Nike put out a press release on its quarterly earnings two days ago and held a conference call on their results yesterday. This has all happened before the actual 10Q with all the detailed information and footnotes is available. So on the one hand, I'd like to be timely and have this done before everybody loses interest, but on the other hand I'd like to have the best information I can have before expressing an opinion. There's a concept!
The prepared comments that started off the conference call had a sort of "Aren't we wonderful? Didn't we do just what we said?" feel to them. From a business point of view I suppose they are and I guess they did. Still, I'd like to do my own analysis and not be lead by the hand to my conclusions. That's why I'd like the 10Q to come out before the press release and the conference call.
Then come the questions from the analysts that work for the investment banks. The questions are usually preceded with some form of "Hey, how are you guys today?" Great Ralph/Sally/Fred! Good to talk with you again!" There's a collegial sense to the conversations that seems to preclude tough questions.
To be fair, I'm not sure there are a lot of tough ones you could ask about Nike, but it still feels a bit like an attorney questioning his own witness at a trial. This isn't an issue just with Nike. At the last Quiksilver conference call, nobody asked, "Where are you going to get revenue growth from?"As I've written, I think that's the key issue they have to address.
There was one question from a guy named Brian on the Nike call whose last name I couldn't quite hear from a company called Research something and I couldn't hear the end of that either. I'm thinking he might not be an investment banker. Nike had announced that they were changing their primary profitability measure from pre-tax income to earnings before interest and taxes, "…which is the primary measure used by our management team and board to make decisions about resource allocation and to evaluate the performance of individual operating segments."
Now, I see Nike's point from a management perspective. But if I were an analyst concerned with the stock price, I'd know that net income is the primary determinant of stock performance over anything but the short term, and that's what I care about when I look at a stock. Not pre-tax income, not earnings before interest and taxes, not proforma income, not earnings before extraordinary items, not even EBITDA- earnings before interest, taxes, depreciation and amortization. Call me old fashioned, I guess.
So my hero Brian steps up and asks, "Will the change to EBIT change the company's focus on how you deploy capital?" I don't think I have his questions exactly as he asked it, but the implication was that it wasn't clear if the change was conducive to focusing on bottom line earnings. Nike, you'll be stunned to learn, said that of course they would continue to be focused on bottom line earnings. They went on to explain that this didn't change the way top management was measured and incentivized and that among the things they were measured on was stock price and earnings. Good answer I thought. Also the only one they could reasonably give.
So Brian, if you're out there, thanks for asking a great question and keep up the good work.
Anyway, in the quarter ended August 31, Nike's revenues fell 12% to $4.8 billion. Gross profit fell 14% to $2.215 billion. Gross profit percentage fell from 47.2% to 46.2% as a result of currency fluctuations and mark downs. Selling and administrative expense was down 17% to $1.546 billion. It actually fell as a percentage of sales from 34.2% to 32.2%, which is a good job with sales also down.
Because their income tax rate fell from 28.5% to 24.7%, they were actually able to increase net income by $3 million to $513 million.
The balance sheet is strong, to say the least. I guess their biggest issue is what they are going to do with $3.6 billion of cash and short term investments. That can't be earning much given current interest rates, and I'm sure they'd like to see it deployed.
Revenues in all their categories (footwear, apparel, and equipment) declined in North America, Western Europe, Central and Eastern Europe, and greater China. Japan managed four and five percent increases in footwear and equipment respectively. The "Other Businesses" group includes Converse and Hurley. We learned in the conference call that "Converse grew revenue by 10% and delivered its most profitable first quarter ever, up 13% over last year."
"Hurley delivered its 2nd biggest revenue quarter ever." Nike reported that it "…gained share in the Action Sports Industry," and "…continued to grow at a double-digit rate with market share gains while the rest of the industry declined."
Overall, Nike's action sports business grew 25% in the first quarter. Without giving any numbers, they noted that the direct-to-consumer business saw record revenue in the quarter. Online business was up 19%.
The interesting thing about Nike, of course, is that we're even talking about them. I'm guessing it was only six or so years ago that nobody in action sports even cared about Nike. We'd go to their parties, drink their beer and laugh at their failed attempts to break in. They now seem to have figured it out. Partly that's because they learned from their mistakes- always a good thing to do. But it's also because being big in this industry is no longer a sin that automatically costs you credibility.
Too much analysis of their numbers is, frankly, kind of a waste of time. Their numbers are big and good. Complaining, as some have, that it's somehow wrong for them to use their size and financial strength to push their action sports business at a time when other companies are weaker is a waste of time. I'd do the same thing in their position. So would you.
The question isn't how Nike is going to run their business. I imagine they are going to do just fine, thank you very much. The question is how you are going to run yours, big or small, given what their success represents to the evolution of the industry.
Jeff Harbaugh is a consultant for the action sports industry and works with companies to identify and focus on critical business issues and opportunities fundamental to the bottom line. For more information, visit www.jeffharbaugh.com.