The Confluence of Internet with Brick and Mortar, and Notes from Nike’s 10Q

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Nike filed its 10Q for the quarter ended February 28th on April 4th. You can see it here. An actual analysis of their financial statements seems like a waste of time. I’ll mention a few comments I pulled out, but then I want to get on to what they are saying about e-commerce as it seems to be consistent with what other companies are saying. 

The first thing about Nike’s 10Q and conference call is what’s conspicuous by its absence. I can’t claim to have read every word, but nowhere did I see “skate,” “skateboard,” or “skate shoe.” I assume those sales are just part of footwear. Hardly a surprise. As I’ve discussed, skate shoe sales were never going to move Nike’s earnings per share. Their goal was to become credible with a piece of the market that didn’t see Nike as quite legitimate. Mission accomplished I’d say. And it doesn’t hurt Nike that the skate shoe market has evolved towards casual footwear, because they are pretty good at that.
 
Next, here’s the little bit we find out about Hurley. Nike’s “other businesses” are Converse, Hurley and Nike golf. Revenues for the quarter of those businesses totaled $615 million, around 10% of total quarterly revenues of $6.187 billion.
 
“Excluding the impact of currency changes, total revenues for these businesses increased by 9% and 8% in the third quarter and year to date periods, respectively, reflecting growth in Converse and NIKE Golf.”
 
I read that to say little if any revenue growth in Hurley.
 
“On a reported basis, EBIT for our Other Businesses increased 23% for the third quarter and 18% year to date, driven by improved profits at Converse and Hurley.”
 
So even if Hurley’s revenues didn’t increase, it’s being managed a little more rigorously to improve operating profitability. You know I like that approach.
 
Meanwhile, here’s what President and CEO Mike Parker says about their online business:
 
“In Q3 our online business grew 33% – outpacing the growth in our total DTC business and for total NIKE, Inc. We’ve delivered strong double-digit results in our e-commerce business every quarter for the last 5 years.”
 
He continues:
 
“That said, I’m not satisfied. Right now e-commerce is a relatively small portion of our total revenue. There’s a pretty big gap between where ecommerce is today and where we can take it. So we’re driving more innovation into the shopping experience, elevating the level of service and expanding customization online. At the same time we’re simplifying the user experience making it easier to find and buy our products. I can assure you given the size of the opportunity; everyone on the leadership team shares my sense of urgency around e-commerce.”
 
We’ve all watched a lot of companies get big percentage increases from their e-commerce business though sometimes those big increases were coming from small bases. We’ve wondered (or at least I’ve wondered) just what the mix of online and brick and mortar was going to be and how the two would influence each other. I think I’m getting an inkling.
 
The two channels are supporting mutual growth, but I suspect that online is going to mean fewer brick and mortar stores. That doesn’t mean there won’t be total brick and mortar revenue growth, but the number and purpose of actual stores will change. 
 
Zumiez alluded to this in their last conference call where they talked about the need for new metrics to measure comparable store sales and discussed how growth in the number of stores no longer translates in the same way into revenue.
 
It’s not that stores still won’t be opened (and closed). But the decisions may be more strategic. That is, there will be more to that decision than what sales that store can generate. The question is becoming, “How can opening a store here contribute to our reaching our customers through all available channels?
 
I don’t know how to measure that, but lots of companies are no doubt working on it. As they figure it out, I expect it to have implications for store size, location and inventory. There isn’t any doubt that e-commerce sales cannibalize brick and mortar sales to some extent, but that doesn’t mean there can’t be growth in the combined channels as well as some potential cost savings in the brick and mortar channel. I assume everybody who’s doing both (which is basically everybody) believes that.
 
We’ve also noted that brands are becoming retailers and retailers are becoming brands. We noted it, however, without really explaining why. Now we’ve got a clue. The internet and the need to be at all consumer touch points (Omni channel to use Zumiez’s phrase) requires it.
 
Uh, am I saying here that branding is becoming more important at a time when product is everywhere, it’s hard to create meaningful differences among a lot of products in a category, and the consumer knows everything and is picky? That implies high marketing costs but not always great margins and would seem to favor larger players.
 
Yeah, I guess I am saying that. I’ll be back to you after I’ve thought about it some more.

 

 

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

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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.

 

 

Nike’s Annual Report and Some Suggested Reading

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Two days ago, Nike filed its 10K annual report with the SEC and I’ve been through it. I’m not going to spend a bunch of time doing a detailed analysis of their already reported results if only because there wouldn’t be a lot of insight to be gained. But there were a few comments in the fine print of the report and in the conference call that I thought were relevant to thinking about the business environment.

As part of that process, I want to point you to a book called The New Rules of Retail, by Robin Lewis and Michael Dart that Roy Turner at Surf Expo turned me on to. It’s also available for Kindle. Let me make the connection between the book and Nike by starting with a quote from Nike Brand President Charlie Denson talking about how the Nike brand achieved a 21% increase in revenues during the year.

“We did it on the strength of our product innovation, the power of the brand, and the differentiation we create through distribution,” he said. Nike Inc. President and CEO Mike Parker notes, “There’s a strong appetite for authentic brands and genuine innovation. Digital technology is just beginning to show what’s possible in products, services and at retail. And new partnerships continue to advance how products are manufactured and distributed.”
 
You might be tempted to say, “Well, no kidding” but having just finished the book, I heard more in that statement than I otherwise might have.
 
The New Rules of Retail (published in 2010) makes a number of predictions we can already see coming true. It says that just to be in the game, you have to do all the operational stuff well. Not just well- really well. And you have to keep improving. That’s no longer a strategic advantage, but the price of entry. I’ve been saying that for a few years, though not with such strategic eloquence, so you can begin to see why I like this book. Like all of us, I’m partial to people who confirm what I think.
 
They also say that “The ultimate collapse of the traditional retail/wholesale business model is now clearly visible.” I’ve said retailers are becoming brands and brands are becoming retailers.  I’m liking the book more and more.
 
They think that as much as 80% to 90% of traditional department store revenues will be generated by their own or exclusive brands. They suggest that retail stores “…will become hybrid enclosed ‘mini-malls’ for increased traffic and higher productivity.” They think Amazon will open stores. They expect preemptive strategies like pop-up stores to “…become proactive strategies as opposed to marketing opportunities.” They expect big retailers “…will accelerate the roll out of their smaller free-standing ‘localized’ neighborhood stores.”
 
They say some other intriguing (or maybe scary?) things too, but I’ll let you read them for yourself and look at the examples they provide.
Why is this happening? Because the consumer has near perfect information and an almost endless number of choices. What to do?
 
The authors suggest that successful companies will do three things. First, and as a condition for accomplishing the other two, they will control their value chain; especially at points of contact with the consumer. This does not mean owning your whole value chain.
 
Second, with consumers expecting more and better all the time and to get things the way they want them, companies have to far exceed the consumers’ expectation. They will accomplish this by creating a “neurological connectivity” with their customers. I know that sounds a bit like voodoo, but the book explains it very well. Think Starbucks or Trader Joes. Or Vans, though that’s my point of view.
 
Third, they will have “…to gain access to consumers ahead of the multiplicity of equally compelling products or services, and precisely where, when and how the consumer wants it.” They call this preemptive distribution.
 
Now, with those three actions in mind, go back and read the quotes from the Nike conference call I started with. The book’s authors note that in all the companies they interviewed, none used their exact words, but the successful ones were doing what they suggested. By the way, they spend quite a bit of time talking about VF and how it’s following their prescription. That’s an interesting read.
 
My immediate reaction on finishing the book was that doing what they say is required was damned expensive and required a strong balance sheet; especially in a lousy economy. Though they don’t address the financial cost of their strategy, I suspect they would agree as they believe “50 percent of retailers and brands will disappear.”
 
They don’t talk about a time frame, so it’s hard to know what to think about that prediction. And they don’t say anything about new brands being created. If their prediction is over three years, it’s pretty harsh. If it’s over 40, it’s probably a low estimate given normal brand cycles.
 
So probably you’re not as big as Nike and might not have their balance sheet. The message isn’t, “If you’re not big you’re doomed.” The message is, first, business was way more fun and easier in the 90s and I really miss that. Second, rapid disruptive change is never something any of us really like, but it’s full of opportunities for the people it doesn’t paralyze.   Some of that opportunity comes from the fact that your competitors may be paralyzed.
 
Third, Lewis and Dart wouldn’t disagree that you still need to know your customers and give them what they want. It’s harder than it used to be, but you also have some technology tools you didn’t have before. In that sense at least, nothing has changed.
Okay, wasn’t this supposed to be about Nike or something?
 
Nike’s revenues for the year were up for almost all categories and brands to $24.1 billion (including Cole Haan and Umbro which they are selling). Sales at Hurley fell from $252 million to $248 million. Nike reports total action sports sales at $499 million, up from $470 million the previous year. That’s 2.1% of Nike’s total sales for the year. I guess “action sports sales” means Hurley plus Nike Skate. Maybe it includes some Converse sales.
 
We know that Hurley lost money, though they don’t say how much. Lower gross margins as well as higher selling and administrative expenses as a percentage of sales contributed to Hurley’s loss. But they are still confident in Hurley’s future. Mike Parker noted in the conference call, “…we’re confident our NIKE, Converse, Jordan and Hurley brands have virtually unlimited growth potential.”
 
Nike’s gross profit margin fell from 45.6% in 2011 to 43.4% in the year ended May 31, 2012. The decline was “…primarily driven by higher product input costs, including materials and labor, across most businesses. Also contributing to the decrease in gross margin were higher customs duty charges, discounts on close-out sales and an increase in investments in our digital business and infrastructure.”
 
I found the mention of higher customs duties interesting. They note in the 10K, “The global economic recession resulted in a significant slow-down in international trade and a sharp rise in protectionist actions around the world. These trends are affecting many global manufacturing and service sectors, and the footwear and apparel industries, as a whole, are not immune. Companies in our industry are facing trade protectionist challenges in many different regions…”
 
On pages four and five, they talk about issues with importing into the European Union, Brazil, Argentina and Turkey and about trade relations with China. Among the reasons the Great Depression lasted so long was the imposition of various “beggar thy neighbor” trade policies (including the Smoot-Hawley tariff act in this country) that reduced worldwide economic activity.
 
Looks like all the world’s helpful and friendly politicians are at it again. You know, I knew they would, but I really hoped they wouldn’t. I better move on. Oh- 58% of Nike’s revenues are from outside the U.S.
 
Well, this is interesting. I’m looking at an income statement with no restructuring charges, goodwill impairment, or intangible and other asset impairment. There’s no “adjusted earnings” offered as an explanation for something or other. No EBITDA reconciliation to GAP. No discontinued operations (There will be next quarter because of the plan to sell Cole Haan and Umbro). There’s hardly any interest or “other” expense. Just net income that rose for the year from $2.13 to $2.22 billion, or by 4.2%. That decline in gross margin really hit them hard.
 
Okay, I’m worried. If too many companies start just reporting what they earned without resorting to various explanations, reconciliations, and obfuscations, who’s going to need me to figure it all out? Where will I be if we have straight forward, easy to read financial statements? I sure hope this isn’t a trend.
 
Revenue in North America rose from $7.58 to $8.84 billion, or by 16.6%. Earnings before interest and taxes were $2.01 billion, up from $1.74 billion the previous year. Revenue from Western Europe was up 7.1% to $4.14 billion, but earnings fell 18.2% from $730 million to $597 million. China sales rose from $2.01 billion to $2.54 billion and earnings rose 17.3% to $911 million.
 
Nike ended the year with 384 retail stores in the U.S., but 109 of those are Cole Haan which will go away when they sell the brand. Hurley had 29 stores. Non-U.S. retail stores totaled 442 including 69 Cole Haan. Direct to consumer revenues totaled 17% of total Nike brand revenue (not Nike, Inc.) And comparable store sales grew 13%.
 
If Nike starts renting space in a Macy’s and stocks and manages the inventory itself, will they call that a “store?” For all I know, they are already doing that. The distinction between brand and retailer just keeps blurring.
  
Nike’s balance sheet is more than solid, with $3.7 billion in cash, a current ratio of 3.0, almost no long term debt and $10.4 billion in equity against $5.1 billion in total liabilities.
 
Nike’s doing well given economic conditions not even they can shrug off. Most importantly, I think they have a clear vision of where brands and retail are going.

 

 

Nike and Their Approach to Product Innovation. It’s Not All About Team Riders

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Nike recently came out with their 10Q for the quarter ended February 29th. I looked through it, read the conference call transcript, and sat down with the intention of doing my usual analysis.

Then I thought to myself, “Who am I kidding?” You want my analysis? They keep growing, make a lot of money, and their balance sheet is as imposing as the Death Star in Star Wars, but in a good way and with no exhaust vent for Luke to fire a proton torpedo into. There. Analysis done. You can see the 10Q here if you want to dig a little deeper.

What I want to focus on instead are President and CEO Mark Parker’s comments on how they constantly search for innovation and new products to “…create opportunities for everyday athletes to connect with NIKE, Inc. and each other around the world.”
 
He goes on to say:
 
“Collaboration is essential to how we innovate and grow. At NIKE, Inc., that always starts with insights from athletes, from the elite competitor to the everyday athlete. And it expands from there to include partners inside and outside our industry who inspire new ways of thinking; our retail partners, our manufacturing partners, universities, technology companies, NGOs, entrepreneurs and many more.”
“In our business, it’s collaboration and the ability to consistently innovate that create momentum and fuel long-term growth.”
 
Interestingly enough, last night I watched Sector 9 President and Co-Founder Steve Lake’s speech at the Transworld Snowboard Conference. Steve talked about constantly trying new things, reinventing his company every five years or so, and never standing still. Sector 9 probably isn’t quite $20 plus billion in revenue yet, but I bet he knows exactly what Mike Parker means. Go watch his speech here.
 
For Nike and Sector 9, doing something different is a core value. Standing still is dangerous and taking no risks is the biggest risk of all. I’ve said that a time or two myself and can’t resist pointing it out.
 
What struck me about CEO Parker’s comments is how their search for input and new ideas doesn’t stop (indeed, it barely begins) with elites athletes. We, on the other hand, too often won’t even consider something our team riders don’t like. Yet team riders aren’t our customers, get the product for free, don’t have that much in common with our average customer in terms of the comparative skill level and frequency of participation and, it occurs to me, might even have a vested interest in product not evolving.
 
We state proudly that our companies are “rider driven,” typically meaning, in my experience, that team riders have a disproportionate say in product decisions.  It looks to me like Nike CEO Parker would disagree with that approach.
 
Please don’t even try to use, “Well, we don’t have the resources of Nike” as an excuse. The issue is the ingrained way of thinking in action sports. It’s spending too much time talking to too many people who we’ve known for too long and who tend to share and validate what we already think. And I am as guilty as you are. I try and remind myself of that so maybe I won’t do it quite as much.
 
Here’s a link to an article about a company that looks for breakthrough ideas by seeking out and listening to “freaks and geeks.” They got together a group of Brazilian transsexuals to try and find out about hair removal products. To me that makes perfect sense. Nike, by the way, is one of their clients.
 
Nike CEO Parker goes on to say, “We consistently refer to 3 key components in our ongoing success: product innovation, brand strength and premium distribution. That’s what drives out growth.”
 
I think I’ve made my point about sources of product innovation. I’ve got nothing to say about Nike’s brand strength, as that’s self-evident. But isn’t it interesting that Nike, a brand available pretty much everywhere, talks about premium distribution?
 
That’s because distribution doesn’t stand alone. If you’ve got innovative product and a strong brand, you can have premium distribution in places other people can’t.
 
 Distribution, in a word, isn’t just about where your product is, but how it got there. And critical product innovations can’t just come from team riders, or at least that what Nike thinks.

 

 

Nike’s First Quarter; Strong. The Integration of Brand and Retail is Particularly Interesting

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Normally, I prefer to wait for the actual quarterly filing to be available before doing this kind of analysis, but I trust you can all appreciate what a monumental waste of time it would be to really dig into Nike’s balance sheet. They’ve got $4.7 billion in cash and short term investments and $9.7 billion in shareholders’ equity. They got only $342 million in long term debt and no outstanding bank borrowings. So my analysis? It’s strong. It’s a monster. They can do anything they want. Let’s move on.

Reported revenue for the quarter ended August 31 was up 8% to $5.175 billion compared to the same quarter last year. Gross profit was up 10% to $2.434 billion with the gross profit margin rising from 46.2% to 47.0%. This increase was the result of “…growth and improved profitability from Direct to Consumer operations, fewer and more profitable close-out sales and improved in-line product margins. These factors more than offset margin pressures resulting from changes in foreign currency and higher air freight costs to meet strong demand for NIKE Brand products.”

They note in the conference call that they were surprised by the strength of their gross margins because some cost increases were hitting later than expected. They see labor, oil, and cotton becoming more expensive. They also note that there was a delay in price increases because they negotiate prices with factories several seasons out. In the long term, they believe they can continue to expand margins.
 
Some of those statements seem worthy of some more discussion. If anticipated cost increases are down the road how, exactly, will they increase gross margins? Maybe it depends what you mean by “long term.” They indicated they might have some pricing power with certain products and maybe that’s where higher margins could come from.
 
We all have marketing or advertising and promotion expenses, but Nike has “Demand creation expense,” which I think is a much more descriptive phrase. It went up 23% to $679 million. They point to a couple of major events as being responsible for much of that increase. Their “Operating overhead expense” (what you and I might call general and administrative expense) was essentially flat at $994 million. Net income was up nine percent to $559 million.
 
Hurley, which we’d all like lots of details on but don’t get, is part of Nike’s “Other Businesses” segment. In addition to Hurley, the segment includes Cole Hann, Converse, NIKE golf and Umbro. That segment generated revenues of $693 in the quarter. Hurley revenues were up double digit, but that’s the only specific we get, and it’s not all that specific.
 
North American Revenues, at $1.903 billion, were up 8% as reported. Western Europe, at $1.056 billion, was down 4%. Central and Eastern Europe, at $263 million, was up 3%. Greater China was up 11% to $460 million but Japan fell 12% to $163 million. Emerging Markets at $591 million grew 30%.
 
For the Nike brand, footwear grew 7% to $2.798 billion and represented 54% of total quarterly revenues. Apparel, up 7% as well, was $1.362 billion or 26% of total revenues for the quarter. Equipment was $276 million, down 5% and representing 5%.
Retail sales were a record for the quarter, with comparative store sales up 13%. Digital sales grew by 22%. 
 
The immediate future looks pretty good. Worldwide future orders for Nike brand apparel and footwear “…scheduled for delivery from September 2010 through January 2010, totaled $7.1 billion, 10 percent higher than orders reported for the same period last year.” They don’t offer any numbers for equipment or the other “other” segment that includes Hurley.
 
Strategically, their discussion of flexibility, balance and alignment as the three reasons for outstanding performance was really interesting. I know it kind of sounds like a platitude, but it’s not. I could write a whole bunch on what they mean, but I couldn’t say it much better than they did. The conference call transcript is here. http://seekingalpha.com/article/226811-nike-ceo-discusses-f1q2011-results-earnings-call-transcript. I strongly suggest you read through their prepared comments in the early part of the transcript to understand what they mean. As part of it, they talk about the integration of retail and brands and how they are “… learning how to integrate and leverage the brands more than ever before.” They specifically refer to how they combined the Nike, Hurley and Converse brands at the U.S. Open in Huntington Beach. Many of you no doubt saw that.
 
This isn’t just about Nike. Multiple brands with a retail and online component seems to be the strategy most larger companies are pursuing. I’d go so far to say you won’t be able to become a larger brand unless you pursue that strategy, so you need to pay attention to it. It not only offers competitive advantages, but really lets a company leverage its back end. Look at Billabong or Quiksilver. Watch as retailer Zumiez works to make itself a brand.
 
You can learn a lot from Nike’s strategy.      

 

 

Nike’s Annual Report- A Few Interesting Facts

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Nike came out with their 10K annual report maybe 10 days ago. Because we’re in the habit of focusing on the press release and the conference call which happens much sooner, nobody seems to have paid any attention to this 145 page document. But never fear, I’m a glutton for punishment and there were a few interesting facts I thought I might provide.

You’ll excuse me if I don’t do my usual financial analysis. With hardly any long term debt (given their balance sheet though some of us probably think $400 million is a lot), a few billions in cash, and just over $19 billion in revenue, I just don’t think I’d discover anything useful if I stared squint eyed at their cash flow statement for very long.

Revenue was down from $19.176 billion in 2010 from $19,014 the previous year. But their gross profit margin, at 46.3%, was the highest since 2006. “The increase in gross margin percentage was primarily the result of favorable product mix, cost reduction initiatives, lower input costs and sales growth in our NIKE-owned retail business. (Emphasis added)” The retail increase was from both new store openings and growing comparable store sales.
 
“While our wholesale business remains the largest component of our NIKE Brand revenues, our NIKE-owned retail business continues to grow, representing approximately 15% of our total NIKE Brand   revenues in fiscal 2010 as compared to 13% in fiscal 2009.”
 
In the U.S., they’ve got 18 Hurley stores, 145 factory stores for closeouts, 12 Nike stores, 11 Niketowns, 51 converse factory stores, and 106 Cole Haan stores. In the rest of the world, there are 205 Nike factory stores, one Hurley, 55 Nike, 2 Niketown, 12 employee only stores, and 68 Cole Haan. They’ve got more stores to handle their closeouts then most chains have stores.
 
 Net income rose from $1.487 to $1.907 billion. They reduced their inventories 13.4% to $2.041 billion.
They’ve got 34,400 employees worldwide and 42% of their sales are in the U.S. The three largest customers represent 24% of U.S. sales, but none are more than 10%.   Hurley’s sales grew from $203 million to $221 million, but that’s the only specific action sports number or comment we get in the whole document.
 
They note that 89% of their U.S. wholesale footwear shipments (excluding “Other Businesses” of which Hurley is part) were made under their futures program. I think that’s the same as prebooks, which is pretty impressive. The number for U.S. apparel shipments is 62%. Where do they get all this stuff made?
 
“Virtually all of our footwear is produced by factories we contract with outside of the United States. In fiscal 2010, contract factories in Vietnam, China, Indonesia, Thailand, and India manufactured approximately 37%, 34%, 23%, 2% and 1% of total NIKE Brand footwear, respectively. We also have manufacturing agreements with independent factories in Argentina, Brazil, India, and Mexico to manufacture footwear for sale primarily within those countries. The largest single footwear factory that we have contracted with accounted for approximately 5% of total fiscal 2010 footwear production.”
 
But not even Nike is immune from macroeconomics and some of the labor issues in China.
 
“We anticipate our gross margins in fiscal 2011 may be negatively impacted by macroeconomic factors including changes in currency exchange rates and rising costs for product input costs. We also anticipate higher air freight costs as we work with our suppliers to meet increasing demand for certain running footwear products in the first half of the year.”
 
I strolled through the U.S. Open of Surfing last week and kind of noticed that Nike and Hurley dominated the place. It looks like Nike has plans for our industry.

 

 

What Are Big Brands Doing in Retail? It’s a Bit Scary

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Below is the handout I distributed at IASC’s Skateboard Industry Summit at the end of April where I talked about the evolving retail environment.  These are quotes from recent fillings and conference calls by Billabong, Genesco (owners of Journeys), Nike and Zumiez about how they see the retail environment and their involvement in it.  Except for Nike, you’ve seen these if you’ve read in detaill my most recent analysis of these company’s results.

These quotes aren’t my opinion or interpretation; they are what the senior executives actually believe and are doing.  In general, they are unclear about their growth opportunities in core stores and the survivability of those stores.  They think they can merchandise their own brands in their own stores better than in the core shops.  They like the higher margins.  You really need to read these comments.  Draw your own conclusions.

Billabong

 There is still “…a little bit of an apprehension to actually placing forward orders, and some customers preferring to do a little bit of business in season.” “I’d say that’s a trend that’s probably going to be there for a little while,” he continues.
 
Jeff’s Comment: I’d be curious to know just what he means by “a little while.”
 
“I can’t sit here at all and say that all the accounts that we are currently dealing with will still be there in three months time,” is how he puts it. He also thinks they may have to tighten credit by the end of the current six months.
 
“If you look at the wholesale level, most of the business going on, the buyers are focused on your price point category and up to your mid price print category.” “…in our own retail, which has definitely outperformed our wholesale side in this period, in our own retail we can showcase and merchandise a product across all the price points and we’re doing really well right across the board.”
 
“The cycles with our own retailers, we are beginning to drop product into our own retail even faster than wholesale channel. We are beginning to, on certain key styles…build product that may go into our own retail before even the wholesale consumer sees it in an indent (sic) process. But we’re beginning to utilize our own retail to test product a lot more and we’re just becoming a little more focused on that shortening of the whole supply side.”
 
“If you look at the big retail brands out there, they don’t have a buyer to get past, they just decide what they’re going to make and they put it in their own stores and therefore they could have a very short cycle.…we are looking more and more at some of our own retail stores where we can looking at touching on a more vertical model. And not having that delay with going out and having an eight week ordering pattern and then go away and ordering product, we’ll just go straight to retail.”
 
What percentage of total revenues could retail represent?” somebody asked. “It’s probably going to depend on what happens with the wholesale account base,” O’Neill responded.
 
Genesco
Genesco is looking at “very modest” store growth in Journeys. They say they don’t want to have happen to them what has happened to other retailers who have over extended themselves on their store count. They mention Footlocker, The Gap, and Starbucks as retailers who are closing stores because they got a bit overextended. They plan to open only 50 net new stores over the next five years across the whole company.
 
They also note that they have another wave of store leases coming up for renewal. They expect to get lower costs and more favorable terms when those leases are renegotiated. Overall, they expect that with very modest store growth and comparable store sales growing by only two to three percent, they can expand operating margins from the current five to eight percent and grow earnings per share by 15% to 20% annually. Obviously, they see a lot of opportunity in reducing costs and operating efficiently.
 
He notes that when, for example, a five store chain has a lease coming up for renewal, it will find Genesco on their landlord’s doorstep taking over that space. 
 
The other thing that’s happening, as they describe in discussing their hat, uniform and sport apparel business, is that they “…are consolidating the industry. The mom and pops are going out of business or they are credit constrained and can’t stay fresh.” 
 
President and CEO Robert Dennis talked about how the economics of their hat and hat related business has changed as they have gone from 150 to 800 stores. The difference, he says, “is enormous.” There is tremendous leverage with landlords, the companies from whom you license product, vendors, and infrastructure.
 
He also characterizes most of these small players’ systems as being “from the dark ages.” 
 
Nike
“We’re also starting to realize the broader benefits of becoming a better retailer. Over the past few years, we’ve spoken about expanding our direct-to-consumer business. We saw a huge upside to bringing innovation and excitement into the marketplace in our own stores, with our wholesale partners and online.”
 
“To do that we committed to building our retail capabilities, smoother product flow, surgical assortment planning that focuses on key items, more compelling merchandising, stronger brand stories and more efficient back-of-house systems. All balanced to produce greater consumer experiences and strong profitability. It’s a powerful mix that helped NIKE Brand Retail deliver 11% revenue growth and 140 basis points of gross margin expansion year-to-date.”
 
“We will continue to invest in bringing world-class solutions to consumers who are hungry for new retail experiences. Nowhere is this more important than online. The digital lifestyle is driving dramatic change in our industry and significant potential to our company. We are attacking that in every dimension; online shopping, customization, immersing our brands in consumer cultures and telling inspiring and entertaining stories.”
 
“Comparable sales for brick and mortar Nike-owned retail stores increased 17%, and online sales grew 25%. Profitability for the businesses grew even faster as better merchandising, lower promotions and more surgical mark downs drove gross margins up 550 basis points versus last year.”
 
Zumiez
 “Our stores bring the look and feel of an independent specialty shop to the mall by emphasizing the action sports lifestyle through a distinctive store environment and high-energy sales personnel. We seek to staff our stores with store associates who are knowledgeable users of our products, which we believe provides our customers with enhanced customer service and supplements our ability to identify and react quickly to emerging trends and fashions. We design our stores to appeal to teenagers and young adults and to serve as a destination for our customers.  Most of our stores, which average approximately 2,900 square feet, feature couches and action sports oriented video game stations that are intended to encourage our customers to shop for longer periods of time and to interact with each other and our store associates.”
 
 Jeff’s Comment: Except for the mall location, how is this different from any other core shop?
 
Zumiez pursues, on a national scale, the same branding strategy the best independent retailers pursue.  “We seek to build relationships with our customers through a multi-faceted marketing approach that is designed to integrate our brand image with the action sports lifestyle.” They spent $822,000 on advertising in fiscal 2009.
 
 “We have developed a disciplined approach to buying and a dynamic inventory planning and allocation process to support our merchandise strategy. We utilize a broad vendor base that allows us to shift our merchandise purchases as required to react quickly to changing market conditions. We manage the purchasing and allocation process by reviewing branded merchandise lines from new and existing vendors, identifying emerging fashion trends and selecting branded merchandise styles in quantities, colors and sizes to meet inventory levels established by management. We also coordinate inventory levels in connection with our promotions and seasonality. Our management information systems provide us with current inventory levels at each store and for our Company as a whole, as well as current selling history within each store by merchandise classification and by style.”

 

 

Nike’s 8/31/09 Quarter, Their Impact on the Industry and Quips on Conference Calls

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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.
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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.