O'Reilly Auto Parts 2006 Annual Report Download - page 34

o’reilly automotive 2006 annual report
page 32
Leases
The Company’s policy is to amortize leasehold improvements over the lesser of the lease term or the estimated economic life of those assets. Generally,
for stores the lease term is the base lease term and for distribution centers the lease term includes the base lease term plus certain renewal option periods
for which renewal is reasonably assured and failure to exercise the renewal option would result in a significant economic penalty. The calculation for
straight-line rent expense is based on the same lease term. Prior to 2003, leasehold improvements were amortized over a period of time which included
both the base lease term and the first renewal option period of the lease and rent expense was recorded as paid.
As a result, the Company’s 2004 statement of income includes an adjustment to correct its lease accounting of $10.4 million ($3.5 million related to
2004), $6.5 million, net of tax. Prior years’ financial statements were not restated due to the immateriality of the amount to the results of operations
and statement of financial position for 2004 or any prior individual year. As the correction relates solely to accounting treatment, it did not affect the
Company’s historical or future cash flows.
The effect from these corrections, which is reflected in the financial statements, is an increase in depreciation expense in 2004 of $6.0 million ($2.6 million
related to 2004), an increase in rent expense in 2004 of $4.4 million ($0.9 million related to 2004), and a decrease in income tax expense in 2004 of
$3.9 million.
Notes Receivable
The Company had notes receivable from vendors and other third parties amounting to $36,955,000 and $34,998,000 at December 31, 2006 and 2005,
respectively. The notes receivable, which bear interest at rates ranging from 0% to 10%, are due in varying amounts through August 2017.
Goodwill
The “Other assets, net” caption in the Consolidated Balance Sheets at December 31, 2006 and 2005 includes goodwill recorded as the result of
previous acquisitions. Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires the Company to assess
goodwill for impairment rather than systematically amortize goodwill against earnings. The goodwill impairment test compares the fair value of a
reporting unit to its carrying amount, including goodwill. The Company operates as one reporting unit and its fair value exceeds its carrying value,
including goodwill. Therefore, the Company has determined that no impairment of goodwill existed at December 31, 2006 and 2005.
Self-Insurance Reserves
The Company uses a combination of insurance and self-insurance mechanisms to provide for the potential liabilities for workers’ compensation, general
liability, vehicle liability, property loss, and employee health care benefits. With the exception of employee health care benefit liabilities, which are limited
by the design of these plans, the Company obtains third-party insurance coverage to limit its exposure. The Company estimates our self-insurance
liabilities by considering a number of factors, including historical claims experience and trend-lines, projected medical and legal inflation, and growth
patterns and exposure forecasts.
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. The liability method provides that deferred tax assets and liabilities are determined based on differences between the financial reporting
and tax bases of assets and liabilities and are measured using tax rates based on currently enacted rules and enacted rates that will be in effect when the
differences are expected to reverse.
Advertising Costs
The Company expenses advertising costs as incurred. Advertising expense charged to operations amounted to $34,929,000, $28,715,000 and $22,999,000
for the years ended December 31, 2006, 2005 and 2004, 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
notes to consolidated financial statements (continued)