O'Reilly Auto Parts 2006 Annual Report Download - page 35

o’reilly automotive 2006 annual report
page 33
notes to consolidated financial statements (continued)
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 accelera-
tion, 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 years ended December 2005 and 2004, 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 in the
year ended December 2005 for purposes of pro forma disclosure. The pro forma effects of recognizing estimated compensation expense under the fair
value method on net income and earnings per common share were as follows:
(In thousands, except per share data) 2005 2004
Net income, as reported $164,266 $139,566
Add stock-based compensation expense, net
of tax, as reported 5,699 3,465
Deduct stock-based compensation expense, net
of tax, under fair value method (26,522) (10,933)
Pro forma net income $143,443 $132,098
Pro forma basic net income per share $ 1.29 $ 1.20
Pro forma net income per share–assuming dilution $ 1.27 $ 1.19
Net income per share, as reported
Basic $ 1.47 $ 1.27
Assuming dilution $ 1.45 $ 1.25
Prior to the adoption of SFAS No. 123R in 2006, the Company presented all tax benefits of deductions resulting from the exercise of stock options as
operating cash flows in the accompanying Consolidated Statement of Cash Flows. SFAS No. 123R requires excess tax benefits, the cash flow resulting
from the tax deductions in excess of the compensation cost recognized for those options, to be classified as financing cash flows. The excess tax benefit
for the year ended December 31, 2006 was $8.5 million.
Earnings per Share
Basic earnings per share is based on the weighted-average outstanding common shares. Diluted earnings per share is based on the weighted-average
outstanding shares adjusted for the effect of common stock equivalents. Common stock equivalents that could potentially dilute basic earnings per share
in the future that were not included in the fully diluted computation because they would have been antidilutive were 448,000, 226,750 and 544,000
for the years ended December 31, 2006, 2005 and 2004, respectively.