Nike 2016 Annual Report Download - page 35

PART II
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 that
are material to NIKE, Inc. We manage these exposures by taking advantage
of natural offsets and currency correlations that exist 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 that exist 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.
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.
When the NTC sells to a NIKE entity with a different functional
currency, the result is 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 the
inventory cost 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 (income) expense, 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
Western Europe and Central & Eastern Europe 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 also entered into other
contractual agreements which have payments that are indexed to foreign
currencies and create embedded derivative contracts that are recorded at
fair value through Other (income) expense, 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 (income) expense, 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 a portion of the remaining effect of exchange rate fluctuations on
probable forecasted future cash flows, including certain product cost
purchase exposures, non-functional currency denominated external sales
and other costs described above. Generally, these are accounted for as cash
flow hedges in accordance with the accounting standards for derivatives and
hedging, except for hedges of the embedded derivatives component of the
product cost exposures as discussed below.
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 the embedded derivative contracts
discussed above are not formally designated as hedging instruments under
the accounting standards for derivatives and hedging. Accordingly, changes
in fair value of these instruments are immediately recognized in Other (income)
expense, 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.
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