Nike’s Quarter- It’s (Still) Good to Have a Big Balance Sheet

Nike’s 10Q was released three days ago, so it’s time to take a look at their results. Sometimes I wonder why we even talk about Nike.   I guess it’s because after arrogantly stumbling around in the dark in the action sports world for a few years, they developed some patience, mixed it with a bit of humility, hired some people who understood this market and used their undeniable skills in product development, distribution and marketing, along with their financial strength, to take a chunk of it. 

But that’s only part of it. We’ve got to look in the mirror and recognize that when we (of course these were all individual company decisions) decided to grow and look for business outside the core action sports market of participants and the first level of lifestyle enthusiasts, we made things a lot easier for Nike and other mainstream companies like them. Remember when we weren’t mainstream?
 
It was inevitable and even appropriate for some companies, and I’ve got no criticism for the companies who pushed into the mainstream. But the competitive equation changed as that happened. When and as the market becomes more about fashion, it gets harder to compete with a mainstream company whose revenues for the quarter is probably larger than the whole core action sports market for the year.
 
Nike had $6.7 billion in revenues in the quarter ended August 31. That’s up 10% from $6.1 billion in the same quarter last year. But its gross margin fell from 44.3% to 43.5%. They note that factors including higher product input costs, more North American sales (up 23%), where margins are lower, and other factors actually decreased their gross margin by 4%. But all but 0.8% of this was offset by product price increases, fewer closeouts, more direct to consumer business, and projects to reduce product costs. Ain’t pricing power grand?
 
Now, no doubt the lower gross margin made them a little more cautious financially.
 
Nah. Their “demand creation expense” (advertising and promotion) rose 29% from $692 million to $891 million. Operating expenses were up 12% from $1.13 billion to $1.26 billion. Those two increases, along with a tax rate that rose from 24.3% to 27.5%, meant that net income actually fell 12% from $645 million to a mere $567 million.
 
Now, you can imagine the conference call if this was anybody besides Nike. There’d be moaning, wailing, gnashing of teeth, expressions of incredulity, and probably groveling as analysts and management alike tried to get their heads around how a company can possible increase their spending so much while net income declined.
 
Obviously, Nike could have not spent all that money and kept their net income from falling in the quarter. But they didn’t take that approach and nobody expected them to. The conference call was very positive, with discussion of all the great marketing opportunities they took advantage of, how well the brand is positioned, and their focus on “…innovative product, strong brand connections with consumers, and transformative distribution…” The implication, with which I agree, is that if you do those things well, the bottom line will work out.
 
Wait a minute. I’m not sure, but I think, yes, it appears to be!  It’s a public company not just managing for quarterly results, but consistently pursuing its long term strategy even at the expense of the short term bottom line!
May have over oozed sarcasm there. I know Nike isn’t the only company that does it. But it’s appropriate to remember the importance of a good strategy consistently applied over time, especially when coupled with a rock solid balance sheet.
 
Nike’s Other Businesses unit, which includes Converse, Hurley and Nike golf, had revenue of $635 million, up from $585 million in last year’s quarter. Other Businesses used to include Umbro and Cole Haan, but they are being sold so are segregated as “Businesses to be Divested.” Converse experienced “low double digit growth” during the quarter. Hurley’s growth was “mid single digit.” That’s all we’re told.
 
Nike brand revenues were up 11% in footwear, 10% in apparel, and 13% in equipment. In constant currency those numbers, respectively, are 16%, 15%, and 17%. Footwear was $3.69 billion, or 55.3% of total revenue. Apparel, at $1.76 billion, was 26.4%. Equipment, at $386 million, is only 5.8%. The remainder is the other businesses and the units being divested.
 
Direct to consumer sales rose 21% from $909 million to $1.1 billion.
 
Without the 23% revenue increase in North America, Nike’s revenues for the quarter would have been up just 1.3%. Western Europe was down 5% to $1.17 billion (Up 6% in constant currency). Greater China revenues grew 8% (7% in constant currency) to $572 million, and Japan was down 6% to $183 million (down 7% in constant currency). Emerging markets grew 8% to $867 million.
 
Of its total earnings before interest and taxes of $779 million, $630 million, or 81%, came from North America. That $779 million includes a loss at the corporate level of $265 million which results from “…unallocated general and administrative expenses…” It also includes a $375 million loss in the Global Brand Divisions which “…primarily represents NIKE brand licensing businesses that are not part of a geographic operating segment and general and administrative expenses that are centrally managed for the NIKE brand.”
 
That’s about it. For all its size, a discussion of Nike’s results never requires writing a treatise. Lessons? Well, the one about a good strategy consistently applied and the value of a strong balance sheet. That’s not new. And I suppose the one where we opened the door for Nike and similar companies as we inevitably took our little, quirky, underground industry mainstream. That’s not new either.
 
Maybe that’s why I don’t write about Nike every quarter.

 

 

Globe’s Results for the Year

I’m kind of late getting this done. The June 30 fiscal year results were released at the end of August. But we only see Australian company results twice a year, so it still seems worthwhile. Happily for me, there’s not that much information in the report so it shouldn’t take long. The “Review of Operations” for the whole year is four short paragraphs- less than half a page. I guess not much happened.  You can see Globe’s whole report here.  It’s the fourth item down on the page. 

To summarize, Globe’s revenues fell 6.1% from $88.5 million to $83.1 million in the pcp (prior calendar period- the previous full year in this case. And all numbers are in Australian dollars). Earnings before interest, tax, depreciation and amortization (EBITDA) were down 41.3% from $2.93 million to $1.72 million. Net income fell 94% from $1.089 million to $62,000. However, those numbers include $1.0 million from settlement of a lawsuit. Without that, Globe’s EBITDA would have been $72,000 and it would have had a bottom line loss.
 
Australasia revenues were $25 million, up 4.3% from $24 million in the pcp. In North America, revenues of $41.8 million declined 15.2% from $49.3 million in the pcp. The press release refers to North American revenues being down “…in single digit percentage terms…” but I keep coming up with 15.2%. Maybe that’s a constant currency number, though it’s not clear.
 
Revenue from Europe rose 7.7% from $15 million to $16.2 million. In Australia (as opposed to the Australasia segment) we see revenues up 6.4% from $21.2 million to $22.5 million. With revenues up $1.0 million for the whole segment, we can see that all the growth in that segment came in Australia itself.
 
Revenues in the United States fell 17.1% from $31.6 million to $26.2 million. In other foreign countries (which I assume means everywhere but the U.S. and Australia) revenues were down 3.5% from $35.5 million to $34.3 million.
 
The sales decline was blamed mostly on the strength of the Australian dollars. We’re told they were basically flat in constant currency.
 
Globe doesn’t provide the gross profit number we’re use to see in the U.S. But there is a cost of sales figure, which I imagine is a reasonable proxy. If we use it to calculate a gross merchandise margin, we see it’s basically unchanged, falling just 0.1% over the year from 45.4% to 45.3%. But the press release says, “Reduced gross margins, which are largely responsible for this decline in profitability, resulted from a combination of sales mix, competitive market pressures and an increase in cost of goods.”
 
They don’t tell us exactly what the gross margin decline was, but it’s pretty clear that what we in the U.S. call ‘cost of goods sold” isn’t the same as “cost of sales” in Australia. Wish I spoke better Australian accounting. Yet you would think an “increase in the cost of goods” would show up in the “cost of sales” as a percentage of merchandise sales. I’ve got some Australian readers. Can one of you tell me the definition of “cost of sales” in Australia?
 
There’s no long term debt on the balance sheet, and the usual ratios are fine. Cash is at $10.2 million down from $12.3 million in the pcp. I would note a 2.2% increase in total receivables to $12.5 million. However, trade receivables rose 11.1% from $8.4 million to $9.4 million. Receivables were down in the Australasia segment even with the revenue increase. But in North America, where revenues fell 15.2%, receivables rose 37% from $2.8 million to $3.85 million. Yikes. That seems to imply something not specifically too good.
 
There was a 14.8% increase in inventory to $14.5 million. They note that there some footwear shipments that arrived in the first quarter of the current year that had been expected to arrive before June 30. Don’t know how big those shipments were, but obviously they would have pushed the year end up inventory up even further.
 
In general, you’d prefer to see receivables and inventory decline when sales decline. It would be interesting to see how much of the inventory growth was in units as opposed to being caused by the higher cost of goods they refer to.
 
The last balance sheet thing I’d mention, under “Other Financial Assets” is an amount of $1.35 million called “Investments in other entities (available for sale).” No big deal, but I wonder what it is because that’s what I do.
 
Well, there was a bit more information in the report than I thought on first read. But we don’t get any sense at all about what they might be planning to do to reverse some of the trends they highlight in the press release. And the sales decline in North America coupled with the increase in receivables is troubling. I guess, unfortunately, it will be six months before we find out how things have evolved. Make that four and a half months, as I’ll try to be more diligent in writing about it.