Other assets consist primarily of deferred taxes, lease buyout costs, trademark costs and acquisition costs. The lease buyout costs are amortized over the remaining life of the leases, generally for no greater than ten years. The trademark costs are amortized over five to fifteen years. Acquisition costs are amortized over five years. These assets, net of amortization, are presented as other assets (long-term) on the Consolidated Balance Sheets.

The Company's interest rate swap agreement is used to manage interest rate risk. The derivative effectively changes the interest rate on the borrowings under the non-revolving term facility from a variable rate to a fixed rate. The Company recognizes its derivative on the balance sheet at fair value at the end of each period. Changes in the fair value of the derivative that is designated and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income (loss). During Fiscal 2003, unrealized net losses on derivative instruments of approximately $0.1 million, net of related tax effects, were recorded in other comprehensive income (loss). The Company does not hold or issue derivative financial instruments for trading purposes.

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On February 24, 2000, the Company's Board of Directors authorized the repurchase of up to 3,750,000 shares of its stock. As part of this stock repurchase program, the Company purchased 40,000, 1,140,000 and 63,800 shares of common stock for approximately $0.6 million, $17.8 million and $1.1 million on the open market during Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively. As of January 31, 2004, approximately 700,000 shares remain authorized for repurchase. Additionally, during Fiscal 2003, Fiscal 2002 and Fiscal 2001, the Company purchased 8,000 shares, 58,000 shares and 44,000 shares, respectively, from certain employees at market prices totaling $0.1 million, $1.6 million and $1.4 million, respectively, for the payment of taxes in connection with the vesting of restricted stock as permitted under the 1999 Stock Incentive Plan. These repurchases have been recorded as treasury stock.

The Company calculates income taxes in accordance with SFAS No. 109, Accounting for Income Taxes, 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. Deferred tax assets and liabilities are measured using the tax rates 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.

The Company accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. The pro forma information below is based on provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure ("SFAS No. 148"), issued in December 2002. SFAS No. 148 requires that the pro forma information regarding net income and earnings per share be determined as if the Company had accounted for its employee stock options granted beginning in the fiscal year subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

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For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:

The Company records revenue for store sales upon the purchase of merchandise by customers. The Company's e-commerce and catalog business records revenue at the time the goods are shipped. 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. Revenue is recorded net of sales returns.

Revenue is not recorded on the sell-off of end-of-season, overstock and irregular merchandise to off-price retailers. These sell-offs are typically sold below cost and the proceeds are reflected in cost of sales. See Note 3 of the Consolidated Financial Statements for further discussion.

Cost of sales consists of merchandise costs, including design, sourcing, importing and inbound freight costs, as well as markdowns, shrinkage and promotional 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.

The gross profit impact of a sales returns reserve, which is recorded in cost of sales, is provided on gross sales for projected merchandise returns based on historical average return percentages. During Fiscal 2003, the Company obtained better information regarding the historical rate components which resulted in a reduction of the estimated return percentage.

Selling, general and administrative expenses consist of compensation and employee benefit expenses, other than for our design, sourcing and importing teams, our buyers and our distribution centers. Such compensation and employee benefit expenses include salaries, incentives and related benefits associated with our stores and corporate headquarters, except as previously noted. Selling, general and administrative expenses also include advertising costs, supplies for our stores and home office, freight related to inter-store transfers, communication costs, travel and entertainment, leasing costs and services purchased.

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Certain advertising costs, including direct mail, in-store photographs and other promotional costs are expensed when the marketing campaign commences. Costs associated with the production of television advertising are expensed over the life of the campaign. All other advertising costs are expensed as incurred. The Company recognized $46.5 million in advertising expense during both Fiscal 2003 and Fiscal 2002 and $45.3 million during Fiscal 2001.

The Company has certain design costs, which include compensation, rent, travel, supplies and samples, which are included in cost of sales as the respective inventory is sold.

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 of the Company.

The following table shows the amounts used in computing earnings per share and the effect on income and the weighted average number of shares of potential dilutive common stock equivalents (stock options and restricted stock).

Options to purchase 5,272,000, 5,438,000 and 779,000 shares of common stock during Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively, were outstanding, but were not included in the computation of net income per diluted share because the options' exercise prices were greater than the average market price of the underlying shares.

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Certain reclassifications have been made to the Consolidated Financial Statements for prior periods in order to conform to the Fiscal 2003 presentation.

The Company and its wholly-owned subsidiaries have various transactions with related parties. The Company believes that the terms of these transactions are as favorable to the Company as those that could be obtained from unrelated third parties. The nature of the Company's relationship with these related parties and a description of the respective transactions are as follows:

As of January 31, 2004, the Schottenstein-Deshe-Diamond families (the "families") owned 26% of the outstanding shares of Common Stock of the Company. The families also own a private company, Schottenstein Stores Corporation ("SSC"), which owns Linmar Realty Company and also includes a publicly-traded subsidiary, Retail Ventures, Inc. ("RVI"), formerly Value City Department Stores, Inc. The Company had the following transactions with these related parties during Fiscal 2003, Fiscal 2002 and Fiscal 2001.

The Company has an operating lease for its corporate headquarters and distribution center with Linmar Realty Company. The lease, which expires on December 31, 2020, provides for annual rental payments of approximately $2.4 million through 2005, $2.6 million through 2015, and $2.7 million through the end of the lease. Rent expense was $2.4 million during Fiscal 2003 and Fiscal 2002 and $2.5 million during Fiscal 2001 under the lease.

The Company and its subsidiaries sell end-of-season, overstock and irregular merchandise to various parties, including RVI. These sell-offs, which are without recourse, are typically sold below cost and the proceeds are reflected in cost of sales. The cost of merchandise disposed of via sell-offs during Fiscal 2003, Fiscal 2002 and Fiscal 2001 was $38.3 million, $21.3 million and $11.9 million, respectively, which resulted in adjustments to cost of sales of $6.0 million, $1.9 million and $1.7 million for the respective years attributed to these transactions. Included in these amounts were $12.9 million, $7.8 million and $4.6 million of merchandise, at cost, which was sold to RVI during Fiscal 2003, Fiscal 2002 and Fiscal 2001, respectively, and resulted in adjustments to cost of sales of $0.3 million, $0.1 million and $1.1 million during the respective periods.

The Company had approximately $2.8 million and $1.3 million included in accounts receivable at January 31, 2004 and February 1, 2003, respectively, that pertained to related party merchandise sell-offs.

SSC and its affiliates charge the Company for various professional services provided to the Company, including certain legal, real estate, travel and insurance services. For Fiscal 2003, Fiscal 2002 and Fiscal 2001, the Company paid approximately $0.9 million, $0.5 million and $1.4 million, respectively, for these services.

Deposits were previously made with SSC totaling approximately $2.5 million in a cost sharing arrangement for the acquisition of an interest in several corporate aircraft.  These deposits were included in other assets, net of accumulated amortization as of February 1, 2003 and February 2, 2002. The Company is currently negotiating a discontinuation of this arrangement and has determined the net realizable value of these deposits based upon an independent third party valuation. As a result, the Company expects to receive approximately $1.4 million from SSC, which was included in related party accounts receivable as of January 31, 2004 (see Note 4 to the Consolidated Financial Statements). The Company has recognized a loss of $1.0 million as a result of this write-down, which was included in selling, general and administrative expenses during Fiscal 2003. Additionally, the Company paid $1.0 million during Fiscal 2003 and Fiscal 2002 and $1.1 million during Fiscal 2001 to cover its share of operating costs based on usage of the corporate aircraft under the cost sharing arrangement.  

In connection with the liquidation of certain inventory from the Canadian acquisition in October 2000, the Company contracted the services of a related party consultant, an affiliate of SSC. The contract was in effect until July 2001, when certain stores closed and were turned over to the Company for conversion to American Eagle stores. During Fiscal 2001, the Company paid $1.7 million to the consultant. As of February 2, 2002, all services were completed under this contract. As a result, there were no payments made during Fiscal 2002 or Fiscal 2003.

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Accounts and note receivable are comprised of the following:

The fabric receivable represents amounts due from a third party vendor for fabric purchased by the Company and sold to the respective vendor. Upon receipt of the finished goods from the vendor, the Company records the full cost of the merchandise in inventory, and reduces the amount of payment due to the third party by the respective fabric receivable.

Property and equipment consists of the following:

Depreciation expense is summarized as follows:

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The Company has an unsecured demand lending arrangement (the "facility") with a bank to provide a $118.6 million line of credit at either the lender's prime lending rate (4.0% at January 31, 2004) or a negotiated rate such as LIBOR. The facility has a limit of $40.0 million to be used for direct borrowing. Because there were no borrowings during any of the past three years, there were no amounts paid for interest on this facility. At January 31, 2004, letters of credit in the amount of $39.7 million were outstanding on this facility, leaving a remaining available balance on the line of $78.9 million.

The Company also has an uncommitted letter of credit facility for $50.0 million with a separate financial institution. At January 31, 2004, letters of credit in the amount of $25.0 million were outstanding on this facility, leaving a remaining available balance on the line of $25.0 million.

The Company has a $29.1 million non-revolving term facility (the "term facility") in connection with its Canadian acquisition. The term facility has an outstanding balance, including foreign currency translation adjustments, of $18.7 million as of January 31, 2004. The facility requires annual payments of $4.8 million and matures in December 2007. The term facility bears interest at the one-month Bankers' Acceptance Rate (2.5% at January 31, 2004) plus 140 basis points. Interest paid under the term facility was $1.5 million, $1.6 million and $1.8 million for the years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively.

The term facility contains restrictive covenants related to financial ratios. As of January 31, 2004, the Company was in compliance with these covenants.

The Company also had an $11.2 million revolving operating facility (the "operating facility") that was used to support the working capital and capital expenditures of the acquired Canadian businesses. The operating facility was due in November 2003 and had four additional one-year extensions. The Company has chosen not to extend the operating facility. During Fiscal 2002, the Company borrowed and subsequently repaid $4.8 million under the operating facility. Interest paid under the operating facility was $0.1 million for the year ended February 1, 2003. There were no borrowings under the operating facility for the years ended January 31, 2004 or February 2, 2002.

On November 30, 2000, the Company entered into an interest rate swap agreement totaling $29.2 million in connection with the term facility. The swap amount decreases on a monthly basis beginning January 1, 2001 until the termination of the agreement in December 2007. The Company utilizes the interest rate swap to manage interest rate risk. The Company pays a fixed rate of 5.97% and receives a variable rate based on the one-month Bankers' Acceptance Rate. This agreement effectively changes the interest rate on the borrowings under the term facility from a variable rate to a fixed rate of 5.97% plus 140 basis points.

In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, the Company recognizes its derivative on the balance sheet at fair value at the end of each period. Changes in the fair value of the derivative that is designated and meets all the required criteria for a cash flow hedge are recorded in accumulated other comprehensive income (loss). Unrealized net gains (losses) on derivative instruments of approximately $(0.1) million, $0.3 million, and $(0.7) million for the years ended January 31, 2004, February 1, 2003 and February 2, 2002, respectively, net of related tax effects, were recorded in other comprehensive income (loss).

The Company does not believe there is any significant exposure to credit risk due to the creditworthiness of the bank. In the event of non-performance by the bank, the Company's loss would be limited to any unfavorable interest rate differential.

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The accumulated balances of other comprehensive income (loss) included as part of the Consolidated Statements of Stockholders' Equity follow:

In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets, effective for fiscal years beginning after December 15, 2001. Under the new standard, goodwill and intangible assets deemed to have indefinite lives are longer amortized but are subject to annual impairment tests. Other intangible assets continue to be amortized over their estimated useful lives.

In accordance with SFAS No. 142, the Company did not restate the fiscal year ended February 2, 2002 to add back the amortization expense of goodwill. If the Company had been accounting for its goodwill under SFAS No. 142 for all prior periods presented, the Company's net income and income per common share would have been as follows for the years ended January 31, 2004, February 1, 2003 and February 2, 2002:

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In accordance with the requirements of SFAS No. 142, the Company assigned and tested its goodwill for impairment at the reporting unit level as of February 3, 2002, the beginning of Fiscal 2002. The Company identified its reporting units, American Eagle and Bluenotes, as operating segments in accordance with SFAS No. 142. The Company considers each American Eagle and Bluenotes retail store location a separate component of the respective brand or operating segment. The Company determined that each store had similar characteristics with others in the same brand. As such, the Company aggregated the stores with the respective brand's operating segment and identified the reporting units at the operating segment level. The Company assigned approximately $10.3 million and $13.7 million in goodwill to the American Eagle and Bluenotes reporting units, respectively, as of February 3, 2002.

The fair value of the Company's goodwill was estimated using discounted cash flow methodologies. As a result of the impairment test performed at February 3, 2002 as well as during the fourth quarter of Fiscal 2002, the Company determined that no goodwill impairment existed. During the fourth quarter of Fiscal 2002, the Company included consideration of recent management changes as well as new merchandising and operating strategies in its model assumptions related to the Bluenotes' goodwill. Based upon these changes, the Company expected to see an improvement in the Bluenotes operations beginning with the back-to-school selling season in the third fiscal quarter of 2003.

During the six months ended August 1, 2003, the Company continued to monitor the Bluenotes' goodwill for impairment and determined that no impairment existed during that time based upon the updated discounted cash flow models. The Company updated its assumptions regarding comparable sales growth, gross margin percentages, and other operating metrics during this time and continued to anticipate that a recovery in the Bluenotes business would occur during the back-to-school selling season.

During the three months ended November 1, 2003, Bluenotes' results of operations were below Management's expectations.  Based on the implementation of the new merchandising and operating strategies as well as the management changes within the division, Management was expecting improved financial results beginning in the third quarter of Fiscal 2003.  However, the segment did not perform to Management's expectations and the assumptions for the discounted cash flow model were amended to reflect a weaker current and expected financial performance.

Based on the unanticipated and continued weak performance of the Bluenotes division during the three months ended November 1, 2003, the Company believed that certain indicators of impairment were present.  As a result, the Company performed an interim test of impairment in accordance with SFAS No. 142.  The Company completed step one and determined that impairment was likely, which also required the completion of step two.  Due to the significant assumptions required for this test, the Company retained an independent third party to perform a step two analysis and to validate Management's assumptions used in step one.  Although the third party valuation was still pending as of November 1, 2003, Management believed that a loss was probable and determined its best estimate at that time in accordance with the provisions of SFAS No. 142, as supplemented by SFAS No. 5, Accounting for Contingencies.  As a result, the Company recorded an $8.0 million estimated impairment loss during the three months ended November 1, 2003. 

During the fourth quarter of Fiscal 2003, the independent third party valuation of the Bluenotes reporting unit was completed. Based upon the step one analysis, it was concluded that the fair market value of the Bluenotes reporting unit was below the book value of the business. The Company completed the step two analysis and allocated the fair value, as determined by the valuation firm, to the existing assets and liabilities and determined that the remaining carrying value of the goodwill was impaired. As a result, the Company recorded an additional $6.1 million loss during the fourth quarter of Fiscal 2003. As of January 31, 2004, the book value related to the Bluenotes goodwill was zero.

The changes in the book value of goodwill by reportable segment during Fiscal 2003 were as follows:

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The $13.5 million change in the book value of goodwill during Fiscal 2003, as noted in the table above, differs from the $14.1 million impairment loss attributed to the Bluenotes goodwill, which was recognized in the Company's Consolidated Statements of Operations, due to foreign currency translation. In accordance with SFAS No. 52, Foreign Currency Translation, goodwill denominated in foreign currencies was translated into U.S. dollars at the exchange rate prevailing at the related acquisition date. Expenses denominated in foreign currencies were translated into U.S. dollars at the monthly average exchange rate for the period.

The Company leases all store premises, some of our office and distribution facility space, and certain information technology and office equipment. The store leases generally have initial terms of ten years. Most of these store leases provide for base rentals and the payment of a percentage of sales as additional rent when sales exceed specified levels. Minimum rentals relating to these leases are recorded on a straight-line basis. These leases are classified as operating leases.

A summary of fixed minimum and contingent rent expense for all operating leases follows:

In addition, the Company is typically responsible under its store, office and distribution center leases for common area maintenance charges, real estate taxes and certain other expenses.

The table below summarizes future minimum lease obligations, consisting of fixed minimum rent, under operating leases in effect at January 31, 2004:

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The Company has segmented its operations in a manner that reflects how its chief operating decision-makers review the results of the operating segments that make up the consolidated entity.

The Company has two reportable segments, American Eagle and Bluenotes. The American Eagle segment includes the Company's 805 U.S. and Canadian retail stores, the Company's e-commerce business, ae.com, as well as the Company's catalog business. The Bluenotes segment includes the Company's 110 Bluenotes/Thriftys stores in Canada. Both segments derive their revenues from the sale of apparel. However, the segments are identified by a distinct brand name and target customer.

A summary of significant accounts and balances by segment follows:

The following is geographical information as of and for the years ended January 31, 2004, February 1, 2003 and February 2, 2002: