Nike 2014 Annual Report Download - page 68

PART II
NTC sells to a NIKE entity with a different functional currency, the result is a
foreign currency exposure for the NTC; (2) Other NIKE entities purchase
product directly from third-party factories in U.S. Dollars. These purchases
generate a foreign currency exposure for those NIKE entities with a functional
currency other than the U.S. Dollar.
In January 2012, the Company implemented a foreign currency adjustment
program with certain factories. The program is designed to more effectively
manage foreign currency risk by assuming certain of the factories’ foreign
currency exposures, some of which are natural offsets to the Company’s
existing foreign currency exposures. Under this program, the Company’s
payments to these factories are adjusted for rate fluctuations in the basket of
currencies (“factory currency exposure index”) in which the labor, materials
and overhead costs incurred by the factories in the production of NIKE
branded products (“factory input costs”) are denominated. For the portion of
the indices denominated in the local or functional currency of the factory, the
Company may elect to place formally designated cash flow hedges. For all
currencies within the indices, excluding the U.S. Dollar and the local or
functional currency of the factory, an embedded derivative contract is created
upon the factory’s acceptance of NIKE’s purchase order. Embedded
derivative contracts are separated from the related purchase order and their
accounting treatment is described further below.
The Company’s policy permits the utilization of derivatives to reduce its
foreign currency exposures where internal netting or other strategies cannot
be effectively employed. Hedged transactions are denominated primarily in
Euros, British Pounds and Japanese Yen. Typically the Company may enter
into hedge contracts starting 12 to 24 months in advance of the forecasted
transaction and may place incremental hedges up to 100% of the exposure
by the time the forecasted transaction occurs.
All changes in the fair value of derivatives designated as cash flow hedges,
excluding any ineffective portion, are recorded in Other comprehensive
income until Net income is affected by the variability of cash flows of the
hedged transaction. In most cases, amounts recorded in Other
comprehensive income will be released to Net income sometime after the
maturity of the related derivative. Effective hedge results are classified within
the Consolidated Statements of Income in the same manner as the
underlying exposure, with the results of hedges of non-functional currency
denominated revenues and product cost exposures, excluding embedded
derivatives as described below, recorded in Revenues or Cost of sales, when
the underlying hedged transaction affects consolidated Net income. Results
of hedges of selling and administrative expense are recorded together with
those costs when the related expense is recorded. Results of hedges of
anticipated purchases and sales of U.S. Dollar-denominated available-for-
sale securities are recorded in Other expense (income), net when the
securities are sold. Results of hedges of certain anticipated intercompany
transactions are recorded in Other expense (income), net when the
transaction occurs. The Company classifies the cash flows at settlement from
these designated cash flow hedge derivatives in the same category as the
cash flows from the related hedged items, generally within the Cash provided
by operations component of the Consolidated Statement of Cash Flows.
Premiums paid on options are initially recorded as deferred charges. The
Company assesses the effectiveness of options based on the total cash flows
method and records total changes in the options’ fair value to Other
comprehensive income to the degree they are effective.
The Company formally assesses, both at a hedge’s inception and on an
ongoing basis, whether the derivatives that are used in the hedging
transaction have been highly effective in offsetting changes in the cash flows
of hedged items and whether those derivatives may be expected to remain
highly effective in future periods. Effectiveness for cash flow hedges is
assessed based on changes in forward rates. Ineffectiveness was immaterial
for the years ended May 31, 2014, 2013, and 2012.
The Company discontinues hedge accounting prospectively when (1) it
determines that the derivative is no longer highly effective in offsetting
changes in the cash flows of a hedged item (including hedged items such as
firm commitments or forecasted transactions); (2) the derivative expires or is
sold, terminated, or exercised; (3) it is no longer probable that the forecasted
transaction will occur; or (4) management determines that designating the
derivative as a hedging instrument is no longer appropriate.
When the Company discontinues hedge accounting because it is no longer
probable that the forecasted transaction will occur in the originally expected
period, but is expected to occur within an additional two-month period of time
thereafter, the gain or loss on the derivative remains in Accumulated other
comprehensive income and is reclassified to Net income when the forecasted
transaction affects consolidated Net income. However, if it is probable that a
forecasted transaction will not occur by the end of the originally specified time
period or within an additional two-month period of time thereafter, the gains
and losses that were accumulated in Other comprehensive income will be
recognized immediately in Other expense (income), net. In all situations in
which hedge accounting is discontinued and the derivative remains
outstanding, the Company will carry the derivative at its fair value on the
Consolidated Balance Sheets, recognizing future changes in the fair value in
Other expense (income), net. For the years ended May 31, 2014, 2013, and
2012, the amounts recorded in Other expense (income), net as a result of the
discontinuance of cash flow hedging because the forecasted transaction was
no longer probable of occurring were immaterial.
As of May 31, 2014, $10 million of deferred net gains (net of tax) on both
outstanding and matured derivatives accumulated in Other comprehensive
income are expected to be reclassified to Net income during the next 12
months concurrent with the underlying hedged transactions also being
recorded in Net income. Actual amounts ultimately reclassified to Net income
are dependent on the exchange rates in effect when derivative contracts that
are currently outstanding mature. As of May 31, 2014, the maximum term
over which the Company is hedging exposures to the variability of cash flows
for its forecasted transactions is 24 months.
Fair Value Hedges
The Company is also exposed to the risk of changes in the fair value of certain
fixed-rate debt attributable to changes in interest rates. Derivatives currently
used by the Company to hedge this risk are receive-fixed, pay-variable
interest rate swaps. As of May 31, 2014, all interest rate swap agreements are
designated as fair value hedges of the related long-term debt and meet the
shortcut method requirements under the accounting standards for derivatives
and hedging. Accordingly, changes in the fair values of the interest rate swap
agreements are considered to exactly offset changes in the fair value of the
underlying long-term debt. The cash flows associated with the Company’s
fair value hedges are periodic interest payments while the swaps are
outstanding, which are reflected within the Cash provided by operations
component of the Consolidated Statement of Cash Flows. The Company
recorded no ineffectiveness from its interest rate swaps designated as fair
value hedges for the years ended May 31, 2014, 2013, or 2012.
Net Investment Hedges
The Company has hedged and may, in the future, hedge the risk of variability
in foreign-currency-denominated net investments in wholly-owned
international operations. All changes in fair value of the derivatives designated
as net investment hedges, except ineffective portions, are reported in the
Cumulative translation adjustment component of Other comprehensive
income along with the foreign currency translation adjustments on those
investments. The Company classifies the cash flows at settlement of its net
investment hedges within the Cash (used) provided by investing activities
component of the Consolidated Statement of Cash Flows. The Company
assesses hedge effectiveness based on changes in forward rates. The
Company recorded no ineffectiveness from its net investment hedges for the
years ended May 31, 2014, 2013, or 2012.
NIKE, INC. 2014 Annual Report and Notice of Annual Meeting 111
FORM 10-K