Nike Inc. reported third-quarter earnings that easily topped Wall Street targets as robust growth overseas offset more modest gains in North America.

Net earnings in the period ended February 28 rose 20.1 percent to $1.14 billion, or 68 cents a share, far surpassing analyst estimates of 52 cents per share. Net revenues grew 5 percent to $8.43 billion while gaining 7 percent on a currency-neutral basis. Revenues were just short of Wall Street’s targets of $8.47 billion.

Shares of Nike on Wednesday were down $4.09, or 7.05 percent, to $53.92 with the decline being blamed on the sales shortfall and a tempered outlook for North America for the near term.

Revenues for the Nike Brand were up 7 percent on a currency-neutral basis. Nike Brand’s net revenues rose 4.7 percent to $7.92 billion. EBIT (earnings before interest and taxes) for Nike Brand advanced 5.9 percent to $1.35 billion.

Revenues for Converse grew 3 percent on a currency-neutral basis, driven by growth in North America. Converse’s net sales rose 1.8 percent to $498 million. EBIT for Converse declined 14.2 percent to $109 million.

The gains by Nike Brand were driven by double-digit growth in Western Europe, Greater China and the Emerging Markets as well as the Nike Brand sportswear and Jordan Brand categories. As expected, Nike brand’s gains were gain bolstered by sizeable gains in DTC (direct to consumer), where revenue increased 13 percent. The DTC gains were driven by 18 percent growth in e-commerce, new store expansion and 6 percent comp store growth.

By category, apparel saw the strongest growth for Nike Brand, growing 9 percent on a currency-neutral basis to $2.3 billion. Footwear grew 7 percent on a currency-neutral basis to $5.3 billion. Equipment sales were down 7 percent on a currency-neutral basis to $321 million.

By region, sales in North America increased 2.7 percent to $3.78 million and gained 3 percent on a currency-neutral basis. The gains were led by strong growth in Nike sportswear and the Jordan Brand. EBIT moved up 8.5 percent to $980 million as gross margin expansion and SG&A leverage delivered increased profitability.

“We continue to make great progress in North America, rebalancing supply and demand, reigniting momentum in our Basketball business, and sustaining momentum in Sportswear,” said Andy Campion, EVP and CFO, on a call with analysts. “That said, the North America retail landscape is not in a steady-state. Digital disruption and other dynamics are resulting in more aggressive promotional activity than we expected 90-days ago. So we are going to remain tight, with respect to the supply that we are putting into the North America market in the short-term, while aggressively driving the initiatives that will reshape and grow the market, and extend Nike’s leadership long-term.”

In Western Europe, sales rose 4.0 percent to $1.5 billion and grew 10 percent on a currency-neutral basis. EBIT was down 13.7 percent to $290 million, reflecting the impact of transactional FX headwinds and higher product costs on gross margin, partially offset by SG&A leverage.

Western Europe marked its 14th consecutive quarter of double-digit gains.

“In Western Europe, we saw growth across nearly all categories, across all territories and across DTC and wholesale, led by digital,” said Trevor Edwards, president, Nike Brand, on the call. “We also reclaimed Western Europe’s No. 1 position in football footwear, as Nike players dominate the top leagues, scoring more goals than any other brand this season. The market continues to grow at a healthy pace. In footwear, we saw growth in running and sportswear, and in apparel, we saw broad-based growth led by sportswear and global football.”

In Greater China, revenue of Nike Brand expanded 9.5 percent to $1.08 billion and jumped 15 percent on a currency-neutral basis. EBIT increased 6.4 percent to $381 million. Double-digit growth was seen in wholesale and DTC, footwear and apparel, and nearly all categories.

Edwards said China is benefiting from a major focus by the nation on sport. He noted that in over the past five years, the number of marathons there has grown 500 percent, and China’s government predicts a sports economy valued at $850 billion by 2025, by far the world’s biggest. Added Edwards, “Our leading brand position in China gives us confidence we will continue to see real growth from this expanded market.”

To support growth in China, Nike opened a Nike and Jordan store in Beijing, its largest basketball-focused store in China; as well as two Jordan-only stores in Chengdu and Taipei; while further partnering with chains such as Topsports and Pousheng. A partnership with tennis star Li Na led to Nike’s first exclusive line for a female Chinese athlete. Nike is also gearing up to capitalize on China’s hosting of the FIBA World Cup of Basketball in 2019.

Said Campion, “With over 350 million Chinese millennials, one of the largest and most important demographics in the world, we believe we’ve just scratched the surface of our growth potential in this important market.”

In the Emerging Markets region, sales of Nike Brand increased 8.1 percent to $950 million. Currency-neutral sales ran up 13 percent. EBIT was down 4.5 percent to $193 million, continuing to be heavily impacted by FX. The revenue gains were led by sportswear and running categories. Double-digit growth was seen across most territories.

In its smaller regions, Central & Eastern Europe’s sales reached $362 million in the quarter, up 0.8 percent on a reported basis and ahead 3 percent on a currency-neutral basis. EBIT was down 17.4 percent to $57 million.

Japan’s revenues for Nike Brand climbed 15.1 percent to $236 million and grew 8 percent on a currency-neutral basis. EBIT climbed 36.1 percent to $49 million.

Elaborating on the performance of some key categories, Edwards noted that Nike Brand is seeing double-digit market share gains in the $100 to $150 price zone in basketball, fueled by the KD9, the LeBron Soldier 10 and the Kyrie 3. The Paul George 1 also saw a “very strong consumer response,” the LeBron 14 “very strong early results,” and the overall Air Force 1 franchise continues to see strong demand. The first-ever re-release of the LeBron Air Zoom Generation is expected to help continue basketball’s recent momentum.

Running in Q3 “saw continued success, especially in our international markets,” with the Air Zoom Pegasus showing strong sell-through. The first Air Max 90 Flyknit, the Air Max 1 OG in its 30th-year anniversary, and the Air Max Jewell also saw strong demand. Edwards said Nike has “high expectations” for this weekend’s launch of the Air VaporMax.

Jordan Brand delivered the largest and most successful shoe launch in the history of Nike with the Space Jam 11. Other strong sellers for Jordan Brand in Q3 included the Jordan OVO and its Black History Month collections. Broadening its range, Jordan Brand partnered with the University of North Carolina’s football team and introduced the women’s model, NikeCourt Flare AJ1.

In apparel for Nike Brand, Zonal Strength Tights, the brand’s Plus Sizing line, and Tech Fleece overall, particularly the Advance Fleece line, continued to sell well.

Companywide, gross margin contracted 140 basis points to 44.5 percent, as higher average selling prices were more than offset by higher product costs, unfavorable changes in foreign exchange rates and the impact of higher off-price sales.

But the bottom line was helped by reduction in selling and administrative expense, down 2.7 percent to $2.5 billion. As a percent of sales, SG&A was reduced to 29.6 percent of sales from 31.9 percent.

Demand creation expense was $749 million, down 7 percent with year-ago spending boosted by marketing investments in last year’s Olympics and the European Championships. Operating overhead expense decreased 1 percent to $1.7 billion, as continued investments in DTC were offset by lower bad debt expense compared to the prior year and lower administrative costs as its Edit-to-Amplify initiatives are driving productivity in core operational spending.

Also bolstering the bottom line was an increase in other income to $88 million from $17 million, primarily due to net foreign currency exchange gains. The effective tax rate was also reduced to 13.8 percent, compared to 16.3 percent for the same period last year, primarily due to a reduction in tax reserves and an increase in the mix of earnings from operations outside of the U.S., which are generally subject to a lower tax rate.

Inventories were $4.9 billion, up 7 percent compared to the prior year as a 3 percent decrease in Nike Brand wholesale unit inventories was offset by increases in average product costs per unit and higher inventories associated with growth in DTC.

For the current fourth quarter, revenues are expected to grow in the mid-single-digit range, slightly below its Q3 reported rate of growth. On a currency-neutral basis, growth is projected in the high single-digit range with “very strong growth” expected to continue in its international geographies, ranging from Greater China to Europe to emerging markets.

Gross margins are expected to contract by 150 to 175 basis points. The decline is greater than expected when the company released second-quarter results due to a more promotional environment in the overall North America marketplace. SG&A is expected to be roughly flat versus the prior year.

In its initial projections for fiscal 2018, Nike is expecting continued revenue growth across all geographies, led by strong growth internationally. Significant operating leverage and expanding profitability are also expected, which on a currency neutral basis would result in earnings growth consistent with its long-term financial model.

However, the U.S. dollar has further strengthened against most international currencies since its Investor Day in October 2016. At current rates, Nike projects it will have absorbed $1.6 to $2 billion in cumulative FX downside over fiscal year 2016, fiscal year 2017 and fiscal year 2018, with the most significant annual impact being in fiscal year 2018. Said Campion, “We look forward to putting these extreme FX headwinds behind us, as we exit fiscal year 2018. In the meantime, we will continue to deliver strong revenue growth, and make Nike a much more efficient and profitable enterprise on a currency neutral basis.”

Photo courtesy Nike