O'Reilly Auto Parts 2005 Annual Report Download - page 43

O’REILLY AUTOMOTIVE 2005 ANNUAL REPORT
41
notes to consolidated financial statements (continued)
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, accounts receivable
and notes receivable.
The Company grants credit to certain customers who meet the Company's pre-established credit requirements. Concentrations of credit risk with
respect to these receivables are limited because the Company’s customer base consists of a large number of smaller customers, thus spreading the credit
risk. The Company controls credit risk through credit approvals, credit limits and monitoring procedures. Generally, the Company does not require
security when credit is granted to customers. Credit losses are provided for in the Company's consolidated financial statements and consistently have
been within management's expectations.
The carrying value of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and long-term
debt, as reported in the accompanying consolidated balance sheets, approximates fair value.
New Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4.
The standard requires that abnormal amounts of idle capacity and spoilage costs should be excluded from the cost of inventory and expensed when
incurred. The standard is effective for fiscal years beginning after June 15, 2005. The Company does not expect the adoption of this standard to have
a material effect on it’s financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment of APB No. 29, Accounting for Nonmonetary
Transactions. SFAS No. 153 requires exchanges of productive assets to be accounted for at fair value, rather than at carryover basis, unless (1) neither
the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or (2) the transactions lack commercial
substance. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does
not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R is a revision of SFAS No. 123, Accounting for Stock Based
Compensation, and supersedes APB No. 25, Accounting for Stock Issued to Employees. Among other items, SFAS No. 123R eliminates the use of APB
No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for
awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. SFAS No. 123R also requires that the
benefits associated with the tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating
cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods
after the effective date. These future amounts cannot be estimated, because they depend on, among other things, when employees exercise stock options.
However, the amount of operating cash flows recognized in prior periods for such tax deductions, as shown in the accompanying Consolidated
Statements of Cash Flows were $7.1 million, $4.5 million, and $5.5 million, for the years ended December 31, 2005, 2004, and 2003, respectively.
The effective date of SFAS 123R is the first reporting period of the first fiscal year beginning on or after June 15, 2005, which is first quarter 2006
for calendar year companies, such as the Company, although early adoption is allowed.
The Company intends to adopt SFAS No. 123R beginning with the first quarter of 2006 using the “modified prospective” method under which
compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all
share-based payments granted after that date, and based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective
date of SFAS No. 123R. 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. As a result, the pro forma impact to net income and net income per share under SFAS No. 123’s fair
value method of accounting as reflected above is not indicative of future annual expense to be recognized under SFAS No. 123R. To the extent that
the Company grants stock options in the future, the associated expense for these awards under the provisions of SFAS No. 123R may have a material
impact on the Company’s consolidated financial statements. Based upon anticipated levels of share-based awards, the Company estimates this impact
to be approximately $2 million or $0.02 per diluted share for 2006. See Note 10 for further information on our stock-based compensation plans.
note 2 – accounting changes
The Company’s inventory consists of automotive hard parts, maintenance items, accessories and tools. During the fourth quarter of 2004, the
Company changed its method of applying its LIFO accounting policy for inventory costs. Under the new method, the Company has inventoried
certain procurement, warehousing and distribution center costs. The Company’s previous method was to recognize those costs as incurred, reported
as a component of costs of goods sold. The Company believes the change in application of the LIFO accounting method is preferable as it better
matches revenues and expenses and is the prevalent method used by other entities within the Company’s industry. The cumulative effect of this
change in application of accounting method was $21,892,000 as of January 1, 2004, net of the related deferred tax effect of $13,303,000. The change
increased 2004 net income by $2,722,000 or $0.02 per share. Pro forma changes to results of operations as if the new method had been applied for
the year ended December 31, 2003 are presented as follows.