O'Reilly Auto Parts 2011 Annual Report Download - page 64

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Company estimates its self-insurance liabilities by considering a number of factors, including historical claims experience and trend-
lines, projected medical and legal inflation, growth patterns and exposure forecasts. Certain of these liabilities were recorded at their
net present value discounted using the Company’s incremental borrowing rate of 4.75% and 5.30% at December 31, 2011 and 2010,
respectively.
The following table identifies the components of the Company’s self-insurance reserves as of December 31, 2011 and 2010 (in
thousands):
2011 2010
Self-insurance reserves (undiscounted) $ 116,696 $ 109,351
Self-insurance reserves (discounted) $ 106,011 $ 99,612
The current portion of the Company’s discounted self-insurance reserves totaled $53.2 million and $51.2 million at December 31,
2011 and 2010, respectively. The remainder was included within ―Other liabilities‖ on the accompanying Consolidated Balance
Sheets at December 31, 2011 and 2010.
Warranties:
The Company offers warranties on the merchandise it sells with warranty periods ranging from 30 days to limited lifetime warranties.
The risk of loss arising from warranty claims is typically the obligation of the Company’s vendors. Certain vendors provide upfront
allowances to the Company in lieu of accepting the obligation for warranty claims. For this merchandise, when sold, the Company
bears the risk of loss associated with the cost of warranty claims. Differences between vendor allowances received by the Company in
lieu of warranty obligations and estimated warranty expense are recorded as an adjustment to cost of sales. Estimated warranty costs,
which are recorded as obligations at the time of sale, are based on the historical failure rate of each individual product line. The
Company’s historical experience has been that failure rates are relatively consistent over time and that the ultimate cost of warranty
claims to the Company has been driven by volume of units sold as opposed to fluctuations in failure rates or the variation of the cost
of individual claims. See Note 8 for further information concerning the Company’s aggregate product warranty liability.
Litigation reserves:
O’Reilly is currently involved in litigation incidental to the ordinary conduct of the Company’s business. The Company records
reserves for litigation losses in instances where a material adverse outcome is probable and the Company is able to reasonably
estimate the probable loss. The Company reserves for an estimate of material legal costs to be incurred on pending litigation matters.
Although the Company cannot ascertain the total amount of liability that it may incur from any of these matters, the Company does
not currently believe that in the aggregate, taking into account applicable insurance coverage, these matters will have a material
adverse effect on its consolidated financial position, results of operations or cash flows. In addition, O’Reilly is involved in resolving
legacy governmental investigations and litigation that were being conducted against certain former CSK Automotive Corporation
(―CSK‖) employees arising out of alleged conduct relating to periods prior to the Company’s acquisition of CSK. See Note 12 for
further information concerning these legal matters.
Closed property liabilities:
The Company maintains reserves for closed stores and other properties that are no longer being utilized in current operations. The
Company provides for these liabilities using a credit-adjusted discount rate to calculate the present value of the remaining non-
cancelable lease payments, occupancy costs and lease termination fees after the close date, net of estimated sublease income. In
conjunction with the acquisition of CSK, the Company’s reserves include purchase accounting liabilities related to acquired properties
that were no longer being utilized in the acquired business as well as the Company’s planned exit activities. See Note 6 for further
information concerning these closed store liabilities.
Derivative instruments and hedging activities:
The Company’s accounting policies for derivative financial instruments are based on whether the instruments meet the criteria for
designation as cash flow or fair value hedges. The criteria for designating a derivative as a hedge include the assessment of the
instrument’s effectiveness in risk reduction, matching of the derivative instrument to its underlying transaction and the probability that
the underlying transaction will occur. A designated hedge of the exposure to variability in the future cash flows of an asset or a
liability qualifies as a cash flow hedge. A designated hedge of the exposure to changes in fair value of an asset or a liability qualifies
as a fair value hedge. For derivatives with cash flow hedge accounting designation, the Company would recognize the after-tax gain
or loss from the effective portion of the hedge as a component of ―Accumulated other comprehensive loss‖ and would reclassify it into
earnings in the same period or periods in which the hedged transaction affects earnings, and within the same income statement line
item as the impact of the hedged transaction. For derivatives with fair value hedge accounting designation, the Company would
recognize gains or losses from the change in fair value of these derivatives, as well as the offsetting change in the fair value of the
underlying hedged item, in earnings. At December 31, 2011, the Company did not hold any instruments that qualified as cash flow or
fair value hedge derivatives.
At December 31, 2010, the Company held derivative financial instruments to manage interest rate risk. The Company designated
these derivative financial instruments as cash flow hedges. The derivative financial instruments were recorded at fair value and were
FORM 10-K