Nike’s Revenue Under Considerable Pressure; Turnaround Will Take Time

Image: Nike’s shares have been under considerable pressure as sales results disappoint.

By Brian Nelson, CFA

Nike (NKE) reported second quarter earnings on December 19 that beat on both the top and bottom lines. However, quarterly revenues still fell 8% on a reported basis and were down 9% on a currency-neutral basis. NIKE Brand revenues fell 7% on a reported basis and 8% on a currency-neutral basis. NIKE Direct revenues dropped 13% on a reported basis and 14% on a currency-neutral basis, while wholesale revenues fell 3% on a reported basis and 4% when holding currency neutral. Converse revenues declined across all territories, falling 17% on a reported basis and 18% on a currency-neutral basis.

Nike’s gross margin dropped 100 basis points in the quarter, to 43.6%, due primarily to higher discounts and changes in its channel mix, two dynamics that overshadowed lower product input costs and reduced warehousing and logistics expenses. Net income in the quarter was $1.2 billion, down 26%, while diluted earnings per share dropped 24%, to $0.78. Inventories were roughly flat on a year-over-year basis, while the company’s cash and short-term investments fell roughly $0.2 billion from last year, as operating cash flow was more than offset by share buybacks, cash dividends, and capital expenditures.  

Management noted on the conference call that conditions in the near term won’t improve either, despite new CEO Elliott Hill taking the reins the past couple months:

We believe the strategic actions that Elliott has outlined are the right moves for NIKE to create better balance in our business and to reignite growth with our wholesale partners in an integrated marketplace. But over the near-term, the net effect of these actions will result in lower revenue, additional gross margin pressure and higher demand creation expenses, with a greater headwind to the fourth quarter compared to the third quarter.

Turning to our third quarter outlook. We expect Q3 revenues to be down low double-digits. This reflects initial steps on the actions outlined above as well as worsening foreign exchange headwinds, partially offset by a timing benefit from Cyber Week shifting into our third quarter. We expect Q3 gross margins to be down approximately 300 basis points to 350 basis points, including restructuring charges during the same period in the prior year. This reflects the actions described earlier to clean and to reset the marketplace. We expect Q3 SG&A dollars to be slightly down year-over-year, including restructuring charges in the prior year. We will continue to tightly manage expenses while we strategically increased investment, as mentioned earlier. We expect other income and expense including net interest income to be $30 million to $40 million for Q3.

Nike’s outlook for the near term doesn’t provide us with much confidence. As we have noted before, Nike has a storied brand that is unmatched by rivals, but it may take more than a new CEO to turn things around. Competition remains fierce and the promotional environment intense, while consumer discretionary spending remains a big wild card. We like Nike, but we continue to stay on the sidelines until we start to see some improvement on the top line, not just better than feared results.

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