American Eagle Outfitters 2004 Annual Report Download - page 26

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Part II
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 tax assets may
not be realized.
Legal Proceedings and Claims. The Company is subject to certain legal proceedings and claims arising out of the
conduct of its business. In accordance with SFAS No. 5, Accounting for Contingencies, Management records a
reserve for estimated losses when the amount is probable and can be reasonably estimated. If a range of possible loss
exists, the Company records the accrual at the low end of the range, in accordance with FIN 14, an interpretation of
SFAS No. 5. As the Company has provided adequate reserves, it believes that the ultimate outcome of any matter
currently pending against the Company will not materially affect the financial position or results of operations of the
Company.
Self Insurance Reserve. The Company is self-insured for certain losses related to employee medical benefits. Costs
for self-insurance claims filed and claims incurred but not reported are accrued based on known claims and historical
experience. Management believes that it has adequately reserved for its self-insurance liability, which is capped
through the use of stop loss contracts with insurance companies. However, any significant variation of future claims
from historical trends could cause actual results to differ from the accrued liability.
Key Performance Indicators
Management of the Company evaluates the following items, which are considered key performance indicators, in
assessing the Company’s performance:
Comparable store sales – A store is included in comparable store sales in the thirteenth month of operation.
However, stores that have a gross square footage increase of 25% or greater due to a remodel are removed from the
comparable store sales base, but are included in total sales. These stores are returned to the comparable store sales
base in the thirteenth month following the remodel.
Management considers comparable store sales to be an important indicator of the Company’s current performance.
Comparable store sales results are important in achieving leveraging of our costs, including store payroll, store
supplies, rent, etc. Positive comparable store sales contribute to greater leveraging of costs while negative
comparable store sales contribute to deleveraging of costs. Comparable store sales also have a direct impact on the
Company’s total net sales, cash and working capital.
Gross profit – Gross profit measures whether the Company is appropriately optimizing the price of its merchandise.
Gross profit is the difference between net sales and cost of sales. Cost of sales consists of merchandise costs,
including design, sourcing, importing and inbound freight costs, as well as markdowns, shrinkage, promotional costs
and buying, occupancy and warehousing costs. Buying, occupancy and warehousing costs consists of compensation
and travel for our buyers; rent and utilities related to our stores, corporate headquarters, distribution centers and
other office space; freight from our distribution centers to the stores; and compensation and supplies for our
distribution centers, including purchasing, receiving and inspection costs. Any inability to obtain acceptable levels of
initial markups or any significant increase in the Company’s use of markdowns could have an adverse effect on the
Company’s gross profit and results of operations.
Operating income – Management views operating income as a key indicator of the Company’s success. The key
drivers of operating income are comparable store sales, gross profit and the Company’s ability to control operating
costs.
Store productivity – Store productivity, including sales per square foot, average unit retail price, number of
transactions per store, number of units sold per store and number of units per transaction, is evaluated by
Management in assessing the operational performance of the Company.