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, 2017
☐ 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☑ | Accelerated filer | ☐ | |
Non-accelerated filer | ☐ | (Do not check if a smaller reporting company) | Smaller Reporting Company | ☐ |
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 March 31, 2017 were:
Class A | 329,245,752 | |
Class B | 1,321,520,800 | |
1,650,766,552 | ||
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) | 2017 | 2016 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and equivalents | $ | 4,021 | $ | 3,138 | ||||
Short-term investments | 2,139 | 2,319 | ||||||
Accounts receivable, net | 3,752 | 3,241 | ||||||
Inventories | 4,932 | 4,838 | ||||||
Prepaid expenses and other current assets | 1,361 | 1,489 | ||||||
Total current assets | 16,205 | 15,025 | ||||||
Property, plant and equipment, net | 3,793 | 3,520 | ||||||
Identifiable intangible assets, net | 283 | 281 | ||||||
Goodwill | 139 | 131 | ||||||
Deferred income taxes and other assets | 2,732 | 2,422 | ||||||
TOTAL ASSETS | $ | 23,152 | $ | 21,379 | ||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Current portion of long-term debt | $ | 6 | $ | 44 | ||||
Notes payable | 23 | 1 | ||||||
Accounts payable | 1,938 | 2,191 | ||||||
Accrued liabilities | 3,228 | 3,037 | ||||||
Income taxes payable | 76 | 85 | ||||||
Total current liabilities | 5,271 | 5,358 | ||||||
Long-term debt | 3,472 | 1,993 | ||||||
Deferred income taxes and other liabilities | 1,687 | 1,770 | ||||||
Commitments and contingencies | ||||||||
Redeemable preferred stock | — | — | ||||||
Shareholders’ equity: | ||||||||
Common stock at stated value: | ||||||||
Class A convertible — 329 and 353 shares outstanding | — | — | ||||||
Class B — 1,323 and 1,329 shares outstanding | 3 | 3 | ||||||
Capital in excess of stated value | 8,395 | 7,786 | ||||||
Accumulated other comprehensive income | 229 | 318 | ||||||
Retained earnings | 4,095 | 4,151 | ||||||
Total shareholders’ equity | 12,722 | 12,258 | ||||||
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY | $ | 23,152 | $ | 21,379 | ||||
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 | Nine Months Ended | |||||||||||||||
(In millions, except per share data) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||
Revenues | $ | 8,432 | $ | 8,032 | $ | 25,673 | $ | 24,132 | ||||||||
Cost of sales | 4,682 | 4,343 | 14,184 | 12,947 | ||||||||||||
Gross profit | 3,750 | 3,689 | 11,489 | 11,185 | ||||||||||||
Demand creation expense | 749 | 804 | 2,552 | 2,405 | ||||||||||||
Operating overhead expense | 1,747 | 1,762 | 5,346 | 5,298 | ||||||||||||
Total selling and administrative expense | 2,496 | 2,566 | 7,898 | 7,703 | ||||||||||||
Interest expense (income), net | 19 | 5 | 41 | 14 | ||||||||||||
Other (income) expense, net | (88 | ) | (17 | ) | (168 | ) | (82 | ) | ||||||||
Income before income taxes | 1,323 | 1,135 | 3,718 | 3,550 | ||||||||||||
Income tax expense | 182 | 185 | 486 | 636 | ||||||||||||
NET INCOME | $ | 1,141 | $ | 950 | $ | 3,232 | $ | 2,914 | ||||||||
Earnings per common share: | ||||||||||||||||
Basic | $ | 0.69 | $ | 0.56 | $ | 1.95 | $ | 1.71 | ||||||||
Diluted | $ | 0.68 | $ | 0.55 | $ | 1.91 | $ | 1.67 | ||||||||
Dividends declared per common share | $ | 0.18 | $ | 0.16 | $ | 0.52 | $ | 0.46 | ||||||||
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 | Nine Months Ended | |||||||||||||||
(In millions) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||
Net income | $ | 1,141 | $ | 950 | $ | 3,232 | $ | 2,914 | ||||||||
Other comprehensive income (loss), net of tax: | ||||||||||||||||
Change in net foreign currency translation adjustment | 12 | (111 | ) | 1 | (221 | ) | ||||||||||
Change in net gains (losses) on cash flow hedges | (175 | ) | (350 | ) | (92 | ) | (389 | ) | ||||||||
Change in net gains (losses) on other | (7 | ) | (1 | ) | 2 | 9 | ||||||||||
Total other comprehensive income (loss), net of tax | (170 | ) | (462 | ) | (89 | ) | (601 | ) | ||||||||
TOTAL COMPREHENSIVE INCOME | $ | 971 | $ | 488 | $ | 3,143 | $ | 2,313 | ||||||||
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 |
Nine Months Ended | ||||||||
(In millions) | February 28, 2017 | February 29, 2016 | ||||||
Cash provided by operations: | ||||||||
Net income | $ | 3,232 | $ | 2,914 | ||||
Income charges (credits) not affecting cash: | ||||||||
Depreciation | 521 | 481 | ||||||
Deferred income taxes | (199 | ) | (6 | ) | ||||
Stock-based compensation | 162 | 176 | ||||||
Amortization and other | 7 | 18 | ||||||
Net foreign currency adjustments | (90 | ) | 192 | |||||
Changes in certain working capital components and other assets and liabilities: | ||||||||
(Increase) in accounts receivable | (546 | ) | (124 | ) | ||||
(Increase) in inventories | (157 | ) | (359 | ) | ||||
(Increase) in prepaid expenses and other current assets | (152 | ) | (149 | ) | ||||
(Decrease) in accounts payable, accrued liabilities and income taxes payable | (27 | ) | (1,231 | ) | ||||
Cash provided by operations | 2,751 | 1,912 | ||||||
Cash used by investing activities: | ||||||||
Purchases of short-term investments | (4,029 | ) | (3,759 | ) | ||||
Maturities of short-term investments | 2,433 | 2,021 | ||||||
Sales of short-term investments | 1,905 | 1,939 | ||||||
Investments in reverse repurchase agreements | — | 150 | ||||||
Additions to property, plant and equipment | (776 | ) | (901 | ) | ||||
Disposals of property, plant and equipment | 13 | 9 | ||||||
Other investing activities | (34 | ) | (3 | ) | ||||
Cash used by investing activities | (488 | ) | (544 | ) | ||||
Cash used by financing activities: | ||||||||
Net proceeds from long-term debt issuance | 1,482 | 981 | ||||||
Long-term debt payments, including current portion | (43 | ) | (104 | ) | ||||
Increase (decrease) in notes payable | 24 | (68 | ) | |||||
Payments on capital lease obligations | (14 | ) | (5 | ) | ||||
Proceeds from exercise of stock options and other stock issuances | 339 | 370 | ||||||
Excess tax benefits from share-based payment arrangements | 125 | 231 | ||||||
Repurchase of common stock | (2,429 | ) | (2,698 | ) | ||||
Dividends — common and preferred | (834 | ) | (752 | ) | ||||
Cash used by financing activities | (1,350 | ) | (2,045 | ) | ||||
Effect of exchange rate changes on cash and equivalents | (30 | ) | (131 | ) | ||||
Net increase (decrease) in cash and equivalents | 883 | (808 | ) | |||||
Cash and equivalents, beginning of period | 3,138 | 3,852 | ||||||
CASH AND EQUIVALENTS, END OF PERIOD | $ | 4,021 | $ | 3,044 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Non-cash additions to property, plant and equipment | $ | 248 | $ | 100 | ||||
Dividends declared and not paid | 303 | 270 | ||||||
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 | ||
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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, 2016 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, 2017 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 2017 presentation.
Recently Adopted Accounting Standards
In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-03, Interest — Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. The updated guidance requires debt issuance costs to be presented as a direct deduction from the carrying amount of the corresponding debt liability on the balance sheet. The Company adopted the standard on a retrospective basis in the first quarter of fiscal 2017. The adoption of this standard reduced both Deferred income taxes and other assets and Long-term debt by $17 million on the Unaudited Condensed Consolidated Balance Sheet as of May 31, 2016.
Recently Issued Accounting Standards
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 ASU is effective for the Company beginning June 1, 2018, using a modified retrospective approach, with the cumulative effect recognized through retained earnings at the date of adoption. Early adoption is permitted as of the beginning of an annual reporting period for which interim or annual financial statements have not been issued. The Company is evaluating the impact this update will have on its existing accounting policies and the Consolidated Financial Statements. The Company anticipates the updated guidance could have a material impact on the Consolidated Financial Statements at adoption through the recognition of a cumulative-effect adjustment to retained earnings of previously deferred charges.
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 updated guidance requires excess tax benefits and deficiencies from share-based payment awards to be recorded in income tax expense in the income statement. Currently, excess tax benefits and deficiencies are recognized in shareholders’ equity on the balance sheet. This change is required to be applied prospectively. In addition, the updated guidance also changes the accounting for statutory tax withholding requirements, classification in the statement of cash flows and provides an option to continue to estimate forfeitures or account for forfeitures as they occur. The Company will adopt the standard on June 1, 2017 and will elect to continue to estimate forfeitures. The Company continues to evaluate the impact this update will have on its existing accounting policies and the Consolidated Financial Statements. The ASU is expected to result in increased volatility to the Company’s income tax expense in future periods dependent upon, among other variables, the price of its common stock and the timing and volume of share-based payment award activity, such as employee exercises of stock options and vesting of restricted stock awards.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), that 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 is in the preliminary stages of the assessment of the effect the guidance will have on its existing accounting policies and the Consolidated Financial Statements, but 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, 2016 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.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), that 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 effective of initially applying the new standard recognized in retained earnings at the date of initial application. The Company is in the process of evaluating the new standard against its existing accounting policies, including the timing of revenue recognition, and its contracts with customers, to determine the effect the guidance will have on the Consolidated Financial Statements.
Note 2 — Inventories |
Inventory balances of $4,932 million and $4,838 million at February 28, 2017 and May 31, 2016, respectively, were substantially all finished goods.
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Note 3 — Accrued Liabilities |
Accrued liabilities included the following:
As of February 28, | As of May 31, | |||||||
(In millions) | 2017 | 2016 | ||||||
Compensation and benefits, excluding taxes | $ | 831 | $ | 943 | ||||
Endorsement compensation | 338 | 393 | ||||||
Dividends payable | 303 | 271 | ||||||
Collateral received from counterparties to hedging instruments | 293 | 105 | ||||||
Import and logistics costs | 257 | 198 | ||||||
Taxes other than income taxes | 189 | 159 | ||||||
Advertising and marketing | 137 | 119 | ||||||
Fair value of derivatives | 118 | 162 | ||||||
Other(1) | 762 | 687 | ||||||
TOTAL ACCRUED LIABILITIES | $ | 3,228 | $ | 3,037 | ||||
(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, 2017 and May 31, 2016. |
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 the 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 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 certain 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 nonperformance risk of the Company and that of its counterparties.
The Company’s fair value processes include controls that are designed to ensure appropriate fair values are recorded. These controls include a comparison of fair values to another independent pricing vendor.
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The following tables present information about the Company’s financial assets measured at fair value on a recurring basis as of February 28, 2017 and May 31, 2016, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of February 28, 2017 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 610 | $ | 610 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 1,195 | 150 | 1,045 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 839 | 812 | 27 | — | ||||||||||||
U.S. Agency securities | 633 | 260 | 373 | — | ||||||||||||
Commercial paper and bonds | 854 | 160 | 694 | — | ||||||||||||
Money market funds | 2,029 | 2,029 | — | — | ||||||||||||
Total Level 2: | 4,355 | 3,261 | 1,094 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 10 | — | — | 10 | ||||||||||||
TOTAL | $ | 6,170 | $ | 4,021 | $ | 2,139 | $ | 10 | ||||||||
As of May 31, 2016 | ||||||||||||||||
(In millions) | Assets at Fair Value | Cash and Equivalents | Short-term Investments | Other Long-term Assets | ||||||||||||
Cash | $ | 774 | $ | 774 | $ | — | $ | — | ||||||||
Level 1: | ||||||||||||||||
U.S. Treasury securities | 1,265 | 100 | 1,165 | — | ||||||||||||
Level 2: | ||||||||||||||||
Time deposits | 831 | 827 | 4 | — | ||||||||||||
U.S. Agency securities | 679 | — | 679 | — | ||||||||||||
Commercial paper and bonds | 733 | 262 | 471 | — | ||||||||||||
Money market funds | 1,175 | 1,175 | — | — | ||||||||||||
Total Level 2: | 3,418 | 2,264 | 1,154 | — | ||||||||||||
Level 3: | ||||||||||||||||
Non-marketable preferred stock | 10 | — | — | 10 | ||||||||||||
TOTAL | $ | 5,467 | $ | 3,138 | $ | 2,319 | $ | 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 (refer to Note 9 — Risk Management and Derivatives). 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 (refer to Note 9 — Risk Management and Derivatives). 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.
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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 February 28, 2017 and May 31, 2016, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
As of February 28, 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) | $ | 607 | $ | 493 | $ | 114 | $ | 116 | $ | 114 | $ | 2 | ||||||||||||
Embedded derivatives | 9 | 1 | 8 | 10 | 4 | 6 | ||||||||||||||||||
TOTAL | $ | 616 | $ | 494 | $ | 122 | $ | 126 | $ | 118 | $ | 8 | ||||||||||||
(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 $114 million as of February 28, 2017. As of that date, the Company had received $293 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 February 28, 2017. |
As of May 31, 2016 | ||||||||||||||||||||||||
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) | $ | 603 | $ | 487 | $ | 116 | $ | 145 | $ | 115 | $ | 30 | ||||||||||||
Embedded derivatives | 7 | 2 | 5 | 9 | 2 | 7 | ||||||||||||||||||
Interest rate swaps(2) | 7 | 7 | — | 45 | 45 | — | ||||||||||||||||||
TOTAL | $ | 617 | $ | 496 | $ | 121 | $ | 199 | $ | 162 | $ | 37 | ||||||||||||
(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 $136 million as of May 31, 2016. As of that date, the Company had received $105 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, 2016. |
(2) | As of May 31, 2016, no amount of cash collateral had been received or posted on the derivative asset or liability balance related to the Company's interest rate swaps. |
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, 2017, the Company held $1,915 million of available-for-sale securities with maturity dates within one year and $224 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, 2017 and February 29, 2016. Unrealized gains and losses on available-for-sale securities included in Accumulated other comprehensive income were immaterial as of February 28, 2017 and May 31, 2016. The Company regularly reviews its available-for-sale securities for other-than-temporary impairment. For the nine months ended February 28, 2017 and February 29, 2016, 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, 2017 and February 29, 2016 was interest income related to the Company's available-for-sale securities of $8 million and $4 million, respectively, and $17 million and $8 million for the nine months ended February 28, 2017 and February 29, 2016, 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, 2017 and the fiscal year ended May 31, 2016.
No transfers among levels within the fair value hierarchy occurred during the nine months ended February 28, 2017 and the fiscal year ended May 31, 2016.
Derivative financial instruments include foreign exchange forwards and options, embedded derivatives and interest rate swaps. Refer to Note 9 — Risk Management and Derivatives for additional detail.
As of February 28, 2017 and May 31, 2016, 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
For fair value information regarding Long-term debt, refer to Note 5 — Long-Term Debt.
The carrying amounts reflected on the Unaudited Condensed Consolidated Balance Sheets for Notes payable approximate fair value.
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Note 5 — Long-Term Debt |
Long-term debt, net of unamortized premiums, discounts and debt issuance costs, comprises the following:
Original Principal | Interest Rate | Interest Payments | Book Value Outstanding as of | ||||||||||||||
Scheduled Maturity (Dollars and Yen in millions) | February 28, 2017 | May 31, 2016 | |||||||||||||||
Corporate Bond Payables:(1) | |||||||||||||||||
May 1, 2023(2) | $ | 500 | 2.25 | % | Semi-Annually | $ | 497 | $ | 497 | ||||||||
November 1, 2026(3) | $ | 1,000 | 2.38 | % | Semi-Annually | 993 | — | ||||||||||
May 1, 2043(2) | $ | 500 | 3.63 | % | Semi-Annually | 495 | 494 | ||||||||||
November 1, 2045(4) | $ | 1,000 | 3.88 | % | Semi-Annually | 981 | 981 | ||||||||||
November 1, 2046(3) | $ | 500 | 3.38 | % | Semi-Annually | 490 | — | ||||||||||
Promissory Notes: | |||||||||||||||||
April 1, 2017(5) | $ | 40 | 6.20 | % | Monthly | — | 38 | ||||||||||
Japanese Yen Notes: | |||||||||||||||||
August 20, 2001 through November 20, 2020(6) | ¥ | 9,000 | 2.60 | % | Quarterly | 15 | 18 | ||||||||||
August 20, 2001 through November 20, 2020(6) | ¥ | 4,000 | 2.00 | % | Quarterly | 7 | 9 | ||||||||||
Total | 3,478 | 2,037 | |||||||||||||||
Less current maturities | 6 | 44 | |||||||||||||||
TOTAL LONG-TERM DEBT | $ | 3,472 | $ | 1,993 | |||||||||||||
(1) | These senior unsecured obligations rank equally with the Company's other unsecured and unsubordinated indebtedness. |
(2) | The bonds are redeemable at the Company's option prior to February 1, 2023 and November 1, 2042, respectively, at a price equal to the greater of (i) 100% of the aggregate principal amount of the notes to be redeemed or (ii) the sum of the present values of the remaining scheduled payments, plus in each case, accrued and unpaid interest. Subsequent to February 1, 2023 and November 1, 2042, respectively, the bonds also feature a par call provision, which allows for the bonds to be redeemed at a price equal to 100% of the aggregate principal amount of the notes being redeemed, plus accrued and unpaid interest. |
(3) | The bonds are redeemable at the Company's option prior to August 1, 2026 and May 1, 2046, respectively, at a price equal to the greater of (i) 100% of the aggregate principal amount of the notes to be redeemed or (ii) the sum of the present values of the remaining scheduled payments, plus in each case, accrued and unpaid interest. Subsequent to August 1, 2026 and May 1, 2046, respectively, the bonds also feature a par call provision, which allows for the bonds to be redeemed at a price equal to 100% of the aggregate principal amount of the notes being redeemed, plus accrued and unpaid interest. |
(4) | The bonds are redeemable at the Company's option prior to May 1, 2045, at a price equal to the greater of (i) 100% of the aggregate principal amount of the notes to be redeemed or (ii) the sum of the present values of the remaining scheduled payments, plus in each case, accrued and unpaid interest. Subsequent to May 1, 2045, the bonds also feature a par call provision, which allows for the bonds to be redeemed at a price equal to 100% of the aggregate principal amount of the notes being redeemed, plus accrued and unpaid interest. |
(5) | During the three months ended February 28, 2017, the Company repaid the notes due April 1, 2017 pursuant to the terms of the debt agreement. |
(6) | NIKE Logistics YK assumed a total of ¥13 billion in loans as part of its agreement to purchase a distribution center in Japan, which serves as collateral for the loans. These loans mature in equal quarterly installments during the period August 20, 2001 through November 20, 2020. |
The scheduled maturity of Long-term debt in each of the twelve month periods ending February 28, 2018 through 2022 are $6 million, $6 million, $6 million, $4 million and $0 million, respectively, at face 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 $3,355 million at February 28, 2017 and $2,125 million at May 31, 2016.
Note 6 — Income Taxes |
The effective tax rate was 13.1% and 17.9% for the nine months ended February 28, 2017 and February 29, 2016, respectively. The decrease in the Company's effective tax rate was primarily due to a discrete benefit related to the resolution of a foreign tax credit matter with the U.S. Internal Revenue Service (IRS). The Company also benefited from a reduction in tax reserves related to foreign operations.
As of February 28, 2017, total gross unrecognized tax benefits, excluding related interest and penalties, were $421 million, $183 million of which would affect the Company’s effective tax rate if recognized in future periods. As of May 31, 2016, total gross unrecognized tax benefits, excluding related interest and penalties, were $506 million. The liability for payment of interest and penalties decreased $36 million during the nine months ended February 28, 2017. As of February 28, 2017 and May 31, 2016, accrued interest and penalties related to uncertain tax positions were $173 million and $209 million, respectively (excluding federal benefit).
The Company incurs tax liabilities primarily in the United States, China and the Netherlands, as well as various state and other foreign jurisdictions. The Company is currently under audit by the IRS for fiscal years 2013 through 2016. As previously disclosed, the Company received statutory notices of deficiency for fiscal 2011 and fiscal 2012 proposing a total increase in tax of $254 million, subject to interest, related to a foreign tax credit matter. The Company contested these deficiencies by filing petitions with the U.S. Tax Court. During the three months ended August 31, 2016, the Company reached a resolution with the IRS on this matter. Decisions were subsequently filed in U.S. District Tax Court stating there is no deficiency in income tax due from the Company. The Company has now resolved all U.S. federal income tax matters through fiscal 2012.
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The Company’s major foreign jurisdictions, China and the Netherlands, have concluded substantially all income tax matters through calendar 2006 and fiscal 2010, 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 $168 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 stock options and other 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 Operating overhead expense over the vesting period using the straight-line method.
The following table summarizes the Company’s total stock-based compensation expense recognized in Operating overhead expense:
Three Months Ended | Nine Months Ended | |||||||||||||||
(In millions) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||
Stock options(1) | $ | 35 | $ | 44 | $ | 110 | $ | 128 | ||||||||
ESPPs | 7 | 7 | 27 | 22 | ||||||||||||
Restricted stock | 9 | 9 | 25 | 26 | ||||||||||||
TOTAL STOCK-BASED COMPENSATION EXPENSE | $ | 51 | $ | 60 | $ | 162 | $ | 176 | ||||||||
(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 $3 million and $8 million for the three months ended February 28, 2017 and February 29, 2016, respectively, and $11 million and $22 million for the nine months ended February 28, 2017 and February 29, 2016, respectively. |
As of February 28, 2017, the Company had $236 million of unrecognized compensation costs from stock options, net of estimated forfeitures, to be recognized in Operating overhead expense 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, 2017 and February 29, 2016, computed as of the grant date using the Black-Scholes pricing model, was $9.38 and $12.67, respectively. The weighted average assumptions used to estimate these fair values were as follows:
Nine Months Ended | ||||||
February 28, 2017 | February 29, 2016 | |||||
Dividend yield | 1.1 | % | 1.0 | % | ||
Expected volatility | 17.4 | % | 23.6 | % | ||
Weighted average expected life (in years) | 6.0 | 5.8 | ||||
Risk-free interest rate | 1.3 | % | 1.7 | % | ||
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. The computations of diluted earnings per common share excluded options, including shares under employee stock purchase plans (ESPPs), to purchase an additional 31.1 million and 20.1 million shares of common stock outstanding for the three months ended February 28, 2017 and February 29, 2016, respectively, and 31.0 million and 1.1 million shares of common stock outstanding for the nine months ended February 28, 2017 and February 29, 2016, respectively, because the options were anti-dilutive.
Three Months Ended | Nine Months Ended | |||||||||||||||
(In millions, except per share data) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||
Determination of shares: | ||||||||||||||||
Weighted average common shares outstanding | 1,653.1 | 1,693.8 | 1,661.5 | 1,703.2 | ||||||||||||
Assumed conversion of dilutive stock options and awards | 33.2 | 43.5 | 34.9 | 45.3 | ||||||||||||
DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING | 1,686.3 | 1,737.3 | 1,696.4 | 1,748.5 | ||||||||||||
Earnings per common share: | ||||||||||||||||
Basic | $ | 0.69 | $ | 0.56 | $ | 1.95 | $ | 1.71 | ||||||||
Diluted | $ | 0.68 | $ | 0.55 | $ | 1.91 | $ | 1.67 | ||||||||
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 or liabilities or forecasted transactions.
The majority of derivatives outstanding as of February 28, 2017 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, 2017 and May 31, 2016:
Derivative Assets | Derivative Liabilities | |||||||||||||||||||
(In millions) | Balance Sheet Location | February 28, 2017 | May 31, 2016 | Balance Sheet Location | February 28, 2017 | May 31, 2016 | ||||||||||||||
Derivatives formally designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | $ | 366 | $ | 447 | Accrued liabilities | $ | 35 | $ | 38 | ||||||||||
Interest rate swaps | Prepaid expenses and other current assets | — | 7 | Accrued liabilities | — | 45 | ||||||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | 100 | 90 | Deferred income taxes and other liabilities | 2 | 12 | ||||||||||||||
Total derivatives formally designated as hedging instruments | 466 | 544 | 37 | 95 | ||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||
Foreign exchange forwards and options | Prepaid expenses and other current assets | 127 | 40 | Accrued liabilities | 79 | 76 | ||||||||||||||
Embedded derivatives | Prepaid expenses and other current assets | 1 | 2 | Accrued liabilities | 4 | 2 | ||||||||||||||
Foreign exchange forwards and options | Deferred income taxes and other assets | 14 | 26 | Deferred income taxes and other liabilities | — | 19 | ||||||||||||||
Embedded derivatives | Deferred income taxes and other assets | 8 | 5 | Deferred income taxes and other liabilities | 6 | 7 | ||||||||||||||
Total derivatives not designated as hedging instruments | 150 | 73 | 89 | 104 | ||||||||||||||||
TOTAL DERIVATIVES | $ | 616 | $ | 617 | $ | 126 | $ | 199 | ||||||||||||
The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three and nine months ended February 28, 2017 and February 29, 2016:
(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 | Location of Gain (Loss) Reclassified From Accumulated Other Comprehensive Income into Income | Three Months Ended | |||||||||||||||
February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||||
Derivatives designated as cash flow hedges: | |||||||||||||||||
Foreign exchange forwards and options | $ | 5 | $ | 107 | Revenues | $ | 24 | $ | (24 | ) | |||||||
Foreign exchange forwards and options | (5 | ) | (142 | ) | Cost of sales | 87 | 153 | ||||||||||
Foreign exchange forwards and options | (3 | ) | — | Total selling and administrative expense | — | — | |||||||||||
Foreign exchange forwards and options | 4 | (91 | ) | Other (income) expense, net | 67 | 73 | |||||||||||
Interest rate swaps | — | (49 | ) | Interest expense (income), net | (2 | ) | — | ||||||||||
Total designated cash flow hedges | $ | 1 | $ | (175 | ) | $ | 176 | $ | 202 | ||||||||
(1) | For the three months ended February 28, 2017 and February 29, 2016, 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. |
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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 | Location of Gain (Loss) Reclassified From Accumulated Other Comprehensive Income into Income | Nine Months Ended | |||||||||||||||
February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||||
Derivatives designated as cash flow hedges: | |||||||||||||||||
Foreign exchange forwards and options | $ | 45 | $ | 97 | Revenues | $ | 96 | $ | (99 | ) | |||||||
Foreign exchange forwards and options | 244 | 63 | Cost of sales | 260 | 451 | ||||||||||||
Foreign exchange forwards and options | (1 | ) | — | Total selling and administrative expense | — | — | |||||||||||
Foreign exchange forwards and options | 149 | 31 | Other (income) expense, net | 141 | 173 | ||||||||||||
Interest rate swaps | (54 | ) | (99 | ) | Interest expense (income), net | (2 | ) | — | |||||||||
Total designated cash flow hedges | $ | 383 | $ | 92 | $ | 495 | $ | 525 | |||||||||
(1) | For the nine months ended February 28, 2017 and February 29, 2016, 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. |
Amount of Gain (Loss) Recognized in Income on Derivatives | Location of Gain (Loss) Recognized in Income on Derivatives | |||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||
(In millions) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||||
Derivatives designated as fair value hedges: | ||||||||||||||||||
Interest rate swaps(1) | $ | — | $ | — | $ | — | $ | 2 | Interest expense (income), net | |||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||
Foreign exchange forwards and options | (66 | ) | (30 | ) | 101 | 4 | Other (income) expense, net | |||||||||||
Embedded derivatives | (1 | ) | (3 | ) | (2 | ) | (3 | ) | Other (income) expense, net | |||||||||
(1) | All interest rate swaps designated as fair value hedges 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. Refer to “Fair Value Hedges” in this note for additional detail. |
Refer to Note 3 — Accrued Liabilities for derivative instruments recorded in Accrued liabilities, Note 4 — Fair Value Measurements for a description of how the above financial instruments are valued and Note 10 — Accumulated Other Comprehensive Income for additional information on changes in Accumulated other comprehensive income for the three and nine months ended February 28, 2017 and February 29, 2016.
Cash Flow Hedges
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 enter into derivative contracts formally designated as 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 $10.5 billion as of February 28, 2017.
16
During the second quarter of fiscal 2017, the Company terminated all forward-starting interest rate swap agreements with a total notional amount of $1.5 billion in connection with the October 21, 2016 debt issuance (refer to Note 5 — Long-Term Debt). Upon termination of these forward-starting swaps, the Company made cash payments to the related counterparties of $92 million, which was recorded in Accumulated other comprehensive income and will be released through Interest expense (income), net as interest expense is incurred over the term of the issued debt.
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. In most cases, amounts recorded in Accumulated other comprehensive income will be released to Net income in periods following the maturity of the related derivative, rather than at maturity. Effective hedge results are classified within the Unaudited Condensed Consolidated Statements of Income in the same manner as the underlying exposure. The results of hedges of non-functional currency denominated revenues and product cost exposures, excluding embedded derivatives, are recorded in Revenues or Cost of sales when the underlying hedged transaction affects consolidated Net income. Results of hedges of selling and administrative expense are recorded together with those costs when the related expense is recorded. Amounts recorded in Accumulated other comprehensive income related to forward-starting interest rate swaps will be released through Interest expense (income), net as interest expense is incurred over the term of the issued debt. Results of hedges of anticipated purchases of U.S. Dollar-denominated available-for-sale securities are recorded in Other (income) expense, net when the securities are sold. Results of hedges of certain anticipated intercompany transactions are recorded in Other (income) expense, net when the transaction occurs. The Company classifies the cash flows at settlement from these designated cash flow hedge derivatives in the same category as the cash flows from the related hedged items, primarily within the Cash provided by operations component of the Unaudited Condensed Consolidated Statements of Cash Flows.
Premiums paid or received on options are initially recorded as deferred charges or deferred credits, respectively. The Company assesses the effectiveness of options based on the total cash flows method and records total changes in the options’ fair value to Accumulated other comprehensive income to the degree they are effective.
The Company formally assesses, both at a hedge’s inception and on an ongoing basis, whether the derivatives that are used in the hedging transaction have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. Effectiveness for cash flow hedges is assessed based on changes in forward rates. Ineffectiveness was immaterial for the three and nine months ended February 28, 2017 and February 29, 2016.
The Company discontinues hedge accounting prospectively when: (1) it determines that the derivative is no longer highly effective in offsetting changes in the cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated or exercised; (3) it is no longer probable that the forecasted transaction will occur; or (4) management determines that designating the derivative as a hedging instrument is no longer appropriate.
When the Company discontinues hedge accounting because it is no longer probable that the forecasted transaction will occur in the originally expected period, but is expected to occur within an additional two-month period of time thereafter, the gain or loss on the derivative remains in Accumulated other comprehensive income and is reclassified to Net income when the forecasted transaction affects consolidated Net income. However, if it is probable that a forecasted transaction will not occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were in Accumulated other comprehensive income will be recognized immediately in Other (income) expense, net. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the Unaudited Condensed Consolidated Balance Sheets, recognizing future changes in the fair value in Other (income) expense, net. For the three and nine months ended February 28, 2017 and February 29, 2016, the amounts recorded in Other (income) expense, net as a result of the discontinuance of cash flow hedging because the forecasted transactions were no longer probable of occurring were immaterial.
As of February 28, 2017, $312 million of deferred net gains (net of tax) on both outstanding and matured derivatives in Accumulated other comprehensive income were 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, 2017, 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 cash flows associated with the Company’s fair value hedges are periodic interest payments while the swaps are outstanding, which are reflected within the Cash provided by operations component of the Unaudited Condensed Consolidated Statements of Cash Flows. The Company recorded no ineffectiveness from its interest rate swaps designated as fair value hedges for the three and nine months ended February 28, 2017 or February 29, 2016. On October 15, 2015, the Company repaid the long-term debt which had previously been hedged with these interest rate swaps. Accordingly, as of February 28, 2017, the Company had no interest rate swaps designated as fair value hedges.
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 Company classifies the cash flows at settlement of its net investment hedges within the Cash used by investing activities component of the Unaudited Condensed Consolidated Statements of Cash Flows. The Company assesses hedge effectiveness based on changes in forward rates. The Company recorded no ineffectiveness from its net investment hedges for the three and nine months ended February 28, 2017 or February 29, 2016. The Company had no outstanding net investment hedges as of February 28, 2017.
17
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 forwards are not designated as hedging instruments under U.S. GAAP. Accordingly, 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 or embedded derivative contract. The Company classifies the cash flows at settlement from undesignated instruments in the same category as the cash flows from the related hedged items, generally within the Cash provided by operations component of the Unaudited Condensed Consolidated Statements of Cash Flows. The total notional amount of outstanding undesignated derivative instruments was $6.6 billion as of February 28, 2017.
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. Embedded derivative contracts are treated as foreign currency forward contracts that are bifurcated from the related purchase order 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 from the date a purchase order is accepted by a factory through the date the purchase price is no longer subject to foreign currency fluctuations.
In addition, the Company has entered 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. These payment terms expose NIKE to variability in foreign exchange rates and create embedded derivative contracts that must be bifurcated from the related contract and recorded at fair value as derivative assets or liabilities on the Unaudited Condensed Consolidated Balance Sheets with their corresponding changes in fair value recognized in Other (income) expense, net until each payment is settled.
At February 28, 2017, the total notional amount of embedded derivatives outstanding was approximately $283 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 February 28, 2017, 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 $2 million. Accordingly, the Company was not required to post any collateral as a result of these contingent features. Further, as of February 28, 2017, the Company had received $293 million of cash collateral 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.
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, 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 gains (losses) before reclassifications(2) | 13 | 2 | — | — | 15 | |||||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | (1 | ) | (177 | ) | — | (7 | ) | (185 | ) | |||||||||||
Other comprehensive income (loss) | 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. |
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(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 gains (losses) before reclassifications(2) | 2 | 406 | — | 18 | 426 | |||||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | (1 | ) | (498 | ) | — | (16 | ) | (515 | ) | |||||||||||
Other comprehensive income (loss) | 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 changes in Accumulated other comprehensive income, net of tax, for the three and nine months ended February 29, 2016 were as follows:
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at November 30, 2015 | $ | (141 | ) | $ | 1,181 | $ | 115 | $ | (48 | ) | $ | 1,107 | ||||||||
Other comprehensive gains (losses) before reclassifications(2) | (113 | ) | (151 | ) | — | 3 | (261 | ) | ||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | 2 | (199 | ) | — | (4 | ) | (201 | ) | ||||||||||||
Other comprehensive income (loss) | (111 | ) | (350 | ) | — | (1 | ) | (462 | ) | |||||||||||
Balance at February 29, 2016 | $ | (252 | ) | $ | 831 | $ | 115 | $ | (49 | ) | $ | 645 | ||||||||
(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, $24 million, $0 million, $(1) million and $23 million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $3 million, $0 million, $0 million and $3 million, respectively. |
(In millions) | Foreign Currency Translation Adjustment(1) | Cash Flow Hedges | Net Investment Hedges(1) | Other | Total | |||||||||||||||
Balance at May 31, 2015 | $ | (31 | ) | $ | 1,220 | $ | 115 | $ | (58 | ) | $ | 1,246 | ||||||||
Other comprehensive gains (losses) before reclassifications(2) | (223 | ) | 132 | — | 14 | (77 | ) | |||||||||||||
Reclassifications to net income of previously deferred (gains) losses(3) | 2 | (521 | ) | — | (5 | ) | (524 | ) | ||||||||||||
Other comprehensive income (loss) | (221 | ) | (389 | ) | — | 9 | (601 | ) | ||||||||||||
Balance at February 29, 2016 | $ | (252 | ) | $ | 831 | $ | 115 | $ | (49 | ) | $ | 645 | ||||||||
(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, $40 million, $0 million, $(3) million and $37 million, respectively. |
(3) | Net of tax (benefit) expense of $0 million, $4 million, $0 million, $0 million and $4 million, respectively. |
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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 | Nine Months Ended | |||||||||||||||||
(In millions) | February 28, 2017 | February 29, 2016 | February 28, 2017 | February 29, 2016 | ||||||||||||||
Gains (losses) on foreign currency translation adjustment | $ | 1 | $ | (2 | ) | $ | 1 | $ | (2 | ) | Other (income) expense, net | |||||||
Total before tax | 1 | (2 | ) | 1 | (2 | ) | ||||||||||||
Tax (expense) benefit | — | — | — | — | ||||||||||||||
Gain (loss) net of tax | 1 | (2 | ) | 1 | (2 | ) | ||||||||||||
Gains (losses) on cash flow hedges: | ||||||||||||||||||
Foreign exchange forwards and options | $ | 24 | $ | (24 | ) | $ | 96 | $ | (99 | ) | Revenues | |||||||
Foreign exchange forwards and options | 87 | 153 | 260 | 451 | Cost of sales | |||||||||||||
Foreign exchange forwards and options | — | — | — | — | Total selling and administrative expense | |||||||||||||
Foreign exchange forwards and options | 67 | 73 | 141 | 173 | Other (income) expense, net | |||||||||||||
Interest rate swaps | (2 | ) | — | (2 | ) | — | Interest expense (income), net | |||||||||||
Total before tax | 176 | 202 | 495 | 525 | ||||||||||||||
Tax (expense) benefit | 1 | (3 | ) | 3 | (4 | ) | ||||||||||||
Gain (loss) net of tax | 177 | 199 | 498 | 521 | ||||||||||||||
Gains (losses) on other | 9 | 4 | 17 | 5 | Other (income) expense, net | |||||||||||||
Total before tax | 9 | 4 | 17 | 5 | ||||||||||||||
Tax (expense) benefit | (2 | ) | — | (1 | ) | — | ||||||||||||
Gain (loss) net of tax | 7 | 4 | 16 | 5 | ||||||||||||||
Total net gain (loss) reclassified for the period | $ | 185 | $ | 201 | $ | 515 | $ | 524 | ||||||||||
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. The Company’s reportable operating segments for the NIKE Brand are: North America, Western Europe, Central & Eastern Europe, Greater China, Japan and Emerging Markets, and include results for the NIKE, Jordan and Hurley brands. The Company’s NIKE Brand Direct to Consumer (DTC) operations are managed within each 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.
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Three Months Ended | Nine Months Ended | |||||||||||||||
(In millions) | February 28, 2017 | |||||||||||||||