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NKE > SEC Filings for NKE > Form 10-Q on 7-Apr-2014All Recent SEC Filings

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Form 10-Q for NIKE INC


7-Apr-2014

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
In the third quarter of fiscal 2014, NIKE, Inc. revenues from continuing operations increased 13% to $7.0 billion. Excluding the impact of foreign currency exchange rates, revenues from continuing operations increased 14%. We delivered net income from continuing operations of $685 million and diluted earnings per share from continuing operations of $0.76, 3% and 4% higher than the third quarter of fiscal 2013, respectively.
Income before income taxes from continuing operations increased 3% compared to the third quarter of the prior year due to an increase in revenues and gross margin expansion, which more than offset higher selling and administrative expense as a percentage of revenue. The NIKE Brand, which represents over 90% of NIKE, Inc. revenues, delivered constant currency revenue growth of 14%, reflecting higher revenues across all geographies, key categories, and product types. Brand strength, innovative products and strong category retail presentation continued to fuel the demand for NIKE Brand products. Constant currency revenue from Converse increased 16%, driven by growth in direct distribution markets, specifically the United States, China, and the United Kingdom.
Our third quarter net income from continuing operations was positively impacted by a year-on-year decrease in our effective tax rate of 40 basis points, largely due to an increase in the amount of earnings from lower tax rate jurisdictions, partially offset by a benefit in the prior period from the retroactive reinstatement of the U.S. research and development credit.
Diluted earnings per share also benefited from a 1% decline in the weighted average diluted common shares outstanding driven by our share repurchase program.
In fiscal 2013, we divested of Cole Haan and Umbro, allowing us to focus our resources on driving growth in the NIKE, Jordan, Converse, and Hurley brands. We have completed all transition services related to the sale of both businesses. Unless otherwise indicated, the following disclosures reflect our continuing operations; refer to our "Discontinued Operations" section for additional information regarding the divestiture of those businesses.

Results of Operations


 Unless otherwise indicated, the following disclosures reflect the Company's
continuing operations.
                                          Three Months Ended February 28,                  Nine Months Ended February 28,
(Dollars in millions, except per
share data)                              2014              2013        % Change         2014               2013         % Change
Revenues                            $     6,972       $     6,187          13 %    $     20,374       $     18,616          9 %
Cost of sales                             3,869             3,451          12 %          11,313             10,522          8 %
Gross profit                              3,103             2,736          13 %           9,061              8,094         12 %
Gross margin %                             44.5 %            44.2 %                        44.5 %             43.5 %
Demand creation expense                     733               619          18 %           2,155              2,103          2 %
Operating overhead expense                1,433             1,244          15 %           4,155              3,655         14 %
Total selling and administrative
expense                                   2,166             1,863          16 %           6,310              5,758         10 %
% of Revenues                              31.1 %            30.1 %                        31.0 %             30.9 %
Interest expense (income), net                9                (2 )         -                25                 (6 )        -
Other expense (income), net                  45                17           -                86                (28 )        -
Income before income taxes                  883               858           3 %           2,640              2,370         11 %
Income tax expense                          198               196           1 %             638                602          6 %
Effective tax rate                         22.4 %            22.8 %                        24.2 %             25.4 %
Net income from continuing
operations                                  685               662           3 %           2,002              1,768         13 %
Net income from discontinued
operations                                    -               204           -                 -                 49          -
Net income                          $       685       $       866         -21 %    $      2,002       $      1,817         10 %
Diluted earnings per share -
continuing operations               $      0.76       $      0.73           4 %    $       2.20       $       1.93         14 %
Diluted earnings per share -
discontinued operations             $         -       $      0.22           -      $          -       $       0.05          -


Table of Contents

Consolidated Operating Results


Revenues
                                  Three Months Ended February 28,                               Nine Months Ended February 28,
                                                                  % Change                                                        % Change
                                                                  Excluding                                                       Excluding
                                                                  Currency                                                        Currency
(Dollars in millions)       2014         2013(1)     % Change    Changes(2)           2014           2013(1)      % Change       Changes(2)
NIKE, Inc. Revenues:
NIKE Brand Revenues by:
Footwear                $   4,216       $ 3,682        15  %         16  %     $    11,806          $ 10,705         10 %          11 %
Apparel                     1,893         1,725        10  %         12  %           5,974             5,582          7 %           8 %
Equipment                     419           393         7  %          9  %           1,223             1,173          4 %           6 %
Global Brand
Divisions(3)                   26            29       -10  %        -13  %              89                84          6 %           4 %
Total NIKE Brand            6,554         5,829        12  %         14  %          19,092            17,544          9 %          10 %
Converse                      420           361        16  %         16  %           1,274             1,095         16 %          15 %
Corporate(4)                   (2 )          (3 )       -             -                  8               (23 )        -             -
TOTAL NIKE, INC.
REVENUES                $   6,972       $ 6,187        13  %         14  %     $    20,374          $ 18,616          9 %          10 %
Supplemental NIKE Brand
Revenues Details:
NIKE Brand Revenues by:
Sales to Wholesale
Customers               $   5,169       $ 4,688        10  %         12  %     $    15,186          $ 14,268          6 %           8 %
Sales Direct to
Consumer                    1,359         1,112        22  %         23  %           3,817             3,192         20 %          20 %
Global Brand
Divisions(3)                   26            29       -10  %        -12  %              89                84          6 %           4 %
TOTAL NIKE BRAND
REVENUES                $   6,554       $ 5,829        12  %         14  %     $    19,092          $ 17,544          9 %          10 %

(1) Certain prior year amounts have been reclassified to conform to fiscal 2014 presentation.

(2) Results have been restated using actual exchange rates in use during the comparative period to enhance the visibility of the underlying business trends by excluding the impact of translation arising from foreign currency exchange rate fluctuations.

(3) Global Brand Divisions revenues primarily represent NIKE Brand licensing businesses that are not part of a geographic segment.

(4) Corporate revenues primarily consist of foreign currency revenue-related hedge gains and losses generated by entities within the NIKE Brand geographic operating segments and Converse through our centrally managed foreign exchange risk management program.

On a currency neutral basis, NIKE, Inc. revenues grew for both the third quarter and first nine months of fiscal 2014, driven by increases in revenues for both the NIKE Brand and Converse. Our category offense continued to deliver innovative products, deep brand connections, and compelling retail experiences to consumers, driving increased demand for NIKE Brand products in the third quarter and first nine months of fiscal 2014. On a currency neutral basis, every NIKE Brand geography delivered higher revenues for the third quarter and year-to-date period. For the third quarter, North America contributed approximately 5 percentage points of the increase in NIKE, Inc. revenues, while Western Europe and Emerging Markets each contributed approximately 3 percentage points. For the year-to-date period, North America contributed approximately 5 percentage points of the increase in NIKE, Inc. revenues, while Western Europe contributed approximately 2 percentage points.
The constant currency increase in NIKE Brand footwear revenue for the third quarter and first nine months of fiscal 2014 was attributable to growth across all categories, led by Basketball, Running, Sportswear, and Football (Soccer). The growth of NIKE footwear revenues continued to be fueled by increased demand for performance products, including NIKE and Brand Jordan Basketball styles, Running models with NIKE Free, Air Max and Lunar technologies, and performance Football (Soccer) products. In the third quarter of fiscal 2014, unit sales of footwear increased approximately 11% and the average selling price per pair increased approximately 5%, driven nearly equally by a shift in mix to higher performance Running and Basketball products and price increases. For the first nine months of fiscal 2014, unit sales of footwear increased approximately 6% and the average selling price per pair increased approximately 5%, driven nearly equally by price increases and a shift in mix to higher priced products. The constant currency increase in NIKE Brand apparel for the third quarter was driven by growth in all key categories; for the first nine months of fiscal 2014, nearly every key category posted higher revenues, led by Running, Football (Soccer), Men's Training (which includes the NFL licensed business), Women's Training, and Basketball. In the third quarter of fiscal 2014, unit sales of apparel increased approximately 8% and the average selling price per unit increased approximately 4%; for the first nine months of fiscal 2014, unit sales increased approximately 5% while average selling price per unit increased approximately 3%. For both the third quarter and nine month periods, the increase in average selling price per unit was driven by price increases.


Table of Contents

While wholesale revenues remain the largest component of overall NIKE Brand revenues, we continue to expand our NIKE Brand Direct to Consumer ("DTC") businesses in each of our geographies. Our NIKE Brand DTC operations include NIKE-owned in-line and factory stores, as well as online sales through NIKE-owned websites. For the third quarter and first nine months of fiscal 2014, DTC revenues represented approximately 21% and 20% of our total NIKE Brand revenues, respectively, compared to 19% and 18% in the third quarter and first nine months of fiscal 2013, respectively. On a currency neutral basis, DTC revenues grew 23% and 20% in the third quarter and first nine months of fiscal 2014, respectively, as comparable store sales grew 10% in each period. Comparable store sales include revenues from NIKE-owned in-line and factory stores for which all three of the following requirements have been met: (1) the store has been open at least one year, (2) square footage has not changed by more than 15% within the past year, and (3) the store has not been permanently repositioned within the past year. Online sales through NIKE-owned websites, which are not included in comparable store sales, grew 57% and 37% in the third quarter and first nine months of fiscal 2014, respectively. Online sales represented approximately 19% and 14% of our total NIKE Brand DTC revenues for the third quarter and first nine months of fiscal 2014, respectively, compared to 15% and 13% for the third quarter and first nine months of fiscal 2013, respectively.
Futures Orders
Futures orders for NIKE Brand footwear and apparel scheduled for delivery from March 2014 through July 2014 totaled $10.9 billion and were 12% higher than the orders reported for the comparable prior year period. The U.S. Dollar futures orders amount is calculated based upon our internal forecast of the currency exchange rates under which our revenues will be translated during this period. Excluding the impact of currency changes, futures orders increased 14%, with unit orders and average selling price per unit contributing approximately 9 and 5 percentage points of growth, respectively. By geography, futures orders growth was as follows:

                                                                                Futures Orders
                                                       Reported Futures        Excluding Currency
                                                         Orders Growth             Changes(1)
North America                                                    9 %                      9  %
Western Europe                                                  33 %                     30  %
Central & Eastern Europe                                         7 %                     13  %
Greater China                                                   -1 %                     -3  %
Japan                                                           -6 %                     -1  %
Emerging Markets                                                12 %                     24  %
TOTAL NIKE BRAND FUTURES ORDERS                                 12 %                     14  %

(1) Growth rates have been restated using constant exchange rates for the comparative period to enhance the visibility of the underlying business trends, excluding the impact of foreign currency exchange rate fluctuations.

The reported futures orders growth is not necessarily indicative of our expectation of revenue growth during this period. This is due to year-over-year changes in shipment timing, because the mix of orders can shift between futures and at-once orders, and the fulfillment of certain orders may fall outside of the schedule noted above. In addition, exchange rate fluctuations as well as differing levels of order cancellations, discounts, and returns can cause differences in the comparisons between futures orders and actual revenues. Moreover, a significant portion of our revenue is not derived from futures orders, including at-once and close-out sales of NIKE Brand footwear and apparel, sales of NIKE Brand equipment, sales from our DTC operations, and sales from Converse, NIKE Golf, and Hurley.

Gross Margin
                                      Three Months Ended February 28,                   Nine Months Ended February 28,
(Dollars in millions)              2014             2013           % Change          2014             2013         % Change
Gross profit                  $     3,103       $     2,736          13 %        $    9,061       $    8,094          12 %
Gross margin %                       44.5 %            44.2 %        30  bps           44.5 %           43.5 %       100  bps

For the third quarter and first nine months of fiscal 2014, our consolidated gross margin was 30 and 100 basis points higher than the respective prior year periods, primarily driven by the following factors:
Higher NIKE Brand average net selling prices (increasing gross margin approximately 180 basis points for the third quarter and 110 basis points for the first nine months) primarily due to pricing increases and a shift in mix to higher priced products, with higher discounts negatively impacting the third quarter and lower discounts benefiting the year-to-date period;

Growth in our higher margin DTC business (increasing gross margin approximately 70 basis points in the third quarter and 30 basis points for the first nine months);

Higher NIKE Brand product costs (decreasing gross margin approximately 180 basis points for the third quarter and 20 basis points for the first nine months) due to labor input cost inflation and a shift in mix to higher cost products;

Unfavorable foreign currency exchange rate movements (decreasing gross margin approximately 20 basis points for the third quarter and 50 basis points for the first nine months); and

Improved margins due to cleaner closeout inventories (increasing margin approximately 20 basis points for the first nine months).


Table of Contents

Selling and Administrative Expense
                                    Three Months Ended February 28,               Nine Months Ended February 28,
(Dollars in millions)             2014             2013         % Change         2014             2013       % Change
Demand creation expense(1)    $      733       $      619          18 %      $    2,155       $    2,103           2 %
Operating overhead expense         1,433            1,244          15 %           4,155            3,655          14 %
Selling and administrative
expense                       $    2,166       $    1,863          16 %      $    6,310       $    5,758          10 %
% of Revenues                       31.1 %           30.1 %       100  bps         31.0 %           30.9 %    10 bps

(1) Demand creation consists of advertising and promotion expenses, including costs of endorsement contracts.

Demand creation expense increased 18% in the third quarter of fiscal 2014 as a result of new product launches, spending for the upcoming 2014 World Cup, investments to upgrade the presentation of our products in wholesale accounts, as well as higher sports marketing expenses. Demand creation expense increased 2% for the first nine months of fiscal 2014 compared to the same period in the prior year, which included the European Football Championships, the Summer Olympics and key product initiatives.
Operating overhead expense increased 15% and 14% during the third quarter and first nine months of fiscal 2014, respectively, primarily attributable to ongoing investments in our digital capabilities and corporate infrastructure, as well as growth in our DTC business driven by new store openings and continued digital commerce launches.
Changes in foreign currency exchange rates did not have a material impact on selling and administrative expense in the third quarter or for the nine month period.

Other Expense (Income), net
                                       Three Months Ended February 28,    Nine Months Ended February 28,
(In millions)                               2014              2013             2014             2013
Other expense (income), net           $            45     $        17     $          86     $      (28 )

Other expense (income), net comprises foreign currency conversion gains and losses from the re-measurement of monetary assets and liabilities denominated in non-functional currencies, and the impact of certain foreign currency derivative instruments, as well as unusual or non-operating transactions that are outside the normal course of business.
Other expense, net for the third quarter of 2014 increased $28 million compared to the third quarter of 2013 due to higher foreign currency conversion losses. Other expense (income), net shifted from $28 million of other income, net in the first nine months of fiscal 2013 to $86 million of other expense, net for the first nine months of fiscal 2014, primarily due to a $92 million adverse change in foreign currency conversion gains and losses and an adverse legal judgment in the second quarter of the current year related to a bankruptcy case for a former customer in Western Europe.
We estimate the combination of the translation of foreign currency-denominated profits from our international businesses and the year-over-year change in foreign currency related gains and losses included in other expense (income), net had an unfavorable impact of approximately $40 million on our income before income taxes for the third quarter of fiscal 2014 and an unfavorable impact of $110 million for the first nine months of fiscal 2014.

Income Taxes
                                 Three Months Ended February 28,         Nine Months Ended February 28,
                                 2014          2013       % Change       2014          2013       % Change
                                                             (40)                                   (120)
Effective tax rate               22.4 %        22.8 %         bps        24.2 %        25.4 %         bps

Our effective tax rate on continuing operations for the third quarter of fiscal 2014 was 40 basis points lower than the prior year period due to an increase in the amount of earnings from lower tax rate jurisdictions, partially offset by a benefit in the prior period from the retroactive reinstatement of the U.S. research and development credit. Our effective tax rate on continuing operations for the first nine months of fiscal 2014 was 120 basis points lower than the prior year period due to an increase in the amount of earnings from lower tax rate jurisdictions.

We do not anticipate our effective tax rate to change substantially from the rate for the most recent nine month period. Discontinued Operations
During fiscal 2013, we divested of Umbro and Cole Haan, allowing us to focus our resources on driving growth in the NIKE, Jordan, Converse and Hurley brands. The results of the divestiture are presented as discontinued operations. Please refer to Note 11 - Discontinued Operations in the accompanying notes to the unaudited condensed consolidated financial statements for more detail.


Table of Contents

Operating Segments

Our reportable operating segments are evidence of the structure of the Company's internal organization, which changed beginning in the first quarter of fiscal 2014. The NIKE Brand segments continue to be defined by geographic regions for operations participating in NIKE Brand sales activity, which now includes the results of NIKE Golf and Hurley. Previously, NIKE Golf and Hurley were combined with Converse and reported as "Other Businesses." Each NIKE Brand geographic segment operates predominantly in one industry: the design, development, marketing and selling of athletic footwear, apparel, and equipment. The Company's reportable operating segments for the NIKE Brand are:
North America, Western Europe, Central & Eastern Europe, Greater China, Japan, and Emerging Markets. The Company's NIKE Brand DTC operations are managed within each geographic segment. Converse is also a reportable segment for NIKE, Inc., and operates in one industry: the design, marketing, licensing, and selling of casual sneakers, apparel, and accessories. Prior year amounts have been restated to conform to the fiscal 2014 presentation.
As part of our centrally managed foreign exchange risk management program, standard foreign currency rates are assigned twice per year to each NIKE Brand entity in our geographic operating segments and Converse. These rates are set approximately nine months in advance of the future selling season based on average market spot rates in the calendar month preceding the date they are established. Inventories and cost of sales for geographic operating segments and Converse reflect use of these standard rates to record non-functional currency product purchases into the entity's functional currency. Differences between assigned standard foreign currency rates and actual market rates are included in Corporate together with foreign currency hedge gains and losses generated from our centrally managed foreign exchange risk management program. The breakdown of revenues is as follows:

                                         Three Months Ended February 28,                             Nine Months Ended February 28,
                                                                          % Change                                                     % Change
                                                                         Excluding                                                    Excluding
                                                                          Currency                                                     Currency
(Dollars in millions)            2014          2013(1)      % Change     Changes(2)          2014           2013(1)      % Change     Changes(2)
North America                $    3,069       $  2,737          12 %          12 %     $     9,005         $  8,167          10 %         10 %
Western Europe                    1,292          1,057          22 %          19 %           3,667            3,141          17 %         13 %
Central & Eastern Europe            356            303          17 %          22 %           1,017              882          15 %         16 %
Greater China                       697            641           9 %           7 %           1,900            1,800           6 %          3 %
Japan                               177            195          -9 %          10 %             545              632         -14 %          7 %
Emerging Markets                    937            867           8 %          19 %           2,869            2,838           1 %          9 %
Global Brand Divisions(3)            26             29         -10 %         -13 %              89               84           6 %          4 %
Total NIKE Brand Revenues         6,554          5,829          12 %          14 %          19,092           17,544           9 %         10 %
Converse                            420            361          16 %          16 %           1,274            1,095          16 %         15 %
Corporate(4)                         (2 )           (3 )         -             -                 8              (23 )         -            -
TOTAL NIKE, INC. REVENUES    $    6,972       $  6,187          13 %          14 %     $    20,374         $ 18,616           9 %         10 %

(1) Certain prior year amounts have been reclassified to conform to fiscal 2014 presentation. These changes had no impact on previously reported results of operations.

(2) Results have been restated using actual exchange rates in use during the comparative period to enhance the visibility of the underlying business trends by excluding the impact of translation arising from foreign currency exchange rate fluctuations.

(3) Global Brand Divisions revenues primarily represent NIKE Brand licensing businesses that are not part of a geographic segment.

(4) Corporate revenues primarily consist of foreign currency revenue-related hedge gains and losses generated by entities within the NIKE Brand geographic operating segments and Converse through our centrally managed foreign exchange risk management program.

The primary financial measure used by the Company to evaluate performance of individual operating segments is earnings before interest and taxes (commonly referred to as "EBIT") which represents net income before interest expense (income), net and income taxes in the consolidated statements of income. As . . .

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