O'Reilly Auto Parts 2007 Annual Report Download - page 36

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Notes to Consolidated Financial Statements (continued)
Income Taxes
The Company accounts for income taxes using the liability method in accordance with Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events
that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined based on differences
between the financial reporting and tax bases of assets and liabilities using enacted tax rules currently scheduled to be in effect for the year in
which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in
the period of the enactment date.
The Company adopted the provisions of FIN 48 on January 1, 2007. This interpretation provides guidance on measurement, derecognition of
benefits, classification, interest and penalties, accounting in interim periods, disclosure and transition and requires that income tax positions must
meet a more-likely-than-not recognition threshold at the effective date to be recognized.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $40,472,000, $34,929,000 and
$28,715,000 for the years ended December 31, 2007, 2006 and 2005, 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.
Share-Based Compensation Plans
The Company currently sponsors share-based employee benefit plans and stock option plans. Please see Note 9 for further information
concerning these plans. In the first quarter of 2006, the Company adopted Statement of Financial Accounting Standards No. 123R, Share
Based Payment (“SFAS No. 123R”), which is a revision of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”) and
supersedes the Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”), using the modified
prospective transition method and began recognizing compensation expense for its share-based payments based on the fair value of the awards.
Under this transition method, compensation cost recognized in 2006 includes the compensation cost for all share-based payments granted prior
to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No.
123, and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in
accordance with the provisions of SFAS No. 123R. Results for prior periods have not been restated. Share-based payments include stock option
awards issued under the Company’s employee stock option plan, director stock option plan, stock issued through the Company’s employee stock
purchase plan and stock awarded to employees through other benefit programs. Prior to January 1, 2006, the Company accounted for share-
based payments using the intrinsic value based recognition method in accordance with APB No. 25. Under APB No. 25, no compensation
expense for stock option awards was recognized since the exercise price of the Company’s stock options equaled the market price of the
underlying stock on the date of grant.
As a result of adopting SFAS No. 123R on January 1, 2006, the Company’s income before income taxes and net income for the year ended
December 31, 2006, are approximately $2.8 million and $1.7 million lower, respectively, than if it had continued to account for share-based
compensation under APB No. 25. Basic and diluted earnings per share for the year ended December 31, 2006 are $0.02 lower than if the
Company had continued to account for share-based compensation under APB No. 25.
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 in
2006. As a result of the vesting acceleration, options to purchase approximately 4.2 million shares of O’Reilly Common Stock became exercisable
immediately. O’Reilly’s Board of Directors took this action with the belief that it is in the best interest of shareholders as it will reduce the
Company’s reported non-cash compensation expense in future periods.
In order to limit unintended personal benefits to employees and officers, the Board of Directors imposed restrictions on any shares received
through the exercise of accelerated options held by those individuals. These restrictions prevent the sale of any stock obtained through exercise
of an accelerated option prior to the earlier of the original vesting date or the individual’s termination of employment. The Company recorded
pre-tax share-based compensation expense of $2.2 million in 2005 based on the intrinsic value of in-the-money options subject to acceleration
and the Company’s estimate of awards that would have expired unexercisable absent the acceleration.
For purposes of pro forma disclosures required under SFAS No. 123 for the year ended December 31, 2005, the estimated fair value of the stock
options was assumed to be amortized to expense over the stock options’ vesting periods. For unvested stock option awards that were included in
the acceleration in the fourth quarter of 2005, any unamortized estimated fair value is assumed to be fully recognized as compensation expense