O'Reilly Auto Parts 2005 Annual Report Download - page 41

straight-line rent expense is based on the same lease term. Prior to 2003, leasehold improvements were amortized over a period of time which includ-
ed both the base lease term and the first renewal option period of the lease and rent expense was recorded as paid.
As a result, the Company’s 2004 statement of income includes an adjustment to correct its lease accounting of $10.4 million ($3.5 million related to
2004), $6.5 million, net of tax. Prior years’ financial statements were not restated due to the immateriality of the amount to the results of operations
and statement of financial position for 2004 or any prior individual year. As the correction relates solely to accounting treatment, it did not affect the
Company’s historical or future cash flows.
The effect from these corrections, which is reflected in the financial statements, is an increase in depreciation expense in 2004 of $6.0 million
($2.6 million related to 2004), an increase in rent expense in 2004 of $4.4 million ($0.9 million related to 2004), and a decrease in income tax expense
in 2004 of $3.9 million.
Notes Receivable
The Company had notes receivable from vendors and other third parties amounting to $28,950,000 and $25,108,000 at December 31, 2005 and 2004,
respectively. The notes receivable, which bear interest at rates ranging from 0% to 10%, are due in varying amounts through August 2017.
Goodwill
The “Other assets, net” caption in the Consolidated Balance Sheets at December 31, 2005 and 2004 includes goodwill recorded as the result of previous
acquisitions. Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets requires the Company to assess
goodwill for impairment rather than systematically amortize goodwill against earnings. The goodwill impairment test compares the fair value of a
reporting unit to its carrying amount, including goodwill. The Company operates as one reporting unit and its fair value exceeds its carrying value,
including goodwill. Therefore, the Company has determined that no impairment of goodwill existed at December 31, 2005 and 2004.
Self-Insurance Reserves
The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation,
general liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities,
which are limited by the design of these plans, the Company obtains third-party insurance coverage to limit its exposure. The Company estimates
our self-insurance liabilities by considering a number of factors, including historical claims experience and trend-lines, projected medical and legal
inflation, and growth patterns and exposure forecasts.
Income Taxes
The Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards (SFAS) No. 109.
The liability method provides that deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases
of assets and liabilities and are measured using tax rates based on currently enacted rules and legislation and anticipated rates that will be in effect
when the differences are expected to reverse.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $28,715,000, $22,999,000 and $19,533,000
for the years ended December 31, 2005, 2004 and 2003, respectively.
Pre-opening Costs
Costs associated with the opening of new stores, which consist primarily of payroll and occupancy costs, are charged to operations as incurred.
Stock Option Plans
The Company currently sponsors share-based employee benefit plans and stock option plans. Please see Notes 9 and 10 for further information
concerning these plans. The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees
(APB 25), and related interpretations in accounting for its employee stock options. Under the intrinsic value method in accordance with APB 25,
because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation
expense is recognized. SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, further established accounting and disclosure
requirements using a fair-value-based method of accounting for stock-based employee compensation plans.
In the fourth quarter of 2005, the Board of Directors approved the accelerated vesting of all unvested stock options previously awarded to employees
and executive officers. Option awards granted subsequent to the Board’s action are not included in the acceleration and will vest equally over the
service period established in the award, typically four years. The primary purpose of the accelerated vesting was to enable the Company to avoid
recognizing future compensation expense associated with these options upon the planned adoption of SFAS No. 123R, Share-Based Payment (SFAS
123R) by O’Reilly in 2006. As a result of the vesting acceleration, options to purchase approximately 4.2 million shares of O’Reilly Common Stock
O’REILLY AUTOMOTIVE 2005 ANNUAL REPORT
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notes to consolidated financial statements (continued)