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, 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 October 3, 2018 were:
Class A | 315,041,752 | |
Class B | 1,273,066,600 | |
1,588,108,352 | ||
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 |
August 31, | May 31, | |||||||
(In millions) | 2018 | 2018 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and equivalents | $ | 3,282 | $ | 4,249 | ||||
Short-term investments | 987 | 996 | ||||||
Accounts receivable, net | 4,330 | 3,498 | ||||||
Inventories | 5,227 | 5,261 | ||||||
Prepaid expenses and other current assets | 1,675 | 1,130 | ||||||
Total current assets | 15,501 | 15,134 | ||||||
Property, plant and equipment, net | 4,487 | 4,454 | ||||||
Identifiable intangible assets, net | 284 | 285 | ||||||
Goodwill | 154 | 154 | ||||||
Deferred income taxes and other assets | 2,057 | 2,509 | ||||||
TOTAL ASSETS | $ | 22,483 | $ | 22,536 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 6 | $ | 6 | ||||
Notes payable | 13 | 336 | ||||||
Accounts payable | 2,333 | 2,279 | ||||||
Accrued liabilities | 4,174 | 3,269 | ||||||
Income taxes payable | 182 | 150 | ||||||
Total current liabilities | 6,708 | 6,040 | ||||||
Long-term debt | 3,467 | 3,468 | ||||||
Deferred income taxes and other liabilities | 3,316 | 3,216 | ||||||
Commitments and contingencies (Note 13) | ||||||||
Redeemable preferred stock | — | — | ||||||
Shareholders’ equity: | ||||||||
Common stock at stated value: | ||||||||
Class A convertible — 320 and 329 shares outstanding | — | — | ||||||
Class B — 1,269 and 1,272 shares outstanding | 3 | 3 | ||||||
Capital in excess of stated value | 6,525 | 6,384 | ||||||
Accumulated other comprehensive loss | (30 | ) | (92 | ) | ||||
Retained earnings | 2,494 | 3,517 | ||||||
Total shareholders’ equity | 8,992 | 9,812 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 22,483 | $ | 22,536 | ||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
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NIKE, Inc. Unaudited Condensed Consolidated Statements of Income |
Three Months Ended August 31, | ||||||||
(In millions, except per share data) | 2018 | 2017 | ||||||
Revenues | $ | 9,948 | $ | 9,070 | ||||
Cost of sales | 5,551 | 5,108 | ||||||
Gross profit | 4,397 | 3,962 | ||||||
Demand creation expense | 964 | 855 | ||||||
Operating overhead expense | 2,099 | 2,001 | ||||||
Total selling and administrative expense | 3,063 | 2,856 | ||||||
Interest expense (income), net | 11 | 16 | ||||||
Other expense (income), net | 53 | 18 | ||||||
Income before income taxes | 1,270 | 1,072 | ||||||
Income tax expense | 178 | 122 | ||||||
NET INCOME | $ | 1,092 | $ | 950 | ||||
Earnings per common share: | ||||||||
Basic | $ | 0.69 | $ | 0.58 | ||||
Diluted | $ | 0.67 | $ | 0.57 | ||||
Dividends declared per common share | $ | 0.20 | $ | 0.18 | ||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
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NIKE, Inc. Unaudited Condensed Consolidated Statements of Comprehensive Income | ||||
Three Months Ended August 31, | ||||||||
(In millions) | 2018 | 2017 | ||||||
Net income | $ | 1,092 | $ | 950 | ||||
Other comprehensive income (loss), net of tax: | ||||||||
Change in net foreign currency translation adjustment | (128 | ) | 22 | |||||
Change in net gains (losses) on cash flow hedges | 193 | (395 | ) | |||||
Change in net gains (losses) on other | (3 | ) | — | |||||
Total other comprehensive income (loss), net of tax | 62 | (373 | ) | |||||
TOTAL COMPREHENSIVE INCOME | $ | 1,154 | $ | 577 | ||||
The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.
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NIKE, Inc. Unaudited Condensed Consolidated Statements of Cash Flows |
Three Months Ended August 31, | ||||||||
(In millions) | 2018 | 2017 | ||||||
Cash provided by operations: | ||||||||
Net income | $ | 1,092 | $ | 950 | ||||
Adjustments to reconcile net income to net cash provided by operations: | ||||||||
Depreciation | 178 | 179 | ||||||
Deferred income taxes | 18 | (59 | ) | |||||
Stock-based compensation | 41 | 50 | ||||||
Amortization and other | 3 | 6 | ||||||
Net foreign currency adjustments | 166 | (19 | ) | |||||
Changes in certain working capital components and other assets and liabilities: | ||||||||
(Increase) in accounts receivable | (294 | ) | (101 | ) | ||||
(Increase) in inventories | (25 | ) | (96 | ) | ||||
(Increase) in prepaid expenses and other current and non-current assets | (83 | ) | (543 | ) | ||||
Increase in accounts payable, accrued liabilities and other current and non-current liabilities | 205 | 208 | ||||||
Cash provided by operations | 1,301 | 575 | ||||||
Cash used by investing activities: | ||||||||
Purchases of short-term investments | (980 | ) | (1,663 | ) | ||||
Maturities of short-term investments | 400 | 1,403 | ||||||
Sales of short-term investments | 586 | 518 | ||||||
Additions to property, plant and equipment | (343 | ) | (270 | ) | ||||
Disposals of property, plant and equipment | 4 | — | ||||||
Cash used by investing activities | (333 | ) | (12 | ) | ||||
Cash used by financing activities: | ||||||||
Long-term debt payments, including current portion | (1 | ) | (1 | ) | ||||
(Decrease) increase in notes payable | (321 | ) | 9 | |||||
Payments on capital lease and other financing obligations | (6 | ) | (6 | ) | ||||
Proceeds from exercise of stock options and other stock issuances | 187 | 158 | ||||||
Repurchase of common stock | (1,360 | ) | (804 | ) | ||||
Dividends — common and preferred | (320 | ) | (300 | ) | ||||
Tax payments for net share settlement of equity awards | (11 | ) | (54 | ) | ||||
Cash used by financing activities | (1,832 | ) | (998 | ) | ||||
Effect of exchange rate changes on cash and equivalents | (103 | ) | 40 | |||||
Net decrease in cash and equivalents | (967 | ) | (395 | ) | ||||
Cash and equivalents, beginning of period | 4,249 | 3,808 | ||||||
CASH AND EQUIVALENTS, END OF PERIOD | $ | 3,282 | $ | 3,413 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Non-cash additions to property, plant and equipment | $ | 110 | $ | 98 | ||||
Dividends declared and not paid | 318 | 295 | ||||||
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 | ||
Note 13 | ||
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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, 2018 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 months ended August 31, 2018 are not necessarily indicative of results to be expected for the entire year.
Recently Adopted Accounting Standards
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), that replaces existing revenue recognition guidance. The new standard 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, Topic 606 requires disclosures of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted this standard using a modified retrospective approach in the first quarter of fiscal 2019 with the cumulative effect of initially applying the new standard recognized in Retained earnings at June 1, 2018. Comparative prior period information has not been adjusted and continues to be reported in accordance with previous revenue recognition guidance in Accounting Standards Codification (ASC) Topic 605 — Revenue Recognition. The Company has applied the new standard to all contracts at adoption.
The Company’s adoption of Topic 606 resulted in a change to the timing of revenue recognition. The satisfaction of the Company’s performance obligation is based upon transfer of control over a product to a customer, which results in sales being recognized upon shipment rather than upon delivery for certain wholesale transactions and substantially all digital commerce sales. A customer is considered to have control once they are able to direct the use and receive substantially all of the benefits of the product. This resulted in a cumulative effect adjustment, which increased Retained earnings by $23 million at June 1, 2018. The adoption of Topic 606 did not have a material effect on the Unaudited Condensed Consolidated Statements of Income in the first quarter of fiscal 2019.
Additionally, the Company’s reserve balances for returns, post-invoice sales discounts and miscellaneous claims for wholesale transactions were previously reported net of the estimated cost of inventory for product returns, and as a reduction to Accounts receivable, net on the Unaudited Condensed Consolidated Balance Sheets. Under Topic 606, an asset for the estimated cost of inventory expected to be returned is now recognized separately from the liability for sales-related reserves. This resulted in an increase to Accounts receivable, net, an increase in Prepaid expenses and other current assets and an increase in Accrued liabilities on the Unaudited Condensed Consolidated Balance Sheets at August 31, 2018. Sales-related reserves for the Company’s direct to consumer operations continue to be recognized in Accrued liabilities, but are now recorded separately from an asset for the estimated cost of inventory for expected product returns, which is recognized in Prepaid expenses and other current assets. The following table presents the related effect of the adoption of Topic 606 on the Unaudited Condensed Consolidated Balance Sheets at August 31, 2018:
As of August 31, 2018 | ||||||||||||
(In millions) | As Reported | Effect of Adoption | Balances Without Adoption of Topic 606 | |||||||||
Accounts receivable, net | $ | 4,330 | $ | 662 | $ | 3,668 | ||||||
Prepaid expenses and other current assets | 1,675 | 367 | 1,308 | |||||||||
Total current assets | 15,501 | 1,029 | 14,472 | |||||||||
TOTAL ASSETS | 22,483 | 1,029 | 21,454 | |||||||||
Accrued liabilities | 4,174 | 1,029 | 3,145 | |||||||||
Total current liabilities | 6,708 | 1,029 | 5,679 | |||||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 22,483 | $ | 1,029 | $ | 21,454 | ||||||
Other impacts from the adoption of Topic 606 on the Unaudited Condensed Consolidated Financial Statements were immaterial. Refer to Note 11 — Revenues for further discussion.
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 adopted 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. The adoption resulted in reductions to Retained earnings, Deferred income taxes and other assets, and Prepaid expenses and other current assets of $507 million, $422 million and $45 million, respectively, and an increase in Deferred income taxes and other liabilities of $40 million.
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 Company elected to early adopt the ASU in the first quarter of fiscal 2019 and the adoption of the new guidance did not have a material impact on the Unaudited Condensed Consolidated Financial Statements.
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
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address aspects of recognition, measurement, presentation and disclosure. The Company adopted the ASU in the first quarter of fiscal 2019 and the adoption of the new guidance did not have a material impact on the Unaudited Condensed Consolidated Financial Statements.
Recently Issued Accounting Standards
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. In July 2018, the FASB issued ASU No. 2018-11, which provides entities with an additional transition method to adopt Topic 842. Under the new transition method, an entity initially applies the new leases standard at the adoption date, versus at the beginning of the earliest period presented, and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The Company expects to elect this transition method at the adoption date of June 1, 2019. 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 is expected to be material. Refer to Note 15 — Commitments and Contingencies of the Annual Report on Form 10-K for the fiscal year ended May 31, 2018 for information about the Company’s lease obligations.
Note 2 — Inventories |
Inventory balances of $5,227 million and $5,261 million at August 31, 2018 and May 31, 2018, respectively, were substantially all finished goods.
Note 3 — Accrued Liabilities |
Accrued liabilities included the following:
As of August 31, | As of May 31, | |||||||
(In millions) | 2018 | 2018 | ||||||
Sales-related reserves(1) | $ | 1,048 | $ | 20 | ||||
Compensation and benefits, excluding taxes | 675 | 897 | ||||||
Endorsement compensation | 476 | 425 | ||||||
Dividends payable | 318 | 320 | ||||||
Import and logistics costs | 290 | 268 | ||||||
Taxes other than income taxes payable | 262 | 224 | ||||||
Advertising and marketing | 185 | 140 | ||||||
Fair value of derivatives | 102 | 184 | ||||||
Collateral received from counterparties to hedging instruments | 31 | 23 | ||||||
Other(2) | 787 | 768 | ||||||
TOTAL ACCRUED LIABILITIES | $ | 4,174 | $ | 3,269 | ||||
(1) | Sales-related reserves as of August 31, 2018 reflect the Company’s fiscal 2019 adoption of Topic 606. As of May 31, 2018, Sales-related reserves reflect the Company's prior accounting under Topic 605. Refer to Note 1 — Summary of Significant Accounting Policies for additional information on the adoption of the new standard. |
(2) | Other consists of various accrued expenses with no individual item accounting for more than 5% of the total Accrued liabilities balance at August 31, 2018 and May 31, 2018. |
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 with 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.
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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 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.
The following tables present information about the Company’s financial assets measured at fair value on a recurring basis as of August 31, 2018 and May 31, 2018, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of August 31, 2018 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 436 | $ | 436 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 851 | 50 | 801 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 1,098 | 1,081 | 17 | — | ||||||||||||
U.S. Agency securities | 1 | — | 1 | — | ||||||||||||
Commercial paper and bonds | 194 | 26 | 168 | — | ||||||||||||
Money market funds | 1,689 | 1,689 | — | — | ||||||||||||
Total Level 2: | 2,982 | 2,796 | 186 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 11 | — | — | 11 | ||||||||||||
TOTAL | $ | 4,280 | $ | 3,282 | $ | 987 | $ | 11 | ||||||||
As of May 31, 2018 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 415 | $ | 415 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 1,178 | 500 | 678 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 925 | 907 | 18 | — | ||||||||||||
U.S. Agency securities | 102 | 100 | 2 | — | ||||||||||||
Commercial paper and bonds | 451 | 153 | 298 | — | ||||||||||||
Money market funds | 2,174 | 2,174 | — | — | ||||||||||||
Total Level 2: | 3,652 | 3,334 | 318 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 11 | — | — | 11 | ||||||||||||
TOTAL | $ | 5,256 | $ | 4,249 | $ | 996 | $ | 11 | ||||||||
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.
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The following tables present information about the Company’s derivative assets and liabilities measured at fair value on a recurring basis as of August 31, 2018 and May 31, 2018, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of August 31, 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) | $ | 476 | $ | 347 | $ | 129 | $ | 99 | $ | 99 | $ | — | ||||||||||||
Embedded derivatives | 9 | 3 | 6 | 12 | 3 | 9 | ||||||||||||||||||
TOTAL | $ | 485 | $ | 350 | $ | 135 | $ | 111 | $ | 102 | $ | 9 | ||||||||||||
(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 $99 million as of August 31, 2018. As of that date, the Company had received $31 million of cash collateral from various counterparties related to foreign exchange derivative instruments. No amount of collateral was posted on the Company’s derivative liability balance as of August 31, 2018. |
As of May 31, 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) | $ | 389 | $ | 237 | $ | 152 | $ | 182 | $ | 182 | $ | — | ||||||||||||
Embedded derivatives | 11 | 3 | 8 | 8 | 2 | 6 | ||||||||||||||||||
TOTAL | $ | 400 | $ | 240 | $ | 160 | $ | 190 | $ | 184 | $ | 6 | ||||||||||||
(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 $182 million as of May 31, 2018. As of that date, the Company had received $23 million of cash collateral from various counterparties related to these foreign exchange derivative instruments. No amount of collateral was posted on the Company’s derivative liability balance as of May 31, 2018. |
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 August 31, 2018, the Company held $954 million of available-for-sale securities with maturity dates within one year and $33 million with maturity dates over one year and less than five years in 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 months ended August 31, 2018 and 2017. Unrealized gains and losses on available-for-sale securities included in Accumulated other comprehensive income were immaterial as of August 31, 2018 and May 31, 2018. The Company regularly reviews its available-for-sale securities for other-than-temporary impairment. For the three months ended August 31, 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 August 31, 2018 and 2017 was interest income related to the Company’s available-for-sale securities of $20 million and $11 million, 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 three months ended August 31, 2018 and the fiscal year ended May 31, 2018.
No transfers among levels within the fair value hierarchy occurred during the three months ended August 31, 2018 and the fiscal year ended May 31, 2018.
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 August 31, 2018 and May 31, 2018, assets or liabilities 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 $3,301 million at August 31, 2018 and $3,294 million at May 31, 2018.
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 August 31, 2018, the Company had no outstanding borrowings under its $2 billion commercial paper program. As of May 31, 2018, $325 million of commercial paper was outstanding at a weighted average interest rate of 1.77%. 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 14.0% for the three months ended August 31, 2018 compared to 11.4% for the three months ended August 31, 2017. The Company’s effective tax rate for the current period reflects the impact of the new U.S. statutory rate and implemented provisions of the U.S. Tax Cuts and Jobs Act (the “Tax Act”).
The Company continued its analysis of the Tax Act during the first quarter of fiscal 2019. This resulted in no change to the provisional amounts recorded in fiscal 2018 related to the one-time transition tax on the deemed repatriation of undistributed foreign earnings and the remeasurement of deferred tax assets and liabilities. The Company will continue its analysis through the measurement period taking into consideration additional guidance provided by the U.S. Internal Revenue Service (IRS), U.S. Treasury Department, FASB or other standard setting and regulatory bodies. This may result in material adjustments to the provisional amounts.
As of August 31, 2018, total gross unrecognized tax benefits, excluding related interest and penalties, were $773 million, $526 million of which would affect the Company’s effective tax rate if recognized in future periods. As of May 31, 2018, total gross unrecognized tax benefits, excluding related interest and penalties, were $698 million. The liability for payment of interest and penalties decreased $8 million during the three months ended August 31, 2018. As of August 31, 2018 and May 31, 2018, accrued interest and penalties related to uncertain tax positions were $149 million and $157 million, respectively.
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 U.S. federal income tax examination for fiscal 2015 and 2016.
The Company’s major foreign jurisdictions, China and the Netherlands, have substantially concluded all income tax matters through calendar 2007 and fiscal 2012, 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 approximately $210 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. From time to time, the Company’s Board of Directors authorizes share repurchase programs for the repurchase of Class B Common Stock. The value of repurchased shares is deducted from Total shareholders’ equity through allocation to Capital in excess of stated value and Retained earnings.
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. The Company generally grants stock options and restricted stock on an annual basis. Substantially all awards outstanding under the Stock Incentive Plan vest ratably over four years, and for stock option grants, 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 for options granted under the Stock Incentive Plan and employees’ purchase rights under the ESPPs by estimating the fair value 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.
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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, | ||||||||
(In millions) | 2018 | 2017 | ||||||
Stock options(1) | $ | 20 | $ | 33 | ||||
ESPPs | 10 | 8 | ||||||
Restricted stock | 11 | 9 | ||||||
TOTAL STOCK-BASED COMPENSATION EXPENSE | $ | 41 | $ | 50 | ||||
(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 $1 million and $3 million for the three months ended August 31, 2018 and 2017, respectively. |
As of August 31, 2018, the Company had $187 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 2.1 years.
The weighted average fair value per share of the options granted during the three months ended August 31, 2018 and 2017, computed as of the grant date using the Black-Scholes pricing model, was $17.44 and $9.82, respectively. The weighted average assumptions used to estimate these fair values were as follows:
Three Months Ended August 31, | ||||||
2018 | 2017 | |||||
Dividend yield | 1.0 | % | 1.2 | % | ||
Expected volatility | 19.7 | % | 16.4 | % | ||
Weighted average expected life (in years) | 6.0 | 6.0 | ||||
Risk-free interest rate | 2.9 | % | 2.0 | % | ||
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.
Note 8 — 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 options, including shares under ESPPs, to purchase an additional 3.1 million and 46.0 million shares of common stock outstanding for the three months ended August 31, 2018 and 2017, respectively, because the options were anti-dilutive.
Three Months Ended August 31, | ||||||||
(In millions, except per share data) | 2018 | 2017 | ||||||
Determination of shares: | ||||||||
Weighted average common shares outstanding | 1,594.0 | 1,639.1 | ||||||
Assumed conversion of dilutive stock options and awards | 40.4 | 37.8 | ||||||
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING | 1,634.4 | 1,676.9 | ||||||
Earnings per common share: | ||||||||
Basic | $ | 0.69 | $ | 0.58 | ||||
Diluted | $ | 0.67 | $ | 0.57 | ||||
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 August 31, 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 August 31, 2018 and May 31, 2018. 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 | August 31, 2018 | May 31, 2018 | Balance Sheet Location | August 31, 2018 | May 31, 2018 | ||||||||||||||
Derivatives formally designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | $ | 207 | $ | 118 | Accrued liabilities | $ | 72 | $ | 156 | ||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | 128 | 152 | Deferred income taxes and other liabilities | — | — | ||||||||||||||
Total derivatives formally designated as hedging instruments | 335 | 270 | 72 | 156 | ||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | 140 | 119 | Accrued liabilities | 27 | 26 | ||||||||||||||
Embedded derivatives | Prepaid expenses and other current assets | 3 | 3 | Accrued liabilities | 3 | 2 | ||||||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | 1 | — | Deferred income taxes and other liabilities | — | — | ||||||||||||||
Embedded derivatives | Deferred income taxes and other assets | 6 | 8 | Deferred income taxes and other liabilities | 9 | 6 | ||||||||||||||
Total derivatives not designated as hedging instruments | 150 | 130 | 39 | 34 | ||||||||||||||||
TOTAL DERIVATIVES | $ | 485 | $ | 400 | $ | 111 | $ | 190 | ||||||||||||
The following tables present 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 for the three months ended August 31, 2018 and 2017:
Three Months Ended August 31, 2018 | ||||||||||||||||||||
(In millions) | Revenues | Cost of Sales | Demand Creation Expense | Other Expense (Income), Net | Interest Expense (Income), Net | |||||||||||||||
Total | $ | 9,948 | $ | 5,551 | $ | 964 | $ | 53 | $ | 11 | ||||||||||
Amount of gain (loss) on cash flow hedge activity | 5 | (44 | ) | — | (9 | ) | (2 | ) | ||||||||||||
Three Months Ended August 31, 2017 | ||||||||||||||||||||
(In millions) | Revenues | Cost of Sales | Demand Creation Expense | Other Expense (Income), Net | Interest Expense (Income), Net | |||||||||||||||
Total | $ | 9,070 | $ | 5,108 | $ | 855 | $ | 18 | $ | 16 | ||||||||||
Amount of gain (loss) on cash flow hedge activity | 2 | 45 | — | 2 | (2 | ) | ||||||||||||||
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The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three months ended August 31, 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 August 31, | Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income | Three Months Ended August 31, | |||||||||||||||
2018 | 2017 | 2018 | 2017 | ||||||||||||||
Derivatives designated as cash flow hedges: | |||||||||||||||||
Foreign exchange forwards and options | $ | 16 | $ | 55 | Revenues | $ | 5 | $ | 2 | ||||||||
Foreign exchange forwards and options | 101 | (277 | ) | Cost of sales | (44 | ) | 45 | ||||||||||
Foreign exchange forwards and options | — | 1 | Demand creation expense | — | — | ||||||||||||
Foreign exchange forwards and options | 26 | (129 | ) | Other expense (income), net | (9 | ) | 2 | ||||||||||
Interest rate swaps(2) | — | — | Interest expense (income), net | (2 | ) | (2 | ) | ||||||||||
Total designated cash flow hedges | $ | 143 | $ | (350 | ) | $ | (50 | ) | $ | 47 | |||||||
(1) | For the three months ended August 31, 2018 and 2017, the amounts recorded in Other expense (income), 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 August 31, | ||||||||||
(In millions) | 2018 | 2017 | ||||||||
Derivatives not designated as hedging instruments: | ||||||||||
Foreign exchange forwards and options | $ | 114 | $ | (194 | ) | Other expense (income), net | ||||
Embedded derivatives | (2 | ) | (1 | ) | Other expense (income), net | |||||
Cash Flow Hedges
All changes in fair value of derivatives designated as cash flow hedges 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 in the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. 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 in Accumulated other comprehensive income will be recognized immediately in Other expense (income), 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 the Company may elect to hedge in this manner include product cost exposures, non-functional currency denominated external and intercompany revenues, demand creation 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. NTC sales to a NIKE entity with a different functional currency result in 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 $9.9 billion as of August 31, 2018.
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As of August 31, 2018, approximately $92 million of deferred net gains (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 currently outstanding mature. As of August 31, 2018, the maximum term over which the Company is hedging exposures to the variability of cash flows for its forecasted transactions was 21 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 had no interest rate swaps designated as fair value hedges as of August 31, 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, are reported in Accumulated other comprehensive income along with the foreign currency translation adjustments on those investments. The Company had no outstanding net investment hedges as of August 31, 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 expense (income), 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 $6.9 billion as of August 31, 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 expense (income), net, through the date the foreign currency fluctuations cease to exist.
As of August 31, 2018, the total notional amount of embedded derivatives outstanding was approximately $315 million.
Credit Risk
The Company is exposed to credit-related losses in the event of nonperformance 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 August 31, 2018, the Company was in compliance with all credit risk-related contingent features and had no derivative instruments with credit risk-related contingent features in a net liability position. Accordingly, the Company was not required to post any collateral as a result of these contingent features. Further, as of August 31, 2018, the Company had $31 million of cash collateral received from various 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 months ended August 31, 2018 were as follows:
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at May 31, 2018 | $ | (173 | ) | $ | 17 | $ | 115 | $ | (51 | ) | $ | (92 | ) | |||||||
Other comprehensive income (loss): | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | (128 | ) | 142 | — | 4 | 18 | ||||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | — | 51 | — | (7 | ) | 44 | ||||||||||||||
Total other comprehensive income (loss) | (128 | ) | 193 | — | (3 | ) | 62 | |||||||||||||
Balance at August 31, 2018 | $ | (301 | ) | $ | 210 | $ | 115 | $ | (54 | ) | $ | (30 | ) | |||||||
(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, $0 million and $(1) million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $1 million, $0 million, $0 million and $1 million, respectively. |
The changes in Accumulated other comprehensive income, net of tax, for the three months ended August 31, 2017 were as follows:
(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 income (loss): | ||||||||||||||||||||
Other comprehensive gains (losses) before reclassifications(2) | 22 | (347 | ) | — | (18 | ) | (343 | ) | ||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | — | (48 | ) | — | 18 | (30 | ) | |||||||||||||
Total other comprehensive income (loss) | 22 | (395 | ) | — | — | (373 | ) | |||||||||||||
Balance at August 31, 2017 | $ | (169 | ) | $ | (447 | ) | $ | 115 | $ | (85 | ) | $ | (586 | ) | ||||||
(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 $(19) million, $3 million, $0 million, $0 million and $(16) million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $(1) million, $0 million, $0 million and $(1) 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 August 31, | ||||||||||
(In millions) | 2018 | 2017 | ||||||||
Gains (losses) on cash flow hedges: | ||||||||||
Foreign exchange forwards and options | $ | 5 | $ | 2 | Revenues | |||||
Foreign exchange forwards and options | (44 | ) | 45 | Cost of sales | ||||||
Foreign exchange forwards and options | (9 | ) | 2 | Other expense (income), net | ||||||
Interest rate swaps | (2 | ) | (2 | ) | Interest expense (income), net | |||||
Total before tax | (50 | ) | 47 | |||||||
Tax (expense) benefit | (1 | ) | 1 | |||||||
(Loss) gain net of tax | (51 | ) | 48 | |||||||
Gains (losses) on other | 7 | (18 | ) | Other expense (income), net | ||||||
Total before tax | 7 | (18 | ) | |||||||
Tax (expense) benefit | — | — | ||||||||
Gain (loss) net of tax | 7 | (18 | ) | |||||||
Total net (loss) gain reclassified for the period | $ | (44 | ) | $ | 30 | |||||
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Note 11 — Revenues |
Nature of Revenues
Revenue transactions associated with the sale of NIKE Brand footwear, apparel and equipment, as well as Converse products, comprise a single performance obligation, which consists of the sale of products to customers either through wholesale or direct to consumer channels. The Company satisfies the performance obligation and records revenues when transfer of control has passed to the customer, based on the terms of sale. A customer is considered to have control once they’re able to direct the use and receive substantially all of the benefits of the product. Transfer of control passes to wholesale customers upon shipment or upon receipt depending on the country of the sale and the agreement with the customer. Control passes to retail store customers at the time of sale and to digital commerce customers upon shipment. The transaction price is determined based upon the invoiced sales price, less anticipated sales returns, discounts and miscellaneous claims from customers. Payment terms for wholesale transactions depend on the country of sale or agreement with the customer, and payment is generally required within 90 days or less of shipment or receipt by the wholesale customer. Payment is due at the time of sale for retail store and digital commerce transactions. At August 31, 2018, the Company did not have any contract assets and had an immaterial amount of contract liabilities recorded in Accrued liabilities on the Unaudited Condensed Consolidated Balance Sheets. Consideration for trademark licensing contracts is earned through sales-based or usage-based royalty arrangements and the associated revenues are recognized over the license period. Licensing revenues for the first quarter of fiscal 2019 were immaterial and are included in the results for the NIKE Brand geographic operating segments, Global Brand Divisions and Converse.
Taxes assessed by governmental authorities that are both imposed on and concurrent with a specific revenue-producing transaction, and are collected by the Company from a customer, are excluded from Revenues and Cost of sales in the Unaudited Condensed Consolidated Statements of Income. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost as incurred, and are included in Cost of sales.
Disaggregation of Revenues
The following table presents the Company’s revenues disaggregated by reportable operating segment, major product lines and by distribution channel for the three months ended August 31, 2018:
North America | Europe, Middle East & Africa | Greater China | Asia Pacific & Latin America | Global Brand Divisions | Total NIKE Brand | Converse | Corporate | Total NIKE, Inc. | |||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||||||
Revenues by: | |||||||||||||||||||||||||||||||||||
Footwear | $ | 2,555 | $ | 1,642 | $ | 958 | $ | 881 | $ | — | $ | 6,036 | $ | 461 | $ | — | $ | 6,497 | |||||||||||||||||
Apparel | 1,407 | 830 | 380 | 332 | — | 2,949 | 30 | — | 2,979 | ||||||||||||||||||||||||||
Equipment | 183 | 135 | 41 | 57 | — | 416 | 8 | — | 424 | ||||||||||||||||||||||||||
Other(1) | — | — | — | — | 16 | 16 | 28 | 4 | 48 | ||||||||||||||||||||||||||
TOTAL REVENUES | $ | 4,145 | $ | 2,607 | $ | 1,379 | $ | 1,270 | $ | 16 | $ | 9,417 | $ | 527 | $ | 4 | $ | 9,948 | |||||||||||||||||
Revenues by: | |||||||||||||||||||||||||||||||||||
Sales to Wholesale Customers | $ | 2,829 | $ | 1,916 | $ | 871 | $ | 934 | $ | — | $ | 6,550 | $ | 366 | $ | — | $ | 6,916 | |||||||||||||||||
Sales through Direct to Consumer | 1,316 | 691 | 508 | 336 | — | 2,851 | 133 | — | 2,984 | ||||||||||||||||||||||||||
Other(1) | — | — | — | — | 16 | 16 | 28 | 4 | 48 | ||||||||||||||||||||||||||
TOTAL REVENUES | $ | 4,145 | $ | 2,607 | $ | 1,379 | $ | 1,270 | $ | 16 | $ | 9,417 | $ | 527 | $ | 4 | $ | 9,948 | |||||||||||||||||
(1) | Other revenues for Global Brand Divisions and Converse are primarily attributable to licensing businesses. Corporate revenues primarily consist of foreign currency hedge gains and losses related to revenues generated by entities within the NIKE Brand geographic operating segments and Converse but managed through the Company’s central foreign exchange risk management program. |
Sales-related Reserves
Consideration promised in the Company’s contracts with customers includes a variable amount related to anticipated sales returns, discounts and miscellaneous claims from customers. This variable consideration is estimated and recorded as a reduction to Revenues and as Accrued liabilities at the time revenues are recognized. The estimated cost of inventory for product returns is recorded in Prepaid expenses and other current assets on the Unaudited Condensed Consolidated Balance Sheets.
The provision for anticipated sales returns consists of both contractual return rights and discretionary authorized returns. Provisions for post-invoice sales discounts consist of both contractual programs and discretionary discounts that are expected to be granted at a later date.
Estimates of discretionary authorized returns, discounts and claims are based on (1) historical rates, (2) specific identification of outstanding returns not yet received from customers and outstanding discounts and claims and (3) estimated returns, discounts and claims expected, but not yet finalized with customers. Actual returns, discounts and claims in any future period are inherently uncertain and thus may differ from estimates recorded. If actual or expected future returns, discounts or claims were significantly greater or lower than the reserves established, a reduction or increase to net revenues would be recorded in the period in which such determination was made. At August 31, 2018, the Company’s sales-related reserve balance, which includes returns, post-invoice sales discounts and miscellaneous claims was 1,048 million and recorded in Accrued liabilities on the Unaudited Condensed Consolidated Balance Sheets. The estimated cost of inventory for expected product returns was $367 million and recorded within Prepaid expenses and other current assets on the Unaudited Condensed Consolidated Balance Sheets. At May 31, 2018, the Company’s sales-related reserve balance, which includes returns, post-invoice sales discounts and miscellaneous claims, was $675 million, net of the estimated cost of inventory for product returns, and recognized as a reduction in Accounts receivable, net on the Condensed Consolidated Balance Sheets.
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Note 12 — 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. 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.
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 represent 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 August 31, | ||||||||
(In millions) | 2018 | 2017 | ||||||
REVENUES | ||||||||
North America | $ | 4,145 | $ | 3,924 | ||||
Europe, Middle East & Africa | 2,607 | 2,344 | ||||||
Greater China | 1,379 | 1,108 | ||||||
Asia Pacific & Latin America | 1,270 | 1,189 | ||||||
Global Brand Divisions | 16 | 20 | ||||||
Total NIKE Brand | 9,417 | 8,585 | ||||||
Converse | 527 | 483 | ||||||
Corporate | 4 | 2 | ||||||
TOTAL NIKE, INC. REVENUES | $ | 9,948 | $ | 9,070 | ||||
EARNINGS BEFORE INTEREST AND TAXES | ||||||||
North America | $ | 1,077 | $ | 1,002 | ||||
Europe, Middle East & Africa | 501 | 451 | ||||||
Greater China | 502 | 394 | ||||||
Asia Pacific & Latin America | 323 | 260 | ||||||
Global Brand Divisions | (818 | ) | (675 | ) | ||||
Total NIKE Brand | 1,585 | 1,432 | ||||||
Converse | 98 | 89 | ||||||
Corporate | (402 | ) | (433 | ) | ||||
Total NIKE, Inc. Earnings Before Interest and Taxes | 1,281 | 1,088 | ||||||
Interest expense (income), net | 11 | 16 | ||||||
TOTAL NIKE, INC. INCOME BEFORE INCOME TAXES | $ | 1,270 | $ | 1,072 | ||||
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As of August 31, | As of May 31, | |||||||
(In millions) | 2018 | 2018 | ||||||
ACCOUNTS RECEIVABLE, NET(1) | ||||||||
North America | $ | 1,650 | $ | 1,443 | ||||
Europe, Middle East & Africa | 1,233 | 870 | ||||||
Greater China | 280 | 101 | ||||||
Asia Pacific & Latin America | 753 | 720 | ||||||
Global Brand Divisions | 118 | 102 | ||||||
Total NIKE Brand | 4,034 | 3,236 | ||||||
Converse | 273 | 240 | ||||||
Corporate | 23 | 22 | ||||||
TOTAL ACCOUNTS RECEIVABLE, NET | $ | 4,330 | $ | 3,498 | ||||
INVENTORIES | ||||||||
North America | $ | 2,214 | $ | 2,270 | ||||
Europe, Middle East & Africa | 1,310 | 1,433 | ||||||
Greater China | 652 | 580 | ||||||
Asia Pacific & Latin America | 714 | 687 | ||||||
Global Brand Divisions | 91 | 91 | ||||||
Total NIKE Brand | 4,981 | 5,061 | ||||||
Converse | 239 | 268 | ||||||
Corporate | 7 | (68 | ) | |||||
TOTAL INVENTORIES | $ | 5,227 | $ | 5,261 | ||||
PROPERTY, PLANT AND EQUIPMENT, NET | ||||||||
North America | $ | 835 | $ | 848 | ||||
Europe, Middle East & Africa | 867 | 849 | ||||||
Greater China | 238 | 256 | ||||||
Asia Pacific & Latin America | 324 | 339 | ||||||
Global Brand Divisions | 599 | 597 | ||||||
Total NIKE Brand | 2,863 | 2,889 | ||||||
Converse | 112 | 115 | ||||||
Corporate | 1,512 | 1,450 | ||||||
TOTAL PROPERTY, PLANT AND EQUIPMENT, NET | $ | 4,487 | $ | 4,454 | ||||
(1) | Accounts receivable, net as of August 31, 2018 reflects the Company’s fiscal 2019 adoption of Topic 606. Refer to Note 1 — Summary of Significant Accounting Policies for additional information on the adoption of the new standard. |
Note 13 — Commitments and Contingencies |
As of August 31, 2018, the Company had letters of credit outstanding totaling $169 million. These letters of credit were issued primarily for the purchase of inventory and guarantees of the Company’s performance under certain self-insurance and other programs.
There have been no other significant subsequent developments relating to the commitments and contingencies reported on the Company’s latest Annual Report on Form 10-K.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
NIKE designs, develops, markets and sells athletic footwear, apparel, equipment, accessories and services worldwide. We are the largest seller of athletic footwear and apparel in the world. We sell our products through NIKE-owned retail stores and through digital platforms (which we refer to collectively as our “NIKE Direct” operations), to retail accounts and a mix of independent distributors, licensees and sales representatives in virtually all countries around the world. Our goal is to deliver value to our shareholders by building a profitable global portfolio of branded footwear, apparel, equipment and accessories businesses. Our strategy is to achieve long-term revenue growth by creating innovative, “must have” products, building deep personal consumer connections with our brands and delivering compelling consumer experiences through digital platforms and at retail. In fiscal 2018, we introduced the Consumer Direct Offense, a new company alignment designed to allow NIKE to better serve the consumer more personally, at scale. Through the Consumer Direct Offense, we are focusing on our Triple Double strategy, with the objective of doubling the impact of innovation, increasing our speed to market and direct connections with consumers.
For the first quarter of fiscal 2019, NIKE, Inc. Revenues increased 10% to $9.9 billion compared to $9.1 billion for the first quarter of fiscal 2018. On a currency-neutral basis, Revenues increased 9%. Net income was $1,092 million and diluted earnings per common share was $0.67 compared to Net income of $950 million and diluted earnings per common share of $0.57 for the first quarter of fiscal 2018.
Income before income taxes increased 18% compared to the first quarter of fiscal 2018, primarily driven by revenue growth, selling and administrative expense leverage and gross margin expansion. The NIKE Brand, which represents over 90% of NIKE, Inc. Revenues, delivered 10% revenue growth on both a reported and currency-neutral basis. On a currency-neutral basis, the growth in NIKE Brand revenues was driven by higher revenues across all geographies and growth in nearly every category, led by Sportswear. Revenues for Converse increased 9% and 7% on a reported and currency-neutral basis, respectively, primarily due to higher revenues in Europe and Asia.
Our effective tax rate was 14.0% for the first quarter of fiscal 2019 compared to 11.4% for the first quarter of fiscal 2018, reflecting the impact of the new U.S. statutory rate and implemented provisions of the U.S. Tax Cuts and Jobs Act.
Diluted earnings per common share reflects a 3% decline in the diluted weighted average common shares outstanding compared to the first quarter of fiscal 2018, primarily driven by our share repurchase program.
While foreign currency markets remain volatile, partly as a result of global trade uncertainty and geopolitical dynamics, we continue to see opportunities to drive future growth and profitability and remain committed to effectively managing our business to achieve our financial goals over the long-term by executing against the operational strategies outlined above.
Use of Non-GAAP Financial Measures
Throughout this Quarterly Report on Form 10-Q, we discuss non-GAAP financial measures, including references to wholesale equivalent revenues and currency-neutral revenues, which should be considered in addition to, and not in lieu of, the financial measures calculated and presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). References to wholesale equivalent revenues are intended to provide context as to the total size of our NIKE Brand market footprint if we had no NIKE Direct operations. NIKE Brand wholesale equivalent revenues consist of (1) sales to external wholesale customers and (2) internal sales from our wholesale operations to our NIKE Direct operations, which are charged at prices comparable to those charged to external wholesale customers. Additionally, currency-neutral revenues are calculated using actual exchange rates in use during the comparative prior year period to enhance the visibility of the underlying business trends excluding the impact of translation arising from foreign currency exchange rate fluctuations.
Management uses these non-GAAP financial measures when evaluating the Company’s performance, including when making financial and operating decisions. Additionally, management believes these non-GAAP financial measures provide investors with additional financial information that should be considered when assessing our underlying business performance and trends. However, references to wholesale equivalent revenues and currency-neutral revenues should not be considered in isolation or as a substitute for other financial measures calculated and presented in accordance with U.S. GAAP and may not be comparable to similarly titled non-GAAP measures used by other companies.
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Results of Operations |
Three Months Ended August 31, | |||||||||||
(Dollars in millions, except per share data) | 2018 | 2017 | % Change | ||||||||
Revenues | $ | 9,948 | $ | 9,070 | 10 | % | |||||
Cost of sales | 5,551 | 5,108 | 9 | % | |||||||
Gross profit | 4,397 | 3,962 | 11 | % | |||||||
Gross margin | 44.2 | % | 43.7 | % | |||||||
Demand creation expense | 964 | 855 | 13 | % | |||||||
Operating overhead expense | 2,099 | 2,001 | 5 | % | |||||||
Total selling and administrative expense | 3,063 | 2,856 | 7 | % | |||||||
% of revenues | 30.8 | % | 31.5 | % | |||||||
Interest expense (income), net | 11 | 16 | — | ||||||||
Other expense (income), net | 53 | 18 | — | ||||||||
Income before income taxes | 1,270 | 1,072 | 18 | % | |||||||
Income tax expense | |||||||||||