NIKE, Inc. — Q1 Fiscal 2015 Form 10-Q
Business context and period: Unaudited results for the three months ended August 31, 2014, compared with the three months ended August 31, 2013. NIKE’s fiscal year ends May 31. The company designs, markets and sells athletic footwear, apparel and equipment; NIKE Brand contributed more than 90% of revenue. Interim results are not necessarily indicative of the full year.
Key financial results
| Metric | Q1 FY2015 | Q1 FY2014 | Change |
|---|---|---|---|
| Revenue | $7.982 billion | $6.971 billion | +15% |
| Gross profit / gross margin | $3.721 billion / 46.6% | $3.132 billion / 44.9% | +19% / +170 bps |
| Selling and administrative expense | $2.480 billion; 31.1% of revenue | $2.058 billion; 29.5% of revenue | +21% |
| Income before tax | $1.229 billion | $1.038 billion | +18% |
| Net income | $962 million | $779 million | +23% |
| Diluted EPS | $1.09 | $0.86 | +27% |
| Cash provided by operations | $588 million | $618 million | Down $30 million |
- Gross-margin expansion reflected higher average selling prices and product mix, growth in higher-margin direct-to-consumer sales, and favorable currency effects, partly offset by higher product costs and discounts.
- Demand creation expense rose 23%, mainly due to World Cup marketing and DTC support. Operating overhead rose 19%, including DTC, infrastructure and digital investments.
- The effective tax rate fell to 21.7% from 25.0%, primarily due to audit resolutions and a higher share of earnings from lower-tax foreign operations. Lower taxes and a 3% reduction in diluted weighted-average shares also supported EPS growth.
Revenue trends and material changes
- NIKE Brand revenue rose 15% to $7.421 billion; footwear increased 18%, apparel 11% and equipment 5%. Converse revenue rose 16% to $575 million, in part as licensed markets shifted to direct distribution.
- All NIKE Brand geographies had constant-currency revenue growth. Western Europe grew 25% and Greater China 20%; North America grew 12%. Central & Eastern Europe and Emerging Markets grew 9% and 10%, respectively, while Japan grew 4%.
- DTC revenue increased 30% on a constant-currency basis and represented about 23% of NIKE Brand revenue, versus 20% a year earlier. Online sales through NIKE-owned websites grew 70%.
- Regional operating performance was uneven: EBIT rose 52% in Western Europe and 28% in Greater China, but fell 16% in Central & Eastern Europe, 54% in Japan and 26% in Emerging Markets. Mexico remained affected by high marketplace inventory and distribution-center transition issues; geopolitical events weighed on Russia and Israel.
Cash, debt and liquidity
- Cash and equivalents were $2.303 billion and short-term investments $2.276 billion at August 31, for combined liquidity of about $4.6 billion, down from about $5.1 billion at May 31. Approximately $2.7 billion was held by foreign subsidiaries.
- Operating cash flow was $588 million. Management attributed the year-over-year decline to increased working-capital investment; working-capital changes used $565 million, including higher receivables and inventory and lower payables, accrued liabilities and taxes payable.
- Investing activities provided $280 million, primarily reflecting net sales and maturities of short-term investments; capital expenditures were $262 million. Financing activities used $882 million, including $819 million of share repurchases and $209 million of dividends.
- Balance-sheet debt included $1.195 billion of long-term debt, $6 million current portion and $146 million of notes payable. No borrowings were outstanding under the $1 billion committed credit facility or $1 billion commercial-paper program. NIKE reported compliance with credit-facility covenants and stated that available liquidity and operating cash flow should meet foreseeable capital needs.
- In the quarter, NIKE repurchased 10.6 million Class B shares for $819 million, averaging $77.06 per share. Under its four-year, $8 billion program, cumulative repurchases reached 62.5 million shares costing $4.236 billion.
Outlook, commentary and risks
- Management expected a full-year fiscal 2015 effective tax rate of approximately 24.5%. The filing provides no clear consolidated full-year revenue, profit or EPS guidance.
- NIKE Brand futures orders for footwear and apparel scheduled for September 2014 through January 2015 were $10.8 billion, up 11% reported and 14% excluding currency changes. Management cautioned that orders are not necessarily indicative of revenue because of shipment timing, at-once orders, cancellations, discounts, returns and sales not based on futures orders.
- Management cited brand strength, innovative products and retail presentation as supporting demand. It also noted exposure to currency movements, competition, changing consumer preferences, product-cost inflation, forecasting and inventory challenges, supply-chain and IT disruptions, and international economic and political risks. The filing reported no material changes to previously disclosed risk factors.
- Foreign-currency translation reduced reported revenue by about $12 million but increased pretax income by about $5 million in the quarter; management estimated the combined effect of translation and foreign-currency gains and losses benefited pretax income by approximately $32 million.
- Gross unrecognized tax benefits were $473 million, excluding interest and penalties; NIKE said they could decrease by up to $71 million within 12 months. The company was under IRS audit for tax years 2011–2014.
- Commitments included $117 million of letters of credit and a maximum $30 million exposure under guarantees of certain former Cole Haan lease payments. The company reported no material developments in previously disclosed legal proceedings and no off-balance-sheet arrangements with a reasonably likely material effect.
- Prior-period figures were revised for immaterial errors, including treatment of internally developed patent and trademark costs and certain cash-flow classifications. The filing states that the revisions were not material to prior periods.
Important facts for investors to verify
- Whether strong futures orders convert into shipped sales and how actual demand, cancellations and discounts compare with the order growth.
- Whether gross-margin gains persist as product input costs, discounts, currency movements and DTC mix change.
- Whether DTC expansion and higher marketing and infrastructure spending generate returns sufficient to offset rising SG&A as a share of revenue.
- Whether inventory, receivables and working-capital use moderate, particularly in Emerging Markets and Mexico.
- How the effective tax rate, IRS audit outcomes and foreign cash deployment affect earnings and liquidity.
- Whether share repurchases remain consistent with operating cash generation and other capital requirements.