Nike (NKE)

Overview

NIKE designs, develops and markets high quality footwear, apparel, equipment and accessory products worldwide. We are the largest seller of athletic footwear and apparel in the world and sell our products primarily through a combination of retail accounts, NIKE-owned retail, including stores and e-commerce, independent distributors, franchisees and licensees worldwide. 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 retail presentation and experiences.

We strive to convert revenue growth to shareholder value by driving operating excellence in several key areas:

Through execution of this strategy, our long-term financial goal is to achieve:

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Since the adoption of this long-term strategy in 2001, on an annual compounded basis, NIKE, Inc.’s revenues and earnings per share have grown 9% and 14%, respectively. During the same period, our return on invested capital increased from 14% to 18%. In fiscal 2009, deteriorating macroeconomic conditions caused significant volatility in global financial markets and put significant pressure on discretionary consumer spending worldwide. NIKE’s fiscal 2009 revenues grew 3% to $19.2 billion, net income decreased 21% to $1.5 billion, and we delivered diluted earnings per share of $3.03, a 19% decrease versus fiscal 2008. Our fiscal 2009 reported results also contain significant non-comparable transactions, including after-tax charges of $144.5 million for our restructuring activities, which were completed in the fourth quarter of fiscal 2009, and $240.7 million for the impairment of goodwill, intangible and other assets of Umbro, which was recorded in the third quarter of fiscal 2009. Our fiscal 2008 reported results include combined gains from the sale of our Starter Brand and NIKE Bauer Hockey businesses of $35.4 million, net of tax, and a one-time tax benefit of $105.4 million. Excluding these non-comparable items, net income would have increased 7% to $1.9 billion and diluted earnings per share would have increased 10% to $3.81 compared to fiscal 2008 (see Reconciliation of Net Income and Diluted Earnings Per Share Excluding Non-Comparable items below). The increase in our net income excluding non-comparable items was higher than our rate of revenue growth in fiscal 2009 due primarily to an increase in other (income) expense, net, which included foreign currency conversion gains of $43.4 million compared to foreign currency conversion losses of $76.6 million in fiscal 2008, and the recognition of licensing income of $24.0 million related to our fiscal 2008 sale of the NIKE Bauer Hockey business. Excluding non-comparable items, our earnings per share for the year grew at a higher rate than net income given lower outstanding shares due to repurchases made under our share repurchase program in the first half of fiscal 2009. Our cash flows from operations and return on invested capital both declined as compared to fiscal 2008.

During fiscal 2009, we took steps we believe prudent and necessary to identify and manage potential exposures and to position ourselves for sustainable, profitable long-term growth. In the fourth quarter of fiscal 2009, we executed a plan of restructuring the organization to streamline our management structure, enhance consumer focus, drive innovation more quickly to market, and establish a more scalable cost structure. As a result of these actions, we reduced our global workforce by approximately 5% and incurred pre-tax restructuring charges of $195 million, primarily consisting of cash charges related to severance costs. As part of this restructuring plan, we also initiated a reorganization of the NIKE brand business into a new operating model consisting of six geographies. As a result of the reorganization, beginning in the first quarter of fiscal 2010, our new organizational structure will consist of the following geographies: North America, Western Europe, Central/Eastern Europe, Greater China, Japan, and Emerging Markets.

Other steps taken in fiscal 2009 included reductions in planned selling and administrative expenses, including the implementation of a hiring freeze, reductions in planned spending for travel, meetings and demand creation, as well as tighter inventory purchasing and working capital management. We also placed increased focus on monitoring the financial health of suppliers and customers and continued to take proactive measures to consolidate production with our strongest, most efficient and innovative manufacturing contractors to ensure we maintain a healthy production base for the present and the future. These capacity consolidation actions could result in additional costs associated with production and logistics as well as supply chain disruptions in the first half of fiscal year 2010 as we transition production between manufacturing contractors; however, we do not believe these potential additional costs will have a material impact on our operating results.

We continue to believe that the Company is well positioned from a business and financial perspective, but we are not immune to the current challenging global economic conditions. These conditions could continue to affect our business in a number of direct and indirect ways, including lower revenue from slowing consumer/customer demand for our products, reduced profit margins and/or increased costs, changes in interest and currency exchange rates, lack of credit availability and business disruptions due to difficulties experiences by suppliers and customers. Our future performance is subject to the inherent uncertainty presented by the evolving macroeconomic conditions and our continued actions to respond to these conditions.

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Overview

As a global company with significant operations outside the U.S., in the normal course of business we are exposed to risk arising from changes in currency exchange rates. Foreign currency fluctuations affect the recording of transactions, such as sales, purchases and intercompany 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 for consolidated reporting. Our primary foreign currency exposures are related to U.S. dollar transactions at wholly-owned foreign subsidiaries, as well as transactions and translation of results denominated in the Euro, British pound, Chinese renminbi and Japanese yen.

Our foreign exchange risk management program is intended to minimize both the positive and negative effects of currency fluctuations on our reported consolidated results of operations, financial position and cash flows. This also has the effect of delaying the impact of current market rates on our consolidated financial statements, dependent upon hedge horizons. We manage global foreign exchange risk centrally on a portfolio basis, to manage those risks that are material to NIKE, Inc. on a consolidated basis. We manage these exposures by taking advantage of natural offsets and currency correlations that exist within the portfolio, and by hedging remaining material exposures, where practical, using derivative instruments such as forward contracts and options. The Company’s hedging policies are designed to partially or entirely offset changes in the underlying exposures being hedged. We account for derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as issued and amended (“FAS 133”). We do not hold or issue derivative financial instruments for speculative trading purposes.

Overview

In the third quarter of fiscal 2009, our revenues declined 2% to $4.4 billion, net income decreased 47% to $243.8 million and we delivered diluted earnings per share of $0.50, a 46% decrease compared to the third quarter of fiscal 2008. Net income for the third quarter of fiscal 2009 includes a $240.7 million after-tax non-cash charge related to the impairment of goodwill, intangible and other assets of Umbro, which decreased diluted earnings per share by $0.49. Excluding these impairment charges, net income would have increased 4% to $484.5 million and diluted earnings per share would have increased 8% to $0.99 compared to the third quarter of fiscal 2008.

As discussed above, in the third quarter of fiscal 2009 we recorded $401.3 million of pre-tax non-cash impairment charges to reduce the carrying value of Umbro’s goodwill, intangible and other assets. Although we expect Umbro’s financial performance for fiscal 2009 to be slightly better than previous guidance, projected future cash flows have fallen below the levels we expected at the time of acquisition. This erosion is a result of both the unprecedented decline in global consumer markets, particularly in the United Kingdom, and our decision to adjust the level of investment in the Umbro business.

Excluding the impairment charges, income before income taxes decreased 5% for the third quarter as a result of declines in revenues and gross margins, partially offset by a decrease in selling and administrative expenses driven primarily by our actions to reduce and refocus both demand creation and operating overhead spending.

Excluding the impairment charges, net income and diluted earnings per share for the third quarter of fiscal 2009 were positively affected by a year-over-year decrease in our effective tax rate from 30.6% to 23.9%. The effective tax rate for the third quarter of fiscal 2009 reflects a reduction in the ongoing effective tax rate on operations outside of the U.S. and the impact of the resolution of audit items during the third quarter of fiscal 2009.

The deteriorating macroeconomic environment has caused significant volatility in global financial markets and has continued to put significant pressure on discretionary consumer spending worldwide. While we believe that the Company is well positioned from a business and financial perspective, we are not immune to global economic conditions. In the future, these conditions could affect our business in a number of direct and indirect ways, including lower revenues from slowing consumer/customer demand for our products, reduced profit margins and/or increased costs, changes in interest and currency exchange rates, lack of credit availability and business disruptions due to difficulties experienced by suppliers and customers.

We are taking steps we believe prudent and necessary to identify and manage potential exposures over the short and long term. Steps taken to date include reductions in planned selling and administrative expenses, including the implementation of a hiring freeze and reductions in planned spending for travel, meetings and demand creation, as well as tighter inventory purchasing and working capital management, and an increased focus on monitoring the financial health of suppliers and customers. We are also in the process of executing a restructuring plan which is intended to streamline our management structure to enhance consumer focus, drive innovation more quickly to market and establish a more scalable cost structure. As a result of these actions, we expect to incur gross restructuring charges of between $175 million and $225 million, consisting primarily of cash charges related to severance costs. We anticipate the majority of these charges will be incurred in the fourth quarter of this fiscal year and the first quarter of fiscal 2010. We are also taking proactive measures to consolidate production with our strongest, most efficient and most innovative manufacturing contractors to ensure we are maintaining a healthy manufacturing base for the present and the future. These capacity consolidation actions could result in additional costs associated with production and logistics as well as supply chain disruptions as we transition production between manufacturing contractors. Notwithstanding these efforts, our future performance is subject to the inherent uncertainty presented by the evolving macroeconomic conditions and our continued actions to respond to these conditions.

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Overview

NIKE designs, develops and markets high quality footwear, apparel, equipment and accessory products worldwide. We are the largest seller of athletic footwear and apparel in the world and sell our products primarily through a combination of retail accounts, NIKE-owned retail, including stores and e-commerce, and independent distributors, franchisees and licensees in the United States and worldwide. 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 create long-term revenue growth by creating compelling consumer experiences by creating and delivering innovative, “must have” products; deep personal connections with our brands; and compelling retail presentation.

We strive to convert revenue growth to shareholder value by driving operating excellence in several key areas:

By executing this strategy, we aim to deliver the following long-term financial goals:

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In fiscal 2008 we met or exceeded these financial goals. Our revenues grew 14% to $18.6 billion, net income grew 26% to $1.9 billion, and we delivered diluted earnings per share of $3.74, a 28% increase versus fiscal 2007. These reported results included combined gains from the sale of our Starter Brand and NIKE Bauer Hockey businesses of $35.4 million, net of tax, in fiscal 2008 and the gain recognized on the sale-leaseback of the Oregon Footwear Distribution Center of $10.0 million, net of tax, in fiscal 2007, one-time tax benefits of $105.4 million and $25.5 million recognized in fiscal 2008 and 2007, respectively, operational losses of $13.3 million, net of tax, from Umbro, which we acquired in the fourth quarter of fiscal 2008, and a $9.6 million gain, net of tax, from the Converse arbitration ruling settlement in fiscal 2007. We estimate that the combination of favorable translation of foreign currency-denominated profits from international businesses and the foreign currency losses included in other (expense) income, net resulted in a year-over-year increase in consolidated income before income taxes of approximately 6%.

For the year, the increase in net income was higher than our rate of revenue growth due to a reduction in our effective tax rate and improved gross margins, partially offset by higher selling and administrative expenses as a percentage of revenue. Fiscal 2008 results were positively affected by a reduction in our effective tax rate of 7.4 percentage points as compared to fiscal 2007, primarily as a result of the $105.4 million one-time tax benefit received in the first quarter of fiscal 2008. Also reflected in the year-over-year effective tax rate improvement was a reduction in our ongoing effective tax rate resulting from our profits earned outside of the United States; our effective tax rates for these operations are generally lower than the U.S. statutory rate. Gross margins for the year grew 110 basis points versus the prior year as inventory management and strategic price increases were partially offset by higher product costs and increased close-out sales. The increase in selling and administrative expenses was attributable to higher investments in growth drivers such as athlete and sport team endorsers of our products, spending around major sporting events, key product initiatives, investments in company owned retail and non-NIKE brand businesses as well as normal wage increases. Our earnings per share for the year grew at a higher rate than net income given lower outstanding shares due to repurchases made under our share repurchase program. In addition, we increased cash flow from operations and continued to return larger amounts of cash to shareholders through higher dividends and increased cash paid for share repurchases. Our return on invested capital increased as compared to fiscal 2007. Although we may not meet all of the financial goals outlined above in any particular fiscal quarter or fiscal year, we continue to believe these are appropriate long-term goals.

Overview

NIKE designs,
develops and markets high quality footwear, apparel, equipment and accessory products worldwide. We are the largest seller of athletic footwear and apparel in the world and sell our products primarily through a combination of retail accounts,
NIKE-owned retail, including stores and e-commerce, and independent distributors, franchisees and licensees in the United States and worldwide. 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 create long-term revenue growth by creating compelling consumer experiences by creating and delivering innovative, “must have” products; deep personal connections
with our brands; and compelling retail presentation.

We strive to convert revenue growth to shareholder value by driving operating
excellence in several key areas:

Overview

NIKE designs, develops and markets high quality footwear, apparel, equipment and accessory products worldwide. We are the largest seller of athletic footwear and apparel in the world and sell our products primarily through a combination of retail accounts, NIKE-owned retail, including stores and e-commerce, and independent distributors and licensees in the United States and worldwide. Our goal is to deliver value to our shareholders by building a profitable global portfolio of branded footwear, apparel, equipment and accessories. Through this diverse portfolio of brands, our strategy is to create long-term revenue growth by connecting with consumers across geographies. We strive to convert revenue growth to value in three key areas:

By executing this strategy, we aim to deliver the following long-term financial goals:

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In fiscal 2007, we met the majority of these financial goals. Our revenues grew 9% to $16.3 billion, net income grew 7% to $1.5 billion, and we delivered diluted earnings per share of $2.93, an 11% increase versus fiscal 2006. These reported results included a $141.9 million pre-tax charge, related to stock-based compensation expense recognized in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment” (“FAS 123R”), which we adopted during the first quarter of fiscal 2007 (see Note 1— Summary of Significant Accounting Policies and Note 10 — Common Stock in the accompanying Notes to Consolidated Financial Statements for more information on the adoption of FAS 123R), and the effects of the Converse arbitration ruling in fiscal 2006 and subsequent settlement in fiscal 2007. Excluding these items, our net income grew 11% and we delivered diluted earnings per share of $3.10, a 15% increase versus fiscal 2006 (see Reconciliation of Net Income and Diluted Earnings Per Share Excluding the Converse Arbitration and Stock-Based Compensation Expense below).

Fiscal 2007 results were positively affected by a reduction in our effective tax rate of 2.8 percentage points as compared to fiscal 2006, primarily as a result of the European tax agreement the Company finalized in the second quarter of fiscal 2007. For the year, the increase in net income was below our rate of revenue growth due to higher selling and administrative expenses versus the same period in the prior year. The increase in selling and administrative expenses was attributable to the adoption of FAS 123R and higher investments in growth drivers such as demand creation and operating overhead. Our earnings per share for the year grew at a higher rate than net income given lower outstanding shares due to repurchases made under our share repurchase program. In addition, we increased cash flow from operations and continued to return larger amounts of cash to shareholders through higher dividends and increased share repurchases. Our return on invested capital declined slightly as compared to fiscal 2006 as a result of the adoption of FAS 123R. Although we may not meet all of the financial goals outlined above in any particular fiscal quarter or fiscal year, we continue to believe these are appropriate long-term goals.

Overview

NIKE designs, develops and markets high quality footwear, apparel, equipment and accessory products worldwide. We are the largest seller of athletic footwear and athletic apparel in the world and sell our products primarily through a combination of retail accounts, NIKE-owned retail stores, independent distributors and licensees, in the United States and over 160 countries worldwide. Our goal is to deliver value to our shareholders by building a profitable portfolio of global footwear, apparel, equipment and accessories brands. Our strategy for building this portfolio is focused in four key areas:

By executing this strategy, we aim to deliver the following long-term financial goals:

In fiscal 2006, we met most of these financial goals. Our revenues grew 9% to $15 billion, net income grew 15% to $1.4 billion, and we delivered diluted earnings per share of $5.28, an 18% increase versus fiscal 2005. These reported results included a $51.9 million charge related to an unfavorable arbitration ruling involving our Converse subsidiary (see Note 5 — Accrued Liabilities in the accompanying Notes to Consolidated Financial Statements for more information on the Converse arbitration charge). Excluding this charge, our net income grew 17% and we delivered diluted earnings per share of $5.39, a 20% increase versus fiscal 2005. For fiscal 2006, our consolidated gross margin percentage decreased 50 basis points to 44.0% primarily due to lower in-line net pricing margins (net revenue for current product offerings minus product costs) partially offset by improvements in year-over-year currency hedge rates. The decline in the gross margin percentage and the Converse arbitration charge were more than offset by 80 basis points of selling and administrative expense leverage (due entirely to slowing the growth of operating overhead spending), and higher interest income resulting in a higher pre-tax income margin in fiscal 2006 than in fiscal 2005. In addition, we increased free cash flow from operations and

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continued to return larger amounts of cash to shareholders through higher dividends and increased share repurchases. Our return on invested capital declined slightly as compared to fiscal 2005. Although we may not meet all of the financial goals outlined above in any particular fiscal quarter or fiscal year, we continue to believe these are appropriate long-term goals.