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EX-32 - SECTION 906 CEO AND CFO CERTIFICATION - NIKE INCnke-8312016xexhibit32.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - NIKE INCnke-8312016xexhibit312.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - NIKE INCnke-8312016xexhibit311.htm
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, 2016
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
orangeswoosha07.jpg
 
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 October 6, 2016 were:
Class A
329,251,752

Class B
1,336,182,454

 
1,665,434,206




NIKE, INC.
FORM 10-Q
Table of Contents
 



PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
NIKE, Inc. Unaudited Condensed Consolidated Balance Sheets
 
 
August 31,
 
May 31,
(In millions)
 
2016
 
2016
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and equivalents
 
$
2,659

 
$
3,138

Short-term investments
 
2,128

 
2,319

Accounts receivable, net
 
3,526

 
3,241

Inventories
 
4,896

 
4,838

Prepaid expenses and other current assets
 
1,380

 
1,489

Total current assets
 
14,589

 
15,025

Property, plant and equipment, net
 
3,572

 
3,520

Identifiable intangible assets, net
 
284

 
281

Goodwill
 
139

 
131

Deferred income taxes and other assets
 
2,572

 
2,422

TOTAL ASSETS
 
$
21,156

 
$
21,379

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Current portion of long-term debt
 
$
44

 
$
44

Notes payable
 
22

 
1

Accounts payable
 
2,088

 
2,191

Accrued liabilities
 
3,147

 
3,037

Income taxes payable
 
62

 
85

Total current liabilities
 
5,363

 
5,358

Long-term debt
 
1,993

 
1,993

Deferred income taxes and other liabilities
 
1,635

 
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 — 1,339 and 1,329 shares outstanding
 
3

 
3

Capital in excess of stated value
 
7,999

 
7,786

Accumulated other comprehensive income
 
85

 
318

Retained earnings
 
4,078

 
4,151

Total shareholders’ equity
 
12,165

 
12,258

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
 
$
21,156

 
$
21,379

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.

3


NIKE, Inc. Unaudited Condensed Consolidated Statements of Income
 
 
Three Months Ended August 31,
(In millions, except per share data)
 
2016
 
2015
Revenues
 
$
9,061

 
$
8,414

Cost of sales
 
4,938

 
4,419

Gross profit
 
4,123

 
3,995

Demand creation expense
 
1,041

 
832

Operating overhead expense
 
1,856

 
1,745

Total selling and administrative expense
 
2,897

 
2,577

Interest expense (income), net
 
7

 
4

Other (income) expense, net
 
(62
)
 
(31
)
Income before income taxes
 
1,281

 
1,445

Income tax expense
 
32

 
266

NET INCOME
 
$
1,249

 
$
1,179

 
 
 
 
 
Earnings per common share:
 
 
 
 
Basic
 
$
0.75

 
$
0.69

Diluted
 
$
0.73

 
$
0.67

 
 
 
 
 
Dividends declared per common share
 
$
0.16

 
$
0.14

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.

4


NIKE, Inc. Unaudited Condensed Consolidated Statements of Comprehensive Income
 
 
Three Months Ended August 31,
(In millions)
 
2016
 
2015
Net income
 
$
1,249

 
$
1,179

Other comprehensive income (loss), net of tax:
 
 
 
 
Change in net foreign currency translation adjustment
 
3

 
(81
)
Change in net gains (losses) on cash flow hedges
 
(240
)
 
(329
)
Change in net gains (losses) on other
 
4

 
(3
)
Total other comprehensive income (loss), net of tax
 
(233
)
 
(413
)
TOTAL COMPREHENSIVE INCOME
 
$
1,016

 
$
766

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.


5


NIKE, Inc. Unaudited Condensed Consolidated Statements of Cash Flows
 
 
Three Months Ended August 31,
(In millions)
 
2016
 
2015
Cash provided by operations:
 
 
 
 
Net income
 
$
1,249

 
$
1,179

Income charges (credits) not affecting cash:
 
 
 
 
Depreciation
 
173

 
154

Deferred income taxes
 
(50
)
 
(31
)
Stock-based compensation
 
57

 
54

Amortization and other
 
7

 
11

Net foreign currency adjustments
 
(61
)
 
32

Changes in certain working capital components and other assets and liabilities:
 
 
 
 
(Increase) decrease in accounts receivable
 
(284
)
 
52

(Increase) in inventories
 
(62
)
 
(100
)
(Increase) in prepaid expenses and other current assets
 
(63
)
 
(73
)
(Decrease) in accounts payable, accrued liabilities and income taxes payable  
 
(245
)
 
(787
)
Cash provided by operations
 
721

 
491

Cash used by investing activities:
 
 
 
 
Purchases of short-term investments
 
(1,279
)
 
(1,188
)
Maturities of short-term investments
 
562

 
721

Sales of short-term investments
 
960

 
450

Investments in reverse repurchase agreements
 

 
(50
)
Additions to property, plant and equipment
 
(277
)
 
(327
)
Disposals of property, plant and equipment
 

 
9

Other investing activities
 
(42
)
 

Cash used by investing activities
 
(76
)
 
(385
)
Cash used by financing activities:
 
 
 
 
Long-term debt payments, including current portion
 
(2
)
 
(1
)
Increase (decrease) in notes payable
 
21

 
(48
)
Payments on capital lease obligations
 
(2
)
 

Proceeds from exercise of stock options and other stock issuances
 
112

 
128

Excess tax benefits from share-based payment arrangements
 
59

 
75

Repurchase of common stock
 
(1,054
)
 
(588
)
Dividends — common and preferred
 
(269
)
 
(240
)
Cash used by financing activities
 
(1,135
)
 
(674
)
Effect of exchange rate changes on cash and equivalents
 
11

 
(38
)
Net decrease in cash and equivalents
 
(479
)
 
(606
)
Cash and equivalents, beginning of period
 
3,138

 
3,852

CASH AND EQUIVALENTS, END OF PERIOD
 
$
2,659

 
$
3,246

Supplemental disclosure of cash flow information:
 
 
 
 
Non-cash additions to property, plant and equipment
 
$
96

 
$
152

Dividends declared and not paid
 
272

 
239

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of this statement.

6


Notes to the Unaudited Condensed Consolidated Financial Statements

7


Note 1 — Summary of Significant Accounting Policies
Basis of Presentation
The Unaudited Condensed Consolidated Financial Statements include the accounts of NIKE, Inc. and its subsidiaries (the “Company”) and reflect all normal adjustments which are, in the opinion of management, necessary for a fair statement of the results of operations for the interim period. The year-end Condensed Consolidated Balance Sheet data as of May 31, 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 months ended August 31, 2016 are not necessarily indicative of results to be expected for the entire year.
On November 19, 2015, the Company announced a two-for-one split of both NIKE Class A and Class B Common Stock. The stock split was in the form of a 100 percent stock dividend payable on December 23, 2015, to shareholders of record at the close of business on December 9, 2015. Common stock began trading at the split-adjusted price on December 24, 2015. All share and per share amounts presented reflect the stock split.
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 in 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 May 2014, the FASB issued an accounting standards update 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. Based on the FASB's decision in July 2015 to defer the effective date and to allow more flexibility with implementation, the new standard will be effective for the Company beginning June 1, 2018, with early application permitted. The new standard is required to be applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying it recognized at the date of initial application. The Company has not yet selected a transition method and is currently evaluating the effect the guidance will have on the 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 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 February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) that replaces existing lease 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 continue to classify leases as either finance or operating, with classification affecting the pattern of expense recognition in the statement of income. The standard is effective for the Company beginning June 1, 2019, with early application permitted. The new standard is required to be applied with a modified retrospective approach to each prior reporting period presented with optional practical expedients. The Company is currently evaluating the effect the guidance will have on the Consolidated Financial Statements.
In March 2016, the FASB Issued ASU No. 2016-09, Compensation Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The updated guidance changes how companies account for certain aspects of share-based payment awards to employees, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. The update to the standard is effective for the Company beginning June 1, 2017, with early application permitted. The Company is currently evaluating the effect the guidance will have on the Consolidated Financial Statements.
Note 2 — Inventories
Inventory balances of $4,896 million and $4,838 million at August 31, 2016 and May 31, 2016, respectively, were substantially all finished goods.

8


Note 3 — Accrued Liabilities
Accrued liabilities included the following:
 
 
As of August 31,
 
As of May 31,
(In millions)
 
2016
 
2016
Compensation and benefits, excluding taxes
 
$
755

 
$
943

Endorsement compensation
 
399

 
393

Fair value of derivatives
 
331

 
162

Dividends payable
 
272

 
271

Taxes other than income taxes
 
216

 
159

Import and logistics costs
 
208

 
198

Advertising and marketing
 
175

 
119

Collateral received from counterparties to hedging instruments
 

 
105

Other(1)
 
791

 
687

TOTAL ACCRUED LIABILITIES
 
$
3,147

 
$
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 August 31, 2016 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.

9


The following tables present information about the Company’s financial assets measured at fair value on a recurring basis as of August 31, 2016 and May 31, 2016, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
 
 
As of August 31, 2016
(In millions)
 
Assets at Fair Value
 
Cash and Equivalents
 
Short-term Investments
 
Other Long-term Assets
Cash
 
$
779

 
$
779

 
$

 
$

Level 1:
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
1,045

 
200

 
845

 

Level 2:
 
 
 
 
 
 
 
 
Time deposits
 
767

 
756

 
11

 

U.S. Agency securities
 
707

 

 
707

 

Commercial paper and bonds
 
671

 
106

 
565

 

Money market funds
 
818

 
818

 

 

Total Level 2:
 
2,963

 
1,680

 
1,283

 

Level 3:
 
 
 
 
 
 
 
 
Non-marketable preferred stock
 
10

 

 

 
10

TOTAL
 
$
4,797

 
$
2,659

 
$
2,128

 
$
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 8 — 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 and other current assets, which would offset against the Company’s derivative liability balance (refer to Note 8 — 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.

10


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, 2016 and May 31, 2016, and indicate the level in the fair value hierarchy in which the Company classifies the fair value measurement.
 
 
As of August 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)
 
$
480

 
$
389

 
$
91

 
$
230

 
$
199

 
$
31

Embedded derivatives
 
7

 
1

 
6

 
9

 
3

 
6

Interest rate swaps(2)
 

 

 

 
129

 
129

 

TOTAL
 
$
487

 
$
390

 
$
97

 
$
368

 
$
331

 
$
37

(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 $180 million as of August 31, 2016. As of that date, the Company had posted $23 million of cash collateral to various counterparties related to these foreign exchange derivative instruments. No amount of collateral was received on the Company’s derivative asset balance as of August 31, 2016.
(2)
As of August 31, 2016, the Company had posted $8 million of cash collateral related to its interest rate swaps.
 
 
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, money market funds, corporate commercial paper and bonds. These securities are valued using market prices on both active markets (Level 1) and less active markets (Level 2). As of August 31, 2016, the Company held $1,889 million of available-for-sale securities with maturity dates within one year and $239 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 months ended August 31, 2016 and 2015. Unrealized gains and losses on available-for-sale securities included in Accumulated other comprehensive income were immaterial as of August 31, 2016 and May 31, 2016. The Company regularly reviews its available-for-sale securities for other-than-temporary impairment. For the three months ended August 31, 2016 and 2015, 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, 2016 and 2015 was interest income related to the Company's available-for-sale securities of $4 million and $2 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, 2016 and the fiscal year ended May 31, 2016.
No transfers among levels within the fair value hierarchy occurred during the three months ended August 31, 2016 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 8 — Risk Management and Derivatives for additional detail.
As of August 31, 2016 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
The Company's long-term debt is recorded at adjusted cost, net of amortized premiums and discounts, amortized debt issuance costs and interest rate swap fair value adjustments. 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 $2,241 million at August 31, 2016 and $2,125 million at May 31, 2016.

11


The carrying amounts reflected on the Unaudited Condensed Consolidated Balance Sheets for Notes payable approximate fair value.
Note 5 — Income Taxes
The effective tax rate was 2.5% and 18.4% for the three month periods ended August 31, 2016 and 2015, 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 one-time adjustment to a deferred tax asset related to the nonqualified deferred compensation plan.
As of August 31, 2016, total gross unrecognized tax benefits, excluding related interest and penalties, were $387 million, $162 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 $13 million during the three months ended August 31, 2016. As of August 31, 2016 and May 31, 2016, accrued interest and penalties related to uncertain tax positions were $196 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 period ended August 31, 2016, the Company reached a resolution with the IRS on this matter. Decisions were subsequently filed in US 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.
The Company’s major foreign jurisdictions, China and the Netherlands, have concluded substantially all income tax matters through calendar 2005 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 $87 million within the next 12 months.
Note 6 — 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). 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 August 31,
(In millions)
 
2016
 
2015
Stock options(1)
 
$
39

 
$
39

ESPPs
 
9

 
7

Restricted stock
 
9

 
8

TOTAL STOCK-BASED COMPENSATION EXPENSE
 
$
57

 
$
54

(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 $5 million and $6 million for the three month periods ended August 31, 2016 and 2015, respectively.
As of August 31, 2016, the Company had $306 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 2.6 years.

12


The weighted average fair value per share of the options granted during the three month periods ended August 31, 2016 and 2015, computed as of the grant date using the Black-Scholes pricing model, was $9.36 and $12.66, respectively. The weighted average assumptions used to estimate these fair values were as follows:
 
 
Three Months Ended August 31,
  
 
2016
 
2015
Dividend yield
 
1.1
%
 
1.0
%
Expected volatility
 
17.3
%
 
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.
Note 7 — Earnings Per Share
The following is a reconciliation from basic earnings per common share to diluted earnings per common share. The computations of diluted earnings per common share excluded options, including shares under employee stock purchase plans (ESPPs), to purchase an additional 31.7 million and 20.5 million shares of common stock outstanding for the three month periods ended August 31, 2016 and 2015, respectively, because the options were anti-dilutive.
 
 
Three Months Ended August 31,
(In millions, except per share data)
 
2016
 
2015
Determination of shares:
 
 
 
 
Weighted average common shares outstanding
 
1,672.0

 
1,709.0

Assumed conversion of dilutive stock options and awards
 
36.9

 
45.5

DILUTED WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
1,708.9

 
1,754.5

 
 
 
 
 
Earnings per common share:
 
 
 
 
Basic
 
$
0.75

 
$
0.69

Diluted
 
$
0.73

 
$
0.67

Note 8 — Risk Management and Derivatives
The Company is exposed to global market risks, including the effect of changes in foreign currency exchange rates and interest rates, and uses derivatives to manage financial exposures that occur in the normal course of business. 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 August 31, 2016 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.

13


The following table presents the fair values of derivative instruments included within the Unaudited Condensed Consolidated Balance Sheets as of August 31, 2016 and May 31, 2016: 
 
 
Derivative Assets
 
Derivative Liabilities
(In millions)
 
Balance Sheet
Location
 
August 31,
2016
 
May 31,
2016
 
Balance Sheet 
Location
 
August 31,
2016
 
May 31,
2016
Derivatives formally designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange forwards and options
 
Prepaid expenses and other current assets
 
$
332

 
$
447

 
Accrued liabilities
 
$
77

 
$
38

Interest rate swaps
 
Prepaid expenses and other current assets
 

 
7

 
Accrued liabilities
 
129

 
45

Foreign exchange forwards and options
 
Deferred income taxes and other assets
 
76

 
90

 
Deferred income taxes and other liabilities
 
27

 
12

Total derivatives formally designated as hedging instruments
 
 
 
408

 
544

 
 
 
233

 
95

Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange forwards and options
 
Prepaid expenses and other current assets
 
57

 
40

 
Accrued liabilities
 
122

 
76

Embedded derivatives
 
Prepaid expenses and other current assets
 
1

 
2

 
Accrued liabilities
 
3

 
2

Foreign exchange forwards and options
 
Deferred income taxes and other assets
 
15

 
26

 
Deferred income taxes and other liabilities
 
4

 
19

Embedded derivatives
 
Deferred income taxes and other assets
 
6

 
5

 
Deferred income taxes and other liabilities
 
6

 
7

Total derivatives not designated as hedging instruments
 
 
 
79

 
73

 
 
 
135

 
104

TOTAL DERIVATIVES
 
 
 
$
487

 
$
617

 
 
 
$
368

 
$
199

The following tables present the amounts affecting the Unaudited Condensed Consolidated Statements of Income for the three months ended August 31, 2016 and 2015:

(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,
2016
 
2015(2)


2016
 
2015(2)
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
Foreign exchange forwards and options
$
53

 
$
29


Revenues

$
33

 
$
(46
)
Foreign exchange forwards and options
(52
)
 
(104
)

Cost of sales

104

 
173

Foreign exchange forwards and options
(16
)
 
(65
)

Other (income) expense, net

43

 
61

Interest rate swaps
(91
)
 

 
Interest expense (income), net
 

 

Total designated cash flow hedges
$
(106
)
 
$
(140
)



$
180

 
$
188

(1)
For the three months ended August 31, 2016 and 2015, the amounts recorded in Other (income) expense, net as a result of hedge ineffectiveness and the discontinuance of cash flow hedges because the forecasted transactions were no longer probable of occurring were immaterial.
(2)
Certain amounts have been updated to reflect the proper classification of $40 million between Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivatives and Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income for the three months ended August 31, 2015.

14


 
 
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)
 
2016
 
2015
 
Derivatives designated as fair value hedges:
 
 
 
 
 
 
Interest rate swaps(1)
 
$

 
$
1

 
Interest expense (income), net
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
Foreign exchange forwards and options
 
(35
)
 
(29
)
 
Other (income) expense, net
Embedded derivatives
 
(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 9 — Accumulated Other Comprehensive Income for additional information on changes in Accumulated other comprehensive income for the three months ended August 31, 2016 and 2015.
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 $11.3 billion as of August 31, 2016.
As of August 31, 2016, the Company had a series of forward-starting interest rate swap agreements with a total outstanding notional amount of $1.5 billion. These instruments were designated as cash flow hedges of the variability in the expected cash outflows of interest payments on future debt due to changes in benchmark interest rates.
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 payments are made 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.

15


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 months ended August 31, 2016 and 2015.
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 months ended August 31, 2016 and 2015, 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 August 31, 2016, $302 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 August 31, 2016, 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 months ended August 31, 2016 or 2015. On October 15, 2015, the Company repaid the long-term debt which had previously been hedged with these interest rate swaps. Accordingly, as of August 31, 2016, 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 months ended August 31, 2016 or 2015. The Company had no outstanding net investment hedges as of August 31, 2016.
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 $7.7 billion as of August 31, 2016.
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 August 31, 2016, the total notional amount of embedded derivatives outstanding was approximately $294 million.

16


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, 2016, 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 $96 million. Accordingly, the Company was required to post $31 million of cash collateral to various counterparties to its derivative contracts as a result of these contingent features (refer to Note 4 — Fair Value Measurements). As of August 31, 2016, the Company had not received any cash collateral from its counterparties to its derivative contracts (refer to Note 4 — Fair Value Measurements). Given the considerations described above, the Company considers the impact of the risk of counterparty default to be immaterial.
Note 9 — Accumulated Other Comprehensive Income
The changes in Accumulated other comprehensive income, net of tax, for the three months ended August 31, 2016 were as follows:
(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)
 
3

 
(60
)
 

 
13

 
(44
)
Reclassifications to net income of previously deferred (gains) losses(3)
 

 
(180
)
 

 
(9
)
 
(189
)
Other comprehensive income (loss)
 
3

 
(240
)
 

 
4

 
(233
)
Balance at August 31, 2016
 
$
(204
)
 
$
223

 
$
115

 
$
(49
)
 
$
85

(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, $46 million, $0 million, $1 million and $47 million, respectively.
(3)
Net of tax (benefit) expense of $0 million, $0 million, $0 million, $(1) million and $(1) million, respectively.
The changes in Accumulated other comprehensive income, net of tax, for the three months ended August 31, 2015 were as follows:
(In millions)
 
Foreign Currency Translation Adjustment(1)(2)
 
Cash Flow Hedges(3)
 
Net Investment Hedges(1)(2)
 
Other
 
Total
Balance at May 31, 2015
 
$
(31
)
 
$
1,220

 
$
115

 
$
(58
)
 
$
1,246

Other comprehensive gains (losses) before reclassifications(4)
 
(81
)
 
(142
)
 

 

 
(223
)
Reclassifications to net income of previously deferred (gains) losses(5)
 

 
(187
)
 

 
(3
)
 
(190
)
Other comprehensive income (loss)
 
(81
)
 
(329
)
 

 
(3
)
 
(413
)
Balance at August 31, 2015
 
$
(112
)
 
$
891

 
$
115

 
$
(61
)
 
$
833

(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)
Beginning and ending balances have been updated to reflect the proper classification of $20 million of deferred tax balances between Foreign Currency Translation Adjustment and Net Investment Hedges.
(3)
Certain amounts have been updated to reflect the proper classification of $40 million between Other comprehensive gains (losses) before reclassifications and Reclassifications to net income of previously deferred (gains) losses for the three months ended August 31, 2015.
(4)
Net of tax benefit (expense) of $0 million, $(2) million, $0 million, $0 million and $(2) million, respectively.
(5)
Net of tax (benefit) expense of $0 million, $1 million, $0 million, $0 million and $1 million, respectively.

17


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)
 
2016
 
2015(1)
 
Gains (losses) on cash flow hedges:
 
 
 
 
 
 
Foreign exchange forwards and options
 
$
33

 
$
(46
)
 
Revenues
Foreign exchange forwards and options
 
104

 
173

 
Cost of sales
Foreign exchange forwards and options
 
43

 
61

 
Other (income) expense, net
Total before tax
 
180

 
188

 
 
Tax (expense) benefit
 

 
(1
)
 
 
Gain (loss) net of tax
 
180

 
187

 
 
Gains (losses) on other
 
8

 
3

 
Other (income) expense, net
Total before tax
 
8

 
3

 
 
Tax (expense) benefit
 
1

 

 
 
Gain (loss) net of tax
 
9

 
3

 
 
Total net gain (loss) reclassified for the period
 
$
189

 
$
190

 
 
(1) Certain amounts have been updated to reflect the proper classification of $40 million between Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income into Income for cash flow hedges for the three months ended August 31, 2015.
Note 10 — 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 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 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.



18


 
 
Three months ended August 31,
(In millions)
 
2016
 
2015
REVENUES
 
 
 
 
North America
 
$
4,031

 
$
3,799

Western Europe
 
1,763

 
1,641

Central & Eastern Europe
 
440

 
401

Greater China
 
1,020

 
886

Japan
 
245

 
179

Emerging Markets
 
945

 
966

Global Brand Divisions
 
15

 
26

Total NIKE Brand
 
8,459

 
7,898

Converse
 
574

 
555

Corporate
 
28

 
(39
)
TOTAL NIKE CONSOLIDATED REVENUES
 
$
9,061

 
$
8,414

EARNINGS BEFORE INTEREST AND TAXES
 
 
 
 
North America
 
$
1,004

 
$
1,042

Western Europe
 
392

 
485

Central & Eastern Europe
 
81

 
98

Greater China
 
371

 
330

Japan
 
50

 
36

Emerging Markets
 
171

 
258

Global Brand Divisions
 
(771
)
 
(624
)
Total NIKE Brand
 
1,298

 
1,625

Converse
 
153

 
147

Corporate
 
(163
)
 
(323
)
Total NIKE Consolidated Earnings Before Interest and Taxes
 
1,288

 
1,449

Interest expense (income), net
 
7

 
4

TOTAL NIKE CONSOLIDATED INCOME BEFORE INCOME TAXES
 
$
1,281

 
$
1,445


19


 
 
As of August 31,
 
As of May 31,
(In millions)
 
2016
 
2016
ACCOUNTS RECEIVABLE, NET
 
 
 
 
North America
 
$
1,571

 
$
1,689

Western Europe
 
569

 
378

Central & Eastern Europe
 
261

 
194

Greater China
 
90

 
74

Japan
 
116

 
129

Emerging Markets
 
519

 
409

Global Brand Divisions
 
92

 
76

Total NIKE Brand
 
3,218

 
2,949

Converse
 
298

 
270

Corporate
 
10

 
22

TOTAL ACCOUNTS RECEIVABLE, NET
 
$
3,526

 
$
3,241

INVENTORIES
 
 
 
 
North America
 
$
2,268

 
$
2,363

Western Europe
 
939

 
929

Central & Eastern Europe
 
200

 
210

Greater China
 
428

 
375

Japan
 
170

 
146

Emerging Markets
 
558

 
478

Global Brand Divisions
 
47

 
35

Total NIKE Brand
 
4,610

 
4,536

Converse
 
306

 
306

Corporate
 
(20
)
 
(4
)
TOTAL INVENTORIES
 
$
4,896

 
$
4,838

PROPERTY, PLANT AND EQUIPMENT, NET
 
 
 
 
North America
 
$
738

 
$
742

Western Europe
 
586

 
589

Central & Eastern Europe
 
47

 
50

Greater China
 
224

 
234

Japan
 
236

 
223

Emerging Markets
 
120

 
109

Global Brand Divisions
 
493

 
511

Total NIKE Brand
 
2,444

 
2,458

Converse
 
123

 
125

Corporate
 
1,005

 
937

TOTAL PROPERTY, PLANT AND EQUIPMENT, NET
 
$
3,572

 
$
3,520

Note 11 — Commitments and Contingencies
At August 31, 2016, the Company had letters of credit outstanding totaling $153 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.

20


ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
On November 19, 2015, we announced a two-for-one split of both NIKE Class A and Class B Common Stock. The stock split was in the form of a 100 percent stock dividend payable on December 23, 2015 to shareholders of record at the close of business on December 9, 2015. Common stock began trading at the split-adjusted price on December 24, 2015. All share and per share amounts presented reflect the stock split.
For the first quarter of fiscal 2017, NIKE, Inc. Revenues increased 8% to $9.1 billion. Excluding the impact of changes in foreign currency exchange rates, Revenues increased 10%. For the first quarter of fiscal 2017, Net income was $1,249 million and diluted earnings per common share was $0.73, 6% and 9% higher, respectively, than the first quarter of fiscal 2016.
Income before income taxes decreased 11% compared to the first quarter of fiscal 2016 as revenue growth was more than offset by lower gross margin and an increase in selling and administrative expense as a percent of revenues. The NIKE Brand, which represents over 90% of NIKE, Inc. Revenues, delivered 7% revenue growth. On a constant currency basis, NIKE Brand revenues grew 10%, driven by higher revenues across all geographies, all product engines and most key categories. Constant currency revenues for Converse increased 4% due to revenue growth in direct distribution markets, primarily the United States.
Our effective tax rate was 2.5% for the first quarter of fiscal 2017 compared to 18.4% for the first quarter of fiscal 2016. The decrease in our effective tax rate was primarily due to a one-time benefit related to the resolution with the U.S. Internal Revenue Service (IRS) of a foreign tax credit matter. We also benefited from a one-time adjustment to our deferred tax asset related to our nonqualified deferred compensation plan.
Diluted earnings per common share benefited from a 3% decline in the diluted weighted average common shares outstanding, driven by our share repurchase program.
Results of Operations
 
 
Three Months Ended August 31,
(Dollars in millions, except per share data)
 
2016
 
2015
 
% Change
Revenues
 
$
9,061

 
$
8,414

 
8
%
Cost of sales
 
4,938

 
4,419

 
12
%
Gross profit
 
4,123

 
3,995

 
3
%
Gross margin %
 
45.5
%
 
47.5
%
 

Demand creation expense
 
1,041

 
832

 
25
%
Operating overhead expense
 
1,856

 
1,745

 
6
%
Total selling and administrative expense
 
2,897

 
2,577

 
12
%
% of Revenues
 
32.0
%
 
30.6
%
 
 
Interest expense (income), net
 
7

 
4

 

Other (income) expense, net
 
(62
)
 
(31
)
 

Income before income taxes
 
1,281

 
1,445

 
-11
%
Income tax expense
 
32

 
266

 
-88
%
Effective tax rate
 
2.5
%
 
18.4
%
 

NET INCOME
 
$
1,249

 
$
1,179

 
6
%
Diluted earnings per common share
 
$
0.73

 
$
0.67

 
9
%

21


Consolidated Operating Results
Revenues
 
Three Months Ended August 31,
(Dollars in millions)
2016
 
2015
 
% Change
 
% Change Excluding Currency
Changes(1)
NIKE, Inc. Revenues:
 
 
 
 
 
 
 
NIKE Brand Revenues by:
 
 
 
 
 
 
 
Footwear
$
5,472

 
$
5,123

 
7
 %
 
10
 %
Apparel
2,549

 
2,341

 
9
 %
 
12
 %
Equipment
423

 
408

 
4
 %
 
6
 %
Global Brand Divisions(2)
15

 
26

 
-42
 %
 
-30
 %
Total NIKE Brand Revenues
8,459

 
7,898

 
7
 %
 
10
 %
Converse
574

 
555

 
3
 %
 
4
 %
Corporate(3)
28

 
(39
)
 

 

TOTAL NIKE, INC. REVENUES
$
9,061

 
$
8,414

 
8
 %
 
10
 %
Supplemental NIKE Brand Revenues Details:
 
 
 
 
 
 
 
NIKE Brand Revenues by:
 
 
 
 
 
 
 
Sales to Wholesale Customers
$
6,139

 
$
5,940

 
3
 %
 
6
 %
Sales Direct to Consumer
2,305

 
1,932

 
19
 %
 
22
 %
Global Brand Divisions(2)
15

 
26

 
-42
 %
 
-30
 %
TOTAL NIKE BRAND REVENUES
$
8,459

 
$
7,898

 
7
 %
 
10
 %
(1)
The percentage change has been calculated using actual exchange rates in use during the comparative prior year period to enhance the visibility of the underlying business trends by excluding the impact of translation arising from foreign currency exchange rate fluctuations, which is considered a non-GAAP financial measure.
(2)
Global Brand Divisions revenues are primarily attributable to NIKE Brand licensing businesses that are not part of a geographic operating segment.
(3)
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 our central foreign exchange risk management program.
Excluding the effects of changes in currency exchange rates, NIKE, Inc. Revenues grew 10% for the first quarter of fiscal 2017, driven by higher revenues for the NIKE Brand and Converse. On a currency-neutral basis, every NIKE Brand geography delivered higher revenues for the first quarter of fiscal 2017 as our category offense continued to deliver innovative products, deep brand connections and compelling retail experiences to consumers online and at NIKE-owned and retail partner stores, driving strong demand for NIKE Brand products. For the first quarter of fiscal 2017, North America contributed approximately 3 percentage points of the increase in NIKE, Inc. Revenues, while Greater China and Western Europe each contributed approximately 2 percentage points, and Central & Eastern Europe, Emerging Markets and Converse each contributed approximately 1 percentage point.
The constant currency increase in NIKE Brand footwear revenues for the first quarter of fiscal 2017 was attributable to growth in our Sportswear, Jordan Brand and Running categories. Unit sales of footwear increased approximately 6%, with higher average selling price (ASP) per pair contributing approximately 4 percentage points of footwear revenue growth, primarily driven by higher full-price ASP.
The currency-neutral growth in NIKE Brand apparel revenues for the first quarter of fiscal 2017 was driven by increases in most key categories, led by Sportswear, Football (Soccer) and Running. Unit sales of apparel increased approximately 9%, while higher ASP per unit contributed approximately 3 percentage points of apparel revenue growth, primarily due to higher full-price ASP.
While wholesale revenues remain the largest component of overall NIKE Brand revenues, we continue to expand our NIKE Brand Direct to Consumer (DTC) operations in each of our geographies. Our NIKE Brand DTC operations include NIKE-owned in-line and factory stores, as well as NIKE-owned digital commerce. For the first quarter of fiscal 2017, DTC revenues represented approximately 27% of our total NIKE Brand revenues compared to 24% for the first quarter of fiscal 2016. On a currency neutral basis, DTC revenues grew 22% for the first quarter of fiscal 2017, driven by strong digital commerce sales growth, the addition of new stores and comparable store sales growth of 8%. Comparable store sales include revenues from NIKE-owned in-line and factory stores for which all three of the following requirements have been met: (1) the store has been open at least one year, (2) square footage has not changed by more than 15% within the past year and (3) the store has not been permanently repositioned within the past year. Digital commerce sales, which are not included in comparable store sales, grew 49% for the first quarter of fiscal 2017. Digital commerce sales represented approximately 21% of our total NIKE Brand DTC revenues for the first quarter of fiscal 2017 compared to 17% for the first quarter of fiscal 2016.

22


Futures Orders
Futures orders for NIKE Brand footwear and apparel scheduled for delivery from September 2016 through January 2017 totaled $12.3 billion and were 5% higher than the orders reported for the comparable prior year period. NIKE Brand reported futures include (1) orders from external wholesale customers and (2) internal orders from our DTC in-line stores and digital commerce operations, which are reflected at prices that are comparable to prices charged to external wholesale customers. The U.S. Dollar futures orders amount is calculated based upon our internal forecast of the currency exchange rates under which our revenues will be translated during this period. Excluding the impact of currency changes, futures orders increased 7%, with unit orders increasing 2% and ASP per unit contributing approximately 5 percentage points of growth.
By geography, futures orders growth was as follows: 
 
 
Reported Futures
Orders
 
Futures Orders 
Excluding Currency Changes(1)
North America
 
1
%
 
1
%
Western Europe
 
4
%
 
9
%
Central & Eastern Europe
 
9
%
 
9
%
Greater China
 
15
%
 
19
%
Japan
 
26
%
 
11
%
Emerging Markets
 
6
%
 
10
%
TOTAL NIKE BRAND FUTURES ORDERS
 
5
%
 
7
%
(1)
Futures orders growth has been calculated using prior year exchange rates for the comparative period to enhance the visibility of the underlying business trends, excluding the impact of foreign currency exchange rate fluctuations.
The reported futures orders growth is not necessarily indicative of our expectation of revenue growth during this period. This is due to year-over-year changes in shipment timing, changes in the mix of orders between futures and at-once orders, and because the fulfillment of certain orders may fall outside of the schedule noted above. In addition, exchange rate fluctuations as well as differing levels of order cancellations, discounts and returns can cause differences in the comparisons between futures orders and actual revenues. Moreover, a portion of our revenue is not derived from futures orders, including sales of at-once and closeout NIKE Brand footwear and apparel, all sales of NIKE Brand equipment, the difference between retail sales and internal orders from our DTC in-line stores and digital commerce operations, and sales from Converse, NIKE Golf and Hurley.
Gross Margin
 
 
Three Months Ended August 31,
(Dollars in millions)
 
2016
 
2015
 
% Change
Gross profit
 
$
4,123

 
$
3,995

 
3
%
Gross margin %
 
45.5
%
 
47.5
%
 
(200) bps

Our consolidated gross margin decreased 200 basis points for the first quarter of fiscal 2017 compared to the first quarter of fiscal 2016, primarily driven by the following factors:
Higher NIKE Brand full-price ASP (increasing gross margin approximately 60 basis points, net of discounts) aligned with our strategy to deliver innovative, premium products to the consumer;
Higher NIKE Brand product costs (decreasing gross margin approximately 40 basis points) as labor input cost inflation more than offset lower material input costs;
Unfavorable changes in foreign currency exchange, net of hedges (decreasing gross margin approximately 40 basis points);
Unfavorable impact of increased off-price sales (decreasing gross margin approximately 30 basis points);
Lower NIKE Brand DTC margins (decreasing gross margin approximately 30 basis points) driven by increased sales through our factory stores; and
Higher other costs (decreasing gross margin approximately 80 basis points) primarily driven by investments in sourcing and manufacturing resources, warehousing and logistics costs, and costs associated with the exit from the Golf equipment business.
Total Selling and Administrative Expense
 
 
Three Months Ended August 31,
(Dollars in millions)
 
2016
 
2015
 
% Change
Demand creation expense(1)
 
$
1,041