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 February 28, 2018
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-10635
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) | (Zip Code) | |
Registrant’s telephone number, including area code: (503) 671-6453 |
Indicate by check mark 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. Yes ☑ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes ☑ No ☐
Indicate by check mark 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 | ☑ | Accelerated filer | ☐ | Smaller reporting company | ☐ |
Non-accelerated filer | ☐ | (Do not check if a smaller reporting company) | Emerging growth company | ☐ | |
If an emerging growth company, indicate by check mark 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. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑
Shares of Common Stock outstanding as of April 2, 2018 were:
Class A | 329,065,752 | |
Class B | 1,282,693,640 | |
1,611,759,392 | ||
NIKE, INC.
FORM 10-Q
Table of Contents
Page | ||
ITEM 1. | ||
ITEM 2. | ||
ITEM 3. | ||
ITEM 4. | ||
ITEM 1. | ||
ITEM 1A. | ||
ITEM 2. | ||
ITEM 6. | ||
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
NIKE, Inc. Unaudited Condensed Consolidated Balance Sheets |
February 28, | May 31, | |||||||
(In millions) | 2018 | 2017 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and equivalents | $ | 3,662 | $ | 3,808 | ||||
Short-term investments | 1,089 | 2,371 | ||||||
Accounts receivable, net | 3,792 | 3,677 | ||||||
Inventories | 5,366 | 5,055 | ||||||
Prepaid expenses and other current assets | 1,446 | 1,150 | ||||||
Total current assets | 15,355 | 16,061 | ||||||
Property, plant and equipment, net | 4,298 | 3,989 | ||||||
Identifiable intangible assets, net | 282 | 283 | ||||||
Goodwill | 139 | 139 | ||||||
Deferred income taxes and other assets | 2,478 | 2,787 | ||||||
TOTAL ASSETS | $ | 22,552 | $ | 23,259 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 6 | $ | 6 | ||||
Notes payable | 11 | 325 | ||||||
Accounts payable | 1,961 | 2,048 | ||||||
Accrued liabilities | 3,727 | 3,011 | ||||||
Income taxes payable | 78 | 84 | ||||||
Total current liabilities | 5,783 | 5,474 | ||||||
Long-term debt | 3,469 | 3,471 | ||||||
Deferred income taxes and other liabilities | 3,518 | 1,907 | ||||||
Commitments and contingencies (Note 12) | ||||||||
Redeemable preferred stock | — | — | ||||||
Shareholders’ equity: | ||||||||
Common stock at stated value: | ||||||||
Class A convertible — 329 and 329 shares outstanding | — | — | ||||||
Class B — 1,290 and 1,314 shares outstanding | 3 | 3 | ||||||
Capital in excess of stated value | 9,325 | 8,638 | ||||||
Accumulated other comprehensive loss | (624 | ) | (213 | ) | ||||
Retained earnings | 1,078 | 3,979 | ||||||
Total shareholders’ equity | 9,782 | 12,407 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 22,552 | $ | 23,259 | ||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
3
NIKE, Inc. Unaudited Condensed Consolidated Statements of Income |
Three Months Ended February 28, | Nine Months Ended February 28, | |||||||||||||||
(In millions, except per share data) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Revenues | $ | 8,984 | $ | 8,432 | $ | 26,608 | $ | 25,673 | ||||||||
Cost of sales | 5,046 | 4,682 | 15,030 | 14,184 | ||||||||||||
Gross profit | 3,938 | 3,750 | 11,578 | 11,489 | ||||||||||||
Demand creation expense | 862 | 749 | 2,594 | 2,552 | ||||||||||||
Operating overhead expense | 1,905 | 1,747 | 5,797 | 5,346 | ||||||||||||
Total selling and administrative expense | 2,767 | 2,496 | 8,391 | 7,898 | ||||||||||||
Interest expense (income), net | 13 | 19 | 42 | 41 | ||||||||||||
Other (income) expense, net | (1 | ) | (88 | ) | 35 | (168 | ) | |||||||||
Income before income taxes | 1,159 | 1,323 | 3,110 | 3,718 | ||||||||||||
Income tax expense | 2,080 | 182 | 2,314 | 486 | ||||||||||||
NET (LOSS) INCOME | $ | (921 | ) | $ | 1,141 | $ | 796 | $ | 3,232 | |||||||
(Loss) earnings per common share: | ||||||||||||||||
Basic | $ | (0.57 | ) | $ | 0.69 | $ | 0.49 | $ | 1.95 | |||||||
Diluted | $ | (0.57 | ) | $ | 0.68 | $ | 0.48 | $ | 1.91 | |||||||
Dividends declared per common share | $ | 0.20 | $ | 0.18 | $ | 0.58 | $ | 0.52 | ||||||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
4
NIKE, Inc. Unaudited Condensed Consolidated Statements of Comprehensive Income | ||||
Three Months Ended February 28, | Nine Months Ended February 28, | |||||||||||||||
(In millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Net (loss) income | $ | (921 | ) | $ | 1,141 | $ | 796 | $ | 3,232 | |||||||
Other comprehensive (loss) income, net of tax: | ||||||||||||||||
Change in net foreign currency translation adjustment | 51 | 12 | 65 | 1 | ||||||||||||
Change in net gains (losses) on cash flow hedges | (107 | ) | (175 | ) | (494 | ) | (92 | ) | ||||||||
Change in net gains (losses) on other | 2 | (7 | ) | 1 | 2 | |||||||||||
Total other comprehensive (loss) income, net of tax | (54 | ) | (170 | ) | (428 | ) | (89 | ) | ||||||||
TOTAL COMPREHENSIVE (LOSS) INCOME | $ | (975 | ) | $ | 971 | $ | 368 | $ | 3,143 | |||||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
5
NIKE, Inc. Unaudited Condensed Consolidated Statements of Cash Flows |
Nine Months Ended February 28, | ||||||||
(In millions) | 2018 | 2017 | ||||||
Cash provided by operations: | ||||||||
Net income | $ | 796 | $ | 3,232 | ||||
Income charges (credits) not affecting cash: | ||||||||
Depreciation | 551 | 521 | ||||||
Deferred income taxes | 564 | (199 | ) | |||||
Stock-based compensation | 158 | 162 | ||||||
Amortization and other | 23 | 7 | ||||||
Net foreign currency adjustments | (130 | ) | (90 | ) | ||||
Changes in certain working capital components and other assets and liabilities: | ||||||||
Decrease (increase) in accounts receivable | 3 | (546 | ) | |||||
(Increase) in inventories | (245 | ) | (157 | ) | ||||
(Increase) in prepaid expenses and other current and non-current assets | (474 | ) | (152 | ) | ||||
Increase in accounts payable, accrued liabilities and other current and non-current liabilities | 1,439 | 106 | ||||||
Cash provided by operations | 2,685 | 2,884 | ||||||
Cash provided (used) by investing activities: | ||||||||
Purchases of short-term investments | (3,644 | ) | (4,029 | ) | ||||
Maturities of short-term investments | 3,101 | 2,433 | ||||||
Sales of short-term investments | 1,797 | 1,905 | ||||||
Additions to property, plant and equipment | (728 | ) | (776 | ) | ||||
Disposals of property, plant and equipment | — | 13 | ||||||
Other investing activities | — | (34 | ) | |||||
Cash provided (used) by investing activities | 526 | (488 | ) | |||||
Cash used by financing activities: | ||||||||
Net proceeds from long-term debt issuance | — | 1,482 | ||||||
Long-term debt payments, including current portion | (4 | ) | (43 | ) | ||||
(Decrease) increase in notes payable | (314 | ) | 24 | |||||
Payments on capital lease and other financing obligations | (16 | ) | (14 | ) | ||||
Proceeds from exercise of stock options and other stock issuances | 554 | 339 | ||||||
Repurchase of common stock | (2,694 | ) | (2,429 | ) | ||||
Dividends — common and preferred | (920 | ) | (834 | ) | ||||
Tax payments for net share settlement of equity awards | (54 | ) | (8 | ) | ||||
Cash used by financing activities | (3,448 | ) | (1,483 | ) | ||||
Effect of exchange rate changes on cash and equivalents | 91 | (30 | ) | |||||
Net (decrease) increase in cash and equivalents | (146 | ) | 883 | |||||
Cash and equivalents, beginning of period | 3,808 | 3,138 | ||||||
CASH AND EQUIVALENTS, END OF PERIOD | $ | 3,662 | $ | 4,021 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Non-cash additions to property, plant and equipment | $ | 190 | $ | 248 | ||||
Dividends declared and not paid | 324 | 303 | ||||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
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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 | ||
7
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”) and reflect all normal 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, 2017 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. The results of operations for the three and nine months ended February 28, 2018 are not necessarily indicative of results to be expected for the entire year.
Reclassifications
Certain prior year amounts have been reclassified to conform to fiscal 2018 presentation, including reclassified geographic operating segment data to reflect the changes in the Company’s operating structure, which became effective on June 1, 2017. Refer to Note 11 — Operating Segments for additional information.
Recently Adopted Accounting Standards
In February 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The standard allows for reclassification of stranded tax effects on items resulting from the Tax Cuts and Jobs Act (the “Tax Act”) from Accumulated other comprehensive income to Retained earnings. Tax effects unrelated to the Tax Act are released from Accumulated other comprehensive income using either the specific identification approach or the portfolio approach based on the nature of the underlying item.
The Company early adopted the ASU in the third quarter of fiscal 2018. As a result of the adoption, during the third quarter and first nine months of fiscal 2018, Retained earnings decreased by $17 million, with a corresponding increase to Accumulated other comprehensive income due to the reduction in the corporate tax rate from 35% to 21%. Refer to Note 6 — Income Taxes for additional information about the Tax Act.
In March 2016, the FASB issued ASU No. 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which changes how companies account for certain aspects of share-based payment awards to employees. The Company adopted the ASU in the first quarter of fiscal 2018. The updated guidance requires excess tax benefits and deficiencies from share-based payment awards to be recorded in income tax expense in the income statement. Previously, excess tax benefits and deficiencies were recognized in shareholders’ equity on the balance sheet. This change is required to be applied prospectively. During the third quarter and first nine months of fiscal 2018, the Company recognized $72 million and $194 million, respectively, of excess tax benefits related to share-based payment awards in Income tax expense in the Unaudited Condensed Consolidated Statements of Income.
Additionally, ASU 2016-09 modified the classification of certain share-based payment activities within the statement of cash flows, which the Company applied retrospectively. As a result, for the nine months ended February 28, 2017, the Company reclassified a cash inflow of $125 million related to excess tax benefits from share-based payment awards from Cash used by financing activities to Cash provided by operations, and reclassified a cash outflow of $8 million related to tax payments for the net settlement of share-based payment awards from Cash provided by operations to Cash used by financing activities within the Unaudited Condensed Consolidated Statements of Cash Flows.
Recently Issued Accounting Standards
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which expands and refines hedge accounting for both financial and non-financial risk components, aligns the recognition and presentation of the effects of hedging instruments and hedge items in the financial statements, and includes certain targeted improvements to ease the application of current guidance related to the assessment of hedge effectiveness. The update to the standard is effective for the Company on June 1, 2019, with early adoption permitted in any interim period. The Company is currently evaluating the effect the guidance will have on the Consolidated Financial Statements.
In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory. The updated guidance requires companies to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Income tax effects of intra-entity transfers of inventory will continue to be deferred until the inventory has been sold to a third party. The Company will adopt the standard on June 1, 2018, using a modified retrospective approach, with the cumulative effect of applying the new standard recognized in retained earnings at the date of adoption. Although the final impact is subject to change, if adopted at February 28, 2018, the ASU would have resulted in a reduction to Retained earnings through a cumulative effect adjustment of approximately $520 million.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which replaces existing lease accounting guidance. The new standard is intended to provide enhanced transparency and comparability by requiring lessees to record right-of-use assets and corresponding lease liabilities on the balance sheet. The new guidance will require the Company to continue to classify leases as either operating or financing, with classification affecting the pattern of expense recognition in the income statement. The Company will adopt the standard on June 1, 2019. The ASU is required to be applied using a modified retrospective approach at the beginning of the earliest period presented, with optional practical expedients. The Company continues to assess the effect the guidance will have on its existing accounting policies and the Consolidated Financial Statements and expects there will be an increase in assets and liabilities on the Consolidated Balance Sheets at adoption due to the recording of right-of-use assets and corresponding lease liabilities, which may be material. Refer to Note 15 — Commitments and Contingencies of the Annual Report on Form 10-K for the fiscal year ended May 31, 2017 for information about the Company’s lease obligations.
In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The updated guidance enhances the reporting model for financial instruments, which includes amendments to address aspects of recognition, measurement, presentation and disclosure. The update to the standard is effective for the Company beginning June 1, 2018. The Company does not expect the adoption to have a material impact on the Consolidated Financial Statements.
8
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which replaces existing revenue recognition guidance. The updated guidance requires companies to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new standard requires that reporting companies disclose the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company will adopt the standard on June 1, 2018, using a modified retrospective approach, with the cumulative effect of initially applying the standard recognized in retained earnings at the date of adoption.
While the Company does not expect the adoption of this standard to have a material impact on the Company’s net Revenues in the Consolidated Statements of Income, the Company anticipates revenues for certain wholesale transactions and substantially all digital commerce sales will be recognized upon shipment rather than upon delivery to the customer.
Additionally, provisions for post-invoice sales discounts, returns and miscellaneous claims will be recognized as accrued liabilities rather than as reductions to Accounts receivable, net; and the estimated cost of inventory associated with the provision for sales returns will be recorded within Prepaid expenses and other current assets on the Consolidated Balance Sheets. The Company continues to evaluate the impact of this new standard, including on accounting policies, disclosures, internal control over financial reporting and its contracts with customers.
Note 2 — Inventories |
Inventory balances of $5,366 million and $5,055 million at February 28, 2018 and May 31, 2017, respectively, were substantially all finished goods.
Note 3 — Accrued Liabilities |
Accrued liabilities included the following:
As of February 28, | As of May 31, | |||||||
(In millions) | 2018 | 2017 | ||||||
Compensation and benefits, excluding taxes | $ | 886 | $ | 871 | ||||
Fair value of derivatives | 539 | 168 | ||||||
Endorsement compensation | 354 | 396 | ||||||
Dividends payable | 324 | 300 | ||||||
Import and logistics costs | 293 | 257 | ||||||
Taxes other than income taxes payable | 244 | 196 | ||||||
Advertising and marketing | 182 | 125 | ||||||
Other(1) | 905 | 698 | ||||||
TOTAL ACCRUED LIABILITIES | $ | 3,727 | $ | 3,011 | ||||
(1) | Other consists of various accrued expenses with no individual item accounting for more than 5% of the total Accrued liabilities balance at February 28, 2018 and May 31, 2017. |
Note 4 — Fair Value Measurements |
The Company measures certain financial assets and liabilities at fair value on a recurring basis, including derivatives and available-for-sale securities. Fair value is the price the Company would receive to sell an asset or pay to transfer a liability in an orderly transaction with a market participant at the measurement date. The Company uses a three-level hierarchy established by the FASB that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques (market approach, income approach and cost approach).
The levels of the fair value hierarchy are described below:
• | Level 1: Quoted prices in active markets for identical assets or liabilities. |
• | Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active. |
• | Level 3: Unobservable inputs for which there is little or no market data available, which require the reporting entity to develop its own assumptions. |
The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability. Financial assets and liabilities are classified in their entirety based on the most conservative level of input that is significant to the fair value measurement.
Pricing vendors are utilized for a majority of Level 1 and Level 2 investments. These vendors either provide a quoted market price in an active market or use observable inputs without applying significant adjustments in their pricing. Observable inputs include broker quotes, interest rates and yield curves observable at commonly quoted intervals, volatilities and credit risks. The fair value of derivative contracts is determined using observable market inputs such as the daily market foreign currency rates, forward pricing curves, currency volatilities, currency correlations and interest rates, and considers non-performance risk of the Company and that of its counterparties.
The Company’s fair value measurement process includes comparing fair values to another independent pricing vendor to ensure appropriate fair values are recorded.
9
The following tables present information about the Company’s financial assets measured at fair value on a recurring basis as of February 28, 2018 and May 31, 2017, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of February 28, 2018 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 620 | $ | 620 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 865 | 150 | 715 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 773 | 769 | 4 | — | ||||||||||||
U.S. Agency securities | 45 | — | 45 | — | ||||||||||||
Commercial paper and bonds | 477 | 152 | 325 | — | ||||||||||||
Money market funds | 1,971 | 1,971 | — | — | ||||||||||||
Total Level 2: | 3,266 | 2,892 | 374 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 11 | — | — | 11 | ||||||||||||
TOTAL | $ | 4,762 | $ | 3,662 | $ | 1,089 | $ | 11 | ||||||||
As of May 31, 2017 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 505 | $ | 505 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 1,545 | 159 | 1,386 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 813 | 769 | 44 | — | ||||||||||||
U.S. Agency securities | 522 | 150 | 372 | — | ||||||||||||
Commercial paper and bonds | 820 | 251 | 569 | — | ||||||||||||
Money market funds | 1,974 | 1,974 | — | — | ||||||||||||
Total Level 2: | 4,129 | 3,144 | 985 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 10 | — | — | 10 | ||||||||||||
TOTAL | $ | 6,189 | $ | 3,808 | $ | 2,371 | $ | 10 | ||||||||
The Company elects to record the gross assets and liabilities of its derivative financial instruments on the Unaudited Condensed Consolidated Balance Sheets. The Company’s derivative financial instruments are subject to master netting arrangements that allow for the offset of assets and liabilities in the event of default or early termination of the contract. Any amounts of cash collateral received related to these instruments associated with the Company’s credit-related contingent features are recorded in Cash and equivalents and Accrued liabilities, the latter of which would further offset against the Company’s derivative asset balance. Any amounts of cash collateral posted related to these instruments associated with the Company’s credit-related contingent features are recorded in Prepaid expenses and other current assets, which would further offset against the Company’s derivative liability balance. Cash collateral received or posted related to the Company’s credit-related contingent features is presented in the Cash provided by operations component of the Unaudited Condensed Consolidated Statements of Cash Flows. Any amounts of non-cash collateral received, such as securities, are not recorded on the Unaudited Condensed Consolidated Balance Sheets pursuant to U.S. GAAP. For further information related to credit risk, refer to Note 9 — Risk Management and Derivatives.
10
The following tables present information about the Company’s derivative assets and liabilities measured at fair value on a recurring basis as of February 28, 2018 and May 31, 2017, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of February 28, 2018 | ||||||||||||||||||||||||
Derivative Assets | Derivative Liabilities | |||||||||||||||||||||||
(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) | $ | 83 | $ | 65 | $ | 18 | $ | 648 | $ | 536 | $ | 112 | ||||||||||||
Embedded derivatives | 13 | 2 | 11 | 8 | 3 | 5 | ||||||||||||||||||
TOTAL | $ | 96 | $ | 67 | $ | 29 | $ | 656 | $ | 539 | $ | 117 | ||||||||||||
(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 $83 million as of February 28, 2018. As of that date, the Company had posted $354 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 February 28, 2018. |
As of May 31, 2017 | ||||||||||||||||||||||||
Derivative Assets | Derivative Liabilities | |||||||||||||||||||||||
(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) | $ | 231 | $ | 216 | $ | 15 | $ | 246 | $ | 166 | $ | 80 | ||||||||||||
Embedded derivatives | 10 | 1 | 9 | 8 | 2 | 6 | ||||||||||||||||||
TOTAL | $ | 241 | $ | 217 | $ | 24 | $ | 254 | $ | 168 | $ | 86 | ||||||||||||
(1) | If the foreign exchange derivative instruments had been netted on the Condensed Consolidated Balance Sheets, the asset and liability positions each would have been reduced by $187 million as of May 31, 2017. As of that date, no amount of cash collateral had been received or posted on the derivative asset and liability balances related to foreign exchange derivative instruments. |
Available-for-sale securities comprise investments in U.S. Treasury and Agency securities, time deposits, money market funds, corporate commercial paper and bonds. These securities are valued using market prices in both active markets (Level 1) and less active markets (Level 2). As of February 28, 2018, the Company held $1,057 million of available-for-sale securities with maturity dates within one year and $32 million with maturity dates over one year and less than five years within Short-term investments on the Unaudited Condensed Consolidated Balance Sheets. The gross realized gains and losses on sales of available-for-sale securities were immaterial for the three and nine months ended February 28, 2018 and 2017. Unrealized gains and losses on available-for-sale securities included in Accumulated other comprehensive income were immaterial as of February 28, 2018 and May 31, 2017. The Company regularly reviews its available-for-sale securities for other-than-temporary impairment. For the nine months ended February 28, 2018 and 2017, the Company did not consider any of its securities to be other-than-temporarily impaired and, accordingly, did not recognize any impairment losses.
Included in Interest expense (income), net for the three months ended February 28, 2018 and 2017 was interest income related to the Company’s available-for-sale securities of $12 million and $8 million, respectively, and $36 million and $17 million for the nine months ended February 28, 2018 and 2017, respectively.
The Company’s Level 3 assets comprise investments in certain non-marketable preferred stock. These Level 3 investments are an immaterial portion of the Company’s portfolio. Changes in Level 3 investment assets were immaterial during the nine months ended February 28, 2018 and the fiscal year ended May 31, 2017.
No transfers among levels within the fair value hierarchy occurred during the nine months ended February 28, 2018 and the fiscal year ended May 31, 2017.
For additional information related to the Company’s derivative financial instruments, refer to Note 9 — Risk Management and Derivatives. The carrying amounts of other current financial assets and other current financial liabilities approximate fair value.
As of February 28, 2018 and May 31, 2017, assets or liabilities that were required to be measured at fair value on a non-recurring basis were immaterial.
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 $3,327 million at February 28, 2018 and $3,401 million at May 31, 2017.
For fair value information regarding Notes payable, refer to Note 5 — Short-Term Borrowings and Credit Lines.
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Note 5 — Short-Term Borrowings and Credit Lines |
As of February 28, 2018, the Company had no outstanding borrowings under its $2 billion commercial paper program. As of May 31, 2017, $325 million of commercial paper was outstanding at a weighted average interest rate of 0.86%. These borrowings are included within Notes payable.
Due to the short-term nature of the borrowings, the carrying amounts reflected on the Unaudited Condensed Consolidated Balance Sheets for Notes payable approximate fair value.
Note 6 — Income Taxes |
The effective tax rate was 74.4% for the nine months ended February 28, 2018 compared to 13.1% for the nine months ended February 28, 2017. The increase in the Company’s effective tax rate was due to the impact of the Tax Cuts and Jobs Act (the “Tax Act”), which included additional income tax expense of $2,030 million in the third quarter of fiscal 2018. The effective tax rate also reflected the tax benefit from stock-based compensation in the current period as a result of the adoption of ASU 2016-09 in the first quarter of fiscal 2018.
Tax Act
On December 22, 2017, the United States enacted the Tax Cuts and Jobs Act, which significantly changes previous U.S. tax laws, including provisions for a one-time transition tax on deemed repatriation of undistributed foreign earnings, a reduction in the corporate tax rate from 35% to 21%, as well as other changes. Under U.S. GAAP, accounting for the effect of tax legislation is required in the period of enactment. For fiscal 2018, the change in the corporate tax rate, effective January 1, 2018, results in a blended U.S. federal statutory rate for the Company of approximately 29%. The Tax Act also includes provisions that are not yet effective for the Company, including a provision to tax global intangible low-taxed income (GILTI) of foreign subsidiaries, which will be effective for the Company beginning June 1, 2018. In accordance with U.S. GAAP, the Company has made an accounting policy election to treat taxes due under the GILTI provision as a current period expense.
Income tax expense for the nine months ended February 28, 2018 includes provisional expense of $2,030 million, which consists primarily of $2,010 million for the one-time transition tax on the deemed repatriation of undistributed foreign earnings, and $107 million resulting from the impact of changes in the tax rate, primarily on the remeasurement of deferred tax assets and liabilities. The remaining provisions of the Tax Act did not have a material impact on the Company’s Unaudited Condensed Consolidated Financial Statements upon enactment.
In accordance with U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”), the provisional amounts recorded represent reasonable estimates of the effects of the Tax Act for which the analysis is not yet complete. As the Company completes its analysis of the Tax Act, including collecting, preparing and analyzing necessary information, performing and refining calculations and obtaining additional guidance from the U.S. Internal Revenue Services (IRS), U.S. Treasury Department, FASB or other standard setting and regulatory bodies on the Tax Act, it may record adjustments to the provisional amounts, which may be material. In accordance with SAB 118, the Company’s accounting for the tax effects of the Tax Act will be completed during the measurement period, which should not extend beyond one year from the enactment date. At February 28, 2018, there were no provisions for which the Company was unable to record a reasonable estimate of the impact.
Transition Tax
The Company recorded a provisional expense of $2,010 million related to the one-time transition tax on the deemed repatriation of undistributed foreign earnings. The transition tax is based on the Company’s estimated total post-1986 undistributed foreign earnings at a tax rate of 15.5% for foreign cash and certain other specified assets, and 8% on the remaining earnings. The actual transition tax due will be based on actual undistributed foreign earnings and cash and certain other specified assets as of the required measurement date, which could materially affect the amount of the transition tax. The Company expects to pay the transition tax in installments over an eight-year period. Accordingly, the non-current portion of the provisional expense for the transition tax of $1,242 million, net of applicable foreign tax credits the Company expects to utilize, has been recorded in Deferred income taxes and other liabilities on the Unaudited Condensed Consolidated Balance Sheets.
Prior to the enactment of the Tax Act, the Company regularly determined certain foreign earnings to be indefinitely reinvested outside the United States. Following enactment of the Tax Act, the Company no longer considers any historical or future earnings to be indefinitely reinvested with its foreign subsidiaries.
Impact of Changes in the Tax Rate
As a result of the reduction in the corporate tax rate from 35% to 21%, the Company recorded a net provisional expense of $107 million for the impact of changes in the tax rate, primarily on deferred tax assets and liabilities. The Company remeasured certain deferred tax assets and liabilities based on the rates at which they are expected to be realized. The total provisional expense recorded during the period for the remeasurement of deferred tax assets and liabilities was $149 million. This was partially offset by a $42 million tax benefit for the reduction in the tax rate applied to current year earnings. These amounts may be adjusted to the extent that actual operating results differ from the Company’s current estimates.
Other Tax Matters
As of February 28, 2018, total gross unrecognized tax benefits, excluding related interest and penalties, were $718 million, $504 million of which would affect the Company’s effective tax rate if recognized in future periods. The Company’s total gross unrecognized tax benefits, excluding related interest and penalties, as of February 28, 2018, and the portion that would affect the effective tax rate if recognized in future periods, were impacted by the enactment of the Tax Act. As of May 31, 2017, total gross unrecognized tax benefits, excluding related interest and penalties, were $461 million. The liability for payment of interest and penalties decreased $25 million during the nine months ended February 28, 2018. As of February 28, 2018 and May 31, 2017, accrued interest and penalties related to uncertain tax positions were $146 million and $171 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 has closed all U.S. federal income tax matters through fiscal 2014, with the exception of certain transfer pricing adjustments. The Company is currently under audit by the IRS for fiscal 2015 and 2016.
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The Company’s major foreign jurisdictions, China and the Netherlands, have concluded substantially all income tax matters through calendar 2007 and fiscal 2011, respectively. 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 $126 million within the next 12 months.
Note 7 — Common Stock and Stock-Based Compensation |
The authorized number of shares of Class A Common Stock, no par value, and Class B Common Stock, no par value, are 400 million and 2,400 million, respectively. Each share of Class A Common Stock is convertible into one share of Class B Common Stock. Voting rights of Class B Common Stock are limited in certain circumstances with respect to the election of directors. There are no differences in the dividend and liquidation preferences or participation rights of the holders of Class A and Class B Common Stock.
The NIKE, Inc. Stock Incentive Plan (the “Stock Incentive Plan”) provides for the issuance of up to 718 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. The exercise price for stock options and stock appreciation rights may not be less than the fair market value of the underlying shares on the date of grant. A committee of the Board of Directors administers the Stock Incentive Plan. The committee has the authority to determine the employees to whom awards will be made, the amount of the awards and the other terms and conditions of the awards. Substantially all stock option grants outstanding under the Stock Incentive Plan are granted in the first quarter of each fiscal year, vest ratably over four years and expire ten years from the date of grant.
In addition to the Stock Incentive Plan, the Company gives employees the right to purchase shares at a discount to the market price under employee stock purchase plans (ESPPs). Subject to the annual statutory limit, employees are eligible to participate through payroll deductions of up to 10% of their compensation. At the end of each six-month offering period, shares are purchased by the participants at 85% of the lower of the fair market value at the beginning or the end of the offering period.
The Company accounts for stock-based compensation by estimating the fair value of options granted under the Stock Incentive Plan and employees’ purchase rights under the ESPPs using the Black-Scholes option pricing model. The Company recognizes this fair value as Cost of sales or Operating overhead expense, as applicable, over the vesting period using the straight-line method.
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 February 28, | Nine Months Ended February 28, | |||||||||||||||
(In millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Stock options(1) | $ | 38 | $ | 35 | $ | 110 | $ | 110 | ||||||||
ESPPs | 7 | 7 | 24 | 27 | ||||||||||||
Restricted stock | 10 | 9 | 24 | 25 | ||||||||||||
TOTAL STOCK-BASED COMPENSATION EXPENSE | $ | 55 | $ | 51 | $ | 158 | $ | 162 | ||||||||
(1) | Expense for stock options includes the expense associated with stock appreciation rights. Accelerated stock option expense is recorded for employees eligible for accelerated stock option vesting upon retirement. Accelerated stock option expense was $6 million and $3 million for the three months ended February 28, 2018 and 2017, respectively, and $14 million and $11 million for the nine months ended February 28, 2018 and 2017, respectively. |
As of February 28, 2018, the Company had $234 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 2.2 years.
The weighted average fair value per share of the options granted during the nine months ended February 28, 2018 and 2017, computed as of the grant date using the Black-Scholes pricing model, was $9.82 and $9.38, respectively. The weighted average assumptions used to estimate these fair values were as follows:
Nine Months Ended February 28, | ||||||
2018 | 2017 | |||||
Dividend yield | 1.2 | % | 1.1 | % | ||
Expected volatility | 16.4 | % | 17.4 | % | ||
Weighted average expected life (in years) | 6.0 | 6.0 | ||||
Risk-free interest rate | 2.0 | % | 1.3 | % | ||
The Company estimates the expected volatility based on the implied volatility in market traded options on the Company’s common stock with a term greater than one year, along with 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.
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Note 8 — Earnings Per Share |
The following is a reconciliation from basic earnings per common share to diluted earnings per common share. As a result of the net loss incurred for the three months ended February 28, 2018, all outstanding options, including shares under ESPPs, to purchase common stock, and other awards of common stock have been excluded from the computation of diluted earnings per common share because the inclusion of the shares would have been anti-dilutive. Additionally, 42.9 million options for the nine months ended February 28, 2018, and 31.1 million and 31.0 million options for the three and nine months ended February 28, 2017, respectively, have been excluded from the computations of diluted earnings per common share because the options were anti-dilutive.
Three Months Ended February 28, | Nine Months Ended February 28, | |||||||||||||||
(In millions, except per share data) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
Determination of shares: | ||||||||||||||||
Weighted average common shares outstanding | 1,623.5 | 1,653.1 | 1,629.9 | 1,661.5 | ||||||||||||
Assumed conversion of dilutive stock options and awards | — | 33.2 | 35.8 | 34.9 | ||||||||||||
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING | 1,623.5 | 1,686.3 | 1,665.7 | 1,696.4 | ||||||||||||
(Loss) earnings per common share: | ||||||||||||||||
Basic | $ | (0.57 | ) | $ | 0.69 | $ | 0.49 | $ | 1.95 | |||||||
Diluted | $ | (0.57 | ) | $ | 0.68 | $ | 0.48 | $ | 1.91 | |||||||
Note 9 — 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. The Company does not hold or issue derivatives for trading or speculative purposes.
The Company may elect to designate certain derivatives as hedging instruments under U.S. GAAP. The Company formally documents all relationships between designated hedging instruments and hedged items as well as its risk management objectives and strategies for undertaking hedge transactions. This process includes linking all derivatives designated as hedges to either recognized assets, liabilities, or forecasted transactions and assessing, both at inception and on an ongoing basis, the effectiveness of the hedging relationships.
The majority of derivatives outstanding as of February 28, 2018 are designated as foreign currency cash flow hedges, primarily for Euro/U.S. Dollar, Japanese Yen/U.S. Dollar and British Pound/Euro 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.
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The following table presents the fair values of derivative instruments included within the Unaudited Condensed Consolidated Balance Sheets as of February 28, 2018 and May 31, 2017. Refer to Note 4 — Fair Value Measurements for a description of how the financial instruments in the table below are valued.
Derivative Assets | Derivative Liabilities | |||||||||||||||||||
(In millions) | Balance Sheet Location | February 28, 2018 | May 31, 2017 | Balance Sheet Location | February 28, 2018 | May 31, 2017 | ||||||||||||||
Derivatives formally designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | $ | 42 | $ | 113 | Accrued liabilities | $ | 403 | $ | 59 | ||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | 18 | 13 | Deferred income taxes and other liabilities | 112 | 73 | ||||||||||||||
Total derivatives formally designated as hedging instruments | 60 | 126 | 515 | 132 | ||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | 23 | 103 | Accrued liabilities | 133 | 107 | ||||||||||||||
Embedded derivatives | Prepaid expenses and other current assets | 2 | 1 | Accrued liabilities | 3 | 2 | ||||||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | — | 2 | Deferred income taxes and other liabilities | — | 7 | ||||||||||||||
Embedded derivatives | Deferred income taxes and other assets | 11 | 9 | Deferred income taxes and other liabilities | 5 | 6 | ||||||||||||||
Total derivatives not designated as hedging instruments | 36 | 115 | 141 | 122 | ||||||||||||||||
TOTAL DERIVATIVES | $ | 96 | $ | 241 | $ | 656 | $ | 254 | ||||||||||||
The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three and nine months ended February 28, 2018 and 2017:
(In millions) | Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivatives(1) | Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income(1) | |||||||||||||||
Three Months Ended February 28, | Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income | Three Months Ended February 28, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Derivatives designated as cash flow hedges: | |||||||||||||||||
Foreign exchange forwards and options | $ | 7 | $ | 5 | Revenues | $ | 9 | $ | 24 | ||||||||
Foreign exchange forwards and options | (118 | ) | (5 | ) | Cost of sales | (41 | ) | 87 | |||||||||
Foreign exchange forwards and options | — | (3 | ) | Total selling and administrative expense | — | — | |||||||||||
Foreign exchange forwards and options | (47 | ) | 4 | Other (income) expense, net | (15 | ) | 67 | ||||||||||
Interest rate swaps(2) | — | — | Interest expense (income), net | (1 | ) | (2 | ) | ||||||||||
Total designated cash flow hedges | $ | (158 | ) | $ | 1 | $ | (48 | ) | $ | 176 | |||||||
(1) | For the three months ended February 28, 2018 and 2017, the amounts recorded in Other (income) expense, net as a result of hedge ineffectiveness and 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, will be released through Interest expense (income), net over the term of the issued debt. |
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(In millions) | Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivatives(1) | Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income(1) | |||||||||||||||
Nine Months Ended February 28, | Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income | Nine Months Ended February 28, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Derivatives designated as cash flow hedges: | |||||||||||||||||
Foreign exchange forwards and options | $ | 26 | $ | 45 | Revenues | $ | 24 | $ | 96 | ||||||||
Foreign exchange forwards and options | (382 | ) | 244 | Cost of sales | (17 | ) | 260 | ||||||||||
Foreign exchange forwards and options | 1 | (1 | ) | Total selling and administrative expense | — | — | |||||||||||
Foreign exchange forwards and options | (169 | ) | 149 | Other (income) expense, net | (33 | ) | 141 | ||||||||||
Interest rate swaps(2) | — | (54 | ) | Interest expense (income), net | (5 | ) | (2 | ) | |||||||||
Total designated cash flow hedges | $ | (524 | ) | $ | 383 | $ | (31 | ) | $ | 495 | |||||||
(1) | For the nine months ended February 28, 2018 and 2017, the amounts recorded in Other (income) expense, net as a result of hedge ineffectiveness and 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, 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 February 28, | Nine Months Ended February 28, | |||||||||||||||||
(In millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||
Foreign exchange forwards and options | $ | (101 | ) | $ | (66 | ) | $ | (270 | ) | $ | 101 | Other (income) expense, net | ||||||
Embedded derivatives | 1 | (1 | ) | (3 | ) | (2 | ) | Other (income) expense, net | ||||||||||
Cash Flow Hedges
All changes in fair value of derivatives designated as cash flow hedges, excluding any ineffective portion, are recorded in Accumulated other comprehensive income until Net income is affected by the variability of cash flows of the hedged transaction. Effective hedge results are classified within the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. The ineffective portion of the unrealized gains and losses on these contracts, if any, is recorded immediately in earnings. Derivative instruments designated as cash flow hedges must be discontinued when it is no longer probable the forecasted hedged transaction will occur in the initially identified time period. The gains and losses associated with discontinued derivative instruments that were in Accumulated other comprehensive income will be 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 all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will account for the derivative as an undesignated instrument as discussed below.
The purpose of the Company’s foreign exchange risk management program is to lessen both the positive and negative effects of currency fluctuations on the Company’s consolidated results of operations, financial position and cash flows. Foreign currency exposures that the Company may elect to hedge in this manner include product cost exposures, non-functional currency denominated external and intercompany revenues, selling and administrative expenses, investments in U.S. Dollar-denominated available-for-sale debt securities and certain other intercompany transactions.
Product cost exposures are primarily generated through non-functional currency denominated product purchases and the foreign currency adjustment program described below. NIKE entities primarily purchase product in two ways: (1) Certain NIKE entities purchase product from the NIKE Trading Company (NTC), a wholly-owned sourcing hub that buys NIKE branded product from third-party factories, predominantly in U.S. Dollars. The NTC, whose functional currency is the U.S. Dollar, then sells the product to NIKE entities in their respective functional currencies. When the NTC sells to a NIKE entity with a different functional currency, the result is a foreign currency exposure for the NTC. (2) Other NIKE entities purchase product directly from third-party factories in U.S. Dollars. These purchases generate a foreign currency exposure for those NIKE entities with a functional currency other than the U.S. Dollar.
The Company operates a foreign currency adjustment program with certain factories. The program is designed to more effectively manage foreign currency risk by assuming certain of the factories’ foreign currency exposures, some of which are natural offsets to the Company’s existing foreign currency exposures. Under this program, the Company’s payments to these factories are adjusted for rate fluctuations in the basket of currencies (“factory currency exposure index”) in which the labor, materials and overhead costs incurred by the factories in the production of NIKE branded products (“factory input costs”) are denominated. For the portion of the indices denominated in the local or functional currency of the factory, the Company may elect to place formally designated cash flow hedges. For all currencies within the indices, excluding the U.S. Dollar and the local or functional currency of the factory, an embedded derivative contract is created upon the factory’s acceptance of NIKE’s purchase order. Embedded derivative contracts are separated from the related purchase order, as further described within the Embedded Derivatives section below.
The Company’s policy permits the utilization of derivatives to reduce its foreign currency exposures where internal netting or other strategies cannot be effectively employed. Typically, the Company may enter into hedge contracts starting up to 12 to 24 months in advance of the forecasted transaction and may place incremental hedges up to 100% of the exposure by the time the forecasted transaction occurs. The total notional amount of outstanding foreign currency derivatives designated as cash flow hedges was $13.4 billion as of February 28, 2018.
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As of February 28, 2018, $356 million of deferred net losses (net of tax) on both outstanding and matured derivatives in Accumulated other comprehensive income 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 that are currently outstanding mature. As of February 28, 2018, the maximum term over which the Company was hedging exposures to the variability of cash flows for its forecasted transactions was 27 months.
Fair Value Hedges
The Company has, in the past, been exposed to the risk of changes in the fair value of certain fixed-rate debt attributable to changes in interest rates. Derivatives used by the Company to hedge this risk are receive-fixed, pay-variable interest rate swaps. All interest rate swaps designated as fair value hedges of the related long-term debt meet the shortcut method requirements under U.S. GAAP. Accordingly, changes in the fair values of the interest rate swaps are considered to exactly offset changes in the fair value of the underlying long-term debt. The Company recorded no ineffectiveness from its interest rate swaps designated as fair value hedges for the three and nine months ended February 28, 2018 or 2017. The Company had no interest rate swaps designated as fair value hedges as of February 28, 2018.
Net Investment Hedges
The Company has, in the past, hedged and may, in the future, hedge the risk of variability in foreign currency-denominated net investments in wholly-owned international operations. All changes in fair value of the derivatives designated as net investment hedges, except ineffective portions, are reported in Accumulated other comprehensive income along with the foreign currency translation adjustments on those investments. The ineffective portion of the unrealized gains and losses on these contracts, if any, are recorded immediately in earnings. The Company recorded no ineffectiveness from net investment hedges for the three and nine months ended February 28, 2018 or 2017. The Company had no outstanding net investment hedges as of February 28, 2018.
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 re-measurement gain or loss from the hedged balance sheet position and/or embedded derivative contract. The total notional amount of outstanding undesignated derivative instruments was $7.1 billion as of February 28, 2018.
Embedded Derivatives
As part of the foreign currency adjustment program described above, an embedded derivative contract is created upon the factory’s acceptance of NIKE’s purchase order for currencies within the factory currency exposure indices that are neither the U.S. Dollar nor the local or functional currency of the factory. In addition, embedded derivative contracts are created when the Company enters into certain other contractual agreements which have payments that are indexed to currencies that are not the functional currency of either substantial party to the contracts. 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 February 28, 2018, the total notional amount of embedded derivatives outstanding was approximately $240 million.
Credit Risk
The Company is exposed to credit-related losses in the event of non-performance by counterparties to hedging instruments. The counterparties to all derivative transactions are major financial institutions with investment grade credit ratings. However, this does not eliminate the Company’s exposure to credit risk with these institutions. This credit risk is limited to the unrealized gains in such contracts should any of these counterparties fail to perform as contracted. To manage this risk, the Company has established strict counterparty credit guidelines that are continually monitored.
The Company’s derivative contracts contain credit risk-related contingent features designed to protect against significant deterioration in counterparties’ creditworthiness and their ultimate ability to settle outstanding derivative contracts in the normal course of business. 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 also trigger collateral requirements. As of February 28, 2018, the Company was in compliance with all credit risk-related contingent features and had derivative instruments with credit risk-related contingent features in a net liability position of $565 million. Accordingly, the Company was required to post $354 million of cash collateral to various counterparties to its derivative contracts as a result of these contingent features. As of February 28, 2018, the Company had received no cash collateral from its counterparties to its derivative contracts (refer to Note 4 — Fair Value Measurements). The Company considers the impact of the risk of counterparty default to be immaterial.
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Note 10 — Accumulated Other Comprehensive Income |
The changes in Accumulated other comprehensive income, net of tax, for the three and nine months ended February 28, 2018 were as follows:
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at November 30, 2017 | $ | (177 | ) | $ | (439 | ) | $ | 115 | $ | (86 | ) | $ | (587 | ) | ||||||
Other comprehensive (loss) income: | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | 51 | (156 | ) | — | (15 | ) | (120 | ) | ||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | — | 49 | — | 17 | 66 | |||||||||||||||
Total other comprehensive (loss) income | 51 | (107 | ) | — | 2 | (54 | ) | |||||||||||||
Reclassifications to retained earnings in accordance with ASU 2018-02(4) | 24 | (7 | ) | — | — | 17 | ||||||||||||||
Balance at February 28, 2018 | $ | (102 | ) | $ | (553 | ) | $ | 115 | $ | (84 | ) | $ | (624 | ) | ||||||
(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, $2 million, $0 million, $0 million and $2 million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $1 million, $0 million, $1 million and $2 million, respectively. |
(4) | Refer to Note 1 — Summary of Significant Accounting Policies for additional information on the adoption of ASU 2018-02 during the third quarter of fiscal 2018. |
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at May 31, 2017 | $ | (191 | ) | $ | (52 | ) | $ | 115 | $ | (85 | ) | $ | (213 | ) | ||||||
Other comprehensive (loss) income: | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | 65 | (523 | ) | — | (35 | ) | (493 | ) | ||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | — | 29 | — | 36 | 65 | |||||||||||||||
Total other comprehensive (loss) income | 65 | (494 | ) | — | 1 | (428 | ) | |||||||||||||
Reclassifications to retained earnings in accordance with ASU 2018-02(4) | 24 | (7 | ) | — | — | 17 | ||||||||||||||
Balance at February 28, 2018 | $ | (102 | ) | $ | (553 | ) | $ | 115 | $ | (84 | ) | $ | (624 | ) | ||||||
(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 $(23) million, $1 million, $0 million, $0 million and $(22) million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $(2) million, $0 million, $1 million and $(1) million, respectively. |
(4) | Refer to Note 1 — Summary of Significant Accounting Policies for additional information on the adoption of ASU 2018-02 during the third quarter of fiscal 2018. |
The changes in Accumulated other comprehensive income, net of tax, for the three and nine months ended February 28, 2017 were as follows:
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at November 30, 2016 | $ | (218 | ) | $ | 546 | $ | 115 | $ | (44 | ) | $ | 399 | ||||||||
Other comprehensive (loss) income: | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | 13 | 2 | — | — | 15 | |||||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | (1 | ) | (177 | ) | — | (7 | ) | (185 | ) | |||||||||||
Total other comprehensive (loss) income | 12 | (175 | ) | — | (7 | ) | (170 | ) | ||||||||||||
Balance at February 28, 2017 | $ | (206 | ) | $ | 371 | $ | 115 | $ | (51 | ) | $ | 229 | ||||||||
(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, $1 million, $0 million, $(1) million and $0 million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $(1) million, $0 million, $2 million and $1 million, respectively. |
18
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at May 31, 2016 | $ | (207 | ) | $ | 463 | $ | 115 | $ | (53 | ) | $ | 318 | ||||||||
Other comprehensive (loss) income: | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | 2 | 406 | — | 18 | 426 | |||||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | (1 | ) | (498 | ) | — | (16 | ) | (515 | ) | |||||||||||
Total other comprehensive (loss) income | 1 | (92 | ) | — | 2 | (89 | ) | |||||||||||||
Balance at February 28, 2017 | $ | (206 | ) | $ | 371 | $ | 115 | $ | (51 | ) | $ | 229 | ||||||||
(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, $23 million, $0 million, $0 million and $23 million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $(3) million, $0 million, $1 million and $(2) million, respectively. |
The following table summarizes the reclassifications from Accumulated other comprehensive income to the Unaudited Condensed Consolidated Statements of Income:
Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income | Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income | |||||||||||||||||
Three Months Ended February 28, | Nine Months Ended February 28, | |||||||||||||||||
(In millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||||
Gains (losses) on foreign currency translation adjustment | $ | — | $ | 1 | $ | — | $ | 1 | Other (income) expense, net | |||||||||
Total before tax | — | 1 | — | 1 | ||||||||||||||
Tax (expense) benefit | — | — | — | — | ||||||||||||||
Gain (loss) net of tax | — | 1 | — | 1 | ||||||||||||||
Gains (losses) on cash flow hedges: | ||||||||||||||||||
Foreign exchange forwards and options | $ | 9 | $ | 24 | $ | 24 | $ | 96 | Revenues | |||||||||
Foreign exchange forwards and options | (41 | ) | 87 | (17 | ) | 260 | Cost of sales | |||||||||||
Foreign exchange forwards and options | (15 | ) | 67 | (33 | ) | 141 | Other (income) expense, net | |||||||||||
Interest rate swaps | (1 | ) | (2 | ) | (5 | ) | (2 | ) | Interest expense (income), net | |||||||||
Total before tax | (48 | ) | 176 | (31 | ) | 495 | ||||||||||||
Tax (expense) benefit | (1 | ) | 1 | 2 | 3 | |||||||||||||
Gain (loss) net of tax | (49 | ) | 177 | (29 | ) | 498 | ||||||||||||
Gains (losses) on other | (16 | ) | 9 | (35 | ) | 17 | Other (income) expense, net | |||||||||||
Total before tax | (16 | ) | 9 | (35 | ) | 17 | ||||||||||||
Tax (expense) benefit | (1 | ) | (2 | ) | (1 | ) | (1 | ) | ||||||||||
Gain (loss) net of tax | (17 | ) | 7 | (36 | ) | 16 | ||||||||||||
Total net gain (loss) reclassified for the period | $ | (66 | ) | $ | 185 | $ | (65 | ) | $ | 515 | ||||||||
19
Note 11 — Operating Segments |
The Company’s operating segments are evidence of the structure of the Company’s internal organization. The NIKE Brand segments are defined by geographic regions for operations participating in NIKE Brand sales activity.
Each NIKE Brand geographic segment operates predominantly in one industry: the design, development, marketing and selling of athletic footwear, apparel and equipment. In June 2017, NIKE, Inc. announced a new company alignment designed to allow NIKE to better serve the consumer personally, at scale. As a result of this organizational realignment, the Company’s reportable operating segments for the NIKE Brand are: North America; Europe, Middle East & Africa; Greater China; and Asia Pacific & Latin America, and include results for the NIKE, Jordan and Hurley brands. Certain prior year amounts have been reclassified to conform to fiscal 2018 presentation. This includes reclassified operating segment data to reflect the changes in the Company’s operating structure, which became effective June 1, 2017. These changes had no impact on previously reported consolidated statements of income, balance sheets, statements of cash flows or statements of shareholders’ equity.
The Company’s NIKE Direct operations are managed within each NIKE Brand geographic operating segment. Converse is also a reportable segment for the Company, and operates in one industry: the design, marketing, licensing and selling of casual sneakers, apparel and accessories.
Global Brand Divisions is included within the NIKE Brand for presentation purposes to align with the way management views the Company. Global Brand Divisions primarily represents NIKE Brand licensing businesses that are not part of a geographic operating segment, and demand creation, operating overhead and product creation and design expenses that are centrally managed for the NIKE Brand.
Corporate consists largely of unallocated general and administrative expenses, including expenses associated with centrally managed departments; depreciation and amortization related to the Company’s headquarters; unallocated insurance, benefit and compensation programs, including stock-based compensation; and certain foreign currency gains and losses, including certain hedge gains and losses.
The primary financial measure used by the Company to evaluate performance of individual operating segments is earnings before interest and taxes (commonly referred to as “EBIT”), which represents Net income before Interest expense (income), net and Income tax expense in the Unaudited Condensed Consolidated Statements of Income.
As part of the Company’s centrally managed foreign exchange risk management program, standard foreign currency rates are assigned twice per year to each NIKE Brand entity in the Company’s geographic operating segments and to Converse. These rates are set approximately nine and twelve months in advance of the future selling seasons to which they relate (specifically, for each currency, one standard rate applies to the fall and holiday selling seasons and one standard rate applies to the spring and summer selling seasons) based on average market spot rates in the calendar month preceding the date they are established. Inventories and Cost of sales for geographic operating segments and Converse reflect the use of these standard rates to record non-functional currency product purchases in the entity’s functional currency. Differences between assigned standard foreign currency rates and actual market rates are included in Corporate, together with foreign currency hedge gains and losses generated from the Company’s centrally managed foreign exchange risk management program and other conversion gains and losses.
Accounts receivable, net, Inventories and Property, plant and equipment, net for operating segments are regularly reviewed by management and are therefore provided below.
Three Months Ended February 28, | Nine Months Ended February 28, | |||||||||||||||
(In millions) | 2018 | 2017 | 2018 | 2017 | ||||||||||||
REVENUES | ||||||||||||||||
North America | $ | 3,571 | $ | 3,782 | $ | 10,980 | $ | 11,463 | ||||||||
Europe, Middle East & Africa | 2,299 | 1,925 | 6,776 | 5,979 | ||||||||||||
Greater China | 1,336 | 1,075 | 3,666 | 3,150 | ||||||||||||
Asia Pacific & Latin America | 1,268 | 1,122 | 3,730 | 3,459 | ||||||||||||
Global Brand Divisions | 21 | 19 | 64 | 55 | ||||||||||||
Total NIKE Brand | 8,495 | 7,923 | 25,216 | 24,106 | ||||||||||||
Converse | 483 | 498 | 1,374 | 1,488 | ||||||||||||
Corporate | 6 | 11 | 18 | 79 | ||||||||||||
TOTAL NIKE, INC. REVENUES | $ | 8,984 | $ | 8,432 | $ | 26,608 | $ | 25,673 | ||||||||
EARNINGS BEFORE INTEREST AND TAXES | ||||||||||||||||
North America | $ | 840 | $ | 980 | $ | 2,625 | $ | 2,896 | ||||||||
Europe, Middle East & Africa | 417 | 361 | 1,205 | 1,159 | ||||||||||||
Greater China | 496 | 381 | 1,268 | 1,127 | ||||||||||||
Asia Pacific & Latin America | 298 | 228 | 849 | 703 | ||||||||||||
Global Brand Divisions | (649 | ) | (598 | ) | (1,926 | ) | (1,988 | ) | ||||||||
Total NIKE Brand | 1,402 | 1,352 | 4,021 | 3,897 | ||||||||||||
Converse | 69 | 109 | 206 | 340 | ||||||||||||
Corporate | (299 | ) | (119 | |||||||||||||