O'Reilly Auto Parts 2007 Annual Report Download - page 20

18
Management’s Discussion and Analysis
of Financial Condition and Results of Operations
The following discussion of our financial condition, results of operations and liquidity and capital resources should be read in conjunction with our consolidated financial
statements, related notes and other financial information included elsewhere in this annual report.
We are one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States,
selling our products to both do-it-yourself (DIY) customers and professional installers. Our stores carry an extensive product line consisting of
new and remanufactured automotive hard parts, maintenance items and accessories and a complete line of auto body paint and related materials,
automotive tools and professional installer service equipment.
We calculate same-store sales based on the change in sales for stores open at least one year. We calculate the percentage increase in same-store
sales based on store sales results, which exclude sales of specialty machinery, sales by outside salesmen and sales to team members.
Cost of goods sold consists primarily of product costs and warehouse and distribution expenses. Cost of goods sold as a percentage of sales may be
affected by variations in our product mix, price changes in response to competitive factors and fluctuations in merchandise costs and vendor programs.
Operating, selling, general and administrative expenses consist primarily of salaries and benefits for store and corporate team members, occupancy
costs, advertising expenses, depreciation, general and administrative expenses, information technology expenses, professional expenses and other
related expenses.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in accordance with accounting policies generally accepted in the United States (“GAAP”) requires
the application of certain estimates and judgments by management. Management bases its assumptions, estimates, and adjustments on historical
experience, current trends and other factors believed to be relevant at the time the consolidated financial statements are prepared. Management
believes that the following policies are critical due to the inherent uncertainty of these matters and the complex and subjective judgments
required to establish these estimates. Management continues to review these critical accounting policies and estimates to ensure that the
consolidated financial statements are presented fairly in accordance with GAAP. However, actual results could differ from our assumptions
and estimates and such differences could be material.
• Vendor concessions – We receive concessions from our vendors through a variety of programs and arrangements, including co-operative
advertising, allowances for warranties, merchandise allowances and volume purchase rebates. Co-operative advertising allowances that are
incremental to our advertising program, specific to a product or event and identifiable for accounting purposes, are reported as a reduction of
advertising expense in the period in which the advertising occurred. All other material vendor concessions are recognized as a reduction to the
cost of inventory. Amounts receivable from vendors also include amounts due to us relating to vendor purchases and product returns.
Management regularly reviews amounts receivable from vendors and assesses the need for a reserve for uncollectible amounts based on our
evaluation of our vendors’ financial position and corresponding ability to meet their financial obligations. Based on our historical results and
current assessment, we have not recorded a reserve for uncollectible amounts in our consolidated financial statements, and we do not believe
there is a reasonable likelihood that our ability to collect these amounts will differ from our expectations. The eventual ability of our vendors to
pay us the obliged amounts could differ from our assumptions and estimates, and we may be exposed to losses or gains that could be material.
• 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 employee health care benefits. With the exception of employee health
care benefit liabilities, which are limited by the design of these plans, we obtain third-party insurance coverage to limit our exposure for any
individual 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 represents our judgment as to the most probable cumulative impact of each factor to our future obligations. Our
calculation of our 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 would 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.
If self-insurance reserves were changed 10% from our estimated reserves at December 31, 2007, the financial impact would have been
approximately $4.7 million or 1.5% of pretax income.
• Accounts receivable – Management estimates the allowance for doubtful accounts based on historical loss ratios and other relevant factors.
Actual results have consistently been within management’s expectations, and we do not believe that there is a reasonable likelihood that there
will be a material change in the future that will require a significant change in the assumptions or estimates we use to calculate our allowance for
doubtful accounts. However, if actual results differ from our estimates, we may be exposed to losses or gains. If the allowance for doubtful
accounts were changed 10% from our estimated allowance at December 31, 2007, the financial impact would have been approximately
$0.3 million or 0.1% of pretax income.