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.