O'Reilly Auto Parts 2015 Annual Report Download - page 43

FORM 10-K
35
• Warranty Reserves:
We offer warranties on certain merchandise we sell with warranty periods ranging from 30 days to limited lifetime warranties. The
risk of loss arising from warranty claims is typically the obligation of our suppliers. Certain suppliers provide upfront allowances
to us in lieu of accepting the obligation for warranty claims. For this merchandise, when sold, we bear the risk of loss associated
with the cost of warranty claims. Differences between supplier allowances received 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. Our historical experience has been that failure
rates are relatively consistent over time and that the ultimate cost of warranty claims has been driven by volume of units sold as
opposed to fluctuations in failure rates or the variation of the cost of individual claims. If warranty reserves were changed 10% from
our estimated reserves at December 31, 2015, the financial impact would have been approximately $4 million or 0.2% of pretax
income for the year ended December 31, 2015.
• Self-Insurance Reserves:
We use a combination of insurance and self-insurance mechanisms to provide for potential liabilities from workers' compensation,
general liability, vehicle liability, property loss, and Team Member health care benefits. With the exception of certain Team Member
health care benefit liabilities, employment related claims and litigation, certain commercial litigation and certain regulatory matters,
we obtain third-party insurance coverage to limit our exposure for any individual workers' compensation, general liability, vehicle
liability or property loss claim. When estimating our self-insurance liabilities, we consider a number of factors, including historical
claims experience and trend-lines, projected medical and legal inflation, and growth patterns and exposure forecasts. The assumptions
made by management as they relate to each of these factors represent our judgment as to the most probable cumulative impact of
each factor to our future obligations. Our calculation of self-insurance liabilities requires management to apply judgment to estimate
the ultimate cost to settle reported claims and claims incurred but not yet reported as of the balance sheet date and the application
of alternative assumptions could result in a different estimate of these liabilities. Actual claim activity or development may vary
from our assumptions and estimates, which may result in material losses or gains. As we obtain additional information that affects
the assumptions and estimates we used to recognize liabilities for claims incurred in prior accounting periods, we adjust our self-
insurance liabilities to reflect the revised estimates based on this additional information. These liabilities are recorded at our estimate
of their net present value, using a credit-adjusted discount rate. These liabilities do not have scheduled maturities, but we can estimate
the timing of future payments based upon historical patterns. We could apply alternative assumptions regarding the timing of payments
or the applicable discount rate that could result in materially different estimates of the net present value of the liabilities. If self-
insurance reserves were changed 10% from our estimated reserves at December 31, 2015, the financial impact would have been
approximately $13 million or 0.9% of pretax income for the year ended December 31, 2015.
• Legal Reserves:
We maintain reserves for expenses associated with litigation for which O'Reilly is currently involved. We are currently involved in
litigation incidental to the ordinary conduct of our business. Management, with the assistance of outside legal counsel, must make
estimates of potential legal obligations and possible liabilities arising from such litigation and records reserves for these expenditures.
If legal reserves were changed 10% from our estimated reserves at December 31, 2015, the financial impact would have been
approximately $5 million or 0.3% of pretax income for the year ended December 31, 2015.
• Taxes:
We operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex
issues, which may require an extended period of time to resolve. We regularly review our potential tax liabilities for tax years subject
to audit. The amount of such liabilities is based on various factors, such as differing interpretations of tax regulations by the responsible
tax authority, experience with previous tax audits and applicable tax law rulings. Changes in our tax liability may occur in the future
as our assessments change based on the progress of tax examinations in various jurisdictions and/or changes in tax regulations. In
management's opinion, adequate provisions for income taxes have been made for all years presented. The estimates of our potential
tax liabilities contain uncertainties because management must use judgment to estimate the exposures associated with our various
tax positions and actual results could differ from our estimates. Alternatively, we could have applied assumptions regarding the
eventual outcome of the resolution of open tax positions that could differ from our current estimates but that would still be reasonable
given the nature of a particular position. While our estimates are subject to the uncertainty noted in the preceding discussion, our
initial estimates of our potential tax liabilities have historically not been materially different from actual results, except in instances
where we have reversed liabilities that were recorded for periods that were subsequently closed with the applicable taxing authority.
INFLATION AND SEASONALITY
For the last three fiscal years, we have generally been successful in reducing the effects of merchandise cost increases principally by
taking advantage of supplier incentive programs, economies of scale resulting from increased volume of purchases and selective forward
buying. To the extent our acquisition cost increased due to base commodity price increases industry-wide, we have typically been able