UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  YES [X] NO [   ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 73,385,355 Common Shares were outstanding at August 31, 2004. 

See Notes to Consolidated Financial Statements

4

See Notes to Consolidated Financial Statements

5

The accompanying Consolidated Financial Statements of American Eagle Outfitters, Inc. (the "Company") at July 31, 2004 and August 2, 2003 and for the three and six month periods ended July 31, 2004 (the "current period") and August 2, 2003 (the "prior period") have been prepared in accordance with accounting principles generally accepted in the United States of America 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 accounting principles generally accepted in the United States of America 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 2003 Annual Report.  In the opinion of management, all adjustments considered necessary for a fair presentation have been included. The Consolidated Balance Sheet at January 31, 2004 was derived from the audited financial statements.

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.

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.

The Company's financial year is a 52/53 week year that ends on the Saturday nearest to January 31.  As used herein, "Fiscal 2004," and "Fiscal 2003" refer to the fifty-two week period ending January 29, 2005 and the fifty-two week period ended January 31, 2004, respectively.  

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of 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, management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.

FIN No. 46, Consolidation of Variable Interest Entities

The FASB issued a final version of Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51, Consolidated Financial Instruments, in December 2003 ("FIN 46R").  FIN 46R requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional financial support from other parties.  All provisions of FIN 46R were effective for the first reporting period ending after March 15, 2004.  The Company fully adopted the provisions of FIN 46R during the three months ended May 1, 2004, which did not have an impact on the Company's consolidated financial position, results of operations or liquidity because the Company has no interest in any variable interest entities. 

6

FASB Exposure Draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95

On March 31, 2004, the FASB issued an exposure draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95.  The proposed change in accounting would replace existing requirements under SFAS 123, Accounting for Stock-Based Compensation, and APB Opinion No. 25, Accounting for Stock Issued to Employees.  The exposure draft covers a wide range of equity-based compensation arrangements.  Under the FASB's proposal, all forms of share-based payments to employees, including employee stock options, would be treated the same as other forms of compensation by recognizing the related cost in the income statement.  The expense of the award would generally be measured at fair value at the grant date.  The comment period for the exposure draft ended on June 30, 2004 and final rules are expected to be issued in late 2004.  The standard would be applicable for fiscal years beginning after December 15, 2004.  The Company will evaluate the impact of any change in the accounting standards on the Company's financial position and results of operations when the final rules are issued.

The Canadian dollar is the functional currency for the Canadian businesses. In accordance with SFAS No. 52, Foreign Currency Translation, assets and liabilities denominated in foreign currencies were translated into U.S. dollars (the reporting currency) at the exchange rate prevailing at the balance sheet date. Revenues and expenses denominated in foreign currencies were translated into U.S. dollars at the monthly average exchange rate 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, net of income taxes, in accordance with SFAS No. 130, Reporting Comprehensive Income (see Note 7 of the Consolidated Financial Statements).

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 5 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.
 

7

Selling, General and Administrative Expenses

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.

Cash includes cash equivalents. The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.  Cash in excess of operating requirements is invested in variable rate or auction rate fixed income notes or money market mutual funds. As of July 31, 2004, the Company's cash equivalents included investments with an average original maturity of approximately one month.

Short-term investments include investments with an original maturity of greater than three months, but not exceeding twelve months.  As of July 31, 2004, the Company's short-term investments consisted primarily of tax-exempt municipal bonds, taxable agency bonds and corporate notes classified as available-for-sale with an average original maturity of approximately six months.

Long-term investments include investments with an original maturity of greater than twelve months, but not exceeding twenty-four months.  As of July 31, 2004, the Company's long-term investments consisted primarily of agency bonds and debt securities issued by states and municipalities classified as available-for-sale with an average original maturity of approximately eighteen months.

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 has 250 million common shares authorized at $.01 par value, 76 million issued and 73 million outstanding at July 31, 2004 and 74 million issued and 71 million outstanding at January 31, 2004 and August 2, 2003, respectively.  The Company has 5 million preferred shares authorized at $.01 par value, with none issued or outstanding at July 31, 2004, January 31, 2004 or August 2, 2003.   

On February 24, 2000, the Company's Board of Directors authorized the repurchase of up to 3,750,000 shares of its stock.  No repurchases were made during the six months ended July 31, 2004 as part of this stock repurchase program.  During the six months ended August 2, 2003, the company purchased 40,000 shares of common stock for approximately $0.5 million on the open market.  Additionally, during the six months ended August 2, 2003, the Company purchased 5,400 shares  from certain employees at market prices totaling $0.1 million 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. 
 

8

Earnings Per Share

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 (stock options and restricted stock).

Options to purchase 804,000 and 1,227,000 shares of common stock during the three and six months ended July 31, 2004, respectively, and 5,420,000 and 5,467,000 shares during the three and six months ended August 2, 2003, 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.

Stock Option Plan

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.

9

Reclassification

Certain reclassifications have been made to the Consolidated Financial Statements for prior periods in order to conform to the July 31, 2004 presentation.

Accounts and note receivable is 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.

4. Property and Equipment

Property and equipment consists of the following:

10

5. Related Party Transactions

The Company and its wholly-owned subsidiaries have historically had various transactions with related parties.  During Fiscal 2004, as part of our strategic plan to eliminate the Company's related party transactions, we significantly reduced these arrangements as discussed below.  The Company believes that the terms of these transactions are as favorable to the Company as those that could have been obtained from unrelated third parties. The nature of the Company's relationship with the related parties and a description of the respective transactions is stated below. 

As of July 31, 2004, the Schottenstein-Deshe-Diamond families (the "families") owned 21% of the outstanding shares of Common Stock of the Company. The families also own a private company, Schottenstein Stores Corporation ("SSC"), which includes a publicly-traded subsidiary, Retail Ventures, Inc. ("RVI"), formerly Value City Department Stores, Inc., and also owned 99% of Linmar Realty Company until June 4, 2004.  The Company had the following transactions with these related parties during the three and six months ended July 31, 2004 and August 2, 2003. 

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.  During April 2004, the Company entered into an agreement with an independent third-party vendor for the sale of merchandise sell-offs, thus reducing sell-offs to related parties.  Below is a summary of merchandise sell-offs for the three and six months ended July 31, 2004 and August 2, 2003:

11

The Company had approximately $15,000, $4,219,000 and $3,759,000 included in accounts receivable at July 31, 2004, January 31, 2004 and August 2, 2003,  respectively, that pertained to related party merchandise sell-offs as well as a corporate aircraft arrangement, which is further discussed below.

SSC and its affiliates charge the Company for various professional services provided to the Company, including certain legal, real estate and insurance services. For the three months ended July 31, 2004 and August 2, 2003, the Company paid approximately $85,000 and $369,000 respectively, for these services.  For the six months ended July 31, 2004 and August 2, 2003, the Company paid approximately $125,000 and $749,000, respectively, for these services. 

During the six months ended July 31, 2004, the Company discontinued its cost sharing arrangement with SSC for the acquisition of an interest in several corporate aircraft.  The Company paid $0.4 million for the three months ended August 2, 2003 and $0.1 million and $0.7 million for the six months ended July 31, 2004 and August 2, 2003, respectively, to cover its share of operating costs based on usage of the corporate aircraft under the cost sharing arrangement.  No payments were made during the three months ended July 31, 2004 as part of this arrangement.    

On June 4, 2004, the Company, through a subsidiary, Linmar Realty Company II LLC, purchased for $20.0 million Linmar Realty Company ("Linmar Realty"), a general partnership that owned the Company's corporate headquarters and distribution center.  The purchase price, less a straight-line rent accrual adjustment of $2.0 million, was recorded as land and building on the consolidated balance sheet during the three months ended July 31, 2004 and is being depreciated over its anticipated useful life of twenty-five years.  Prior to the purchase, the Company had an operating lease with Linmar Realty for the corporate headquarters and distribution center.  Rent expense was $0.2 million and $0.6 million for the three months ended July 31, 2004 and August 2, 2003, respectively, and $0.8 million and $1.2 million for the six months ended July 31, 2004 and August 2, 2003, respectively, under the lease.

6. Accounting for 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 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.  Unrealized net gains (losses) on derivative instruments of approximately $131,000 and $(39,000) for the three months ended July 31, 2004 and August 2, 2003, respectively, and $54,000 and $(4,000) for the six months ended July 31, 2004 and August 2, 2003, respectively, net of related tax effects, were recorded in other comprehensive income. 

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.

12

Other comprehensive income is comprised of the following:

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 825 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 107 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.

Segment information as of and for the three and six months ended July 31, 2004 and August 2, 2003 follows:

The decrease in Bluenotes total assets from August 2, 2003 to July 31, 2004 is due primarily to an impairment of the segment's total goodwill and a decrease in the segment's long-term deferred tax asset during the third and fourth quarters of Fiscal 2003.

13

Ernst & Young LLP, our independent accountants, have performed a limited review of the Consolidated Financial Statements for the three and six month periods ended July 31, 2004 and August 2, 2003, as indicated in their report on the limited review included below. Since they did not perform an audit, they express no opinion on the Consolidated Financial Statements referred to above. Management has given effect to any significant adjustments and disclosures proposed in the course of the limited review.

The Board of Directors and Stockholders
American Eagle Outfitters, Inc.

We have reviewed the accompanying consolidated balance sheets of American Eagle Outfitters, Inc. (the "Company") as of July 31, 2004 and August 2, 2003, the related consolidated statements of income for the three-month and six-month periods ended July 31, 2004 and August 2, 2003, and the consolidated statements of cash flows for the six-month periods ended July 31, 2004 and August 2, 2003. These financial statements are the responsibility of the Company's management. 

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. 

Based on our review, we are not aware of any material modifications that should be made to the consolidated interim financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles. 

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of American Eagle Outfitters, Inc. as of January 31, 2004, and the related consolidated statements of operations, comprehensive income, shareholders' equity, and cash flows for the year then ended (not presented herein), and in our report dated February 25, 2004 we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated balance sheet as of January 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ Ernst & Young LLP

Pittsburgh, Pennsylvania
August 10, 2004

15

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Overview

We achieved record second quarter sales and earnings during the three months ended July 31, 2004 (the "second quarter").  Our product assortments were well received by our target customers, we managed our inventories efficiently and curtailed promotions which led to broad-based sales strength and improved profitability during the quarter.

Consolidated net sales for the second quarter increased 22.8% to $413.8 million from $337.1 million and our consolidated comparable store sales increased 12.7%.  Our gross profit margin increased to 39.7% for the second quarter this year from 33.0% last year led by strong merchandise sell-throughs and a significant reduction in markdowns.  We also achieved lower product costs and leveraged rent expense within cost of sales.  Selling, general and administrative expenses leveraged by 90 basis points as a result of our strong comparable store sales as well as ongoing expense control initiatives.  We achieved an 11.6% operating margin for the second quarter, which was our highest second quarter rate to sales since Fiscal 1999.  Year-to-date, we have increased our net income to $54.7 million compared to $14.5 million for the corresponding period last year.

16

The Company has two reportable segments, American Eagle and Bluenotes. The American Eagle segment includes the Company's 825 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 107 Bluenotes/Thriftys stores in Canada.

Net Sales

Consolidated net sales increased 22.8% to $413.8 million from $337.1 million.  The sales increase was due to a 12.7% consolidated comparable store sales increase and an 8.6% increase in gross square feet, consisting primarily of the net addition of 45 stores. 

American Eagle net sales increased 24.4% to $395.4 million from $317.8 million. The sales increase was due to a 13.8% comparable store sales increase and a 9.5% increase in gross square footage.  The gross square footage increase consisted primarily of the net addition of 49 stores. The comparable store sales increase was driven by a higher average unit retail price, resulting primarily from fewer markdowns.  Additionally, units sold per average store and the number of transactions per average store increased during the quarter while units sold per transaction declined slightly.  Comparable store sales increased in the mid-teens in the women's business and the men's business increased in the low double-digits over last year.  

Bluenotes net sales decreased 4.7% to $18.4 million from $19.3 million. The sales decline was due to a comparable store sales decline of 4.2% as well as a stronger Canadian dollar during the period compared to the same period last year.  The comparable store sales decrease, which excludes the impact of foreign currency fluctuations, was due to a decline in the number of transactions per average store as well as a lower average unit retail price.  Units sold per average store were flat for the period while units sold per transaction increased compared to the corresponding period last year. 

17

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 an expansion and/or relocation 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 expansion and/or relocation. 

Gross profit as a percent to net sales increased to 39.7% from 33.0%.  The percentage increase was primarily attributed to an improvement in merchandise margins.  Merchandise margins increased significantly for the period due primarily to lower markdowns and an improved markon reflecting better sourcing and a continuation of our cost control initiatives at American Eagle as well as Bluenotes.  Buying, occupancy and warehousing expenses leveraged due primarily to the leveraging of rent expense at American Eagle.  By segment, both American Eagle and Bluenotes contributed to the increase in gross margin as a percent to sales. 

The Company's gross profit may not be comparable to that of other retailers, as some retailers include all costs related to their distribution network as well as design costs in cost of sales and others may exclude a portion of these costs from cost of sales, including them in a line item such as selling, general and administrative expenses. See Note 2 of the Consolidated Financial Statements for a description of the Company's accounting policy regarding cost of sales, including certain buying, occupancy and warehousing expenses.

Selling, general and administrative expenses as a percent to net sales decreased to 24.3% from 25.2% due to our strong comparable store sales as well as our cost control initiatives.  During the quarter we leveraged direct salaries, advertising, leasing costs, communications and services purchased.  These improvements were partially offset by the deleveraging of incentive compensation, which was not incurred in the prior year.  By segment, American Eagle leveraged selling, general and administrative expenses for the period while Bluenotes deleveraged slightly. 

Depreciation and amortization expense as a percent to net sales decreased to 3.8% from 4.1% due primarily to the comparable store sales increase.

Other income remained relatively flat for the period.  Investment income increased resulting from a higher cash balance during the period compared to last year offset by the strengthening of the Canadian dollar compared to a year ago.  

Net Income

Net income increased to $29.6 million, or 7.2% as a percent to net sales, from $8.1 million or 2.4% as a percent to net sales.  The increase in net income was attributable to the factors noted above.

18

Comparison of six months ended July 31, 2004 to the six months ended August 2, 2003

Net Sales

Consolidated net sales increased 21.4% to $763.8 million from $628.9 million.  The sales increase was due to an 11.1% consolidated comparable store sales increase and an 8.5% increase in gross square feet, consisting primarily of the net addition of 45 stores. 

American Eagle net sales increased 22.5% to $727.6 million from $593.8 million. The sales increase was due to an 11.9% comparable store sales increase and a 9.5% increase in gross square footage.  The gross square footage increase consisted primarily of the net addition of 49 stores. The comparable store sales increase was driven by a higher average unit retail price, resulting primarily from fewer markdowns.  Additionally, units sold per average store, units sold per transaction and the number of transactions per average store all increased during the period.  Comparable store sales increased in the mid-teens in the women's business and the men's business increased in the high single-digits over last year.  

Bluenotes net sales increased 3.1% to $36.2 million from $35.1 million. The sales increase was due to a stronger Canadian dollar during the period compared to the same period last year partially offset by a comparable store sales decline of 1.0%.  The comparable store sales decrease, which excludes the impact of foreign currency fluctuations, was due to a decline in the average unit retail price as well as a slight decrease in the number of transactions per average store.  Units sold per transaction and units sold per average store both increased compared to the corresponding period last year. 

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 an expansion and/or relocation 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 expansion and/or relocation. 

Gross profit as a percent to net sales increased to 41.1% from 34.5%.  The percentage increase was primarily attributed to an improvement in merchandise margins.  Merchandise margins increased significantly for the period due primarily to lower markdowns and an improved markon reflecting better sourcing and a continuation of our cost control initiatives at American Eagle as well as Bluenotes.  Buying, occupancy and warehousing expenses leveraged due primarily to the leveraging of rent expense at American Eagle.  By segment, both American Eagle and Bluenotes contributed to the increase in gross margin as a percent to sales.

The Company's gross profit may not be comparable to that of other retailers, as some retailers include all costs related to their distribution network as well as design costs in cost of sales and others may exclude a portion of these costs from cost of sales, including them in a line item such as selling, general and administrative expenses. See Note 2 of the Consolidated Financial Statements for a description of the Company's accounting policy regarding cost of sales, including certain buying, occupancy and warehousing expenses.

Selling, general and administrative expenses as a percent to net sales decreased to 25.6% from 26.7% due to our strong comparable store sales as well as our cost control initiatives.  During the period we leveraged direct salaries, advertising, leasing costs, communications, travel and services purchased.  These improvements were partially offset by the deleveraging of incentive compensation, which was not incurred in the prior year.  By segment, both American Eagle and Bluenotes contributed to the leveraging of selling, general and administrative expenses. 

19

Depreciation and amortization expense as a percent to net sales decreased to 4.0% from 4.3% due primarily to the comparable store sales increase.

Other income increased to $1.5 million from $1.2 million due primarily to higher investment income resulting from a higher cash balance during the period compared to last year.

Net Income

Net income increased to $54.7 million, or 7.2% as a percent to net sales, from $14.5 million or 2.3% as a percent to net sales.  The increase in net income was attributable to the factors noted above.

The Company's uses of cash are generally for working capital, the construction of new stores and the remodeling of existing stores, information technology upgrades, distribution center improvements and the purchase of both short and long-term investments. Historically, these uses of cash have been met through cash flow from operations.

The following sets forth certain measures of the Company's liquidity:

Net cash provided by operating activities of $34.5 million for the six months ended July 31, 2004 reflects net income earned from operations partially offset by changes in working capital.  The changes in working capital were primarily due to an increase in cash used for inventory purchases related to our upcoming back-to-school selling season.

Investing activities for the six months ended July 31, 2004 included $52.3 million for capital expenditures and $24.6 million for the net purchase of investments.  Capital expenditures consisted primarily of $20.4 million related to our American Eagle stores in the United States and $20.0 million related to the purchase of our corporate headquarters and distribution center during June 2004.

The Company invests primarily in tax-exempt municipal bonds, taxable agency bonds and corporate notes with an original maturity between three and twenty-four months and an expected rate of return of approximately a 2% taxable equivalent yield. The Company places an emphasis on investing in tax-exempt and tax-advantaged asset classes. Additionally, all investments must have a highly liquid secondary market.

Cash provided by financing activities resulted from $17.1 million in proceeds from stock option exercises during the quarter partially offset by principle payments on the note payable.

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 (4.3% at July 31, 2004) or a negotiated rate such as LIBOR. The facility has a limit of $40.0 million to be used for direct borrowing. No borrowings were required against the line for the current or prior periods. At July 31, 2004, letters of credit in the amount of $41.4 million were outstanding on this facility, leaving a remaining available balance on the line of $77.2 million. The Company also has an uncommitted letter of credit facility for $50.0 million with a separate financial institution. At July 31, 2004, letters of credit in the amount of $34.1 million were outstanding on this facility, leaving a remaining available balance on the line of $15.9 million.

20

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 $16.3 million as of July 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 (2.1% at July 31, 2004) plus 140 basis points.

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.

We expect capital expenditures for Fiscal 2004 to be approximately $85 to $90 million, which will relate primarily to approximately 50 new American Eagle stores in the United States and Canada, the remodeling of approximately 45 American Eagle stores in the United States and the purchase of the Company's corporate headquarters and distribution center.  Remaining capital expenditures will relate to new fixtures and enhancements to existing stores, information technology upgrades and distribution center improvements. Additionally, during Fiscal 2004, we plan to pay $4.8 million in scheduled principal payments on the term facility. We plan to fund these capital expenditures and debt repayments primarily through existing cash and cash generated from operations. These forward-looking statements will be influenced by our financial position, consumer spending, availability of financing, and the number of acceptable leases that may become available.

Our growth strategy includes the possibility of acquisitions and/or internally developing new brands. We periodically consider and evaluate these options to support future growth. In the event we do pursue such options, we could require additional equity or debt financing. There can be no assurance that we would be successful in closing any potential transaction, or that any endeavor we undertake would increase our profitability.

The Company's critical accounting policies are described in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and in the notes to the Company's consolidated financial statements for the year ended January 31, 2004 contained in the Company's Fiscal 2003 Annual Report on Form 10-K.  Any new accounting policies or updates to existing accounting policies as a result of new accounting pronouncements have been discussed in the notes to the Company's consolidated financial statements for the period ended July 31, 2004.  The application of the Company's critical accounting policies may require management to make judgments and estimates about the amounts reflected in the consolidated financial statements.  Management uses historical experience and all available information to make these estimates and judgments, and different amounts could be reported using different assumptions and estimates.

As of July 31, 2004, we had deferred tax assets of $11.5 million associated with foreign tax loss carryforwards. We anticipate that future taxable income in Canada will be sufficient to utilize the full amount of the deferred tax assets. Assuming a 38% effective tax rate, we will need to recognize pretax net income of approximately $30.7 million in future periods to recover this deferred tax amount.

We do not believe that inflation has had a significant effect on our net sales or our profitability. Substantial increases in cost, however, could have a significant impact on our business and the industry in the future. Additionally, while deflation could positively impact our merchandise costs, it could have an adverse effect on our average unit retail price, resulting in lower sales and profitability.
 

21

Safe Harbor Statement, Seasonality and Risk Factors

This report contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs concerning future events, including the following:

• the planned opening of approximately 50 American Eagle stores in the United States and Canada in Fiscal 2004,

• the selection of approximately 45 stores in the United States for remodeling,

• the sufficiency of existing cash and investment balances, cash flows and line of credit facilities to meet Fiscal 2004 cash requirements, and

• the possibility of growth through acquisitions and/or internally developing new brands.

We caution that these statements are further qualified by factors that could cause our actual results to differ materially from those in the forward-looking statements, including without limitation, the following:

The Company's future success depends, in part, upon its ability to identify and respond to fashion trends in a timely manner. The specialty retail apparel business fluctuates according to changes in the economy and customer preferences, dictated by fashion and season. These fluctuations especially affect the inventory owned by apparel retailers, since merchandise typically must be ordered well in advance of the selling season. While we endeavor to test many merchandise items before ordering large quantities, we are still susceptible to changing fashion trends and fluctuations in customer demands.

In addition, the cyclical nature of the retail business requires that we carry a significant amount of inventory, especially during our peak selling seasons. We enter into agreements for the manufacture and purchase of our private label apparel well in advance of the applicable selling season. As a result, we are vulnerable to changes in consumer demand, pricing shifts, and the timing and selection of merchandise purchases. Changes in fashion trends, if unsuccessfully identified, forecasted or responded to by the Company, could, among other things, lead to lower sales, excess inventories and higher markdowns, which in turn could have a material adverse effect on the Company's results of operations and financial condition.

The specialty retail industry is highly competitive. The Company competes primarily on the basis of quality, fashion, service, selection and price. There can be no assurance that the Company will be able to successfully compete in the future.

The success of the Company's operations also depends to a significant extent upon a number of factors relating to discretionary consumer spending, including economic conditions affecting disposable consumer income such as employment, consumer debt, interest rates, rising gasoline prices and consumer confidence. There can be no assurance that consumer spending will not be negatively affected by general or local economic conditions, thereby adversely impacting the Company's continued growth and results of operations.

22

Our ability to expand through new store growth

The Company's continued growth and success will depend in part on its ability to open and operate new stores on a timely and profitable basis. During Fiscal 2004, the Company plans to open approximately 50 new American Eagle stores in the United States and Canada. Accomplishing the Company's new store expansion goals will depend upon a number of factors, including the ability to obtain suitable sites for new stores at acceptable costs, the hiring and training of qualified personnel, particularly at the store management level, the integration of new stores into existing operations, the expansion of the Company's buying and inventory capabilities and the availability of capital. There can be no assurance that the Company will be able to achieve its store expansion goals, manage its growth effectively, successfully integrate the planned new stores into the Company's operations or operate its new stores profitably.

The Company's future earnings depend, in part, upon its ability to successfully reposition the Bluenotes brand.  During both Fiscal 2002 and Fiscal 2003, the Bluenotes business incurred operating losses due to a combination of merchandising and operating challenges.  As a result, we recorded a $14.1 million goodwill impairment loss during Fiscal 2003 related to the Bluenotes segment.  The Company made management changes in the division and has implemented a number of merchandising and operational strategy changes.  During the six months ended July 31, 2004, the Bluenotes business did see an improvement in its results of operations.  However, there can be no assurance that the division will continue to improve its financial performance.  The Bluenotes business continues to face challenges, including the installation of a new design team and increased competitive pressures.  If the business trend does not continue to improve and the Company is not successful repositioning the Bluenotes brand, Management may need to evaluate potential strategic alternatives for this division.

The Company purchases merchandise from domestic and foreign suppliers. Historically, a majority of the Company's merchandise has been purchased from foreign suppliers. Since we rely on a small number of overseas sources for a significant portion of our purchases, any event causing the disruption of imports including the insolvency of a significant supplier or a significant labor dispute, such as a dock strike could have an adverse effect on our operations. Other events which could also cause a disruption of imports include the imposition of additional trade law provisions or import restrictions, such as increased duties, tariffs, anti-dumping provisions, increased Custom's enforcement actions, or political or economic disruptions.

Additionally, a majority of the merchandise imported by the Company has been subject to import quotas. These quotas restrict the quantity of a given textile or apparel product that can be exported on an annual basis from a given country. As of January 1, 2005, the U.S. has agreed to phase out these quotas. This phase-out of textile and apparel quotas, and the resulting removal of country specific restrictions on the quantity of goods that can be imported into the U.S., could have a significant impact on worldwide sourcing patterns during the fourth quarter of Fiscal 2004 as well as in 2005. However, the extent of this impact, if any, and the possible effect on the Company's purchasing patterns and costs, cannot be determined at this time.

We do not maintain any long-term or exclusive commitments or arrangements to purchase from any single supplier.
 

23

Seasonality

Historically, our operations have been seasonal, with a significant amount of net sales and net income occurring in the fourth fiscal quarter, reflecting increased demand during the year-end holiday selling season and, to a lesser extent, the third quarter, reflecting increased demand during the back-to-school selling season. During Fiscal 2003, the third and fourth fiscal quarters accounted for approximately 58.6% of our sales. As a result of this seasonality, any factors negatively affecting us during the third and fourth fiscal quarters of any year, including adverse weather or unfavorable economic conditions, could have a material adverse effect on our financial condition and results of operations for the entire year. Our quarterly results of operations also may fluctuate based upon such factors as the timing of certain holiday seasons, the number and timing of new store openings, the amount of net sales contributed by new and existing stores, the timing and level of markdowns, store closings, refurbishments and relocations, competitive factors, weather and general economic conditions.

In March 2004, the FASB issued an exposure draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95 ("the exposure draft").  The proposed change in accounting would replace existing requirements under SFAS 123, Accounting for Stock-Based Compensation, and APB Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25").  Under the FASB's proposal, all forms of share-based payments to employees, including employee stock options, would be treated the same as other forms of compensation by recognizing the related cost in the income statement. 

Currently, the Company accounts for its stock-based compensation plans under APB No. 25 and provides the related pro forma information regarding net income and earnings per share, as required by SFAS No. 123, as amended by SFAS No. 148, in the notes to the consolidated financial statements.  If the FASB changes the accounting standards related to employee stock option grants and requires the related cost to be recognized in the income statement, it could have an adverse affect on our results of operations.