Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

NIKE designs, develops, markets and sells athletic footwear, apparel, equipment, accessories and services worldwide. We are the largest seller of athletic footwear and apparel in the world. We sell our products through NIKE-owned retail stores and through digital platforms (which we refer to collectively as our “NIKE Direct” operations), to retail accounts and a mix of independent distributors, licensees and sales representatives in virtually all countries around the world. Our goal is to deliver value to our shareholders by building a profitable global portfolio of branded footwear, apparel, equipment and accessories businesses. Our strategy is to achieve long-term revenue growth by creating innovative, “must have” products, building deep personal consumer connections with our brands and delivering compelling consumer experiences through digital platforms and at retail.

In June 2017, we announced the Consumer Direct Offense, a new company alignment designed to allow NIKE to better serve the consumer personally, at scale. Leveraging the power of digital, NIKE plans to drive growth — by accelerating innovation and product creation, moving even closer to the consumer through key cities, and deepening one-to-one connections. As a result of this organizational realignment, beginning in fiscal 2018, the Company’s reportable operating segments for the NIKE Brand are: North America; Europe, Middle East & Africa (EMEA); Greater China; and Asia Pacific & Latin America (APLA).

Through the Consumer Direct Offense, we are focusing on our Triple Double strategy, with the objective of doubling the impact of innovation, increasing our speed to market and growing our direct connections with consumers. As a result of the execution of this strategy, our long-term financial goals through fiscal 2023, on average, per year, are as follows:

•High single-digit revenue growth;
•Gross margin expansion of as much as 50 basis points;
•Slight selling and administrative expense leverage;
•Mid-teens earnings per share growth; and
•Low-thirties percentage rate of return on invested capital.

Over the past ten years, we have achieved strong growth in many of these metrics. During this time, revenues for NIKE, Inc. have grown 7% on an annual compounded basis, annual gross margin has ranged from 43.5% to 46.4%, diluted earnings per common share has grown steadily and our return on invested capital has been as high as 34.7%.

Our fiscal 2018 results demonstrated the power of the NIKE, Inc. portfolio to generate revenue growth, while investing in capabilities in support of our Triple Double strategy to fuel our next phase of long-term growth and profitability. We achieved record revenues for fiscal 2018, growing 6% to $36.4 billion. The NIKE Brand, which represents over 90% of NIKE, Inc. Revenues, delivered 7% revenue growth. On a currency-neutral basis, NIKE Brand revenues grew 5%, driven by strong revenue growth across all international geographies and NIKE Direct, as well as growth in footwear, apparel and most key categories. Revenues for Converse decreased 8% and 11% on a reported and currency-neutral basis, respectively, primarily driven by lower revenues in North America.

Income before income taxes decreased 11% for fiscal 2018, in part reflecting the negative impact of weakening foreign currency exchange rates. Revenue growth was more than offset by higher selling and administrative expense, gross margin contraction, and a shift to other expense, net from other income, net for fiscal 2017. NIKE, Inc. gross margin decreased 80 basis points primarily due to foreign currency exchange rate headwinds. Selling and administrative expense was higher as a percent of revenues, reflecting investments in digital capabilities, consumer experiences and product and brand marketing to drive long-term growth under the Consumer Direct Offense.

Diluted earnings per common share reflects a 2% decline in the weighted average diluted common shares outstanding, driven by our share repurchase program.

While foreign currency markets remain volatile, we continue to see opportunities to drive future growth and profitability, and remain committed to effectively managing our business to achieve our financial goals over the long-term by executing against the operational strategies outlined above.

Use of Non-GAAP Financial Measures

Throughout this Annual Report on Form 10-K, we discuss non-GAAP financial measures, including references to wholesale equivalent revenues and currency-neutral revenues, which should be considered in addition to, and not in lieu of, the financial measures calculated and presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). References to wholesale equivalent revenues are intended to provide context as to the total size of our NIKE Brand market footprint if we had no NIKE Direct operations. NIKE Brand wholesale equivalent revenues consist of (1) sales to external wholesale customers and (2) internal sales from our wholesale operations to our NIKE Direct operations, which are charged at prices comparable to those charged to external wholesale customers. Additionally, currency-neutral revenues are calculated using actual exchange rates in use during the comparative prior year period to enhance the visibility of the underlying business trends excluding the impact of translation arising from foreign currency exchange rate fluctuations.

Management uses these non-GAAP financial measures when evaluating the Company’s performance, including when making financial and operating decisions. Additionally, management believes these non-GAAP financial measures provide investors with additional financial information that should be considered when assessing our underlying business performance and trends. However, references to wholesale equivalent revenues and currency-neutral revenues should not be considered in isolation or as a substitute for other financial measures calculated and presented in accordance with U.S. GAAP and may not be comparable to similarly titled non-GAAP measures used by other companies.

Results of Operations
(Dollars in millions, except per share data)Fiscal 2018Fiscal 2017% ChangeFiscal 2016% Change
Revenues$36,397$34,3506%$32,3766%
Cost of sales20,44119,0387%17,4059%
Gross profit15,95615,3124%14,9712%
Gross margin43.8%44.6%46.2%
Demand creation expense3,5773,3417%3,2782%
Operating overhead expense7,9347,22210%7,1910%
Total selling and administrative expense11,51110,5639%10,4691%
% of revenues31.6%30.8%32.3%
Interest expense (income), net5459—19—
Other expense (income), net66(196)—(140)—
Income before income taxes4,3254,886-11%4,6236%
Income tax expense2,392646270%863-25%
Effective tax rate55.3%13.2%18.7%
NET INCOME$1,933$4,240-54%$3,76013%
Diluted earnings per common share$1.17$2.51-53%$2.1616%
Consolidated Operating Results

Revenues

(Dollars in millions)Fiscal 2018Fiscal 2017(1)% Change% Change Excluding Currency Changes(2)Fiscal 2016(1)% Change% Change Excluding Currency Changes(2)
NIKE, Inc. Revenues:
NIKE Brand Revenues by:
Footwear$22,268$21,0816%4%$19,8716%8%
Apparel10,7339,65411%9%9,0676%9%
Equipment1,3961,425-2%-4%1,496-5%-3%
Global Brand Divisions(3)887321%12%730%2%
Total NIKE Brand Revenues34,48532,2337%5%30,5076%8%
Converse1,8862,042-8%-11%1,9554%6%
Corporate(4)2675——(86)——
TOTAL NIKE, INC. REVENUES$36,397$34,3506%4%$32,3766%8%
Supplemental NIKE Brand Revenues Details:
NIKE Brand Revenues by:
Sales to Wholesale Customers$23,969$23,0784%2%$22,5772%5%
Sales through NIKE Direct10,4289,08215%12%7,85716%18%
Global Brand Divisions(3)887321%12%730%2%
TOTAL NIKE BRAND REVENUES$34,485$32,2337%5%$30,5076%8%
NIKE Brand Revenues on a Wholesale Equivalent Basis:(5)
Sales to Wholesale Customers$23,969$23,0784%2%$22,5772%5%
Sales from our Wholesale Operations to NIKE Direct Operations6,3325,61613%10%4,67220%22%
TOTAL NIKE BRAND WHOLESALE EQUIVALENT REVENUES$30,301$28,6946%4%$27,2495%8%
NIKE Brand Wholesale Equivalent Revenues by:(5)
Men’s$17,114$16,0417%5%$15,4104%6%
Women’s6,9156,6444%2%6,2966%8%
Young Athletes’4,9064,8381%-1%4,5606%8%
Others(6)1,3661,17117%13%98319%21%
TOTAL NIKE BRAND WHOLESALE EQUIVALENT REVENUES$30,301$28,6946%4%$27,2495%8%
NIKE Brand Wholesale Equivalent Revenues by:(5)
Running$5,198$4,8607%5%$4,40110%13%
NIKE Basketball1,4941,29216%14%1,378-6%-5%
Jordan Brand2,8563,098-8%-9%2,75313%13%
Football (Soccer)2,1461,9848%5%2,143-7%-4%
Training3,1263,0801%0%3,150-2%-1%
Sportswear10,0188,98811%8%8,12911%14%
Others(7)5,4635,3921%0%5,2952%3%
TOTAL NIKE BRAND WHOLESALE EQUIVALENT REVENUES$30,301$28,6946%4%$27,2495%8%
(1)Certain prior year amounts have been reclassified to conform to fiscal 2018 presentation. These changes had no impact on previously reported consolidated results of operations or shareholders’ equity.
(2)The percent 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.
(3)Global Brand Divisions revenues are primarily attributable to NIKE Brand licensing businesses that are not part of a geographic operating segment.
(4)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.
(5)References to NIKE Brand wholesale equivalent revenues, which are considered non-GAAP financial measures, are intended to provide context as to the total size of our NIKE Brand market footprint if we had no NIKE Direct operations. NIKE Brand wholesale equivalent revenues consist of (1) sales to external wholesale customers and (2) internal sales from our wholesale operations to our NIKE Direct operations, which are charged at prices comparable to those charged to external wholesale customers.
(6)Others include all unisex products, equipment and other products not allocated to Men’s, Women’s and Young Athletes’, as well as certain adjustments that are not allocated to products designated by gender or age.
(7)Others include all other categories and certain adjustments that are not allocated at the category level.

Fiscal 2018 Compared to Fiscal 2017

On a currency-neutral basis, NIKE, Inc. Revenues grew 4% for fiscal 2018, driven by growth in the NIKE Brand. All international NIKE Brand geographies delivered higher revenues for fiscal 2018 as our Consumer Direct Offense delivered innovative products, deep brand connections and compelling retail experiences to consumers through digital platforms and at NIKE-owned and retail partner stores, driving demand for NIKE Brand products. Revenue growth was broad-based, as Greater China, EMEA and APLA each contributed approximately 2 percentage points of the increase in NIKE, Inc. Revenues. For fiscal 2018, lower revenues from North America and Converse each reduced NIKE, Inc. Revenues by approximately 1 percentage point.

On a currency-neutral basis, NIKE Brand footwear and apparel revenues increased 4% and 9%, respectively, for fiscal 2018, while NIKE Brand equipment revenues decreased 4%. On a category basis, the increase in NIKE Brand footwear revenues was due to strong growth in Sportswear and Running, which was partially offset by lower revenues in several other categories, most notably the Jordan Brand. Footwear unit sales for fiscal 2018 increased 2% and higher average selling price (ASP) per pair contributed approximately 2 percentage points of footwear revenue growth, primarily due to the favorable impact of growth in our NIKE Direct business.

The currency-neutral increase in NIKE Brand apparel revenues for fiscal 2018 was fueled by growth in nearly all key categories, most notably Sportswear, NIKE Basketball and Football (Soccer). Unit sales of apparel increased 4% and higher ASP per unit contributed approximately 5 percentage points of apparel revenue growth, primarily due to higher ASPs from full-price, off-price and NIKE Direct sales.

For fiscal 2018, NIKE Direct revenues represented approximately 30% of our total NIKE Brand revenues compared to 28% for fiscal 2017. On a currency-neutral basis, NIKE Direct revenues increased 12% for fiscal 2018, driven by strong digital commerce sales growth of 25%, the addition of new stores and 4% comparable store sales growth. 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. On a reported basis, digital commerce sales, which are not included in comparable store sales, were $2.8 billion for fiscal 2018 compared to $2.2 billion for fiscal 2017, and represented approximately 27% of our total NIKE Brand NIKE Direct revenues for fiscal 2018 compared to 24% for fiscal 2017.

On a wholesale equivalent and currency-neutral basis, fiscal 2018 NIKE Brand Men’s revenues increased 5%, as growth in Sportswear, Running and NIKE Basketball more than offset lower Football (Soccer) and Jordan Brand revenues. Women’s revenues increased 2%, led by growth in Sportswear, partially offset by a decline in Training. Revenues for our Young Athletes’ business decreased 1%, as growth in Football (Soccer), was more than offset by lower revenues in the Jordan Brand.

Fiscal 2017 Compared to Fiscal 2016

On a currency-neutral basis, NIKE, Inc. Revenues grew 8% for fiscal 2017, driven by higher revenues for all NIKE Brand geographies and Converse. Revenue growth was broad-based, as EMEA, Greater China, APLA and North America each contributed approximately 2 percentage points of the increase in NIKE, Inc. Revenues.

On a currency-neutral basis, NIKE Brand footwear and apparel revenues increased 8% and 9%, respectively, for fiscal 2017, while NIKE Brand equipment revenues decreased 3%. On a category basis, the increase in NIKE Brand footwear revenues was driven by strong growth in Sportswear, Running and the Jordan Brand. Footwear unit sales for fiscal 2017 increased 7%, with higher ASP per pair contributing approximately 1 percentage point of footwear revenue growth, primarily driven by higher full-price and off-price ASPs, partially offset by the impact of higher off-price sales.

The currency-neutral increase in NIKE Brand apparel revenues for fiscal 2017 was fueled by growth in all key categories, led by Sportswear, Running and Training. Unit sales of apparel increased 6%, while higher ASP per unit contributed approximately 3 percentage points of apparel revenue growth, primarily due to higher full-price ASP and, to a lesser extent, growth in our higher-priced NIKE Direct business.

For fiscal 2017, NIKE Direct revenues represented approximately 28% of our total NIKE Brand revenues compared to 26% for fiscal 2016. On a currency-neutral basis, NIKE Direct revenues increased 18% for fiscal 2017, driven by strong digital commerce sales growth of 30%, the addition of new stores and 7% comparable store sales growth. On a reported basis, digital commerce sales, which are not included in comparable store sales, were $2.2 billion for fiscal 2017 compared to $1.7 billion for fiscal 2016 and represented approximately 24% of our total NIKE Direct revenues for fiscal 2017 compared to 22% for fiscal 2016.

On a wholesale equivalent and currency-neutral basis, fiscal 2017 NIKE Brand Men’s revenues increased 6%, driven by significant growth in Sportswear, Running and the Jordan Brand, while Women’s revenues increased 8%, led by growth in Sportswear and Running. Revenues for our Young Athletes’ business increased 8%, with growth across multiple categories, most notably the Jordan Brand.

Gross Margin

(Dollars in millions)Fiscal 2018Fiscal 2017% ChangeFiscal 2016% Change
Gross profit$15,956$15,3124%$14,9712%
Gross margin43.8%44.6%(80) bps46.2%(160) bps

Fiscal 2018 Compared to Fiscal 2017

For fiscal 2018, our consolidated gross margin was 80 basis points lower than fiscal 2017, primarily reflecting the following factors:

•Unfavorable changes in net foreign currency exchange rates, including hedges (decreasing gross margin approximately 90 basis points);
•Lower NIKE Direct margin (decreasing gross margin approximately 10 basis points) reflecting higher mix of off-price sales in the first half of fiscal 2018, which was partially offset by margin expansion in the second half of fiscal 2018;
•NIKE Brand full-price ASP, net of discounts, on a wholesale equivalent basis, which was flat for fiscal 2018 as higher discounts in the first half of fiscal 2018 were offset by higher full-price ASP in the second half of the year; and
•NIKE Brand product costs, on a wholesale equivalent basis, which were flat.

Fiscal 2017 Compared to Fiscal 2016

For fiscal 2017, our consolidated gross margin was 160 basis points lower than fiscal 2016, primarily driven by the following factors:

•Higher NIKE Brand full-price ASP, net of discounts, on a wholesale equivalent basis (increasing gross margin approximately 70 basis points) aligned with our strategy to deliver innovative, premium products to the consumer;
•Higher NIKE Brand product costs (decreasing gross margin approximately 100 basis points) as an increase in the mix of higher cost products and labor input cost inflation more than offset lower material input costs;
•Unfavorable changes in net foreign currency exchange rates, including hedges (decreasing gross margin approximately 90 basis points); and
•Lower NIKE Direct margins (decreasing gross margin approximately 20 basis points) reflecting the impact of higher off-price sales.

Total Selling and Administrative Expense

(Dollars in millions)Fiscal 2018Fiscal 2017% ChangeFiscal 2016% Change
Demand creation expense(1)$3,577$3,3417%$3,2782%
Operating overhead expense7,9347,22210%7,1910%
Total selling and administrative expense$11,511$10,5639%$10,4691%
% of revenues31.6%30.8%80bps32.3%(150) bps
(1)Demand creation expense consists of advertising and promotion costs, including costs of endorsement contracts, complimentary product, television, digital and print advertising and media costs, brand events and retail brand presentation.

Fiscal 2018 Compared to Fiscal 2017

Demand creation expense increased 7% for fiscal 2018 compared to fiscal 2017, driven by higher sports marketing costs. Changes in foreign currency exchange rates increased Demand creation expense by approximately 3 percentage points for fiscal 2018.

Operating overhead expense increased 10% compared to fiscal 2017, due to higher administrative costs, continued investments in our growing NIKE Direct business and one-time wage-related costs associated with the Consumer Direct Offense organizational realignment. Changes in foreign currency exchange rates increased Operating overhead expense by approximately 2 percentage points for fiscal 2018.

Fiscal 2017 Compared to Fiscal 2016

Demand creation expense increased 2% for fiscal 2017 compared to fiscal 2016, driven by higher sports marketing costs, as well as higher marketing and advertising costs, primarily to support key sporting events including the Rio Olympics and European Football Championship. These increases were partially offset by lower retail brand presentation costs. Changes in foreign currency exchange rates reduced Demand creation expense by approximately 1 percentage point.

Operating overhead expense was flat compared to fiscal 2016 as continued investments in our growing NIKE Direct business were offset by administrative cost efficiencies and lower variable compensation. Changes in foreign currency exchange rates reduced Operating overhead expense by approximately 1 percentage point for fiscal 2017.

Other Expense (Income), Net

(In millions)Fiscal 2018Fiscal 2017Fiscal 2016
Other expense (income), net$66$(196)$(140)

Other expense (income), net comprises foreign currency conversion gains and losses from the re-measurement of monetary assets and liabilities denominated in non-functional currencies, and the impact of certain foreign currency derivative instruments, as well as unusual or non-operating transactions outside the normal course of business.

Fiscal 2018 Compared to Fiscal 2017

Other expense (income), net changed from $196 million of other income, net for fiscal 2017 to $66 million of other expense, net for fiscal 2018, primarily due to a $287 million net detrimental change in foreign currency conversion gains and losses, including hedges.

We estimate the combination of the translation of foreign currency-denominated profits from our international businesses and the year-over-year change in foreign currency-related gains and losses included in Other expense (income), net had an unfavorable impact on our Income before income taxes of $110 million for fiscal 2018.

Fiscal 2017 Compared to Fiscal 2016

Other expense (income), net increased from $140 million of other income, net for fiscal 2016 to $196 million of other income, net for fiscal 2017, primarily due to a $56 million net beneficial change in foreign currency conversion gains and losses.

We estimate the combination of the translation of foreign currency-denominated profits from our international businesses and the year-over-year change in foreign currency-related gains and losses included in Other expense (income), net had an unfavorable impact on our Income before income taxes of $59 million for fiscal 2017.

Income Taxes

Fiscal 2018Fiscal 2017% ChangeFiscal 2016% Change
Effective tax rate55.3%13.2%4,210bps18.7%(550) bps

Fiscal 2018 Compared to Fiscal 2017

Our effective tax rate was 55.3% for fiscal 2018, reflecting the impact of the Tax Cuts and Jobs Act (the “Tax Act”). The impact of the Tax Act primarily reflects provisional expense of $1,875 million for the one-time transition tax on the deemed repatriation of undistributed foreign earnings and $158 million resulting from the remeasurement of deferred tax assets and liabilities. The remaining provisions of the Tax Act, which were a net benefit to the effective tax rate, did not have a material impact on our Consolidated Financial Statements during fiscal 2018. The increase in the effective tax rate resulting from the Tax Act was partially offset by the tax benefit from stock-based compensation in the current period as a result of the adoption of Accounting Standards Update (ASU) 2016-09 in the first quarter of fiscal 2018.

Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for additional information on the impact of ASU 2016-09, and Note 9 — Income Taxes for additional information on the impact of the Tax Act.

Fiscal 2017 Compared to Fiscal 2016

The 550 basis point decrease in our effective tax rate for the fiscal year was primarily due to a one-time benefit in the first quarter of the fiscal year related to the resolution with the IRS of a foreign tax credit matter and a decrease in foreign earnings taxed in the United States.

Operating Segments

Our operating segments are evidence of the structure of the Company’s internal organization. The NIKE Brand segments are defined by geographic regions for operations participating in NIKE Brand sales activity.

Each NIKE Brand geographic segment operates predominantly in one industry: the design, development, marketing and selling of athletic footwear, apparel and equipment. The Company’s reportable operating segments for the NIKE Brand are: North America; Europe, Middle East & Africa; Greater China; and Asia Pacific & Latin America, and include results for the NIKE, Jordan and Hurley brands.

The Company’s NIKE Direct operations are managed within each 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.

As part of our centrally managed foreign exchange risk management program, standard foreign currency rates are assigned twice per year to each NIKE Brand entity in our geographic operating segments and 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 into 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 our centrally managed foreign exchange risk management program and other conversion gains and losses.

The breakdown of revenues is as follows:

(Dollars in millions)Fiscal 2018Fiscal 2017(1)% Change% Change Excluding Currency Changes(2)Fiscal 2016(1)% Change% Change Excluding Currency Changes(2)
North America$14,855$15,216-2%-2%$14,7643%3%
Europe, Middle East & Africa9,2427,97016%9%7,5685%10%
Greater China5,1344,23721%18%3,78512%17%
Asia Pacific & Latin America5,1664,7379%10%4,31710%13%
Global Brand Divisions(3)887321%12%730%2%
TOTAL NIKE BRAND34,48532,2337%5%30,5076%8%
Converse1,8862,042-8%-11%1,9554%6%
Corporate(4)2675——(86)——
TOTAL NIKE, INC. REVENUES$36,397$34,3506%4%$32,3766%8%
(1)Certain prior year amounts have been reclassified to conform to fiscal 2018 presentation. This includes reclassified operating segment data to reflect the changes in the Company’s operating structure, which became effective June 1, 2017. These changes had no impact on previously reported consolidated results of operations or shareholders’ equity.
(2)The percent 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 excluding the impact of translation arising from foreign currency exchange rate fluctuations, which is considered a non-GAAP financial measure.
(3)Global Brand Divisions revenues are primarily attributable to NIKE Brand licensing businesses that are not part of a geographic operating segment.
(4)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.

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 discussed in Note 17 — Operating Segments and Related Information in the accompanying Notes to the Consolidated Financial Statements, certain corporate costs are not included in EBIT of our operating segments.

The breakdown of earnings before interest and taxes is as follows:

(Dollars in millions)Fiscal 2018Fiscal 2017(1)% ChangeFiscal 2016(1)% Change
North America$3,600$3,875-7%$3,7633%
Europe, Middle East & Africa1,5871,5075%1,787-16%
Greater China1,8071,50720%1,37210%
Asia Pacific & Latin America1,18998021%1,002-2%
Global Brand Divisions(2,658)(2,677)1%(2,596)-3%
TOTAL NIKE BRAND5,5255,1926%5,328-3%
Converse310477-35%487-2%
Corporate(1,456)(724)-101%(1,173)38%
TOTAL NIKE, INC. EARNINGS BEFORE INTEREST AND TAXES4,3794,945-11%4,6427%
Interest expense (income), net5459—19—
TOTAL NIKE, INC. INCOME BEFORE INCOME TAXES$4,325$4,886-11%$4,6236%
(1)Certain prior year amounts have been reclassified to conform to fiscal 2018 presentation. This includes reclassified operating segment data to reflect the changes in the Company’s operating structure, which became effective June 1, 2017. These changes had no impact on previously reported consolidated results of operations or shareholders’ equity.

North America

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues by:
Footwear$9,322$9,684-4%-4%$9,2994%4%
Apparel4,9384,8861%1%4,7463%3%
Equipment595646-8%-8%719-10%-10%
TOTAL REVENUES$14,855$15,216-2%-2%$14,7643%3%
Revenues by:
Sales to Wholesale Customers$10,159$10,756-6%-6%$10,6741%1%
Sales through NIKE Direct4,6964,4605%5%4,0909%9%
TOTAL REVENUES$14,855$15,216-2%-2%$14,7643%3%
EARNINGS BEFORE INTEREST AND TAXES$3,600$3,875-7%$3,7633%

In the current marketplace environment, we believe there has been a meaningful shift in the way consumers shop for product and make purchasing decisions. Consumers are demanding a constant flow of fresh and innovative product, and have an expectation for superior service and real-time delivery, all fueled by the shift toward digital. Specifically, in North America we anticipate continued evolution within the retail landscape, driven by shifting consumer traffic patterns across digital and physical channels. The evolution of the North America marketplace has resulted in third-party retail store closures; however, we are currently seeing stabilization and momentum building in our business, fueled by innovative product and NIKE Brand consumer experiences, leveraging digital.

Fiscal 2018 Compared to Fiscal 2017

North America revenues decreased 2%, as growth in our Sportswear and NIKE Basketball categories was more than offset by declines in all other categories, most notably the Jordan Brand and Running. NIKE Direct revenues increased 5% for fiscal 2018 due to digital commerce sales growth and the addition of new stores.

Footwear revenues declined 4% for fiscal 2018, as lower revenues in nearly all categories, most notably the Jordan Brand, more than offset higher revenues in Sportswear. Unit sales of footwear decreased 5%, while ASP per pair contributed approximately 1 percentage point of footwear growth, driven by the favorable impact of growth in our NIKE Direct business.

Apparel revenue growth of 1% for fiscal 2018 was attributable to higher revenues in our Sportswear and NIKE Basketball categories, which was only partially offset by declines in nearly all other categories. Unit sales of apparel decreased 4%, while higher ASP per unit contributed approximately 5 percentage points of apparel revenue growth, primarily due to the favorable impact of growth in our NIKE Direct business and, to a lesser extent, higher full-price ASP and favorable changes in off-price sales.

EBIT declined 7% for fiscal 2018, primarily reflecting lower revenues and higher selling and administrative expense. Gross margin declined 10 basis points as lower full-price ASP more than offset the favorable impact of growth in our NIKE Direct business. Selling and administrative expense grew due to higher operating overhead expense resulting from continued investments in our growing NIKE Direct business. Demand creation expense also increased, as higher sports marketing costs were only partially offset by lower retail brand presentation costs.

Fiscal 2017 Compared to Fiscal 2016

North America revenues increased 3%, driven by growth in our Sportswear and Jordan Brand categories, partially offset by declines in other categories, including NIKE Basketball. NIKE Direct revenues increased 9% for fiscal 2017 due to digital commerce sales growth, the addition of new stores and comparable store sales growth of 3%.

Footwear revenue growth for fiscal 2017 was attributable to higher revenues in our Sportswear and Jordan Brand categories, partially offset by declines in other categories. Unit sales of footwear increased 4%, while ASP per pair was flat as higher off-price ASP was offset by unfavorable off-price mix.

The increase in apparel revenues for fiscal 2017 was due to growth concentrated in Sportswear, partially offset by declines in other categories. Unit sales of apparel grew 2% and higher ASP per unit contributed approximately 1 percentage point of apparel revenue growth, primarily due to higher full-price ASP.

EBIT grew 3% for fiscal 2017 as revenue growth and gross margin expansion were partially offset by higher selling and administrative expense as a percent of revenues. Gross margin increased 10 basis points as higher full-price ASP and favorable off-price margin more than offset higher product costs and increased off-price mix as a result of clearing excess inventories through off-price channels, including through our NIKE Direct business. Selling and administrative expense grew due to higher operating overhead as continued investments in our growing NIKE Direct business were partially offset by lower bad debt expense. Demand creation was flat as higher sports marketing and retail brand presentation costs offset lower marketing and advertising costs.

Europe, Middle East & Africa

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues by:
Footwear$5,875$5,19213%6%$5,0433%8%
Apparel2,9402,39523%16%2,14911%17%
Equipment42738311%6%3762%7%
TOTAL REVENUES$9,242$7,97016%9%$7,5685%10%
Revenues by:
Sales to Wholesale Customers$6,765$5,91714%8%$5,8691%5%
Sales through NIKE Direct2,4772,05321%13%1,69921%27%
TOTAL REVENUES$9,242$7,97016%9%$7,5685%10%
EARNINGS BEFORE INTEREST AND TAXES$1,587$1,5075%$1,787-16%

Fiscal 2018 Compared to Fiscal 2017

On a currency-neutral basis, EMEA revenues for fiscal 2018 increased 9%, driven by higher revenues in every territory, most notably our UK & Ireland territory, which grew 21%. Revenues increased in nearly all key categories, led by Sportswear and Football (Soccer). NIKE Direct revenues grew 13% for fiscal 2018 due to strong digital commerce sales growth, comparable store sales growth of 6% and the addition of new stores.

The 6% increase in currency-neutral footwear revenues for fiscal 2018 was due to growth in most key categories, led by Sportswear. For fiscal 2018, unit sales of footwear increased 6% while ASP per pair was flat, as higher off-price ASP was offset by lower full-price ASP.

Currency-neutral apparel revenues grew 16% for fiscal 2018, driven by higher revenues in all key categories, most notably Sportswear and Football (Soccer). Unit sales of apparel increased 12% and higher ASP per unit contributed approximately 4 percentage points of apparel revenue growth. The increase in ASP per unit was primarily attributable to higher full-price ASP.

Reported EBIT increased 5% for fiscal 2018 due to revenue growth and slight selling and administrative expense leverage, which was partially offset by gross margin contraction. Gross margin declined 180 basis points as lower product costs were more than offset by unfavorable standard foreign currency exchange rates, lower full-price ASP due to product mix, and lower NIKE Direct margin. Selling and administrative expense increased due to higher demand creation expense driven by sports marketing and advertising costs. Operating overhead also increased primarily due to continued investments in our growing NIKE Direct business and, to a lesser extent, higher administrative costs.

Fiscal 2017 Compared to Fiscal 2016

On a currency-neutral basis, EMEA revenues for fiscal 2017 increased 10%. Revenue growth was broad-based across all territories, led by the UK & Ireland, which grew 11%. On a category basis, revenues increased for nearly all key categories, led by Sportswear and, to a lesser extent, Running and the Jordan Brand. NIKE Direct revenues grew 27% for fiscal 2017 due to comparable store sales growth of 15%, strong digital commerce sales growth and the addition of new stores.

The currency-neutral increase in footwear revenues was led by Sportswear, Running and the Jordan Brand, partially offset by declines in Football (Soccer) and Training. For fiscal 2017, unit sales of footwear increased 5% and higher ASP per pair contributed approximately 3 percentage points of footwear revenue growth. Higher ASP per pair was primarily due to the favorable impact of growth in our NIKE Direct business.

Currency-neutral apparel revenue growth was driven by higher revenues in all key categories, most notably Sportswear and, to a lesser extent, Training and Football (Soccer). Unit sales of apparel for fiscal 2017 increased 12%, while higher ASP per unit contributed approximately 5 percentage points of apparel revenue growth. The increase in ASP per unit was primarily attributable to the favorable impact of growth in our NIKE Direct business and higher full-price ASP.

Reported EBIT decreased 16% for fiscal 2017, in part reflecting the negative impact of weakening foreign currency exchange rates. Higher revenues and selling and administrative expense leverage were more than offset by significant gross margin contraction. Gross margin declined 530 basis points primarily driven by the effects of significant unfavorable standard foreign currency exchange rates. Selling and administrative expense increased due to higher demand creation expense, as increased sports marketing and advertising expenses more than offset lower marketing costs. Operating overhead also increased due to continued investments in our growing NIKE Direct business, partially offset by administrative cost efficiencies and lower variable compensation costs.

Greater China

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues by:
Footwear$3,496$2,92020%16%$2,59912%18%
Apparel1,5081,18827%23%1,05513%18%
Equipment1301291%-1%131-2%3%
TOTAL REVENUES$5,134$4,23721%18%$3,78512%17%
Revenues by:
Sales to Wholesale Customers$3,216$2,77416%13%$2,6236%11%
Sales through NIKE Direct1,9181,46331%27%1,16226%32%
TOTAL REVENUES$5,134$4,23721%18%$3,78512%17%
EARNINGS BEFORE INTEREST AND TAXES$1,807$1,50720%$1,37210%

Fiscal 2018 Compared to Fiscal 2017

On a currency-neutral basis, Greater China revenues for fiscal 2018 increased 18%, driven by higher revenues in all key categories, led by Running, Sportswear and the Jordan Brand. NIKE Direct revenues increased 27%, driven by strong digital commerce sales growth, the addition of new stores and comparable store sales growth of 10%.

Currency-neutral footwear revenues increased 16% for fiscal 2018, driven by growth in nearly all key categories, most notably Running and the Jordan Brand. Unit sales of footwear increased 19%, while lower ASP per pair reduced footwear revenue growth by approximately 3 percentage points, driven by lower full-price ASP resulting from product mix, as well as unfavorable off-price mix.

The currency-neutral apparel revenue growth of 23% for fiscal 2018 was fueled by higher revenues in all key categories, most notably Sportswear and, to a lesser extent, NIKE Basketball, the Jordan Brand and Running. Unit sales of apparel increased 20% and higher ASP per unit increased apparel revenue growth by approximately 3 percentage points. The increase in ASP per unit was attributable to higher full-price, off-price and NIKE Direct ASPs.

Reported EBIT increased 20% for fiscal 2018, driven by higher revenues and selling and administrative expense leverage, partially offset by lower gross margin. Gross margin contracted 210 basis points primarily due to unfavorable standard foreign currency exchange rates and lower off-price margin, including through our NIKE Direct business. Selling and administrative expense increased due to growth in operating overhead expense, primarily reflecting ongoing investments in our NIKE Direct business. Demand creation expense also grew, primarily driven by higher retail brand presentation costs.

Fiscal 2017 Compared to Fiscal 2016

On a currency-neutral basis, Greater China revenues for fiscal 2017 increased 17%, driven by higher revenues in nearly all key categories, led by Running, Sportswear and the Jordan Brand. NIKE Direct revenues increased 32%, driven by strong digital commerce sales growth, the addition of new stores and comparable store sales growth of 9%.

The currency-neutral increase in footwear revenue for fiscal 2017 was driven by growth in nearly all key categories, most notably Running, Sportswear and the Jordan Brand. Unit sales of footwear increased 21%, while lower ASP per pair reduced footwear revenue growth by approximately 3 percentage points as higher off-price ASP was more than offset by lower NIKE Direct ASP and unfavorable off-price mix.

The currency-neutral apparel revenue growth for fiscal 2017 was due to higher revenues in nearly all key categories, led by Sportswear and Running. Unit sales of apparel increased 15% and higher ASP per unit increased apparel revenue growth by approximately 3 percentage points. The increase in ASP per unit was attributable to higher full-price ASP, partially offset by lower ASP in our NIKE Direct business and unfavorable off-price mix.

Despite the negative impact of translation, reported EBIT increased 10% for fiscal 2017 driven by higher revenues and selling and administrative expense leverage, partially offset by lower gross margin. Gross margin contracted 240 basis points primarily due to unfavorable standard foreign currency exchange rates and higher product costs. Selling and administrative expense increased due to higher operating overhead to support NIKE Direct growth. Demand creation expense also increased as higher marketing costs more than offset lower retail brand presentation and sports marketing expenses.

Asia Pacific & Latin America

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues by:
Footwear$3,575$3,2859%9%$2,93012%16%
Apparel1,3471,18514%15%1,1176%9%
Equipment244267-9%-8%270-1%-1%
TOTAL REVENUES$5,166$4,7379%10%$4,31710%13%
Revenues by:
Sales to Wholesale Customers$3,829$3,6315%6%$3,4116%10%
Sales through NIKE Direct1,3371,10621%21%90622%21%
TOTAL REVENUES$5,166$4,7379%10%$4,31710%13%
EARNINGS BEFORE INTEREST AND TAXES$1,189$98021%$1,002-2%

Fiscal 2018 Compared to Fiscal 2017

On a currency-neutral basis, APLA revenues increased 10%, driven by higher revenues in every territory. Territory revenue growth was broad-based, led by SOCO (which comprises Argentina, Uruguay and Chile), which grew 19%. Revenues increased in all key categories, led by Sportswear and Running. NIKE Direct revenues increased 21%, fueled by comparable store sales growth of 11%, strong digital commerce sales growth and the addition of new stores.

The 9% increase in currency-neutral footwear revenues for fiscal 2018 was attributable to growth in every key category, led by Sportswear and Running. Unit sales of footwear increased 5% and higher ASP per pair contributed approximately 4 percentage points of footwear revenue growth, driven by higher full-price, off-price and NIKE Direct ASPs.

Currency-neutral apparel revenues grew 15% for fiscal 2018, driven by higher revenues in every key category, most notably Sportswear and, to a lesser extent, Football (Soccer), Training and NIKE Basketball. Unit sales of apparel increased 11% and higher ASP per unit contributed approximately 4 percentage points of apparel revenue growth. The increase in ASP per unit was primarily driven by higher full-price ASP and, to a lesser extent, favorable off-price mix and higher off-price ASP.

Reported EBIT increased 21% due to revenue growth, strong selling and administrative expense leverage and gross margin expansion. Gross margin increased 90 basis points as higher full-price ASP and favorable standard foreign currency exchange rates more than offset higher product costs. Selling and administrative expense increased as higher operating overhead costs resulting from continued investments in our growing NIKE Direct business more than offset lower demand creation expense. The decrease in demand creation expense was primarily attributable to lower marketing costs as a result of prior year investments to support the Rio Olympics.

Fiscal 2017 Compared to Fiscal 2016

On a currency-neutral basis, APLA revenues for fiscal 2017 increased 13%. Revenue growth was broad-based across all territories, led by SOCO, Korea and Mexico, which grew 34%, 14% and 18%, respectively. Additionally, revenues increased in all key categories, led by Running and Sportswear. NIKE Direct revenues increased 21%, fueled by the addition of new stores, comparable store sales growth of 11% and higher digital commerce sales.

The increase in currency-neutral footwear revenue for fiscal 2017 was attributable to growth in all key categories, most notably Running and Sportswear. Unit sales of footwear increased 9%. Higher ASP per pair contributed approximately 7 percentage points of footwear revenue growth, primarily attributable to higher full-price ASP, in part reflecting inflationary conditions in certain territories.

Currency-neutral growth in apparel revenue was fueled by increases in all key categories, led by Sportswear and Running. For fiscal 2017, unit sales of apparel increased 3% and higher ASP per unit contributed approximately 6 percentage points of apparel revenue growth. The increase in ASP per unit was primarily driven by higher full-price ASP, in part reflecting inflationary conditions in certain territories.

Reported EBIT decreased 2%, in part reflecting the negative impact of changes in foreign currency exchange rates, primarily the Argentine Peso and Mexican Peso. Reported revenue growth and selling and administrative expense leverage were more than offset by lower gross margin. Gross margin decreased 370 basis points as higher full-price ASP was more than offset by unfavorable standard foreign currency exchange rates and higher product costs. Selling and administrative expense increased due to higher operating overhead costs primarily resulting from ongoing investments in our growing NIKE Direct business, partially offset by administrative cost efficiencies. Demand creation expense also increased as lower advertising costs were more than offset by increased marketing support for the Rio Olympics in the first quarter, as well as higher sports marketing costs.

Global Brand Divisions

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues$88$7321%12%$730%2%
(Loss) Before Interest and Taxes$(2,658)$(2,677)-1%$(2,596)3%

Global Brand Divisions primarily represent demand creation, operating overhead and product creation and design expenses that are centrally managed for the NIKE Brand. Revenues for Global Brand Divisions are primarily attributable to NIKE Brand licensing businesses that are not part of a geographic operating segment.

Fiscal 2018 Compared to Fiscal 2017

Global Brand Divisions’ loss before interest and taxes decreased 1% for fiscal 2018 as total selling and administrative expense was largely unchanged compared to fiscal 2017. Operating overhead expense increased due to higher administrative costs, which more than offset lower wage-related expenses. Demand creation expense decreased driven by lower advertising and marketing costs, largely resulting from prior year investments to support the Rio Olympics and the European Football Championship, which were only partially offset by higher sports marketing costs.

Fiscal 2017 Compared to Fiscal 2016

Global Brand Divisions’ loss before interest and taxes increased 3% for fiscal 2017 primarily due to higher demand creation expense, which was only partially offset by a decline in operating overhead expense. The increase in demand creation expense was due to higher marketing and advertising expenses for key brand and sporting events, including the Rio Olympics and the European Football Championship in the first quarter. Operating overhead expense decreased as higher wage-related expenses were more than offset by administrative cost efficiencies and lower variable compensation.

Converse

(Dollars in millions)Fiscal 2018Fiscal 2017% Change% Change Excluding Currency ChangesFiscal 2016% Change% Change Excluding Currency Changes
Revenues$1,886$2,042-8%-11%$1,9554%6%
Earnings Before Interest and Taxes$310$477-35%$487-2%

In territories we define as “direct distribution markets,” Converse designs, markets and sells products directly to distributors and wholesale customers, and to consumers through direct to consumer operations. The largest direct distribution markets are the United States, the United Kingdom and China. We do not own the Converse trademarks in Japan and accordingly do not earn revenues in Japan. Territories other than direct distribution markets and Japan are serviced by third-party licensees who pay royalty revenues to Converse for the use of its registered trademarks and other intellectual property rights.

Fiscal 2018 Compared to Fiscal 2017

On a currency-neutral basis, revenues for Converse declined 11% for fiscal 2018. Comparable direct distribution markets (i.e., markets served under a direct distribution model for comparable periods in the current and prior fiscal years) declined 12%, reducing total Converse revenues by approximately 11 percentage points for fiscal 2018. Comparable direct distribution market unit sales decreased 14%, while higher ASP per unit contributed approximately 2 percentage points of direct distribution markets revenue growth. On a territory basis, the decrease in comparable direct distribution market revenues was primarily attributable to declines in both the United States and Europe, in part reflecting efforts to manage inventory levels in the marketplace, partially offset by revenue growth in Asia. Conversion of markets from licensed to direct distribution increased total Converse revenues by approximately 1 percentage point for fiscal 2018. Revenues from comparable licensed markets decreased 14%, reducing total Converse revenues by approximately 1 percentage point, driven by lower revenues in Latin America.

Reported EBIT declined 35% for fiscal 2018 driven by lower revenues, higher selling and administrative expense and, to a lesser extent, gross margin contraction. Gross margin decreased 100 basis points as higher full-price ASP was more than offset by higher product costs and the unfavorable impact of lower licensing revenues. Selling and administrative expense increased due to higher operating overhead and demand creation expense. Higher operating overhead expense was due to continued investment in our direct to consumer business and, to a lesser extent, higher wage-related costs, while higher demand creation expense was due to increased marketing support for initiatives to drive growth.

Fiscal 2017 Compared to Fiscal 2016

On a currency-neutral basis, revenues for Converse increased 6% for fiscal 2017. Comparable direct distribution markets grew 4%, contributing approximately 4 percentage points of total Converse revenue growth for fiscal 2017. Comparable direct distribution market unit sales increased 2%, while higher ASP per unit contributed approximately 2 percentage points of direct distribution markets revenue growth. On a territory basis, the increase in comparable direct distribution market revenues was primarily attributable to growth in the United States, partially offset by lower revenues in Europe. Conversion of markets from licensed to direct distribution increased total Converse revenues by approximately 2 percentage points for fiscal 2017, primarily driven by the market transition in Italy. Revenues from comparable licensed markets decreased 5%, having an insignificant impact to total Converse revenue. The decrease in comparable licensed markets revenues is primarily due to lower revenues in Latin America.

Reported EBIT declined 2% for fiscal 2017 as revenue growth and lower selling and administrative expense were more than offset by gross margin contraction. Gross margin decreased 300 basis points as higher full-price ASP was more than offset by unfavorable standard foreign currency exchange rates and higher product costs, primarily due to a shift in mix to lower margin products. Gross margin also contracted due to the unfavorable impact of lower licensing revenues, primarily due to market transitions. Selling and administrative expense decreased due to lower demand creation expense, primarily as a result of lower retail brand presentation costs, partially offset by higher advertising expense. Operating overhead increased as higher wage-related expenses were only partially offset by lower administrative costs.

Corporate

(Dollars in millions)Fiscal 2018Fiscal 2017% ChangeFiscal 2016% Change
Revenues$26$75—$(86)—
(Loss) Before Interest and Taxes$(1,456)$(724)101%$(1,173)-38%

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.

The Corporate loss before interest and taxes largely consists of unallocated general and administrative expenses, including expenses associated with centrally managed departments; depreciation and amortization related to our corporate headquarters; unallocated insurance, benefit and compensation programs, including stock-based compensation; and certain foreign currency gains and losses.

In addition to the foreign currency gains and losses recognized in Corporate revenues, foreign currency results in Corporate include gains and losses resulting from the difference between actual foreign currency rates and standard rates used to record non-functional currency denominated product purchases within the NIKE Brand geographic operating segments and Converse; related foreign currency hedge results; conversion gains and losses arising from re-measurement of monetary assets and liabilities in non-functional currencies; and certain other foreign currency derivative instruments.

Fiscal 2018 Compared to Fiscal 2017

For fiscal 2018, Corporate’s loss before interest and taxes increased $732 million primarily due to the following:

•a detrimental change in net foreign currency gains and losses of $281 million related to the re-measurement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments, reported as a component of consolidated Other expense (income), net;
•an unfavorable change of $255 million, primarily due to higher operating overhead expense driven by higher wage-related costs, in part reflecting one-time costs associated with our organizational realignment in the first half of fiscal 2018, as well as higher administrative costs; and
•a detrimental change of $196 million related to the difference between actual foreign currency exchange rates and standard foreign currency exchange rates assigned to the NIKE Brand geographic operating segments and Converse, net of hedge gains and losses; these results are reported as a component of consolidated gross margin.

Fiscal 2017 Compared to Fiscal 2016

For fiscal 2017, Corporate’s loss before interest and taxes decreased $449 million primarily due to the following:

•a beneficial change of $280 million related to the difference between actual foreign currency exchange rates and standard foreign currency exchange rates assigned to the NIKE Brand geographic operating segments and Converse, net of hedge gains and losses; these results are reported as a component of consolidated gross margin;
•a beneficial change of $115 million, primarily driven by lower variable compensation and administrative costs in operating overhead expense; and
•an increase in net foreign currency gains of $54 million related to the re-measurement of monetary assets and liabilities denominated in non-functional currencies and the impact of certain foreign currency derivative instruments, reported as a component of consolidated Other expense (income), net.
Foreign Currency Exposures and Hedging Practices

Overview

As a global company with significant operations outside the United States, in the normal course of business we are exposed to risk arising from changes in currency exchange rates. Our primary foreign currency exposures arise from the recording of transactions denominated in non-functional currencies and the translation of foreign currency denominated results of operations, financial position and cash flows into U.S. Dollars.

Our foreign exchange risk management program is intended to lessen both the positive and negative effects of currency fluctuations on our consolidated results of operations, financial position and cash flows. We manage global foreign exchange risk centrally on a portfolio basis to address those risks material to NIKE, Inc. We manage these exposures by taking advantage of natural offsets and currency correlations existing within the portfolio and, where practical and material, by hedging a portion of the remaining exposures using derivative instruments such as forward contracts and options. As described below, the implementation of the NIKE Trading Company (“NTC”) and our foreign currency adjustment program enhanced our ability to manage our foreign exchange risk by increasing the natural offsets and currency correlation benefits existing within our portfolio of foreign exchange exposures. Our hedging policy is designed to partially or entirely offset the impact of exchange rate changes on the underlying net exposures being hedged. Where exposures are hedged, our program has the effect of delaying the impact of exchange rate movements on our Consolidated Financial Statements; the length of the delay is dependent upon hedge horizons. We do not hold or issue derivative instruments for trading or speculative purposes.

Refer to Note 6 — Fair Value Measurements and Note 16 — Risk Management and Derivatives in the accompanying Notes to the Consolidated Financial Statements for additional description of how the above financial instruments are valued and recorded, as well as the fair value of outstanding derivatives at each reported period end.

Transactional Exposures

We conduct business in various currencies and have transactions which subject us to foreign currency risk. Our most significant transactional foreign currency exposures are:

•Product Costs — NIKE’s product costs are exposed to fluctuations in foreign currencies in the following ways:
1.Product purchases denominated in currencies other than the functional currency of the transacting entity:
a.Certain NIKE entities purchase product from the NTC, a wholly-owned sourcing hub that buys NIKE branded products from third-party factories, predominantly in U.S. Dollars. The NTC, whose functional currency is the U.S. Dollar, then sells the products to NIKE entities in their respective functional currencies. NTC sales to a NIKE entity with a different functional currency result in a foreign currency exposure for the NTC.
b.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.

In both purchasing scenarios, a weaker U.S. Dollar decreases inventory costs incurred by NIKE whereas a stronger U.S. Dollar increases its cost.

2.Factory input costs: NIKE 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 our existing foreign currency exposures. Under this program, our 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 currency within the factory currency exposure indices that is the local or functional currency of the factory, the currency rate fluctuation affecting the product cost is recorded within Inventories and is recognized in Cost of sales when the related product is sold to a third-party. All currencies within the indices, excluding the U.S. Dollar and the local or functional currency of the factory, are recognized as embedded derivative contracts and are recorded at fair value through Other expense (income), net. Refer to Note 16 — Risk Management and Derivatives in the accompanying Notes to the Consolidated Financial Statements for additional detail.

As an offset to the impacts of the fluctuating U.S. Dollar on our non-functional currency denominated product purchases described above, a strengthening U.S. Dollar against the foreign currencies within the factory currency exposure indices decreases NIKE’s U.S. Dollar inventory cost. Conversely, a weakening U.S. Dollar against the indexed foreign currencies increases our inventory cost.

•Non-Functional Currency Denominated External Sales — A portion of our EMEA geography revenues, as well as a portion of our Converse European operations revenues, are earned in currencies other than the Euro (e.g., the British Pound) but are recognized at a subsidiary that uses the Euro as its functional currency. These sales generate a foreign currency exposure.
•Other Costs — Non-functional currency denominated costs, such as endorsement contracts, also generate foreign currency risk, though to a lesser extent. In certain cases, the Company has entered into contractual agreements which have payments indexed to foreign currencies that create embedded derivative contracts recorded at fair value through Other expense (income), net. Refer to Note 16 — Risk Management and Derivatives in the accompanying Notes to the Consolidated Financial Statements for additional detail.
•Non-Functional Currency Denominated Monetary Assets and Liabilities — Our global subsidiaries have various assets and liabilities, primarily receivables and payables, including intercompany receivables and payables, denominated in currencies other than their functional currencies. These balance sheet items are subject to re-measurement which may create fluctuations in Other expense (income), net within our consolidated results of operations.

Managing Transactional Exposures

Transactional exposures are managed on a portfolio basis within our foreign currency risk management program. We manage these exposures by taking advantage of natural offsets and currency correlations that exist within the portfolio and may also elect to use currency forward and option contracts to hedge the remaining effect of exchange rate fluctuations on probable forecasted future cash flows, including certain product cost exposures, non-functional currency denominated external sales and other costs described above. Generally, these are accounted for as cash flow hedges in accordance with U.S. GAAP, except for hedges of the embedded derivatives components of the product cost exposures and other contractual agreements as discussed above.

Certain currency forward contracts used to manage the foreign exchange exposure of non-functional currency denominated monetary assets and liabilities subject to re-measurement and embedded derivative contracts are not formally designated as hedging instruments under U.S. GAAP. Accordingly, changes in fair value of these instruments are immediately recognized in Other expense (income), net and are intended to offset the foreign currency impact of the re-measurement of the related non-functional currency denominated asset or liability or the embedded derivative contract being hedged.

Translational Exposures

Many of our foreign subsidiaries operate in functional currencies other than the U.S. Dollar. Fluctuations in currency exchange rates create volatility in our reported results as we are required to translate the balance sheets, operational results and cash flows of these subsidiaries into U.S. Dollars for consolidated reporting. The translation of foreign subsidiaries’ non-U.S. Dollar denominated balance sheets into U.S. Dollars for consolidated reporting results in a cumulative translation adjustment to Accumulated other comprehensive income within the Consolidated Statements of Shareholders’ Equity. In the translation of our Consolidated Statements of Income, a weaker U.S. Dollar in relation to foreign functional currencies benefits our consolidated earnings whereas a stronger U.S. Dollar reduces our consolidated earnings. The impact of foreign exchange rate fluctuations on the translation of our consolidated Revenues was a benefit of approximately $832 million and a detriment of approximately $542 million for the years ended May 31, 2018 and 2017, respectively. The impact of foreign exchange rate fluctuations on the translation of our Income before income taxes was a benefit of approximately $177 million and a detriment of approximately $115 million for the years ended May 31, 2018 and 2017, respectively.

Management generally identifies hyper-inflationary markets as those markets whose cumulative inflation rate over a three-year period exceeds 100%. Beginning in fiscal 2019, we anticipate the functional currency of our Argentina subsidiary within our APLA operating segment will change from the local currency to U.S. Dollars as the subsidiary will be operating in a hyper-inflationary market. As a result, its non-U.S. Dollar denominated monetary assets and liabilities will now be subject to re-measurement and recorded in Other expense (income), net, within the Consolidated Statements of Income beginning in fiscal 2019. Although we continue to evaluate the impact, at current rates, we do not anticipate the re-measurement to have a material impact on our results of operations or financial condition.

Managing Translational Exposures

To minimize the impact of translating foreign currency denominated revenues and expenses into U.S. Dollars for consolidated reporting, certain foreign subsidiaries use excess cash to purchase U.S. Dollar denominated available-for-sale investments. The variable future cash flows associated with the purchase and subsequent sale of these U.S. Dollar denominated securities at non-U.S. Dollar functional currency subsidiaries creates a foreign currency exposure that qualifies for hedge accounting under the accounting standards for derivatives and hedging. We utilize forward contracts and/or options to mitigate the variability of the forecasted future purchases and sales of these U.S. Dollar investments. The combination of the purchase and sale of the U.S. Dollar investment and the hedging instrument has the effect of partially offsetting the year-over-year foreign currency translation impact on net earnings in the period the investments are sold. Hedges of available-for-sale investments are accounted for as cash flow hedges.

We estimate the combination of translation of foreign currency-denominated profits from our international businesses and the year-over-year change in foreign currency related gains and losses included in Other expense (income), net had an unfavorable impact of approximately $110 million and $59 million on our Income before income taxes for the years ended May 31, 2018 and 2017, respectively.

Net Investments in Foreign Subsidiaries

We are also exposed to the impact of foreign exchange fluctuations on our investments in wholly-owned foreign subsidiaries denominated in a currency other than the U.S. Dollar, which could adversely impact the U.S. Dollar value of these investments and therefore the value of future repatriated earnings. We have, in the past, hedged and may, in the future, hedge net investment positions in certain foreign subsidiaries to mitigate the effects of foreign exchange fluctuations on these net investments. These hedges are accounted for in accordance with U.S. GAAP. There were no outstanding net investment hedges as of May 31, 2018 and 2017. There were no cash flows from net investment hedge settlements for the years ended May 31, 2018 and 2017.

Liquidity and Capital Resources

Cash Flow Activity

Cash provided by operations was $4,955 million for fiscal 2018 compared to $3,846 million for fiscal 2017. Net income, adjusted for non-cash items, generated $3,473 million of operating cash flow for fiscal 2018 compared to $4,781 million for fiscal 2017. The net change in working capital and other assets and liabilities resulted in an increase of $1,482 million for fiscal 2018, compared to a decrease of $935 million for fiscal 2017. Impacting the change in working capital during fiscal 2018 was the accrual of $1,172 million for the transition tax under the Tax Act, which will be paid in cash over an eight-year period. Refer to Note 9 — Income Taxes for additional information on the Tax Act. Cash provided by operations was also impacted by the change in Accounts Receivable, net, which decreased $187 million, primarily due to improved collection timing, compared to an increase of $426 million in fiscal 2017.

Cash provided (used) by investing activities was an inflow of $276 million for fiscal 2018, compared to an outflow of $1,008 million for fiscal 2017, driven primarily by the net change in short-term investments. During fiscal 2018, the net change in investments (including sales, maturities and purchases) resulted in a cash inflow of $1,326 million compared to an inflow of $118 million in fiscal 2017.

In fiscal 2019, we plan to continue investing in our infrastructure to support future growth, including corporate facilities, expanding our digital capabilities and new NIKE Direct stores. We continue to expect such investments to approximate 3% to 4% of revenues, on average.

Cash used by financing activities was $4,835 million for fiscal 2018 compared to $2,148 million for fiscal 2017. The increase in Cash used by financing activities was primarily driven by $1,482 million of net proceeds from the issuance of long-term debt in fiscal 2017, which did not recur in fiscal 2018. The increase in Cash used by financing activities was also impacted by increased repurchases of common stock, which resulted in a cash outflow of $4,254 million for fiscal 2018 compared to an outflow of $3,223 million for fiscal 2017.

In fiscal 2018, we purchased 69.7 million shares of NIKE’s Class B Common Stock for $4,267 million (an average price of $61.25 per share) under the four-year, $12 billion program approved by the Board of Directors in November 2015. As of May 31, 2018, we had repurchased 149.4 million shares at a cost of $8,704 million (an average price of $58.25 per share) under this program. Although the timing and number of shares purchased will be dictated by our capital needs and stock market conditions, we currently anticipate completing this program during fiscal 2019. In June 2018, our Board of Directors approved a new four-year, $15 billion program to repurchase shares of NIKE’s Class B Common Stock, which we anticipate will commence at the completion of our current program. We continue to expect funding of share repurchases will come from operating cash flows, excess cash and/or proceeds from debt.

Capital Resources

On July 21, 2016, we filed a shelf registration statement (the “Shelf”) with the SEC which permits us to issue an unlimited amount of debt securities from time to time. The Shelf expires on July 21, 2019. For additional detail refer to Note 8 — Long-Term Debt in the accompanying Notes to the Consolidated Financial Statements.

On August 28, 2015, we entered into a committed credit facility agreement with a syndicate of banks, which provides for up to $2 billion of borrowings. The facility matures August 28, 2020, with a one-year extension option prior to any anniversary of the closing date, provided that in no event shall it extend beyond August 28, 2022. As of and for the periods ended May 31, 2018 and 2017, we had no amounts outstanding under the committed credit facility.

We currently have long-term debt ratings of AA- and A1 from Standard and Poor’s Corporation and Moody’s Investor Services, respectively. If our long-term debt ratings were to decline, the facility fee and interest rate under our committed credit facility would increase. Conversely, if our long-term debt ratings were to improve, the facility fee and interest rate would decrease. Changes in our long-term debt ratings would not trigger acceleration of maturity of any then-outstanding borrowings or any future borrowings under the committed credit facility. Under this facility, we have agreed to various covenants. These covenants include limits on our disposal of fixed assets and the amount of debt secured by liens we may incur as well as limits on the indebtedness we can incur relative to our net worth. In the event we were to have any borrowings outstanding under this facility and failed to meet any covenant, and were unable to obtain a waiver from a majority of the banks in the syndicate, any borrowings would become immediately due and payable. As of May 31, 2018, we were in full compliance with each of these covenants and believe it is unlikely we will fail to meet any of these covenants in the foreseeable future.

Liquidity is also provided by our $2 billion commercial paper program. During the year ended May 31, 2018, the maximum amount of commercial paper borrowings outstanding at any point was $1.4 billion. As of May 31, 2018, there were $325 million of outstanding borrowings under this program. We may continue to issue commercial paper or other debt securities during fiscal 2019 depending on general corporate needs. We currently have short-term debt ratings of A1+ and P1 from Standard and Poor’s Corporation and Moody’s Investor Services, respectively.

To date, in fiscal 2018, we have not experienced difficulty accessing the credit markets or incurred higher interest costs; however, future volatility in the capital markets may increase costs associated with issuing commercial paper or other debt instruments or affect our ability to access those markets.

As of May 31, 2018, we had cash, cash equivalents and short-term investments totaling $5.2 billion, primarily consisting of deposits held at major banks, money market funds, commercial paper, corporate notes, U.S. Treasury obligations, U.S. government sponsored enterprise obligations and other investment grade fixed-income securities. Our fixed-income investments are exposed to both credit and interest rate risk. All of our investments are investment grade to minimize our credit risk. While individual securities have varying durations, as of May 31, 2018, the weighted-average days to maturity of our cash equivalents and short-term investments portfolio was 33 days.

We believe that existing cash, cash equivalents, short-term investments and cash generated by operations, together with access to external sources of funds as described above, will be sufficient to meet our domestic and foreign capital needs in the foreseeable future.

Off-Balance Sheet Arrangements

In connection with various contracts and agreements, we routinely provide indemnification relating to the enforceability of intellectual property rights, coverage for legal issues that arise and other items where we are acting as the guarantor. Currently, we have several such agreements in place. Based on our historical experience and the estimated probability of future loss, we have determined that the fair value of such indemnification is not material to our financial position or results of operations.

Contractual Obligations

Our significant long-term contractual obligations as of May 31, 2018, and significant endorsement contracts, including related marketing commitments, entered into through the date of this report are as follows:

Description of CommitmentCash Payments Due During the Year Ending May 31,
(In millions)20192020202120222023ThereafterTotal
Operating Leases$589$523$472$412$361$1,608$3,965
Capital Leases and Other Financing Obligations(1)4437403836229424
Long-Term Debt(2)1151151121096094,7135,773
Endorsement Contracts(3)1,3911,3061,1581,2669424,43810,501
Product Purchase Obligations(4)4,566—————4,566
Other Purchase Obligations(5)1,43751228192702542,646
Transition Tax Related to the Tax Act(6)94949494947021,172
TOTAL$8,236$2,587$2,157$2,011$2,112$11,944$29,047
(1)Capital leases and other financing obligations include payments related to build-to-suit lease arrangements.
(2)The cash payments due for long-term debt include estimated interest payments. Estimates of interest payments are based on outstanding principal amounts, applicable fixed interest rates or currently effective interest rates as of May 31, 2018 (if variable), timing of scheduled payments and the term of the debt obligations.
(3)The amounts listed for endorsement contracts represent approximate amounts of base compensation and minimum guaranteed royalty fees we are obligated to pay athlete, public figure, sport team and league endorsers of our products. Actual payments under some contracts may be higher than the amounts listed as these contracts provide for bonuses to be paid to the endorsers based upon athletic achievements and/or royalties on product sales in future periods. Actual payments under some contracts may also be lower as these contracts include provisions for reduced payments if athletic performance declines in future periods.

In addition to the cash payments, we are obligated to furnish our endorsers with NIKE product for their use. It is not possible to determine how much we will spend on this product on an annual basis as the contracts generally do not stipulate a specific amount of cash to be spent on the product. The amount of product provided to the endorsers will depend on many factors, including general playing conditions, the number of sporting events in which they participate and our own decisions regarding product and marketing initiatives. In addition, the costs to design, develop, source and purchase the products furnished to the endorsers are incurred over a period of time and are not necessarily tracked separately from similar costs incurred for products sold to customers.

(4)We generally order product at least four to five months in advance of sale based primarily on advanced orders received from external wholesale customers and internal orders from our NIKE Direct in-line stores and digital commerce operations. The amounts listed for product purchase obligations represent agreements (including open purchase orders) to purchase products in the ordinary course of business that are enforceable and legally binding and specify all significant terms. In some cases, prices are subject to change throughout the production process.
(5)Other purchase obligations primarily include construction, service and marketing commitments, including marketing commitments associated with endorsement contracts, made in the ordinary course of business. The amounts represent the minimum payments required by legally binding contracts and agreements that specify all significant terms, including open purchase orders for non-product purchases.
(6)Represents a provisional estimate of the future cash payments due as part of the transition tax on deemed repatriation of undistributed earnings of foreign subsidiaries, which is reflected net of foreign tax credits we expect to utilize. Actual amounts could vary as we complete our analysis of the Tax Act. Refer to Note 9 — Income Taxes in the accompanying Notes to the Financial Statements for additional information.

In addition to the above, we have long-term obligations for uncertain tax positions and various post-retirement benefits for which we are not able to reasonably estimate when cash payments will occur. Refer to Note 9 — Income Taxes and Note 13 — Benefit Plans in the accompanying Notes to the Consolidated Financial Statements for further information related to uncertain tax positions and post-retirement benefits, respectively.

We also have the following outstanding short-term debt obligations as of May 31, 2018. Refer to Note 7 — Short-Term Borrowings and Credit Lines in the accompanying Notes to the Consolidated Financial Statements for further description and interest rates related to the short-term debt obligations listed below.

Outstanding as of May 31, 2018
(In millions)
Notes payable, due at mutually agreed-upon dates within one year of issuance or on demand$336
Payable to Sojitz America for the purchase of inventories, generally due 60 days after shipment of goods from a foreign port61

As of May 31, 2018, the Company had letters of credit outstanding totaling $165 million. These letters of credit were issued primarily for the purchase of inventory and as guarantees of the Company’s performance under certain self-insurance and other programs.

New Accounting Pronouncements

Refer to Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements for recently adopted and recently issued accounting standards.

Critical Accounting Policies

Our previous discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Note 1 — Summary of Significant Accounting Policies in the accompanying Notes to the Consolidated Financial Statements describes the significant accounting policies and methods used in the preparation of our Consolidated Financial Statements.

We believe the estimates, assumptions and judgments involved in the accounting policies described below have the greatest potential impact on our financial statements, so we consider these to be our critical accounting policies and estimates. Management has reviewed and discussed these critical accounting policies with the Audit & Finance Committee of the Board of Directors.

These policies require we make estimates in the preparation of our financial statements as of a given date. Because of the uncertainty inherent in these matters, actual results could differ from the estimates we use in applying the critical accounting policies. Within the context of these critical accounting policies, we are not currently aware of any reasonably likely events or circumstances that would result in materially different amounts being reported.

Revenue Recognition

We record wholesale revenues when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment or upon receipt by the customer depending on the country of the sale and the agreement with the customer. Retail store revenues are recorded at the time of sale and digital commerce revenues are recorded upon delivery to the customer.

In some instances, we ship product directly from our supplier to the customer and recognize revenue when the product is delivered to and accepted by the customer. Our revenues may fluctuate in cases when our customers delay accepting shipment of product for periods of up to several weeks.

In certain countries, precise information regarding the date of receipt by the customer is not readily available. In these cases, we estimate the date of receipt by the customer based upon historical delivery times by geographic location. On the basis of our tests of actual transactions, we have no indication these estimates have been materially inaccurate historically.

As part of our revenue recognition policy, we record estimated sales returns, discounts and miscellaneous claims from customers as reductions to revenues at the time revenues are recorded. Our post invoice sales discounts consist of contractual programs with certain customers or discretionary discounts expected to be granted to certain customers at a later date. We base our estimates on (1) historical rates of product returns, discounts and claims, (2) specific identification of outstanding claims and outstanding returns not yet received from customers and (3) estimated returns, discounts and claims expected but not yet finalized with our customers. Actual returns, discounts and claims in any future period are inherently uncertain and thus may differ from our estimates. If actual or expected future returns, discounts and claims are significantly greater or lower than established reserves, we record a reduction or increase to net revenues in the period in which we make such determination.

Allowance for Uncollectible Accounts Receivable

We make ongoing estimates relating to the ability to collect our accounts receivable and maintain an allowance for estimated losses resulting from the inability of our customers to make required payments. In determining the amount of the allowance, we consider our historical level of credit losses and make judgments about the creditworthiness of significant customers based on ongoing credit evaluations. Since we cannot predict future changes in the financial stability of our customers, actual future losses from uncollectible accounts may differ from our estimates. If the financial condition of our customers were to deteriorate, resulting in their inability to make payments, a larger allowance might be required. In the event we determine a smaller or larger allowance is appropriate, we would record a credit or a charge to Operating overhead expense in the period in which such a determination is made.

Inventory Reserves

We also make ongoing estimates relating to the net realizable value of inventories based upon our assumptions about future demand and market conditions. If we estimate the net realizable value of our inventory is less than the cost of the inventory recorded on our books, we record a reserve equal to the difference between the cost of the inventory and the estimated net realizable value. This reserve is recorded as a charge to Cost of sales. If changes in market conditions result in reductions in the estimated net realizable value of our inventory below our previous estimate, we would increase our reserve in the period in which we made such a determination.

Contingent Payments under Endorsement Contracts

A significant amount of our Demand creation expense relates to payments under endorsement contracts. In general, endorsement payments are expensed on a straight-line basis over the term of the contract. However, certain contract elements may be accounted for differently based upon the facts and circumstances of each individual contract.

Certain contracts provide for contingent payments to endorsers based upon specific achievements in their sports (e.g., winning a championship). We record demand creation expense for these amounts when the endorser achieves the specific goal.

Certain contracts provide for variable payments based upon endorsers maintaining a level of performance in their sport over an extended period of time (e.g., maintaining a specified ranking in a sport for a year). When we determine payments are probable, the amounts are reported in Demand creation expense ratably over the contract period based on our best estimate of the endorser’s performance. In these instances, to the extent actual payments to the endorser differ from our estimate due to changes in the endorser’s performance, adjustments to Demand creation expense may be recorded in a future period.

Certain contracts provide for royalty payments to endorsers based upon a predetermined percent of sales of particular products. We expense these payments in Cost of sales as the related sales occur. In certain contracts, we offer minimum guaranteed royalty payments. For contracts for which we estimate we will not meet the minimum guaranteed amount of royalty fees through sales of product, we record the amount of the guaranteed payment in excess of that earned through sales of product in Demand creation expense uniformly over the contract term.

Property, Plant and Equipment and Definite-Lived Assets

We review the carrying value of long-lived assets or asset groups to be used in operations whenever events or changes in circumstances indicate the carrying amount of the assets might not be recoverable. Factors that would necessitate an impairment assessment include a significant adverse change in the extent or manner in which an asset is used, a significant adverse change in legal factors or the business climate that could affect the value of the asset or a significant decline in the observable market value of an asset, among others. If such facts indicate a potential impairment, we would assess the recoverability of an asset group by determining if the carrying value of the asset group exceeds the sum of the projected undiscounted cash flows expected to result from the use and eventual disposition of the assets over the remaining economic life of the primary asset in the asset group. If the recoverability test indicates the carrying value of the asset group is not recoverable, we will estimate the fair value of the asset group using appropriate valuation methodologies that would typically include an estimate of discounted cash flows. Any impairment would be measured as the difference between the asset group’s carrying amount and its estimated fair value.

Hedge Accounting for Derivatives

We use derivative contracts to hedge certain anticipated foreign currency and interest rate transactions as well as certain non-functional currency monetary assets and liabilities. When the specific criteria to qualify for hedge accounting has been met, changes in the fair value of contracts hedging probable forecasted future cash flows are recorded in Accumulated other comprehensive income, rather than Net income, until the underlying hedged transaction affects Net income. In most cases, this results in gains and losses on hedge derivatives being released from Other comprehensive income into Net income sometime after the maturity of the derivative. One of the criteria for this accounting treatment is that the notional value of these derivative contracts should not be in excess of specifically identified anticipated transactions. By their very nature, our estimates of anticipated transactions may fluctuate over time and may ultimately vary from actual transactions. When anticipated transaction estimates or actual transaction amounts decline below hedged levels, or if it is no longer probable a forecasted transaction will occur by the end of the originally specified time period or within an additional two-month period of time thereafter, we are required to reclassify the cumulative change in fair value of the over-hedged portion of the related hedge contract from Other comprehensive income to Other expense (income), net during the quarter in which the decrease occurs.

Stock-based Compensation

We account for stock-based compensation by estimating the fair value of stock-based compensation on the date of grant using the Black-Scholes option pricing model. The Black-Scholes option pricing model requires the input of highly subjective assumptions including volatility. Expected volatility is estimated based on implied volatility in market traded options on our common stock with a term greater than one year, along with other factors. Our decision to use implied volatility was based on the availability of actively traded options on our common stock and our assessment that implied volatility is more representative of future stock price trends than historical volatility. If factors change and we use different assumptions for estimating stock-based compensation expense in future periods, stock-based compensation expense may differ materially in the future from that recorded in the current period.

Income Taxes

We are subject to taxation in the United States, as well as various state and foreign jurisdictions. The determination of our provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. On an interim basis, we estimate what our effective tax rate will be for the full fiscal year. This estimated annual effective tax rate is then applied to the year-to-date Income before income taxes excluding infrequently occurring or unusual items, to determine the year-to-date Income tax expense. The income tax effects of infrequent or unusual items are recognized in the interim period in which they occur. As the fiscal year progresses, we continually refine our estimate based upon actual events and earnings by jurisdiction during the year. This continual estimation process periodically results in a change to our expected effective tax rate for the fiscal year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs.

We record valuation allowances against our deferred tax assets, when necessary. Realization of deferred tax assets (such as net operating loss carry-forwards) is dependent on future taxable earnings and is therefore uncertain. At least quarterly, we assess the likelihood that our deferred tax asset balance will be recovered from future taxable income. To the extent we believe that recovery is not likely, we establish a valuation allowance against our net deferred tax asset, which increases our Income tax expense in the period when such determination is made.

On a quarterly basis, we evaluate the probability a tax position will be effectively sustained and the appropriateness of the amount recognized for uncertain tax positions based on factors including changes in facts or circumstances, changes in tax law, settled audit issues and new audit activity. Changes in our assessment may result in the recognition of a tax benefit or an additional charge to the tax provision in the period our assessment changes. We recognize interest and penalties related to income tax matters in Income tax expense.

On December 22, 2017, the United States enacted the Tax Act, which significantly changes previous U.S. tax laws, including provisions for a one-time transition tax on deemed repatriation of undistributed foreign earnings, a reduction in the corporate tax rate from 35% to 21%, as well as other changes. In accordance with U.S. Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”), we recorded provisional amounts, which represent reasonable estimates of the effects of the Tax Act for which the analysis is not yet complete. As the Company completes its analysis of the Tax Act, including collecting, preparing and analyzing necessary information, performing and refining calculations and obtaining additional guidance from the U.S. Internal Revenue Services (IRS), U.S. Treasury Department, Financial Accounting Standards Board (FASB) or other standard setting and regulatory bodies on the Tax Act, it may record adjustments to the provisional amounts, which may be material. In accordance with SAB 118, the Company’s accounting for the tax effects of the Tax Act will be completed during the measurement period, which should not extend beyond one year from the enactment date.

Refer to Note 9 — Income Taxes in the accompanying Notes to the Consolidated Financial Statements for additional information.

Other Contingencies

In the ordinary course of business, we are involved in legal proceedings regarding contractual and employment relationships, product liability claims, trademark rights and a variety of other matters. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third-party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. If future adjustments to estimated probable future losses or actual losses exceed our recorded liability for such claims, we would record additional charges during the period in which the actual loss or change in estimate occurred. In addition to contingent liabilities recorded for probable losses, we disclose contingent liabilities when there is a reasonable possibility the ultimate loss will materially exceed the recorded liability. While we cannot predict the outcome of pending legal matters with certainty, we do not believe any currently identified claim, proceeding or litigation, either individually or in aggregate, will have a material impact on our results of operations, financial position or cash flows.

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