NKE Shows Expense Discipline in Challenging Environment

For Gilmartin's preview heading into the Nike conference call, please click here.

Nike (NKE - commentary - Cramer's Take) reported second-quarter 2009 earnings that beat expectations while revenue missed. EPS of 80 cents beat the 79-cent consensus estimate, thanks to a lower effective tax rate and good expense control, but revenue of $4.59 billion missed the estimate of $4.706 billion by $111 million. The biggest negative in the quarter was the U.S. pre-tax income, which fell by 18% year over year. While the U.S. is just one-third of Nike's total revenue, it is anywhere from 50% to two-thirds of the company's total operating income, and the 18% drop in profitability for the retailer was a function of lower gross margins and higher SG&A.

Futures orders (constant currency) rose 6%, a little better than the 3% o 5% expected coming into the call.

The prevalent theme during the conference call was expense management, and Nike displayed its willingness and ability to control expenses as SG&A grew just 8% year over year, the lowest rate of year-over-year growth since May 2007. Gross margins rose 40 by basis points year over year.

By region:

• While the U.S. futures orders rose 6% (again, better than expected coming into the call), U.S. revenue fell 1% as footwear was stronger than apparel (-3% revenue growth) in the U.S. Six of Nike's top 10 accounts grew in the second quarter. In U.S. footwear, Nike and Jordan brands gained 3% market share in the quarter. U.S. pre-tax income fell 18% as lower gross margins and higher SG&A pressured margins.
• Footwear and apparel revenue grew in Europe, the continent's emerging markets demonstrated good strength (still), and pre-tax income rose 19% year over year.
• Every product line grew by double digits in constant currency in Asia-Pacific. China's revenue grew 27%, and China futures rose by 25%, a little worse than the 30% expected.
• In the Americas, Nike saw double-digit revenue growth across all product lines and countries, and revenue grew 21% while pre-tax income grew 36%.

Guidance was conservative, as revenue was guided to low to mid single digits going forward vs. midteens last year. Gross-margin guidance was in line with last year, but gross margins will be lower in the second half. SG&A will see a "double-digit" decline in the fourth quarter. Nike has instituted a hiring freeze for the foreseeable future.

To conclude, earnings and revenue estimates will decline after the Nike results, but the ability and willingness to control expenses, particularly SG&A, will help management offset a brutal consumer environment. A world-class brand with strong cash flow and free cash flow will likely survive this current environment and emerge stronger as some of the weaker competitors get squeezed. The spate of recent dollar weakness should help global consumer brands, of which Nike is one, and a stable dollar will help more in the long run than this recent volatility.

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Know What You Own: Nike operates in the apparel, footwear and accessories textile industry, and some of the other stocks in its field include Coach (COH - commentary - Cramer's Take), Wolverine Worldwide (WWW - commentary - Cramer's Take), Deckers Outdoor (DECK - commentary - Cramer's Take), Timberland (TBL - commentary - Cramer's Take), Skechers (SKX - commentary - Cramer's Take) and Iconix Brand (ICON - commentary - Cramer's Take). For more on the value of knowing what you own, visit TheStreet.com's Investing A-to-Z section.

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At the time of publication, Gilmartin was long Nike, although positions may change at any time.

Brian Gilmartin, CFA, founded Trinity Asset Management (TAM) in 1995, where he is currently a portfolio manager. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Gilmartin appreciates your feedback; click here to send him an email.