Nike 2011 Annual Report Download - page 31

31NIKE,INC.-Form10-K
PARTII
ITEM7Management’s Discussion and Analysis of Financial Condition and Results of Operations
Hedge Accounting for Derivatives
We use forward and option contracts to hedge certain anticipated foreign
currency exchange transactions as well as certain non-functional monetary
assets and liabilities. When the specifi c criteria to qualify for hedge accounting
has been met, changes in the fair value of contracts hedge probable forecasted
future cash fl ows are recorded in other comprehensive income, rather than net
income, until the underlying hedged transaction affects net income. In most
cases, this results in gains and losses on hedge derivatives being released
from other comprehensive income into net income some time after the maturity
of the derivative. One of the criteria for this accounting treatment is that the
forward and option contracts amount should not be in excess of specifi cally
identifi ed anticipated transactions. By their very nature, our estimates of
anticipated transactions may fl uctuate over time and may ultimately vary
from actual transactions. When anticipated transaction estimates or actual
transaction amounts decline below hedged levels, or if it is no longer probable
that a forecasted transaction will occur by the end of the originally specifi ed
time period or within an additional two-month period of time thereafter, we
are required to reclassify the ineffective portion of the cumulative changes in
fair values of the related hedge contracts from other comprehensive income
to other (income), net during the quarter in which such changes occur.
We use forward contracts to hedge our investment in the net assets of certain
international subsidiaries to offset foreign currency translation related to our
net investment in those subsidiaries. The change in fair value of the forward
contracts hedging our net investments is reported in the cumulative translation
adjustment component of accumulated other comprehensive income within
stockholders’ equity, to the extent effective, to offset the foreign currency
translation adjustments on those investments. As the value of our underlying
net investments in wholly-owned international subsidiaries is known at the time
a hedge is placed, the designated hedge is matched to the portion of our net
investment at risk. Accordingly, the variability involved in net investment hedges
is substantially less than that of other types of hedge transactions and we do
not expect any material ineffectiveness. We consider, on a quarterly basis,
the need to redesignate existing hedge relationships based on changes in the
underlying net investment. Should the level of our net investment decrease
below hedged levels, any resulting ineffectiveness would be reported directly
to earnings in the period incurred.
Stock-based Compensation
We account for stock-based compensation by estimating the fair value of
stock-based compensation on the date of grant using the Black-Scholes option
pricing model. The Black-Scholes option pricing model requires the input of
highly subjective assumptions including volatility. Expected volatility is estimated
based on implied volatility in market traded options on our common stock with
a term greater than oneyear, along with other factors. Our decision to use
implied volatility was based on the availability of actively traded options on our
common stock and our assessment that implied volatility is more representative
of future stock price trends than historical volatility. Iffactors change and we
use different assumptions for estimating stock-based compensation expense
in future periods, stock-based compensation expense may differ materially in
the future from that recorded in the current period.
Taxes
We record valuation allowances against our deferred tax assets, when
necessary. Realization of deferred tax assets (such as net operating loss
carry-forwards) is dependent on future taxable earnings and is therefore
uncertain. At least quarterly, we assess the likelihood that our deferred tax
asset balance will be recovered from future taxable income. To the extent we
believe that recovery is not likely, we establish a valuation allowance against
our deferred tax asset, which increases our income tax expense in the period
when such determination is made.
In addition, we have not recorded U.S. income tax expense for foreign earnings
that we have determined to be indefi nitely reinvested offshore, thus reducing our
overall income tax expense. The amount of earnings designated as indefi nitely
reinvested offshore is based upon the actual deployment of such earnings inour
offshore assets and our expectations of the future cash needs of our U.S. and
foreign entities. Income tax considerations are also a factor indetermining the
amount of foreign earnings to be indefi nitely reinvested offshore.
We carefully review all factors that drive the ultimate disposition of foreign
earnings determined to be reinvested offshore, and apply stringent standards
to overcoming the presumption of repatriation. Despite this approach, because
the determination involves our future plans and expectations of future events,
the possibility exists that amounts declared as indefi nitely reinvested offshore
may ultimately be repatriated. For instance, the actual cash needs of our U.S.
entities may exceed our current expectations, or the actual cash needs of our
foreign entities may be less than our current expectations. This would result
in additional income tax expense in theyear we determined that amounts
were no longer indefi nitely reinvested offshore. Conversely, our approach
may also result in a determination that accumulated foreign earnings (for
which U.S. income taxes have been provided) will be indefi nitely reinvested
offshore. In this case, our income tax expense would be reduced in theyear
of such determination.
On an interim basis, we estimate what our effective tax rate will be for the
full fi scalyear. The estimated annual effective tax rate is then applied to
theyear-to-date pre-tax income excluding infrequently occurring or unusual
items, to determine theyear-to-date tax expense. The income tax effects of
infrequent or unusual items are recognized in the interim period in which they
occur. Asthefi scalyear progresses, we continually refi ne our estimate based
upon actual events and earnings by jurisdiction during theyear. This continual
estimation process periodically results in a change to our expected effective tax
rate for the fi scalyear. When this occurs, we adjust the income tax provision
during the quarter in which the change in estimate occurs.
On a quarterly basis, we reevaluate the probability that a tax position will
be effectively sustained and the appropriateness of the amount recognized
for uncertain tax positions based on factors including changes in facts or
circumstances, changes in tax law, settled audit issues and new audit activity.
Changes in our assessment may result in the recognition of a tax benefi t
or an additional charge to the tax provision in the period our assessment
changes. We recognize interest and penalties related to income tax matters
in income tax expense.
Other Contingencies
In the ordinary course of business, we are involved in legal proceedings
regarding contractual and employment relationships, product liability claims,
trademark rights, and a variety of other matters. We record contingent liabilities
resulting from claims against us, including related legal costs, when a loss is
assessed to be probable and the amount of the loss is reasonably estimable.
Assessing probability of loss and estimating probable losses requires analysis
of multiple factors, including in some cases judgments about the potential
actions of third party claimants and courts. Recorded contingent liabilities
are based on the best information available and actual losses in any future
period are inherently uncertain. If future adjustments to estimated probable
future losses or actual losses exceed our recorded liability for such claims,
wewould record additional charges as other (income), net during the period in
which the actual loss or change in estimate occurred. In addition to contingent
liabilities recorded for probable losses, we disclose contingent liabilities when
there is a reasonable possibility that the ultimate loss will materially exceed the
recorded liability. Currently, we do not believe that any of our pending legal
proceedings or claims will have a material impact on our fi nancial position or
results of operations.