American Eagle Outfitters 2006 Annual Report Download - page 24

Asset Impairment.In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
Accounting forthe Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), we evaluate long-lived
assets for impairment whenever eventsorchanges in circumstances indicate that the carrying value of an asset
might not be recoverable. Assets are evaluated for impairment by comparing the projected undiscounted future
cash flows of the asset tothecarrying value. If the future cash flows are projected to be less than the carrying
value of the asset, we adjust the assetvalue to estimated fair value and an impairmentloss is recorded in selling,
general and administrative expenses.
Our impairment loss calculations require management tomake assumptions and to apply judgment to estimate
future cash flows and asset fair values, including forecasting useful lives of the assets and selecting the discount
rate that reflects the risk inherent in future cash flows. We do not believe there is areasonable likelihood that
there will be a material change in the estimates or assumptions we use to calculate long-lived asset impairment
losses. However, if actual results are not consistent with our estimates and assumptions, our operating results
could be adversely affected.
Share-Based Payments.Weaccount for share-based payments in accordance with the provisions of SFAS
No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123(R)”). To determine the fair value of our stock
option awards, we use the Black-Scholesoption pricingmodel, whichrequires management to applyjudgment
and make assumptions to determine the fair value of our awards. These assumptions include estimating the
length of time employees will retain their vested stock options before exercising them (the “expected term”), the
estimated volatility of the price of our common stock over the expected term and an estimate of the number of
options that will ultimately be forfeited.
We calculate aweighted-average expected term using the “simplified method”aspermitted by Staff Accounting
Bulletin (“SAB”) No. 107, Share-Based Payment (“SAB No. 107”). The “simplifiedmethod” calculates the
expected term as the average of the vesting term and original contractual term of the options. Expected stock
price volatility is based on acombination of historical volatility of our common stock and implied volatility. We
chose to use acombination of historical and implied volatility as we believe that this combination is more
representative of future stock price trends than historical volatility alone. Estimated forfeitures are calculated
based on historical experience. Changes in these assumptions can materiallyaffect the estimate of the fair value
of our share-based payments and therelated amount recognized in our Consolidated Financial Statements.
Income Taxes. We calculate income taxesinaccordance with SFAS No. 109, Accounting forIncome Taxes
(“SFAS No. 109”), which requires the use of the assetandliability 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. Deferred taxassets and liabilities
are measured using the tax rates, based on certain judgments regarding enacted taxlaws and published guidance,
in effect in the years when those temporary differences are expected to reverse. Avaluation allowance is
established againstthe deferred taxassets when it is more likely than not that some portion or all of the deferred
taxes may not be realized. Changes in our level and composition of earnings,tax laws or the deferred tax
valuation allowance, as well as the results of tax auditsmay materially impact our effective tax rate.
Both thecalculation of the deferred taxassets and liabilities, as well as the decision to establish avaluation
allowance require management tomake estimates and assumptions. Although we do not believe there is a
reasonable likelihood that there will be a material change in the estimates and assumptions used, if actual results
are not consistent with theestimates and assumptions, the balancesofthe deferred taxassets, liabilities and
valuation allowance could be adversely affected.
PAGE 18 ANNUAL REPORT 2006
Key Performance Indicators
Our management evaluates the following items, which are considered keyperformance indicators, in assessing
our performance:
Comparable store sales-Comparable store sales provide ameasure of sales growth for stores open at least one
year. A store is included in comparable store salesinthe thirteenth month of operation. However, stores that have
agross square footage increase of 25% or greater due to aremodel are removed from the comparable store sales
base, but are includedin total sales. These stores are returned to the comparable store salesbase in the thirteenth
month following the remodel.
Management considers comparable store sales to be an importantindicator of our current performance.
Comparable store sales results are important in achievingleveraging of our costs, including store payroll, store
supplies, rent, etc. Positive comparable store sales contributetogreater leveraging of costs while negative
comparable store sales contributetodeleveraging of costs. Comparable store sales also have adirect impact on
our total net sales, cash and working capital.
Gross profit -Gross profit measures whether we are appropriately optimizing the price and inventory levels of
our merchandise. Grossprofit 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, certain promotional 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 andutilities 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. Any inability to obtain acceptable levels of initial markups or any
significant increase in our use of markdowns could have an adverse effect on our gross profit andresults of
operations.
Operating income-Management views operating income as akey indicator of our success. The key drivers of
operating income are comparable store sales, gross profit and our ability to control selling, general and
administrative expenses.
Store productivity -Store productivity, including net sales per average square foot, sales per productive hour,
average unit retailprice, conversion rate, the number of transactions per store, the number of units sold per store
and thenumber of units per transaction, is evaluated by management in assessing our operational performance.
Inventory turnover -Management evaluates inventory turnover as ameasure of how productively inventory is
bought and sold. Inventory turnover is important as it can signal slow moving inventory. This can be critical in
determining the need to take markdowns on merchandise.
Cash flow and liquidity -Management evaluates cashflow from operations, investing and financing in
determining the sufficiency of our cash position. Cash flow from operations has historically been sufficient to
cover our uses of cash. Management believes that cash flow from operations will be sufficient tofund anticipated
capital expenditures and working capital requirements.
Results of Operations
Overview
In Fiscal 2006, we delivered strong financial performance, marking the third consecutive year of record earnings.
Our results were driven by our on-going customer focus, the depth of talent within our teams and acompany-
wide commitment tostrong operating disciplines. During the year, we increased profitability and margins while
investing in talent, new technology, infrastructure and new concepts to support future growth.
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