On February 7, 2005, the Office of the Chief Accountant of the Securities and Exchange Commission ("SEC") issued a letter to the American Institute of Certified Public Accountants expressing its views regarding certain operating lease accounting issues and their application under generally accepted accounting principles ("GAAP"). In light of this letter, the Company's management initiated a review of its lease-related accounting and determined that its historical method of accounting for rent holidays and tenant allowances, as more fully described below, was not in accordance with GAAP. As a result, the Company restated its Consolidated Financial Statements for the year ended January 31, 2004 in its 2004 Annual Report on Form 10-K.  The Company also restated its quarterly financial information for Fiscal 2004, as described in Note 16 of the Consolidated Financial Statements included in its 2004 Annual Report on Form 10-K. The Company did not amend its previously filed Annual Reports on Form 10-K or Quarterly Reports on Form 10-Q for the restatement. Accordingly, the financial statements and related financial information contained in such reports should no longer be relied upon. All referenced amounts for prior quarterly periods in this Quarterly Report on Form 10-Q are presented on a restated basis.

Historically, the Company had recognized straight line rent expense for leases beginning on the store opening date. This had the effect of excluding the build-out period of its stores from the calculation of the period over which it expenses rent and recognizes construction allowances. In accordance with Financial Accounting Standards Board Technical Bulletin No. 85-3, Accounting for Operating Leases with Scheduled Rent Increases, the Company changed this practice to include the build-out period in the calculations of rent expense and construction allowance amortization.

Additionally, in accordance with Financial Accounting Standards Board Technical Bulletin No. 88-1, Issues Relating to Accounting for Leases, the Company changed its classification of construction allowances on its Consolidated Financial Statements to record them as deferred credits, which are amortized as a reduction to rent expense. Furthermore, construction allowances are now presented within operating activities on its Consolidated Statements of Cash Flows. Historically, construction allowances had been classified on the Company's Consolidated Balance Sheets as a reduction of property and equipment and the related amortization had been classified as a reduction to depreciation and amortization expense (over the lesser of the useful life or the life of the lease) on the Consolidated Statements of Operations. The Company's Consolidated Statements of Cash flows had historically reflected construction allowances as a reduction of capital expenditures within investing activities.

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Net Sales

Net sales increased 36.7% to $454.0 million from $332.2 million. The sales increase was due to a 27.1% comparable store sales increase as well as a 6.2% increase in gross square footage. The gross square footage increase consisted primarily of the net addition of 36 stores. The comparable store sales increase was driven by strong increases in the number of transactions per average store and the number of units sold per average store, which both increased in the high-teens. Additionally, we achieved a higher average unit retail price, resulting primarily from fewer markdowns. Comparable store sales percentages increased in the high-twenties in both the men's and women's businesses over 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 by 420 basis points to 48.9% from 44.7%.  The percentage increase was primarily attributed to the leveraging of buying, occupancy and warehousing costs and an improvement in merchandise margins. Buying, occupancy and warehousing costs declined as a percent to net sales due primarily to the leveraging of rent expense.  Merchandise margins increased for the period due primarily to lower markdowns as well as an improved markon.

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 27.0% due to our strong comparable store sales growth. During the quarter, we leveraged direct salaries, leasing costs, services purchased, insurance and communication expenses.  These improvements were partially offset by development costs for our new brand concept and the deleveraging of advertising and travel costs.

Depreciation and amortization expense as a percent to net sales decreased to 4.0% from 4.7% due primarily to the comparable store sales increase.

Other income, net increased to $3.0 million from $0.9 million due primarily to increased investment income resulting from higher cash and investment balances this year compared to last year as well as improved investment rates.  The improvement in investment rates is partially attributable to an increase in long-term investments resulting from a change in the Company's investment policy.

Net income increased 119% to $55.3 million, or 12.2% as a percent to net sales, from $25.3 million, or 7.6% as a percent to net sales last year. Net income per diluted common share increased to $0.35 from $0.17 in the prior year (which included a $0.01 loss from discontinued operations related to Bluenotes). The increase in net income was attributable to the factors noted above.     

Net cash provided by operating activities from continuing operations totaled $26.9 million for the three months ended April 30, 2005. The Company's major source of cash from operations was merchandise sales. Our primary outflows of cash for operations were for the purchase of inventory and operational costs.

Investing activities for the three months ended April 30, 2005 included $16.8 million for capital expenditures and $31.9 million for the net purchase of investments.  Capital expenditures consisted primarily of $12.9 million related to six new and nine remodeled stores in the United States and Canada. The remaining capital expenditures were primarily related to improvements at our distribution centers and information technology upgrades at our home office.

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 4% 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 primarily from $29.6 million in proceeds from stock option exercises during the period partially offset by $10.2 million used for the purchase of shares from certain employees for the payment of taxes in connection with the vesting of restricted stock. Additionally, the Company used $7.7 million for the payment of dividends.

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 (5.75% at April 30, 2005) or at LIBOR plus a negotiated margin rate. The full facility is available for letters of credit and $40.0 million of the facility is available for direct borrowing. At April 30, 2005, letters of credit in the amount of $41.5 million were outstanding on this facility, leaving a remaining available balance on the line of $77.1 million. No direct borrowings were required against the line for the current or prior periods. The Company also has an uncommitted letter of credit facility for $75.0 million with a separate financial institution. At April 30, 2005, letters of credit in the amount of $34.7 million were outstanding on this facility, leaving a remaining available balance on the line of $40.3 million.

During the first quarter of Fiscal 2005, the Board of Directors (the "Board") voted to raise the Company's cash dividend to an annual rate of twenty cents per share from twelve cents per share. As a result, a quarterly dividend of five cents per share was paid on April 8, 2005. The payment of future dividends is at the discretion of our Board and is based on future earnings, cash flow, financial condition, capital requirements, changes in U.S. taxation and other relevant factors. It is anticipated that any future dividends paid will be declared on a quarterly basis.

We expect capital expenditures for Fiscal 2005 to be approximately $100 million, which will relate primarily to approximately 40 to 45 new stores in the United States and Canada and the remodeling of 50 to 55 stores in the United States. Remaining capital expenditures will relate to new fixtures and enhancements to existing stores, information technology upgrades, distribution center improvements and the construction of a new data center.

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In addition to our current new brand concept, our growth strategy includes the possibility of acquisitions and/or internally developing additional 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.

Recent Financial Accounting Standards Board Pronouncements

FSP No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004

In December 2004, the FASB issued Staff Position No. FAS 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 ("FSP No. 109-2").  FSP No. 109-2 allows additional time for companies to determine how the American Jobs Creation Act of 2004 (the "Act") affects a company's accounting for the deferred tax liabilities on un-remitted foreign earnings. The Act provides for a special one-time deduction of 85% of certain foreign earnings that are repatriated and which meet certain requirements. The Company is currently evaluating whether any of the earnings of our non-U.S. operations will be repatriated in accordance with the terms of the Act. Unremitted earnings that are considered reasonably possible for repatriation range from zero to $12.6 million. Repatriation of these earnings would require the Company to pay income taxes in the range of zero to $0.7 million. At this time, the Company has not established a provision for income taxes on unremitted earnings of the Canadian subsidiaries as it is the Company's intention to permanently invest these earnings in the Canadian Operations. However, additional taxes may be required to be recorded for any funds repatriated under the Act. The Company expects to complete its evaluation of the repatriation provision of the Act by July 30, 2005.

SFAS No. 123 (revised 2004), Share-Based Payment

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("SFAS No. 123(R)"), a revision of SFAS No. 123. SFAS No. 123(R) requires that companies recognize all share-based payments to employees, including grants of employee stock options, in the financial statements. The recognized cost will be based on the fair value of the equity or liability instruments issued. Pro forma disclosure of this cost will no longer be an alternative under SFAS No. 123(R).

In April 2005, the SEC adopted a rule that amended the effective dates of SFAS No. 123(R). Under this guidance SFAS No. 123(R) is now effective for public companies at the beginning of the first fiscal year that begins after June 15, 2005. Transition methods available to public companies include either the modified prospective or modified retrospective adoption. The modified prospective transition method requires that compensation cost be recognized beginning on the effective date, or date of adoption if earlier, for all share-based payments granted after the date of adoption and for all unvested awards existing on the date of adoption. The modified retrospective transition method, which includes the requirements of the modified prospective transition method, additionally requires the restatement of prior period financial information based on amounts previously recognized under SFAS No. 123 for purposes of pro forma disclosures. The Company is currently in the process of determining the transition method that it will use to adopt the new standard, which will be adopted no later than the beginning of Fiscal 2006 as required.

The Company currently accounts for its stock-based compensation plans under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, using the intrinsic value method. As a result of using this method, the Company generally recognizes no compensation cost for employee stock options. The adoption of SFAS No. 123(R) and the use of the fair value method will have an impact on our results of operations. The impact of SFAS No. 123(R) cannot be predicted at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123(R) in prior periods, the impact would have approximated the amounts in our pro forma disclosure within the Stock Option Plan section of Note 2 of the Consolidated Financial Statements. SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current standards. This requirement will reduce net operating cash flows and increase net financing cash flows in the periods after adoption. We cannot estimate what those amounts will be in the future because they are dependent on, among other things, when employees exercise stock options.

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Staff Accounting Bulletin No. 107, Share-Based Payment

In March 2005, the SEC issued Staff Accounting Bulletin No. 107, Share-Based Payment ("SAB No. 107"). SAB No. 107 provides guidance regarding the interaction between SFAS No. 123(R) and certain SEC rules and regulations, including guidance related to valuation methods; the classification of compensation expense; non-GAAP financial measures; the accounting for income tax effects of share-based payment arrangements; disclosures in Management's Discussion and Analysis subsequent to adoption of SFAS No. 123(R); and modifications of options prior to the adoption of SFAS No. 123(R). The Company is currently assessing the guidance in SAB No. 107 as part of its evaluation of the adoption of SFAS No. 123(R).

Critical Accounting Policies

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 29, 2005 contained in the Company's Fiscal 2004 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 April 30, 2005.  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 April 30, 2005, we had deferred tax assets of $7.6 million associated with Canadian tax loss carryforwards, which expire beginning in 2010. We anticipate that future taxable income in Canada will be sufficient to utilize the full amount of the deferred tax assets. Assuming a 37% effective tax rate, we will need to recognize pretax net income of approximately $20.4 million in future periods to recover this deferred tax amount.

Income tax accruals of $15.3 million and $9.2 million were recorded at April 30, 2005 and May 1, 2004, respectively. As of April 30, 2005, the Company had recorded contingent tax reserves of approximately $13.6 million.

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.

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 40 to 45 American Eagle stores in the United States and Canada during Fiscal 2005,

• the selection of approximately 50 to 55 stores in the United States for remodeling during Fiscal 2005,

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

• the expected payment of a dividend in future periods.

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:

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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. The failure to enter into agreements for the manufacture and purchase of merchandise in a timely manner could, among other things, lead to a shortage of inventory and lower sales. 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.

During the past several quarters, the Company realized substantial growth in both sales and earnings. A number of factors have historically affected, and will continue to affect, the Company's rate of growth and performance. These factors include, among other things, customer trends and preferences, competition, economic conditions and new store openings. There can be no assurance that the Company will be able to continue the rates of growth or performance that it has been recently experiencing. Additionally, any decline in the Company's future growth or performance could have a material adverse effect on the market price of the Company's common stock.

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, 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.

The Company's continued growth and success will depend in part on its ability to open and operate new stores and expand and remodel existing stores on a timely and profitable basis. During Fiscal 2005, the Company plans to open approximately 40 to 45 new American Eagle stores in the U.S. and Canada. Additionally, the Company plans to remodel or expand approximately 50 to 55 existing stores during Fiscal 2005. Accomplishing the Company's new and existing store expansion goals will depend upon a number of  factors, including the ability to obtain suitable sites for new and expanded 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 and the expansion of the Company's buying and inventory capabilities. 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 and remodeled stores profitably.

During Fiscal 2004, the Company announced that it began development of a new brand concept. The ability to succeed in this new concept requires significant capital expenditures and management attention. Additionally, any new concept is subject to certain risks including customer acceptance, competition, product differentiation and the ability to attract and retain qualified personnel, including management and designers. There can be no assurance that the Company will be able to develop a new concept that will grow or become profitable. If we are unable to succeed in developing a profitable new brand, this could adversely impact the Company's continued growth and results of operations.

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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 foreign 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 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.

Since the time of the attack on the World Trade Centers in 2001, the Company believes that there has been an increased risk of terrorist activity on a global basis. Such activity might take the form of a physical act that impedes the flow of imported goods or the insertion of a harmful or injurious agent to an imported shipment. The Company has instituted policies and procedures to prevent such actions including, but not limited to, a significant increase in the number of factory audits performed; the revision of our factory audit protocol to include all critical security issues; the review of security procedures of our other international trading partners, including forwarders, consolidators, shippers and brokers; and the cancellation of agreements with entities who fail to meet our security requirements. In addition, the Company has become a certified member of the Customs – Trade Partnership Against Terrorism program, a voluntary program in which an importer agrees to work with Customs to strengthen overall supply chain security. The Company cannot predict at this time the likelihood of such events, the extent of their impact, if any, and the possible effect on the Company's operations.

As a member of the World Trade Organization ("WTO"), the U.S. agreed to a world wide phase out of textile quotas on January 1, 2005, resulting in the removal of country specific restrictions on the quantity of goods being imported into the U.S. Notwithstanding these general phase outs, under the terms of the People's Republic of China's accession agreement to the WTO, the U.S. was empowered to impose "Temporary Safeguard" quotas on certain categories of textile merchandise manufactured in China if there was an affirmative determination by government agencies that imports of such products were disruptive to the U.S. market. On May 23, 2005, the U.S. Government's Committee on the Implementation of Tariff Agreements (CITA) invoked safeguards on several categories of textiles being exported from China. The Company also believes that additional safeguard quotas will be invoked during Fiscal 2005 and that further steps may be taken, such as the application for imposition of anti-dumping or countervailing duties, to impede the importation of textile goods from China. Any of the foregoing actions could have a significant impact on worldwide sourcing patterns during Fiscal 2005; however, the likelihood of such events, the extent of their impact, if any, and the possible effect on the Company's purchasing patterns and costs, cannot be determined at this time.

Although we have historically purchased a significant portion of our merchandise from a single vendor, we do not maintain any exclusive commitments to purchase from any single supplier.

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 2004, the third and fourth fiscal quarters accounted for approximately 61% of our sales and approximately 74% of our income from continuing operations. 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 December 2004, the FASB issued SFAS No. 123(R), a revision of SFAS No. 123. Under SFAS No. 123(R), all forms of share-based payments to employees, including grants of employee stock options, are treated the same as other forms of compensation by recognizing the related cost in the Statement of Operations.

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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 Note 2 of the Consolidated Financial Statements. The Company will adopt SFAS No. 123(R) no later than its first quarter of Fiscal 2006, beginning January 29, 2006, as required. The Company is currently in the process of determining the transition method that it will use to adopt the new standard. When we implement SFAS No. 123(R), the requirement to recognize the cost of share-based payments in our Consolidated Statement of Operations will have an impact on our results of operations.

The Company's success depends to a significant extent upon the continued services of its key personnel, including senior management, as well as its ability to attract and retain qualified key personnel and skilled employees in the future. The Company's operations could be adversely affected if, for any reason, one or more key executive officers ceased to be active in the Company's management.

The Company relies upon its various information systems to manage its operations and regularly makes investments to upgrade, enhance or replace these systems. Any delays or difficulties in transitioning to these or other new systems, or in integrating these systems with the Company's current systems, or any other disruptions affecting the Company's information systems, could have a material adverse impact on the Company's business.

In order to meet the requirements of the Sarbanes-Oxley Act of 2002 in future periods, the Company must continuously document, test, monitor and enhance its internal control over financial reporting. There can be no assurance that the periodic evaluation of our internal controls required by Section 404 of the Sarbanes-Oxley Act will not result in the identification of significant control deficiencies and/or material weaknesses or that our auditors will be able to attest to the effectiveness of our internal control over financial reporting. Failure to maintain the effectiveness of our internal control over financial reporting or to comply with the requirements of this Act could have a material adverse effect on our reputation, financial condition and market price of our common stock.

Additionally, other factors could adversely affect our financial performance, including factors such as: our ability to successfully acquire and integrate other businesses; any interruption of our key business systems; any disaster or casualty resulting in the interruption of service from our distribution centers or in a large number of our stores; any interruption of key services provided by third party vendors; changes in weather patterns; the effects of changes in current exchange rates and interest rates; and international and domestic acts of terror.

The impact of all of the previously discussed factors, some of which are beyond our control, may cause our actual results to differ materially from expected results in these statements and other forward-looking statements we may make from time-to-time.