O'Reilly Auto Parts 2010 Annual Report Download - page 65

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Inventory:
Inventory, which consists of automotive hard parts, maintenance items, accessories and tools, is stated at the lower of cost or market.
Inventory also includes capitalized costs related to procurement, warehousing and distribution centers (“DC”). Cost has been
determined using the last-in, first-out method, which more accurately matches costs with related revenues. The replacement cost of
inventory was $2,046 million and $1,922 million as of December 31, 2010 and 2009, respectively.
Amounts receivable from vendors:
The Company receives concessions from its vendors through a variety of programs and arrangements, including co-operative
advertising, devaluation programs, allowances for warranties and volume purchase rebates. Co-operative advertising allowances that
are incremental to the Company’s 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 includes amounts due to the Company
for changeover merchandise and product returns. The Company regularly reviews vendor receivables for collectability and assesses
the need for a reserve for uncollectible amounts based on an evaluation of the Company’s vendors’ financial positions and
corresponding abilities to meet financial obligations. Management does not believe there is a reasonable likelihood that the Company
will be unable to collect the amounts receivable from vendors and the Company did not record a reserve for uncollectible amounts
from vendors in the consolidated financial statements at December 31, 2010 and 2009.
Debt issuance costs:
Deferred debt issuance costs totaled $21.6 million and $30.2 million, net of amortization, at December 31, 2010 and 2009,
respectively, of which $8.6 million was included within “Other current assets” at December 31, 2010 and 2009. The remainder was
included within “Other assets” at December 31, 2010 and 2009. Deferred debt issuance costs are amortized using the straight-line
method over the term of the corresponding long-term debt issue and the amortization is included as a component of “Interest expense”
in the Company’s Consolidated Statements of Income. All remaining debt issuance costs related to the Company’s asset-based
revolving credit facility were expensed on January 14, 2011, in conjunction with the issuance of the Company’s $500 million of
unsecured 4.875% Senior Notes due 2021 (the “2011 4.875% Senior Notes”) and subsequent repayment and retirement of the asset-
based revolving credit facility as further described below and in Note 4.
Property and equipment:
Property and equipment are carried at cost. Depreciation is calculated using the straight-line method generally over the estimated
useful lives of the assets. Leasehold improvements are amortized over the lesser of the lease term or the estimated economic life of
the assets. The lease term includes renewal options determined by management at lease inception for which failure to renew options
would result in a substantial economic penalty to the Company. Maintenance and repairs are charged to expense as incurred. Upon
retirement or sale, the cost and accumulated depreciation are eliminated and the gain or loss, if any, is included as a component of
“Other income (expense)” in the Company’s Consolidated Statements of Income. The Company reviews long-lived assets for
impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.
Property and equipment consist of the following as of December 31, 2010 and 2009 (in thousands, except useful lives):
Original
Useful Lives
December 31,
2010
December 31,
2009
Land $ 392,600 $ 331,456
Buildings and building improvements 15 – 39 years 921,929 766,446
Leasehold improvements 3 – 25 years 370,018 314,751
Furniture, fixtures and equipment 3 – 20 years 777,485 645,839
Vehicles 5 – 10 years 182,942 157,535
Construction in progress 60,460 137,213
Total property and equipment 2,705,434 2,353,240
Less: accumulated depreciation and amortization 775,339 626,861
Net property and equipment $ 1,930,095 $ 1,726,379
The gross value of capital lease assets included in the “Furniture, fixtures and equipment” amounts of the above table was $7.7 million
and $17.4 million at December 31, 2010 and 2009, respectively. The gross value of capital lease assets included in the “Vehicles”
amount of the above table was $9.6 million and $9.7 million at December 31, 2010 and 2009, respectively. As of December 31, 2010
and 2009, the Company recorded accumulated amortization on all capital lease assets in the amount of $14.4 million and $10.5
million, respectively, all of which is included in “accumulated depreciation and amortization” in the above table.
The Company capitalizes interest costs as a component of construction in progress, based on the weighted-average interest rates
incurred on long-term borrowings. Total interest costs capitalized for the years ended December 31, 2010, 2009 and 2008, were $5.1
million, $6.7 million and $2.3 million, respectively.
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Goodwill and other intangible assets:
The accompanying Consolidated Balance Sheets at December 31, 2010 and 2009, include goodwill and other intangible assets
recorded as the result of acquisitions. The Company reviews goodwill for impairment annually on December 31, or when events or
changes in circumstances indicate the carrying value of these assets might exceed their current fair values, rather than systematically
amortizing 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 a single reporting unit, and its fair value exceeded its carrying value, including
goodwill, at December 31, 2010 and 2009; as such, no goodwill impairment adjustment was required at December 31, 2010 and 2009.
Operating 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, the lease term for stores is the base lease term and the lease term for DCs 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 Company recognizes rent expense on a straight-line basis over these respective lease terms.
Notes receivable:
The Company had notes receivable from vendors and other third parties amounting to $22.2 million and $16.6 million at December
31, 2010 and 2009, respectively. The notes receivable, which bear interest at rates ranging from 0% to 10%, are due in varying
amounts through March of 2018. Interest income on notes receivable is recorded in accordance with the note terms to the extent that
such amounts are expected to be collected. The Company regularly reviews its notes receivable for collectability and assesses the
need for a reserve for uncollectible amounts based on an evaluation of the Company’s borrowers’ financial positions and
corresponding abilities to meet financial obligations. At December 31, 2010, the Company did not have a reserve for uncollectible
amounts of notes receivable in the consolidated financial statements. At December 31, 2009, the Company had a reserve balance of
$7.1 million related to a note receivable acquired in the CSK acquisition that was settled in 2010, which was included as a component
of “Notes receivable, less current portion” in its Condensed Consolidated Balance Sheets.
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 its 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. These liabilities are
recorded at their net present value discounted using the Company’s incremental borrowing rate for instruments with similar maturities
of 5.30% and 6.93% at December 31, 2010 and 2009, respectively.
The components of the Company’s self-insurance reserves were as follows on December 31, 2010 and 2009 (in thousands):
2010 2009
Self-insurance reserves (undiscounted) $ 109,351 $ 101,074
Self-insurance reserves (discounted) $ 99,612 $ 90,968
The current portion of the Company’s discounted self-insurance reserves totaled $51.2 million and $55.3 million at December 31,
2010 and 2009, respectively. The remainder was included within “Other liabilities” at December 31, 2010 and 2009.
Warranty costs:
The Company offers warranties on the merchandise it sells with warranty periods ranging from 30 days to limited lifetime warranties.
The risk of loss arising from warranty claims is typically the obligation of the Company’s vendors. Certain vendors provide upfront
allowances to the Company in lieu of accepting the obligation for warranty claims. For this merchandise, when sold, the Company
bears the risk of loss associated with the cost of warranty claims. Differences between vendor allowances received by the Company 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. The
Company’s historical experience has been that failure rates are relatively consistent over time and that the ultimate cost of warranty
claims to the Company has been driven by volume of units sold as opposed to fluctuations in failure rates or the variation of the cost
of individual claims. The change in the Company’s aggregate product warranty liability for the years ended December 31, 2010 and
2009 is as follows (in thousands):
2010 2009
Balance at January 1, $ 19,637 $ 16,758
Warranty claims (44,791) (33,227)
Warranty accruals 47,583 36,106
Balance December 31, $ 22,429 $ 19,637
FORM 10-K