China mars a robust quarter for Nike

Slumping sales in China were the most significant drag in yet another impressive quarter for the Nike brand. Its Chinese sales declined by 10 percent in constant currencies for the three months until the end of February, as the company continued to clean up inventories with discounts that battered its operating profit in the country.

In dollars, Nike's turnover in China was off by 9 percent to $635 million for the third quarter of the company's fiscal year. The group's operating profit in China shrank by 20 percent to $218 million. The profit margin contracted due to more abundant discounting as well as provisions for product returns to stock.

At the end of the quarter, the Nike brand's orders in Greater China were up by 4 percent, or by 3 percent in constant currencies, but the company emphasized that the improvement came from Taiwan and Hong Kong, while orders for mainland China were flat. Even these stable orders do not accurately portray the situation, several Nike executives said in a conference call to discuss the results last week: Sales in the current quarter will probably come out lower, as Nike has decided to cut back on deliveries as a means to improve inventories at the retail level.

This cleanup is the short-term part of a wider strategy that should continue to affect Nike's performance for several quarters. The company has been working on its assortment, adjusting fits and narrowing its offer. It has taken multiple measures in conjunction with its retail partners to improve sell-through and retail productivity. And the whole time, Nike has continued to invest in marketing around the brand in China, putting more emphasis on sports performance products.

Charlie Denson, president of the Nike brand, saw some early signs that this strategy was taking hold. With improved merchandising assortments in its own stores, Nike said that it had achieved comparable store sales increases in the mid-teen range. Wholesale partners are reporting continuing rises in comparable store sales as well. The most striking improvements have been achieved in partner stores where Nike has adjusted retail space to align with its category offense strategy – with deeper assortments in fewer categories. The approach was described as being “aggressive where we can and patient where we must.”

Overall, the Nike group's sales increased by 9 percent to $6,187 million for the quarter, or a rise of 10 percent in constant currencies, driven by unabated expansion for the Nike brand. Its turnover advanced by 9 percent to $5,583 million, amounting to a jump of 10 percent in constant currencies. It improved in all categories except sportswear and action sports, for which Nike has repeatedly altered its strategy in the last few years.

Nike executives were most enthused about the brand's performance in running, which again yielded double-digit sales growth for the quarter. Basketball was another category that buoyed the group, with sales also picking up in regions such as Western Europe, where basketball is not among the largest performance categories.

Footwear sales were up by 9 percent in constant currencies, compared with a rise of 8 percent for apparel and 23 percent for equipment. The Nike brand's orders increased by 7 percent at the end of the quarter in constant currencies, adding 4 percent growth in units to a 3 percent increase in average selling prices. Sales in the company's own stores were up by 23 percent, with an increase of 12 percent in comparable store sales and a jump of 33 percent in online sales. As for inventory levels, they inflated by 4 percent, with China as the only point of concern.

While Nike might be expected to surge in China and to chug along in North America, this quarter again showed exactly the opposite: The Nike brand's turnover in North America soared by 18 percent to $2,546 million for the quarter, up by 15 percent for footwear and by 22 percent for apparel. The group's earnings before interest and tax (Ebit) in North America jumped by 24 percent to $625 million. Mark Parker, the Nike group's chief executive, said that the group was gaining market share in North America, but that it was also expanding the entire market.

Nike returned to robust growth in Western Europe, where sales reached $1,040 million for the quarter, an increase of 8 percent in dollars as well as in constant currencies. The regional improvement was driven by footwear, for which sales inflated by 14 percent, while apparel and equipment sales suffered a small decline. Running and basketball both produced double-digit sales rises in this part of Europe.

The brand's wholesale revenues increased in all countries other than Italy, where Nike's turnover dropped by 17 percent in euros, and Iberia, where they contracted by 29 percent for the quarter. Germany and the U.K. were described as countries where Nike was in vigorous shape, along with much of northern Europe. Sales in Nike's own stores in Western Europe jumped by 24 percent for the quarter, with strong comparable store sales.

The group delivered an even more encouraging improvement in Ebit for Western Europe, which was up by 19 percent to $178 million. Yet the uptick might be short-lived, since the group reports that orders for the Nike brand in Western Europe declined by 5 percent at the end of the quarter, both in dollars and in constant currencies. This was partly due to the fact that orders had been buoyed in the fourth quarter of last year ahead of the European football championships and the London Olympics.

Central and Eastern Europe delivered another strong quarter, with sales up by 16 percent to $318 million, a rise of 13 percent in constant currencies, fueled by Russia and Turkey. Orders were still on the rise for the Nike brand in the region at the end of the quarter, up by 11 percent in reported terms and in constant currencies. Its Ebit for the region was up by 18 percent for the quarter to $71 million.

Sales in Emerging Markets advanced by 6 percent to $839 million, which was equivalent to an increase of 8 percent in constant currencies. Only South Korea and Argentina were somewhat weaker than the entire region, partly due to tougher economic conditions. Orders for the region remained robust at the end of the quarter, climbing by 12 percent in dollars and by 16 percent in constant currencies. The group's Ebit for Emerging Markets increased less vigorously, up by 3 percent to $221 million.

Along with China, Japan was the second regional unit that suffered a sales decline for the quarter, with sales down by 13 percent to $175 million in dollars and by 6 percent in yen. This appears to back up claims by Adidas that the Three Stripes are reinforcing their market share in Japan. Nike attributed its dropping sales in that country to measures taken to segment the market and to significantly lower closeout sales.

The Nike brand's orders for Japan were still down by 8 percent at the end of the quarter in reported terms, but they improved by 5 percent in yen. The group's operating profit in Japan was almost entirely flat at just $24 million.

Sales from other brands still owned by the Nike group reached $615 million, which was an increase of 9 percent in reported terms and in constant currencies. Hurley's sales were off, but this decline was compensated by increases for Nike Golf and Converse. The Converse brand lifted its sales by 12 percent for the quarter, partly due to the fact that it continues to rapidly expand its turnover in the U.K. and China – both countries where Converse took over its own distribution in the last two years.

The group's gross margin crept up by 0.3 percentage points to 44.2 percent in the quarter. The margin was hurt by discounts in China, and labor costs continued to climb. Another factor that adversely affects the company's gross margin is its impressive rise in North America and other regions where margins are relatively weak. Yet all of this could be compensated by easing costs of raw materials, and price increases for Nike products.

Selling and administrative expenses advanced at the same rate as the group's turnover, although marketing costs increased by only 5 percent to $619 million. The company's Ebit climbed by 9 percent to $856 million. Its net income from continuing operations was up by 16 percent to $662 million.

The discontinued operations are Umbro and Cole Haan, which the Nike group both decided to divest in May last year. The sale of some Umbro assets to the Iconix group already resulted in a loss of $107 million that was recorded in the second quarter of Nike's fiscal year. The sale of Cole Haan to Apax Partners was completed at the beginning of February, yielding $561 million after purchase price adjustments.

The group's quarterly results include a gain on this sale of $231 million, amounting to the sales price less the asset value of Cole Haan and other charges. The Nike group still reaped net income of $204 million from discontinued operations in the third quarter. This sum consists of the gain recorded for the sale of Cole Haan, less the operating losses and divestiture costs for Cole Haan and Umbro during the quarter.

With this income derived from the sale of Cole Haan, the Nike group's net income jumped by 55 percent to $866 million. Nike will continue to provide some services for Cole Haan and to license some of its technologies to the footwear brand during a transition period. 

Adding the two previous quarters, the group's sales ended the first nine months of its current fiscal year at $18,616 million. This amounts to a rise of 9 percent in dollars and 12 percent in constant currencies. The same increase rates apply for the Nike brand alone, which lifted its turnover to $16,906 million for the nine months. Sales of other brands still owned by Nike amounted to $1,768 million, up by 8 percent.

Despite the slight improvement in the third quarter, the group's gross margin eased by 0.2 percentage points to 43.5 percent for the nine months. The group ended the nine months with Ebit of $2,364 million, an increase of 3 percent. The company's net profit from continuing operations landed at $1,768 million, up by 3 percent. The income from discontinued operations reached only $49 million for the three quarters, so that the group's final net income advanced by 9 percent to $1,817 million.

The Nike group expects its turnover to increase at a mid-single-digit rate for the fourth quarter of its fiscal year in reported terms. It should then end the year with a sales up by a mid- to high-single-digit rate in dollars.

With regard to its gross margin, the company predicts an increase of about 0.5 percentage points for the fourth quarter, which would make it roughly flat for the full year. This forecast includes updated projections for product mix along with discounts and reserves in China.

For the next full fiscal year, Nike expects its turnover to grow at or slightly above its high-single-digit target range and earnings per share growth approaching its long-term mid-teens target.