarizes the fair market values for the Company’s cash and marketable securities, which are recorded on the Consolidated Balance Sheets:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Cash and cash equivalents: |
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Cash |
$ | 248,824 | $ | 370,692 | $ | 186,840 | ||||||
Money-market |
78,466 | 40,005 | 53,606 | |||||||||
Treasury bills |
— | — | 22,182 | |||||||||
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Total cash and cash equivalents |
$ | 327,290 | $ | 410,697 | $ | 262,628 | ||||||
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Total |
$ | 327,290 | $ | 410,697 | $ | 262,628 | ||||||
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In accordance with ASC 820, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents) measured at fair value on a recurring basis at August 1, 2015 and August 2, 2014:
Fair Value Measurements at August 1, 2015 | ||||||||||||||||
(In thousands) | Carrying Amount |
Quoted Market Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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Cash and cash equivalents: |
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Cash |
$ | 248,824 | $ | 248,824 | — | — | ||||||||||
Money-market |
78,466 | 78,466 | — | — | ||||||||||||
Total cash and cash equivalents |
$ | 327,290 | $ | 327,290 | — | — | ||||||||||
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Total |
$ | 327,290 | $ | 327,290 | — | — | ||||||||||
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Fair Value Measurements at August 2, 2014 | ||||||||||||||||
(In thousands) | Carrying Amount |
Quoted Market Prices in Active Markets for Identical Assets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
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Cash and cash equivalents: |
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Cash |
$ | 186,840 | $ | 186,840 | — | — | ||||||||||
Money-market |
53,606 | 53,606 | — | — | ||||||||||||
Treasury bills |
22,182 | 22,182 | — | — | ||||||||||||
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Total cash and cash equivalents |
$ | 262,628 | $ | 262,628 | — | — | ||||||||||
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Total |
$ | 262,628 | $ | 262,628 | — | — | ||||||||||
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Property and equipment consists of the following:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Property and equipment, at cost |
$ | 1,752,491 | $ | 1,684,709 | $ | 1,731,661 | ||||||
Less: Accumulated depreciation |
(1,040,212 | ) | (989,853 | ) | (1,002,198 | ) | ||||||
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Property and equipment, net |
$ | 712,279 | $ | 694,856 | $ | 729,463 | ||||||
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Intangible assets consist of the following:
(In thousands) | August 1, 2015 |
January 31, 2015 |
August 2, 2014 |
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Trademarks and other intangibles, at cost |
$ | 61,065 | $ | 59,385 | $ | 59,015 | ||||||
Less: Accumulated amortization |
(13,911 | ) | (12,179 | ) | (10,505 | ) | ||||||
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Intangible assets, net |
$ | 47,154 | $ | 47,206 | $ | 48,510 | ||||||
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A rollforward of the liabilities recognized in the Consolidated Balance Sheets is as follows:
(In thousands) | ||||
Accrued liability as of January 31, 2015 |
$ | 12,456 | ||
Add: Costs incurred |
— | |||
Less: Cash payments |
(7,933 | ) | ||
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Accrued liability as of August 1, 2015 |
$ | 4,523 | ||
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A rollforward of the liabilities recognized in the Consolidated Balance Sheets is as follows:
(In thousands) | ||||
Accrued liability as of January 31, 2015 |
$ | 14,636 | ||
Add: Costs incurred |
— | |||
Less: Cash payments |
(1,542 | ) | ||
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Accrued liability as of August 1, 2015 |
$ | 13,094 | ||
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