Aarons 2006 Annual Report Download - page 32

30
Notes to Consolidated Financial Statements
identifiable, and incremental costs incurred in selling those ven-
dors’ products. The prepaid advertising asset was $2.0 million
and $3.4 million at December 31, 2006 and 2005, respectively.
STOCK-BASED COMPENSATION— The Company has stock-based
employee compensation plans, which are more fully described in
Note H below. Prior to January 1, 2006, the Company accounted
for awards granted under those plans following the recognition
and measurement principles of Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and
related interpretations. Effective January 1, 2006, the Company
adopted the fair value recognition provisions of the Financial
Accounting Standards Board’s (“FASB”) Statement of Financial
Accounting Standards (“SFAS”) No. 123(R), Share-Based Payments
(“SFAS 123R”), using the modified prospective application
method. Under this transition method, compensation expense
recognized in the year ended December 31, 2006 includes the
applicable amounts of compensation expense of all stock-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, Accounting for
Stock-Based Compensation (“SFAS 123”), and previously
presented in the pro forma footnote disclosures.
The Company has in the past granted stock options for a fixed
number of shares to employees primarily with an exercise price
equal to the fair value of the shares at the date of grant and,
accordingly, recognized no compensation expense for these stock
option grants. The Company did not grant any stock options in
2006. The Company also has granted stock options for a fixed
number of shares to certain key executives with an exercise price
below the fair value of the shares at the date of grant (“Key
Executive grants”). Compensation expense for Key Executive
grants is recognized over the three-year vesting period of the
options for the difference between the exercise price and the fair
value of a share of Common Stock on the date of grant times the
number of options granted. Income tax benefits resulting from
stock option exercises credited to additional paid-in capital
totaled $5.2 million, $1.9 million, and $3.2 million in 2006,
2005, and 2004, respectively.
The Company amended the Key Executive grants in 2006 and
raised the exercise price of each of the stock options to the fair
market value of the common stock on the original grant date,
adjusted for a 3-for-2 stock dividend that occurred on August 2,
2004 in the case of those stock options with an original grant
date that preceded the stock dividend date. The amendment
also provides that, in order to compensate the grantees for
the increase in the exercise price of the stock options, the
full original discounted amount will be paid in cash on the
applicable 2007 vesting date.
Under the modified prospective application method, results for
prior periods have not been restated to reflect the effects of
implementing SFAS 123R. For purposes of pro forma disclosures
under SFAS 123 as amended by SFAS No. 148, Accounting for Stock-
Based Compensation — Transition and Disclosure—an amendment
of FASB Statement 123, the estimated fair value of the options
is amortized to expense over the options’ vesting period. The
following table illustrates the effect on net earnings and earnings
per share if the fair value based method had been applied to all
outstanding and unvested awards for the following periods:
Year Ended Year Ended
December 31, December 31,
(In Thousands, Except Per Share) 2005 2004
Net Earnings before effect
of Key Executive grants $58,522 $52,854
Expense effect of Key
Executive grants recognized (529) (238)
Net earnings as reported 57,993 52,616
Stock-based Employee Compensation
Cost, Net of Tax— Pro Forma (1,996) (1,687)
Pro forma net earnings $55,997 $50,929
Earnings per share:
Basic— as reported $ 1.16 $ 1.06
Basic— pro forma $ 1.12 $ 1.03
Diluted — as reported $ 1.14 $ 1.04
Diluted — pro forma $ 1.10 $ 1.01
INSURANCE RESERVES — Estimated insurance reserves are
accrued primarily for group health and workers compensation
benefits provided to the Company’s employees. Estimates for
these insurance reserves are made based on actual reported but
unpaid claims and actuarial analyses of the projected claims run
off for both reported and incurred but not reported claims.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES — From
time to time, the Company uses interest rate swap agreements to
synthetically manage the interest rate characteristics of a portion
of its outstanding debt and to limit the Company’s exposure to
rising interest rates. The Company designates at inception that
interest rate swap agreements hedge risks associated with future
variable interest payments and monitors each swap agreement to
determine if it remains an effective hedge. The effectiveness of
the derivative as a hedge is based on a high correlation between
changes in the value of the underlying hedged item and the
derivative instrument. The Company records amounts to be
received or paid as a result of interest swap agreements as an
adjustment to interest expense. Generally, the Company’s interest
rate swaps are designated as cash flow hedges. The Company
does not enter into derivatives for speculative or trading
purposes. At December 31, 2006 and 2005 the Company
did not have any swap agreements.