American Eagle Outfitters 2006 Annual Report Download - page 35

Merchandise Inventory
Merchandise inventory is valued at the lowerofaverage cost or market, utilizing the retail method. Average cost
includes merchandisedesign andsourcing costsand related expenses. TheCompany records merchandise
receipts at the time merchandise is delivered to the foreign shippingport by the manufacturer(FOB port). This is
the point at whichtitle and risk of loss transfer to the Company.
The Company reviews its inventory levels in order to identify slow-moving merchandise and generally uses
markdowns to clear merchandise. Additionally, the Company estimates amarkdown reserve for futureplanned
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 itscurrently ticketed price.
Such markdowns may have amaterial adverse impact on earnings, depending on the extent and amount of
inventory affected. The Company also estimates ashrinkage reserve for the period between the last physical
count and the balance sheet date. The estimate for the shrinkage reserve can be affected by changes in
merchandise mix and changes in actual shrinkage trends.
The Company and its subsidiaries sell end-of-season, overstock and irregular merchandise to third party vendors.
Historically, the proceeds and cost of sell-offs, whichare without recourse, were presented on anetbasis within
cost of sales. During the threemonths ended October 28, 2006, the Company began classifying its merchandise
sell-offs on a gross basis, with proceeds and cost of sell-offs recorded in net sales and cost of sales, respectively.
Amounts for prior periods were not adjusted to reflect this change as the amounts were determined to be
immaterial. Below is asummary of merchandise sell-offs for Fiscal 2006, Fiscal 2005 and Fiscal 2004.
For the Years Ended
(in thousands)
February 3,
2007
January 28,
2006
January 29,
2005
Proceeds from sell-offs $16,061 $14,472 $15,421
Marked-downcost of merchandise disposed of via sell-offs $22,656 $18,832 $15,780
Propertyand Equipment
Property and equipment is recorded on the basis of cost with depreciation computed utilizing the straight-line
method over the estimated useful lives as follows:
Buildings 25 years
Leasehold improvement Lesser of 5to 10 years or the term of the lease
Fixtures and equipment 3to 5years
In accordance with SFAS No. 144, management evaluates theongoing value of the Company’s property and
equipment, including but not limited to leasehold improvements and store fixtures associated with retail stores
which have been open longer than one year. Impairment losses are recorded on long-lived assets used in
operations when eventsand circumstances indicate that the assets might be impairedandtheundiscounted cash
flows estimated to be generated by those assets are less than the carrying amounts of those assets. When events
such as these occur, the impaired assets are adjustedtoestimated fair value and an impairmentloss is recorded in
selling, general and administrative expenses. The Company did not recognize any impairment losses during
Fiscal 2006 and recognized $1.2 million and $1.4 million in impairment losses during Fiscal 2005 and Fiscal
2004, respectively.
Goodwill
As of February 3, 2007, the Company had approximately $10.0 million of goodwill, whichis primarily related to
the acquisition of our importing operations on January 31, 2000. In accordance with SFAS No. 142, Goodwill
and Other Intangible Assets,management evaluates goodwill for possible impairment on at least an annual basis.
PAGE 40 ANNUAL REPORT 2006
Other Assets
Other assets consist primarily of deferred taxes, assets related to our deferred compensation plans and trademark
costs. Trademark costs are amortizedover five to fifteen years. These assets, net of amortization, are presented as
other assets (long-term) on the ConsolidatedBalance Sheets.
Deferred Lease Credits
Deferred lease credits represent the unamortizedportion 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. TheCompany records a
receivable and adeferred lease creditliabilityatthe lease commencement date(dateofinitial possession of the
store). The deferred lease creditisamortized on astraight-line basis as areduction of rent expense over the term
of the lease (including the pre-opening build-out period) and the receivable is reduced as amounts are received
from the landlord.
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.
Customer Loyalty Program
Gift Cards
The value of a gift card is recorded as acurrent liabilityupon purchase and revenue is recognized when the gift
card is redeemed for merchandise. If agift card remains inactive for greater than 24 months, the Company
assesses the recipient a one dollar per monthservice fee, where allowed by law, which is automatically deducted
from the remaining value of the card. For those jurisdictions where assessing aservice fee is not allowable by
law, the estimated breakage is recorded in amanner consistent with that described above, starting after 24
months of inactivity. Bothgift card service fees and breakage estimates are recorded within other income, net.
Derivative Instruments and Hedging Activities
On November 30, 2000, the Company entered into an interest rate swap agreement totaling $29.2 million in
connection with a $29.1 million non-revolving term loan facility (the “term facility”). The swap amount
decreased on a monthly basis beginning January 1, 2001 until the early termination of the agreement during
Fiscal 2004. The Company also retired its term facility for $16.2 million at that time.
In accordance with SFAS No. 133, Accounting forDerivative Instruments and Hedging Activities,theCompany
recognized its derivative on the balance sheet at fair value at the end of each period. Changes in the fair value of
AMERICAN EAGLE OUTFITTERS PAGE 41