adidas Group saw double-digit growth across all regions in the fourth quarter and both brands under the Group umbrella at the end of the year, but the company will now have to contend with issues with an acquired Reebok business that brought with it a sharp decline in order backlog, a projected sales decline, lower margins, and lower operating margins. Still, management thinks the worst is behind the Reebok business as it looks forward to integration of the business that is expected to provide accretion to earnings in 2006 and an improving revenue picture in the back half of the year.

The company, which divested its Salomon business at the end of the 2005 third quarter, posted solid gains in its continuing Brand adidas and TaylorMade-adidas Golf businesses and saw sales in Europe pick up some steam again in the fourth quarter.

adidas Group sales, excluding the Salomon business that was sold to Amer Sports, increased 27.2% in the fourth quarter to €1.52 billion ($1.81 bn) from €1.20 billion ($1.55 bn) in the year-ago period. Currency-neutral sales, excluding the Salomon business, grew 21% for the period.

Gross margins declined 60 basis points to 47.1%, due primarily to negative effects from TaylorMade-adidas Golf’s golf ball manufacturing contract buy-out which more than offset gross margin improvements at Brand adidas.
Operating profit for the continuing business increased 74% to €35 million ($41.6 mm), compared to €20 million ($25.9 mm) in Q4 2004.

The Group’s net income from continuing operations was down 64% in the fourth quarter to €4.0 million ($5 mm) versus €10.0 million ($13 mm) in the prior year quarter, due to the one-time effects of the cost for options related to the hedging of the Reebok purchase price, a loss from other financial assets, as well as the new interpretation of IFRS standards, and unrealized losses from short-term financial assets. Income from discontinued operations, net of tax, declined 189% to negative €7 million ($8 mm) in 2005 from €8 million ($10 mm) in the fourth quarter of 2004.

Net income attributable to shareholders decreased 118% to negative €4 million ($5 mm) in the fourth quarter of 2005. The net loss per share from continuing and discontinued operations was €0.07 (8 cents) compared to earnings per share of €0.43 (56 cents) in the prior year quarter.

Reebok sales decreased 5% to $930 million in the fourth quarter from $975 million in the prior year period. Currency-neutral sales for the Reebok Group declined 3% in Q4. Excluding Ralph Lauren Footwear revenues, a business that was sold prior to Q4, Reebok sales in the fourth quarter increased one percent in currency-neutral terms, but was down one percent in U.S. dollars. Reebok gross margin increased 100 basis points to 39.5% of sales in Q4 compared to 38.5% in Q4 2004, mainly driven by hedging activities that allowed the Reebok Group to benefit from favorable currency movements. SG&A expenses were reduced by 3% to $310 million in the fourth quarter of 2005 from $320 million in the prior year. Net income was flat at $47.4 million in the fourth quarter of 2005. Excluding the impact of integration costs and the positive tax effects, diluted EPS for the quarter would have been 60 cents, in line with Reebok’s guidance of between 55 cents and 65 cents.

For the year, sales for the Group’s continuing operations increased 13.1% to €6.57 billion ($8.18 bn) from €5.81 billion ($7.22 bn) for full year 2004. Currency-neutral sales for continuing operations for the year rose 12%.

At Brand adidas, Sport performance sales grew 7% in currency-neutral terms, with double-digit growth in all regions except Europe. The growth came across all major categories, but training, tennis, and running were called out as key drivers. In Euro terms, sales grew 7.6% to €4.55 billion ($5.66 bn) from €4.22 billion ($5.25 bn) in the prior year.

Sport Heritage sales jumped 41% for the year in currency-neutral terms, driven by 40%+ growth rates in both footwear and apparel. The gains were seen as strong across all regions. Sport Heritage sales surpassed the billion Euro mark for the first time in 2005, increasing more than 42% to €1.29 billion ($1.61 bn) from €907 million ($1.13 bn) in 2004.

Sport Style sales were said to have grown “modestly” for the year, with strong fourth quarter sales offsetting a weaker first half of the year. Sales improved about 2% in both Euros and currency-neutral terms to €19 million ($24 mm) from €18 million ($22 mm) in the previous year.

Brand adidas added 84 additional concept shops and 5 new outlet stores to its owned-retail business in 2005, growing to 312 concept stores, 221 outlets, and 174 concession corners worldwide. Owned-retail made up 13% of total Brand adidas revenues in 2005, up from 11% the previous year. Total sales improved 36% in currency-neutral terms to €757 million ($943 mm) from €555 million ($640 mm) in 2004.

Excluding owned-retail revenues, total Brand adidas sales grew 10.5% in Euro terms to €5.10 billion ($6.36 bn) from €4.62 billion ($5.75 bn) in 2004.

Brand adidas backlogs at the year-end were up 8% on a currency-neutral basis, or up 15% in Euro terms. Footwear backlogs were up 4% in currency-neutral terms and up 11% in Euros, reflecting improvements in Sport Performance football (soccer) and Sport Heritage products, among others. Apparel backlogs grew 9% on a currency-neutral basis and 16% in Euros due to improvements made in the Sport Performance categories, particularly football and basketball, as well as in Sport Heritage. Hardgoods backlogs were up in double-digits at year-end.

Reebok backlog fell 22% at year-end on a currency-neutral basis, or a 24% drop when measured in U.S. dollars. The sharp decline was driven by a 28% decrease in the U.S. business, with footwear falling 30% and apparel declining 23% at the end of the year, while international backlog declined 12% on a currency-neutral basis, reflecting a 7% decline in footwear backlog and an 18% decrease in apparel orders.

Herbert Hainer, chairman and CEO of adidas Group, said the brand profile and the marketing orientation at Reebok needed to be strengthened to improve its performance and its positioning, but saw three primary reasons why the Reebok backlog declined so much at the end of the year. Number one, Hainer said that the Reebok product needs to be “upgraded and improved to better match emerging tastes and needs of today's sporting goods consumers.” Second, he said a market misperception clearly existed during the closing of the acquisition that impacted orders. He felt that this misperception, based on talk in the market about taking the brand down market, clearly had an impact on forward orders, but he also said the tone in the market has changed dramatically since they closed the deal in January. Hainer also said that part of the reason for the backlog decline was due to moves by Reebok to deploy a “considerably more selective distribution strategy” than before, indicating the company was “limiting the distribution of key products in the marketplace.”

Looking ahead, the adidas Group expects Reebok sales to be around €2.8 billion for the remaining eleven months of 2006, which reflects a mid-single-digit decline in sales for the balance of the period following the January 31 closing date for the acquisition. Still, the Group expects to see a high-double-digit increase in sales for the consolidated company for the year including the Reebok business. Since the Reebok business is more heavily weighted toward the lower-margin U.S. market, gross margins are expected to decline to the mid 40’s and the operating margin is expected to settle in at around 9% of sales.

Excluding the Reebok impact, the Group sees high-single-digit sales growth for the year, with double-digit growth forecasted for Asia and North America, high-single-digit growth in Latin America and mid-single-digit growth for Europe. The adidas Group’s gross margin is expected to be between 47% and 48%, a bit lower than usual due to a cooperation agreement with Amer Sports Corporation whereas some adidas subsidiaries will continue to generate marginal income by selling Salomon products at gross margins lower than the Group average. Operating margin is projected to be between 10% and 10.5% for the adidas Group excluding Reebok in 2006, again lower than historical targets due to over-investment in 2006 World Cup marketing efforts.

Net income for the adidas Group excluding Reebok is projected to grow by double-digits in 2006.


>>> This will take some work, but the key will be holding off analysts and investors while they work to integrate Reebok into the culture. Would be tough to do in the U.S. with Wall Street looking over your shoulder…

adidas Group
2005 Fourth Quarter and Full Year
Results
Continuing Operations ex-Salomon
(in $ millions) Fourth Quarter Full Year Brand adidas Backlog*
2005** 2004** € Chg 2005** 2004** € Chg CC Chg* FW APP Total
Total Sales $1,809 $1,551 27.2% $8,182 $7,223 13.1% 12% 4% 9% 8%
Europe $748 $698 16.9% $3,943 $3,816 3.2% 3% flat 2% 3%
N. America $426 $363 27.9% $1,944 $1,657 17.2% 17% 15% 19% 17%
Asia/Pacific $490 $402 32.9% $1,897 $1,483 27.8%
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