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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED AUGUST 31, 2021
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .
Commission File No. 1-10635
NIKE, Inc.
(Exact name of Registrant as specified in its charter)
| | | | | | | | | | | |
Oregon | 93-0584541 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
One Bowerman Drive, Beaverton, Oregon 97005-6453
(Address of principal executive offices and zip code)
(503) 671-6453
(Registrant's telephone number, including area code)
| | | | | | | | | | | |
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: |
Class B Common Stock | NKE | New York Stock Exchange |
(Title of each class) | (Trading symbol) | (Name of each exchange on which registered) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Indicate by check mark: | | YES | NO |
• | | whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. | | þ | ☐ |
• | | whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). | | þ | ☐ |
• | | whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. |
| | Large accelerated filer | þ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | ☐ | Emerging growth company | ☐ |
• | | if an emerging growth company, if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. | | ☐ |
• | | whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). | | ☐ | þ |
| | | | | |
As of September 28, 2021, the number of shares of the Registrant's Common Stock outstanding were: |
Class A | 305,011,252 | |
Class B | 1,277,806,465 | |
| 1,582,817,717 | |
NIKE, INC.
FORM 10-Q
TABLE OF CONTENTS
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| | PAGE |
PART I - FINANCIAL INFORMATION | |
ITEM 1. | | |
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ITEM 3. | | |
ITEM 4. | | |
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ITEM 1. | | |
ITEM 1A. | | |
ITEM 2. | | |
ITEM 6. | | |
| | |
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NIKE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
| | | | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, | |
(In millions, except per share data) | 2021 | 2020 | | |
Revenues | $ | 12,248 | | $ | 10,594 | | | |
Cost of sales | 6,552 | | 5,853 | | | |
Gross profit | 5,696 | | 4,741 | | | |
Demand creation expense | 918 | | 677 | | | |
Operating overhead expense | 2,654 | | 2,298 | | | |
Total selling and administrative expense | 3,572 | | 2,975 | | | |
Interest expense (income), net | 57 | | 65 | | | |
Other (income) expense, net | (39) | | (14) | | | |
Income before income taxes | 2,106 | | 1,715 | | | |
Income tax expense | 232 | | 197 | | | |
NET INCOME | $ | 1,874 | | $ | 1,518 | | | |
Earnings per common share: | | | | |
Basic | $ | 1.18 | | $ | 0.97 | | | |
Diluted | $ | 1.16 | | $ | 0.95 | | | |
Weighted average common shares outstanding: | | | | |
Basic | 1,581.9 | | 1,561.8 | | | |
Diluted | 1,619.6 | | 1,593.3 | | | |
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| | | | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, | |
(Dollars in millions) | 2021 | 2020 | | |
Net income | $ | 1,874 | | $ | 1,518 | | | |
Other comprehensive income (loss), net of tax: | | | | |
Change in net foreign currency translation adjustment | (128) | | 318 | | | |
Change in net gains (losses) on cash flow hedges | 438 | | (658) | | | |
Change in net gains (losses) on other | 3 | | (5) | | | |
Total other comprehensive income (loss), net of tax | 313 | | (345) | | | |
TOTAL COMPREHENSIVE INCOME | $ | 2,187 | | $ | 1,173 | | | |
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
| | | | | | | | | | | |
| AUGUST 31, | | MAY 31, |
(In millions) | 2021 | | 2021 |
ASSETS | | | |
Current assets: | | | |
Cash and equivalents | $ | 10,720 | | | $ | 9,889 | |
Short-term investments | 2,975 | | | 3,587 | |
Accounts receivable, net | 4,341 | | | 4,463 | |
Inventories | 6,699 | | | 6,854 | |
Prepaid expenses and other current assets | 1,655 | | | 1,498 | |
Total current assets | 26,390 | | | 26,291 | |
Property, plant and equipment, net | 4,869 | | | 4,904 | |
Operating lease right-of-use assets, net | 3,078 | | | 3,113 | |
Identifiable intangible assets, net | 267 | | | 269 | |
Goodwill | 242 | | | 242 | |
Deferred income taxes and other assets | 3,071 | | | 2,921 | |
TOTAL ASSETS | $ | 37,917 | | | $ | 37,740 | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | |
Current liabilities: | | | |
Current portion of long-term debt | $ | — | | | $ | — | |
Notes payable | 15 | | | 2 | |
Accounts payable | 2,135 | | | 2,836 | |
Current portion of operating lease liabilities | 462 | | | 467 | |
Accrued liabilities | 5,296 | | | 6,063 | |
Income taxes payable | 361 | | | 306 | |
Total current liabilities | 8,269 | | | 9,674 | |
Long-term debt | 9,415 | | | 9,413 | |
Operating lease liabilities | 2,898 | | | 2,931 | |
Deferred income taxes and other liabilities | 2,992 | | | 2,955 | |
Redeemable preferred stock | — | | | — | |
Shareholders' equity: | | | |
Common stock at stated value: | | | |
Class A convertible — 305 and 305 shares outstanding | — | | | — | |
Class B — 1,278 and 1,273 shares outstanding | 3 | | | 3 | |
Capital in excess of stated value | 10,521 | | | 9,965 | |
Accumulated other comprehensive income (loss) | (67) | | | (380) | |
Retained earnings (deficit) | 3,886 | | | 3,179 | |
Total shareholders' equity | 14,343 | | | 12,767 | |
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY | $ | 37,917 | | | $ | 37,740 | |
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
| | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, |
(Dollars in millions) | 2021 | 2020 |
Cash provided (used) by operations: | | |
Net income | $ | 1,874 | | $ | 1,518 | |
Adjustments to reconcile net income to net cash provided (used) by operations: | | |
Depreciation | 177 | | 176 | |
Deferred income taxes | (145) | | (220) | |
Stock-based compensation | 136 | | 136 | |
Amortization, impairment and other | (9) | | 41 | |
Net foreign currency adjustments | 43 | | (45) | |
Changes in certain working capital components and other assets and liabilities: | | |
(Increase) decrease in accounts receivable | 36 | | (990) | |
(Increase) decrease in inventories | 101 | | 689 | |
(Increase) decrease in prepaid expenses, operating lease right-of-use assets and other current and non-current assets | (242) | | (338) | |
Increase (decrease) in accounts payable, accrued liabilities, operating lease liabilities and other current and non-current liabilities | (860) | | (85) | |
Cash provided (used) by operations | 1,111 | | 882 | |
Cash provided (used) by investing activities: | | |
Purchases of short-term investments | (2,550) | | (1,401) | |
Maturities of short-term investments | 2,096 | | 302 | |
Sales of short-term investments | 1,037 | | 384 | |
Additions to property, plant and equipment | (184) | | (176) | |
Other investing activities | 102 | | 2 | |
Cash provided (used) by investing activities | 501 | | (889) | |
Cash provided (used) by financing activities: | | |
Increase (decrease) in notes payable | 13 | | (30) | |
Repayment of borrowings | — | | (83) | |
Proceeds from exercise of stock options and other stock issuances | 473 | | 302 | |
Repurchase of common stock | (752) | | — | |
Dividends — common and preferred | (435) | | (384) | |
Other financing activities | (42) | | (53) | |
Cash provided (used) by financing activities | (743) | | (248) | |
Effect of exchange rate changes on cash and equivalents | (38) | | 55 | |
Net increase (decrease) in cash and equivalents | 831 | | (200) | |
Cash and equivalents, beginning of period | 9,889 | | 8,348 | |
CASH AND EQUIVALENTS, END OF PERIOD | $ | 10,720 | | $ | 8,148 | |
Supplemental disclosure of cash flow information: | | |
Non-cash additions to property, plant and equipment | $ | 103 | | $ | 114 | |
Dividends declared and not paid | 436 | | 383 | |
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| COMMON STOCK | CAPITAL IN EXCESS OF STATED VALUE | ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) | RETAINED EARNINGS (DEFICIT) | TOTAL |
| CLASS A | | CLASS B |
(In millions, except per share data) | SHARES | AMOUNT | | SHARES | AMOUNT |
Balance at May 31, 2021 | 305 | | $ | — | | | 1,273 | | $ | 3 | | $ | 9,965 | | $ | (380) | | $ | 3,179 | | $ | 12,767 | |
Stock options exercised | | | | 10 | | | 469 | | | | 469 | |
Repurchase of Class B common stock | | | | (5) | | | (29) | | | (713) | | (742) | |
Dividends on common stock ($0.275 per share) and preferred stock ($0.10 per share) | | | | | | | | (435) | | (435) | |
Issuance of shares to employees, net of shares withheld for employee taxes | | | | | | (20) | | | (19) | | (39) | |
Stock-based compensation | | | | | | 136 | | | | 136 | |
Net income | | | | | | | | 1,874 | | 1,874 | |
Other comprehensive income (loss) | | | | | | | 313 | | | 313 | |
Balance at August 31, 2021 | 305 | | $ | — | | | 1,278 | | $ | 3 | | $ | 10,521 | | $ | (67) | | $ | 3,886 | | $ | 14,343 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| COMMON STOCK | CAPITAL IN EXCESS OF STATED VALUE | ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) | RETAINED EARNINGS (DEFICIT) | TOTAL |
| CLASS A | | CLASS B |
(In millions, except per share data) | SHARES | AMOUNT | | SHARES | AMOUNT |
Balance at May 31, 2020 | 315 | | $ | — | | | 1,243 | | $ | 3 | | $ | 8,299 | | $ | (56) | | $ | (191) | | $ | 8,055 | |
Stock options exercised | | | | 7 | | | 291 | | | | 291 | |
Dividends on common stock ($0.245 per share) and preferred stock ($0.10 per share) | | | | | | | | (383) | | (383) | |
Issuance of shares to employees, net of shares withheld for employee taxes | | | | | | (31) | | | (17) | | (48) | |
Stock-based compensation | | | | | | 136 | | | | 136 | |
Net income | | | | | | | | 1,518 | | 1,518 | |
Other comprehensive income (loss) | | | | | | | (345) | | | (345) | |
Balance at August 31, 2020 | 315 | | $ | — | | | 1,250 | | $ | 3 | | $ | 8,695 | | $ | (401) | | $ | 927 | | $ | 9,224 | |
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
| | | | | | | | |
Note 1 | | |
Note 2 | | |
Note 3 | | |
Note 4 | | |
Note 5 | | |
Note 6 | | |
Note 7 | | |
Note 8 | | |
Note 9 | | |
Note 10 | | |
Note 11 | | |
Note 12 | | |
Note 13 | | |
| | |
NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
BASIS OF PRESENTATION
The Unaudited Condensed Consolidated Financial Statements include the accounts of NIKE, Inc. and its subsidiaries (the “Company” or “NIKE”) and reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair statement of the results of operations for the interim period. The year-end Condensed Consolidated Balance Sheet data as of May 31, 2021, was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S. GAAP”). The interim financial information and notes thereto should be read in conjunction with the Company's latest Annual Report on Form 10-K for the fiscal year ended May 31, 2021. The results of operations for the three months ended August 31, 2021, are not necessarily indicative of results to be expected for the entire fiscal year.
The extent to which the evolving COVID-19 pandemic impacts the Company's financial statements will depend on a number of factors, including the magnitude and duration of the pandemic. There may be developments outside our control that require us to adjust our operating plan, such as our assumption on the pace of reopening and return to full production of factories in Vietnam and the planned shift of production capacity to other countries following factory closures in Vietnam and Indonesia. Such developments and other impacts of COVID-19, such as new or prolonged factory closures, higher inventory levels or inventory shortages in various markets, other adverse impacts on the global supply chain, revised payment terms with certain of our wholesale customers, higher sales-related reserves, factory cancellation costs and a volatile effective tax rate driven by changes in the mix of earnings across our jurisdictions, among other factors, could have material adverse impacts on our revenue growth as well as our overall profitability in future periods.
Inventory balances of $6,699 million and $6,854 million at August 31, 2021 and May 31, 2021, respectively, were substantially all finished goods.
| | |
NOTE 3 — ACCRUED LIABILITIES |
Accrued liabilities included the following:
| | | | | | | | | | | |
| AUGUST 31, | | MAY 31, |
(Dollars in millions) | 2021 | | 2021 |
Compensation and benefits, excluding taxes | $ | 1,039 | | | $ | 1,472 | |
Sales-related reserves | 1,029 | | | 1,077 | |
Taxes other than income taxes payable | 505 | | | 468 | |
Import and logistics costs | 491 | | | 393 | |
Dividends payable | 437 | | | 436 | |
Allowance for expected loss on sale(1) | 344 | | | 358 | |
Other | 1,451 | | | 1,859 | |
TOTAL ACCRUED LIABILITIES | $ | 5,296 | | | $ | 6,063 | |
(1)Refer to Note 12 — Acquisitions and Divestitures for additional information.
| | |
NOTE 4 — FAIR VALUE MEASUREMENTS |
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including derivatives, equity securities and available-for-sale debt securities. For additional information about the Company's fair value policies, refer to Note 1 — Summary of Significant Accounting Policies of the Annual Report on Form 10-K for the fiscal year ended May 31, 2021.
The following tables present information about the Company's financial assets measured at fair value on a recurring basis as of August 31, 2021 and May 31, 2021, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement:
| | | | | | | | | | | |
| AUGUST 31, 2021 |
(Dollars in millions) | ASSETS AT FAIR VALUE | CASH AND EQUIVALENTS | SHORT-TERM INVESTMENTS |
Cash | $ | 759 | | $ | 759 | | $ | — | |
Level 1: | | | |
U.S. Treasury securities | 2,888 | | 601 | | 2,287 | |
Level 2: | | | |
Commercial paper and bonds | 759 | | 74 | | 685 | |
Money market funds | 8,122 | | 8,122 | | — | |
Time deposits | 1,167 | | 1,164 | | 3 | |
| | | |
Total Level 2 | 10,048 | | 9,360 | | 688 | |
TOTAL | $ | 13,695 | | $ | 10,720 | | $ | 2,975 | |
| | | | | | | | | | | |
| MAY 31, 2021 |
(Dollars in millions) | ASSETS AT FAIR VALUE | CASH AND EQUIVALENTS | SHORT-TERM INVESTMENTS |
Cash | $ | 840 | | $ | 840 | | $ | — | |
Level 1: | | | |
U.S. Treasury securities | 2,892 | | — | | 2,892 | |
Level 2: | | | |
Commercial paper and bonds | 748 | | 57 | | 691 | |
Money market funds | 7,701 | | 7,701 | | — | |
Time deposits | 1,293 | | 1,291 | | 2 | |
U.S. Agency securities | 2 | | — | | 2 | |
Total Level 2 | 9,744 | | 9,049 | | 695 | |
TOTAL | $ | 13,476 | | $ | 9,889 | | $ | 3,587 | |
As of August 31, 2021, the Company held $2,308 million of available-for-sale debt securities with maturity dates within one year and $667 million with maturity dates over one year and less than five years in Short-term investments on the Unaudited Condensed Consolidated Balance Sheets. The fair value of the Company's available-for-sale debt securities approximates their amortized cost.
Included in Interest expense (income), net was interest income related to the Company's investment portfolio of $17 million and $7 million for the three months ended August 31, 2021 and 2020, respectively.
The following tables present information about the Company's derivative assets and liabilities measured at fair value on a recurring basis and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement:
| | | | | | | | | | | | | | | | | | | | | | | |
| AUGUST 31, 2021 |
| DERIVATIVE ASSETS | | DERIVATIVE LIABILITIES |
(Dollars in millions) | ASSETS AT FAIR VALUE | OTHER CURRENT ASSETS | OTHER LONG-TERM ASSETS | | LIABILITIES AT FAIR VALUE | ACCRUED LIABILITIES | OTHER LONG-TERM LIABILITIES |
Level 2: | | | | | | | |
Foreign exchange forwards and options(1) | $ | 247 | | $ | 178 | | $ | 69 | | | $ | 127 | | $ | 127 | | $ | — | |
Embedded derivatives | — | | — | | — | | | 4 | | 4 | | — | |
TOTAL | $ | 247 | | $ | 178 | | $ | 69 | | | $ | 131 | | $ | 131 | | $ | — | |
(1)If the foreign exchange derivative instruments had been netted on the Unaudited Condensed Consolidated Balance Sheets, the asset and liability positions each would have been reduced by $116 million as of August 31, 2021. As of that date, no amount of cash collateral had been received or posted on the derivative asset and liability balances related to these foreign exchange derivative instruments.
| | | | | | | | | | | | | | | | | | | | | | | |
| MAY 31, 2021 |
| DERIVATIVE ASSETS | | DERIVATIVE LIABILITIES |
(Dollars in millions) | ASSETS AT FAIR VALUE | OTHER CURRENT ASSETS | OTHER LONG-TERM ASSETS | | LIABILITIES AT FAIR VALUE | ACCRUED LIABILITIES | OTHER LONG-TERM LIABILITIES |
Level 2: | | | | | | | |
Foreign exchange forwards and options(1) | $ | 92 | | $ | 76 | | $ | 16 | | | $ | 456 | | $ | 415 | | $ | 41 | |
Embedded derivatives | — | | — | | — | | | 1 | | 1 | | — | |
TOTAL | $ | 92 | | $ | 76 | | $ | 16 | | | $ | 457 | | $ | 416 | | $ | 41 | |
(1)If the foreign exchange derivative instruments had been netted on the Consolidated Balance Sheets, the asset and liability positions each would have been reduced by $93 million as of May 31, 2021. As of that date, the Company had posted $39 million of cash collateral to various counterparties related to foreign exchange derivative instruments. No amount of collateral was received on the Company's derivative asset balance as of May 31, 2021.
For additional information related to the Company's derivative financial instruments and credit risk, refer to Note 8 — Risk Management and Derivatives.
The carrying amounts of other current financial assets and other current financial liabilities approximate fair value.
FINANCIAL ASSETS AND LIABILITIES NOT RECORDED AT FAIR VALUE
The Company's Long-term debt is recorded at adjusted cost, net of unamortized premiums, discounts and debt issuance costs. The fair value of long-term debt is estimated based upon quoted prices for similar instruments or quoted prices for identical instruments in inactive markets (Level 2). The fair value of the Company's Long-term debt, including the current portion, was approximately $10,575 million at August 31, 2021 and $10,275 million at May 31, 2021.
The carrying amounts reflected on the Unaudited Condensed Consolidated Balance Sheets for Notes payable approximate fair value.
The effective tax rate was 11.0% and 11.5% for the three months ended August 31, 2021 and 2020, respectively. The decrease in the Company's effective tax rate was primarily due to a more favorable impact from stock-based compensation and discrete items such as the recognition of a reserve in the first quarter of fiscal 2021 related to Altera Corp. v. Commissioner. The decrease in the Company's effective tax rate was partially offset by a change in the proportion of earnings taxed in the U.S.
As of August 31, 2021, total gross unrecognized tax benefits, excluding related interest and penalties, were $906 million, $627 million of which would affect the Company's effective tax rate if recognized in future periods. The majority of the total gross unrecognized tax benefits are long-term in nature and included within Deferred income taxes and other liabilities on the Unaudited Condensed Consolidated Balance Sheets. As of May 31, 2021, total gross unrecognized tax benefits, excluding related interest and penalties, were $896 million. The liability for payment of interest and penalties increased by $9 million during the three months ended August 31, 2021. As of August 31, 2021 and May 31, 2021, accrued interest and penalties related to uncertain tax positions were $212 million and $203 million, respectively (excluding federal benefit).
The Company is subject to taxation in the United States, as well as various state and foreign jurisdictions. The Company is currently under audit by the U.S. Internal Revenue Service ("IRS") for fiscal years 2017 through 2019. The Company has closed all U.S. federal income tax matters through fiscal 2016, with the exception of certain transfer pricing adjustments.
Tax years after 2010 remain open in certain major foreign jurisdictions. Although the timing of resolution of audits is not certain, the Company evaluates all domestic and foreign audit issues in the aggregate, along with the expiration of applicable statutes of limitations, and estimates that it is reasonably possible the total gross unrecognized tax benefits could decrease by up to $20 million within the next 12 months. In January 2019, the European Commission opened a formal investigation to examine whether the Netherlands has breached State Aid rules when granting certain tax rulings to the Company. The Company believes the investigation is without merit. If this matter is adversely resolved, the Netherlands may be required to assess additional amounts with respect to current and prior periods, and the Company's Netherlands income taxes in the future could increase.
| | |
NOTE 6 — STOCK-BASED COMPENSATION |
STOCK-BASED COMPENSATION
The NIKE, Inc. Stock Incentive Plan (the “Stock Incentive Plan”) provides for the issuance of up to 798 million previously unissued shares of Class B Common Stock in connection with equity awards granted under the Stock Incentive Plan. The Stock Incentive Plan authorizes the grant of non-statutory stock options, incentive stock options, stock appreciation rights, restricted stock, restricted stock units and performance-based awards. In addition to the Stock Incentive Plan, the Company gives employees the right to purchase shares at a discount from the market price under employee stock purchase plans (ESPPs). Refer to Note 11 — Common Stock and Stock-Based Compensation of the Annual Report on Form 10-K for the fiscal year ended May 31, 2021 for further information.
The following table summarizes the Company's total stock-based compensation expense recognized in Cost of sales or Operating overhead expense, as applicable:
| | | | | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, | | |
(Dollars in millions) | 2021 | 2020 | | | |
Stock options(1) | $ | 65 | | $ | 70 | | | | |
ESPPs | 15 | | 18 | | | | |
Restricted stock and restricted stock units(1)(2) | 56 | | 48 | | | | |
TOTAL STOCK-BASED COMPENSATION EXPENSE | $ | 136 | | $ | 136 | | | | |
(1)Expense for stock options includes the expense associated with stock appreciation rights. Accelerated stock option expense is primarily recorded for employees meeting certain retirement eligibility requirements.
(2)Includes expense for performance-based restricted stock units granted during the three months ended August 31, 2021.
The income tax benefit related to stock-based compensation expense was $186 million and $81 million for the three months ended August 31, 2021 and 2020, respectively.
STOCK OPTIONS
The weighted average fair value per share of the options granted during the three months ended August 31, 2021 and 2020, computed as of the grant date using the Black-Scholes pricing model, was $38.64 and $22.55, respectively. The weighted average assumptions used to estimate these fair values were as follows:
| | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, |
| 2021 | 2020 |
Dividend yield | 0.7 | % | 1.0 | % |
Expected volatility | 25.2 | % | 27.2 | % |
Weighted average expected life (in years) | 5.9 | 6.0 |
Risk-free interest rate | 0.8 | % | 0.3 | % |
Expected volatilities are based on the historical volatility of the Company's common stock, the implied volatility in market-traded options on the Company's common stock with a term greater than one year, as well as other factors. The weighted average expected life of options is based on an analysis of historical and expected future exercise patterns. The interest rate is based on the U.S. Treasury (constant maturity) risk-free rate in effect at the date of grant for periods corresponding with the expected term of the options.
As of August 31, 2021, the Company had $382 million of unrecognized compensation costs from stock options, net of estimated forfeitures, to be recognized in Cost of sales or Operating overhead expense, as applicable, over a weighted average remaining period of 2.4 years.
RESTRICTED STOCK AND RESTRICTED STOCK UNITS
The weighted average fair value per share of restricted stock and restricted stock units granted for the three months ended August 31, 2021 and 2020, computed as of the grant date, was $161.46 and $98.47, respectively.
During the three months ended August 31, 2021, under the Stock Incentive Plan, the Company granted performance-based restricted stock units (PSUs), which were historically in the form of cash-based long-term incentive awards under the Company's Long-Term Incentive Plan. The Company estimates the fair value of these PSUs as of the grant date using a Monte Carlo simulation. The weighted average fair value per share of PSUs granted for the three months ended August 31, 2021, computed as of the grant date, was $247.06. The impact of granting PSUs during the period was not material to the Company's Unaudited Condensed Consolidated Financial Statements.
As of August 31, 2021, the Company had $527 million of unrecognized compensation costs from restricted stock, restricted stock units and PSUs, net of estimated forfeitures, to be recognized in Cost of sales or Operating overhead expense, as applicable, over a weighted average remaining period of 2.5 years.
| | |
NOTE 7 — EARNINGS PER SHARE |
The following is a reconciliation from basic earnings per common share to diluted earnings per common share. The computations of diluted earnings per common share excluded restricted stock, restricted stock units and options, including shares under ESPPs, to purchase an additional 1.1 million and 2.1 million shares of common stock outstanding for the three months ended August 31, 2021 and 2020, respectively, because the awards were anti-dilutive.
| | | | | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, | | |
(In millions, except per share data) | 2021 | 2020 | | | |
Net income available to common stockholders | $ | 1,874 | | $ | 1,518 | | | | |
Determination of shares: | | | | | |
Weighted average common shares outstanding | 1,581.9 | | 1,561.8 | | | | |
Assumed conversion of dilutive stock options and awards | 37.7 | | 31.5 | | | | |
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING | 1,619.6 | | 1,593.3 | | | | |
Earnings per common share: | | | | | |
Basic | $ | 1.18 | | $ | 0.97 | | | | |
Diluted | $ | 1.16 | | $ | 0.95 | | | | |
| | |
NOTE 8 — RISK MANAGEMENT AND DERIVATIVES |
The Company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates, and uses derivatives to manage financial exposures that occur in the normal course of business. As of and for the three months ended August 31, 2021, there have been no material changes to the Company's hedging program or strategy from what was disclosed within the Annual Report on Form 10-K. For additional information about the Company's derivatives and hedging policies refer to Note 1 — Summary of Significant Accounting Policies and Note 14 — Risk Management and Derivatives of the Annual Report on Form 10-K for the fiscal year ended May 31, 2021.
The majority of derivatives outstanding as of August 31, 2021, are designated as foreign currency cash flow hedges, primarily for Euro/U.S. Dollar, British Pound/Euro, Chinese Yuan/U.S. Dollar, and Japanese Yen/U.S. Dollar currency pairs. All derivatives are recognized on the Unaudited Condensed Consolidated Balance Sheets at fair value and classified based on the instrument's maturity date.
The following tables present the fair values of derivative instruments included within the Unaudited Condensed Consolidated Balance Sheets:
| | | | | | | | | | | | | | |
| DERIVATIVE ASSETS |
| BALANCE SHEET LOCATION | AUGUST 31, | | MAY 31, |
(Dollars in millions) | 2021 | | 2021 |
Derivatives formally designated as hedging instruments: | | | | |
Foreign exchange forwards and options | Prepaid expenses and other current assets | $ | 151 | | | $ | 42 | |
Foreign exchange forwards and options | Deferred income taxes and other assets | 69 | | | 16 | |
Total derivatives formally designated as hedging instruments | | 220 | | | 58 | |
Derivatives not designated as hedging instruments: | | | | |
Foreign exchange forwards and options | Prepaid expenses and other current assets | 27 | | | 34 | |
Embedded derivatives | Prepaid expenses and other current assets | — | | | — | |
| | | | |
| | | | |
Total derivatives not designated as hedging instruments | | 27 | | | 34 | |
TOTAL DERIVATIVE ASSETS | | $ | 247 | | | $ | 92 | |
| | | | |
| DERIVATIVE LIABILITIES |
| BALANCE SHEET LOCATION | AUGUST 31, | | MAY 31, |
(Dollars in millions) | 2021 | | 2021 |
Derivatives formally designated as hedging instruments: | | | | |
Foreign exchange forwards and options | Accrued liabilities | $ | 106 | | | $ | 385 | |
Foreign exchange forwards and options | Deferred income taxes and other liabilities | — | | | 41 | |
Total derivatives formally designated as hedging instruments | | 106 | | | 426 | |
Derivatives not designated as hedging instruments: | | | | |
Foreign exchange forwards and options | Accrued liabilities | 21 | | | 30 | |
Embedded derivatives | Accrued liabilities | 4 | | | 1 | |
| | | | |
| | | | |
Total derivatives not designated as hedging instruments | | 25 | | | 31 | |
TOTAL DERIVATIVE LIABILITIES | | $ | 131 | | | $ | 457 | |
The following table presents the amounts in the Unaudited Condensed Consolidated Statements of Income in which the effects of cash flow hedges are recorded and the effects of cash flow hedge activity on these line items:
| | | | | | | | | | | | | | | | | |
| THREE MONTHS ENDED AUGUST 31, |
| 2021 | | 2020 |
(Dollars in millions) | TOTAL | AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY | | TOTAL | AMOUNT OF GAIN (LOSS) ON CASH FLOW HEDGE ACTIVITY |
Revenues | $ | 12,248 | | $ | (21) | | | $ | 10,594 | | $ | 14 | |
Cost of sales | 6,552 | | (66) | | | 5,853 | | 114 | |
Demand creation expense | 918 | | 1 | | | 677 | | 1 | |
Other (income) expense, net | (39) | | (9) | | | (14) | | 8 | |
Interest expense (income), net | 57 | | (2) | | | 65 | | (2) | |
The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | AMOUNT OF GAIN (LOSS) RECOGNIZED IN OTHER COMPREHENSIVE INCOME (LOSS) ON DERIVATIVES(1) | | AMOUNT OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME(1) |
THREE MONTHS ENDED AUGUST 31, | | LOCATION OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME | | THREE MONTHS ENDED AUGUST 31, |
2021 | 2020 | | | 2021 | 2020 |
Derivatives designated as cash flow hedges: | | | | | | | |
Foreign exchange forwards and options | $ | (6) | | $ | — | | | Revenues | | $ | (21) | | $ | 14 | |
Foreign exchange forwards and options | 265 | | (371) | | | Cost of sales | | (66) | | 114 | |
Foreign exchange forwards and options | (1) | | 1 | | | Demand creation expense | | 1 | | 1 | |
Foreign exchange forwards and options | 130 | | (160) | | | Other (income) expense, net | | (9) | | 8 | |
Interest rate swaps(2) | — | | — | | | Interest expense (income), net | | (2) | | (2) | |
TOTAL DESIGNATED CASH FLOW HEDGES | $ | 388 | | $ | (530) | | | | | $ | (97) | | $ | 135 | |
(1)For the three months ended August 31, 2021 and 2020, the amounts recorded in Other (income) expense, net as a result of the discontinuance of cash flow hedges because the forecasted transactions were no longer probable of occurring were immaterial.
(2)Gains and losses associated with terminated interest rate swaps, which were previously designated as cash flow hedges and recorded in Accumulated other comprehensive income (loss), will be released through Interest expense (income), net over the term of the issued debt.
| | | | | | | | | | | | | | |
| AMOUNT OF GAIN (LOSS) RECOGNIZED IN INCOME ON DERIVATIVES | LOCATION OF GAIN (LOSS) RECOGNIZED IN INCOME ON DERIVATIVES |
| THREE MONTHS ENDED AUGUST 31, | | |
(Dollars in millions) | 2021 | 2020 | | | |
| | | | | | |
| | | | | | |
Derivatives not designated as hedging instruments: | | | | | | |
Foreign exchange forwards and options | $ | 23 | | $ | (38) | | | | | Other (income) expense, net |
Embedded derivatives | (5) | | (4) | | | | | Other (income) expense, net |
CASH FLOW HEDGES
All changes in fair value of derivatives designated as cash flow hedge instruments are recorded in Accumulated other comprehensive income (loss) until Net income is affected by the variability of cash flows of the hedged transaction. Effective hedge results are classified in the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. When it is no longer probable the forecasted hedged transaction will occur in the initially identified time period, hedge accounting is discontinued and the Company accounts for the associated derivative as an undesignated instrument as discussed below. Additionally, the gains and losses associated with derivatives no longer designated as cash flow hedge instruments in Accumulated other comprehensive income (loss) are recognized immediately in Other (income) expense, net, if it is probable the forecasted hedged transaction will not occur by the end of the initially identified time period or within an additional two-month period thereafter. In rare circumstances, the additional period of time may exceed two months due to extenuating circumstances related to the nature of the forecasted transaction that are outside the control or influence of the Company.
The total notional amount of outstanding foreign currency derivatives designated as cash flow hedges was approximately $15.2 billion as of August 31, 2021. Approximately $10 million of deferred net losses (net of tax) on both outstanding and matured derivatives in Accumulated other comprehensive income (loss) as of August 31, 2021, are expected to be reclassified to Net income during the next 12 months concurrent with the underlying hedged transactions also being recorded in Net income. Actual amounts ultimately reclassified to Net income are dependent on the exchange rates in effect when derivative contracts currently outstanding mature. As of August 31, 2021, the maximum term over which the Company hedges exposures to the variability of cash flows for its forecasted transactions was 24 months.
UNDESIGNATED DERIVATIVE INSTRUMENTS
The Company may elect to enter into foreign exchange forwards to mitigate the change in fair value of specific assets and liabilities on the Unaudited Condensed Consolidated Balance Sheets and/or embedded derivative contracts. These undesignated instruments are recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, together with the remeasurement gain or loss from the hedged balance sheet position and/or embedded derivative contract. The total notional amount of outstanding undesignated derivative instruments was $4.4 billion as of August 31, 2021.
EMBEDDED DERIVATIVES
Embedded derivative contracts are treated as foreign currency forward contracts that are bifurcated from the related contract and recorded at fair value as a derivative asset or liability on the Unaudited Condensed Consolidated Balance Sheets with their corresponding change in fair value recognized in Other (income) expense, net, through the date the foreign currency fluctuations cease to exist.
As of August 31, 2021, the total notional amount of embedded derivatives outstanding was approximately $502 million.
CREDIT RISK
The Company's bilateral credit-related contingent features generally require the owing entity, either the Company or the derivative counterparty, to post collateral for the portion of the fair value in excess of $50 million should the fair value of outstanding derivatives per counterparty be greater than $50 million. Additionally, a certain level of decline in credit rating of either the Company or the counterparty could trigger collateral requirements. As of August 31, 2021, the Company was in compliance with all credit risk-related contingent features, and derivative instruments with such features were in a net liability position of approximately $11 million. Accordingly, the Company was not required to post cash collateral as a result of these contingent features. Further, no amount of collateral was received on the Company's derivative asset balance as of August 31, 2021. The Company considers the impact of the risk of counterparty default to be immaterial.
For additional information related to the Company's derivative financial instruments and collateral, refer to Note 4 — Fair Value Measurements.
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NOTE 9 — ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) |
The changes in Accumulated other comprehensive income (loss), net of tax, were as follows:
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(Dollars in millions) | FOREIGN CURRENCY TRANSLATION ADJUSTMENT(1) | CASH FLOW HEDGES | NET INVESTMENT HEDGES(1) | OTHER | TOTAL |
Balance at May 31, 2021 | $ | 2 | | $ | (435) | | $ | 115 | | $ | (62) | | $ | (380) | |
Other comprehensive income (loss): | | | | | |
Other comprehensive gains (losses) before reclassifications(2) | (128) | | 349 | | — | | 8 | | 229 | |
Reclassifications to net income of previously deferred (gains) losses(3) | — | | 89 | | — | | (5) | | 84 | |
Total other comprehensive income (loss) | (128) | | 438 | | — | | 3 | | 313 | |
Balance at August 31, 2021 | $ | (126) | | $ | 3 | | $ | 115 | | $ | (59) | | $ | (67) | |
(1)The accumulated foreign currency translation adjustment and net investment hedge gains/losses related to an investment in a foreign subsidiary are reclassified to Net income upon sale or upon complete or substantially complete liquidation of the respective entity.
(2)Net of tax benefit (expense) of $0 million, $(39) million, $0 million, $(2) million, and $(41) million, respectively.
(3)Net of tax (benefit) expense of $0 million, $(8) million, $0 million, $1 million and $(7) million, respectively.
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(Dollars in millions) | FOREIGN CURRENCY TRANSLATION ADJUSTMENT(1) | CASH FLOW HEDGES | NET INVESTMENT HEDGES(1) | OTHER | TOTAL |
Balance at May 31, 2020 | $ | (494) | | $ | 390 | | $ | 115 | | $ | (67) | | $ | (56) | |
Other comprehensive income (loss): | | | | | |
Other comprehensive gains (losses) before reclassifications(2) | 318 | | (526) | | — | | (13) | | (221) | |
Reclassifications to net income of previously deferred (gains) losses(3) | — | | (132) | | — | | 8 | | (124) | |
Total other comprehensive income (loss) | 318 | | (658) | | — | | (5) | | (345) | |
Balance at August 31, 2020 | $ | (176) | | $ | (268) | | $ | 115 | | $ | (72) | | $ | (401) | |
(1)The accumulated foreign currency translation adjustment and net investment hedge gains/losses related to an investment in a foreign subsidiary are reclassified to Net income upon sale or upon complete or substantially complete liquidation of the respective entity.
(2)Net of tax benefit (expense) of $0 million, $4 million, $0 million, $1 million and $5 million, respectively.
(3)Net of tax (benefit) expense of $0 million, $3 million, $0 million, $0 million and $3 million, respectively.
The following table summarizes the reclassifications from Accumulated other comprehensive income (loss) to the Unaudited Condensed Consolidated Statements of Income:
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| AMOUNT OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME | LOCATION OF GAIN (LOSS) RECLASSIFIED FROM ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) INTO INCOME |
| THREE MONTHS ENDED AUGUST 31, | | |
(Dollars in millions) | 2021 | 2020 | | | |
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Gains (losses) on cash flow hedges: | | | | | | |
Foreign exchange forwards and options | $ | (21) | | $ | 14 | | | | | Revenues |
Foreign exchange forwards and options | (66) | | 114 | | | | | Cost of sales |
Foreign exchange forwards and options | 1 | | 1 | | | | | Demand creation expense |
Foreign exchange forwards and options | (9) | | 8 | | | | | Other (income) expense, net |
Interest rate swaps | (2) | | (2) | | | | | Interest expense (income), net |
Total before tax | (97) | | 135 | | | | | |
Tax (expense) benefit | 8 | | (3) | | | | | |
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