NIKE, Inc. — Fiscal 2017 Second-Quarter Form 10-Q
Reporting period: Three and six months ended November 30, 2016; comparisons are with the same periods in 2015 unless stated otherwise. NIKE designs, markets and sells athletic footwear, apparel and equipment; the NIKE Brand accounts for more than 90% of company revenue. Amounts are in U.S. dollars.
Financial performance
| Metric | Three months | Six months |
|---|---|---|
| Revenue | $8.180 billion, +6% reported; +8% currency-neutral | $17.241 billion, +7% reported; +9% currency-neutral |
| Gross profit / margin | $3.616 billion / 44.2%; margin down 140 bps | $7.739 billion / 44.9%; margin down 170 bps |
| Net income | $842 million, +7% | $2.091 billion, +6% |
| Diluted EPS | $0.50, +11% | $1.23, +10% |
| Operating cash flow | $1.684 billion for the six months, versus $1.036 billion |
Quarterly pretax income rose 15% to $1.114 billion, while six-month pretax income declined 1% to $2.395 billion. Selling and administrative expense fell 2% in the quarter to $2.505 billion, or 30.6% of revenue, and rose 5% year to date to $5.402 billion, or 31.3% of revenue. Interest expense, net, was $15 million for the quarter and $22 million year to date.
Operating cash flow improved year over year as working-capital cash outflows moderated, including changes in cash collateral related to hedging. Investing activities provided $236 million, compared with $697 million used in the prior-year period; capital expenditures were $512 million. Financing activities used $680 million, including $1.954 billion of share repurchases and $536 million of dividends.
At November 30, cash and equivalents were $4.339 billion and short-term investments were $1.604 billion. Total debt, including current maturities, was approximately $3.517 billion, up from $2.037 billion at May 31, largely following a $1.5 billion senior-note issuance. The company reported $5.9 billion of cash, equivalents and short-term investments, including $5.3 billion held by foreign subsidiaries. It had no borrowings under its committed credit facility or commercial-paper program at period end and stated existing liquidity and expected cash generation should meet foreseeable capital needs.
Changes and business drivers
- NIKE Brand revenue grew 6% reported in the quarter; Direct to Consumer (DTC) revenue increased 23% reported (25% currency-neutral). DTC represented about 28% of NIKE Brand revenue, compared with 24% a year earlier. Digital commerce sales grew 49%.
- Greater China revenue grew 12% reported and 17% currency-neutral; Western Europe grew 7% and 12%, respectively. Converse revenue rose 5% reported and currency-neutral, while Converse EBIT declined 8% in the quarter.
- Gross margin contracted despite higher full-price selling prices. Management cited labor-cost inflation, unfavorable currency effects net of hedges, increased off-price sales, and other costs; higher full-price prices partly offset these pressures.
- Currency-neutral futures orders for NIKE Brand footwear and apparel scheduled for December 2016 through April 2017 were up 2%; reported orders were flat. The filing cautions that futures orders are not necessarily indicative of revenue growth.
- Share repurchases reduced diluted weighted-average shares 3% in the quarter, supporting EPS growth. During the first six months NIKE repurchased 35.9 million shares for $1.954 billion under its $12 billion, four-year program.
Outlook, commentary and risks
- Management expected a full-fiscal-year effective tax rate of approximately 17%. The six-month rate was 12.7%, primarily reflecting a one-time benefit from resolution of a U.S. foreign-tax-credit matter and a deferred-tax-asset adjustment; the quarterly rate rose to 24.4% as a larger share of earnings came from the United States.
- The IRS matter covering fiscal 2011 and 2012 was resolved with no tax deficiency. The company remained under IRS audit for fiscal 2013–2016; unrecognized tax benefits could decrease by up to $170 million within 12 months, though timing was uncertain.
- Foreign exchange remains a material exposure: management estimated currency translation and related foreign-currency gains and losses reduced pretax income by about $29 million in the quarter and $26 million for the six months. The filing also identifies competition, changing consumer demand, inventory and forecasting risks, product costs, supply-chain and technology disruptions, and international-market risks.
- NIKE issued $1.5 billion of senior notes in October 2016, with maturities in 2026 and 2046. Management reported compliance with credit-facility covenants. No material changes to previously disclosed risk factors or legal proceedings were reported.
- New accounting standards were expected to affect future reporting: lease accounting was expected to increase reported assets and liabilities and could be material; stock-compensation guidance could increase future tax-expense volatility. The company was evaluating the impact of revenue-recognition guidance.
Important facts for investors to verify
- Whether gross-margin pressure from currency, product-cost inflation and off-price mix persists, and whether DTC growth remains profitable.
- How the 2% currency-neutral futures-order increase converts into actual shipments and revenue; management notes timing, order mix, cancellations, discounts and returns can affect the comparison.
- The sustainability of earnings growth given the one-time tax benefits, the 17% full-year tax-rate expectation and regional EBIT declines, particularly in Western Europe.
- Cash generation and capital allocation relative to increased debt, continued repurchases and the substantial portion of liquidity held by foreign subsidiaries.
- Developments in tax audits and unrecognized tax benefits, and the eventual financial-statement impact of forthcoming accounting standards.