With its forewarning the prior week that full-year results would sharply miss plan and it would also fall well short of its Route 2015 targets, the surprise from Adidas' second-quarter announcement last week was its plans to launch the company's biggest marketing campaign ever next year to build brand strength. Marketing will be expanded to between 13 percent and 14 percent of sales in 2015, above the previous target of 12 percent to 13 percent. That compares to 13 percent this year, which included World Cup spending. In 2013, marketing was 12.4 percent of sales.
One side-effect is that operating margin this year will range from 6.5 percent to 7.0 percent, lower than a previous target of 8.5 percent to 9.0 percent.
“We know driving higher levels of profitability is absolutely critical to our long-term success… but we won't get there if we aren't constantly winning in the marketplace,” Chief Executive Herbert Hainer said on a conference call with analysts.
The related surprise was the admission that underemployed investments had caused it to lose market share to competitors, implying Nike, in its home Western Europe markets.
Hainer lamented on Adidas’ failure to meet its “high expectations” that was part of its Route 2015 agenda as well as its full-year 2014 targets. The lowered guidance was attributed to currency challenges, the unstable environment in Russia, ongoing weakness at TaylorMade-Adidas Golf and planned increased investments in Adidas and Reebok. Slowed store expansion is planned for Russia and expense cuts for TaylorMade.
“While there is no doubt that our Group has endured external pressure over the past 18 months, missing our goals is something we take very seriously as a management team and we definitely reflect critically on it,” said Hainer. “We clearly recognize that part of this underperformance is due to our executional mistakes and we take full responsibility to rectify our shortfalls swiftly and to return the Group to stronger earnings growth.”
On the positive side, Hainer remains “convinced the fundamentals of our business model remain fully intact,” further noting that the company delivered “a good second quarter with increasing momentum across most of our business units and markets as expected.”
In the quarter, earnings slid 16.0 percent to €144 million ($198 mm). Sales were up 2.4 percent to €3.47 billion ($4.75 bn) and up 10 percent c-n. Earnings were largely in line with analysts’ average €3.48 billion estimate although earnings were a bit off the €150 million consensus estimate. The earning shortfall was blamed on currency woes, weakening golf-equipment sales, lower consumer spending in Russia and, ironically, higher marketing spend for the 2014 FIFA World Cup.
EMERGING MARKETS DRIVE SECOND QUARTER GROWTH
Highlights of the quarter included the emerging markets, with sales on a c-n basis in Latin America, European emerging markets and Greater China climbing 32.7 percent, 14.4 percent and 10.7 percent, respectively.
In Latin America, Adidas saw significant sales growth across the brands, with Adidas up 35 percent and Reebok up 26 percent during the quarter. Said Hainer, “Our investments in controlled space also yielded strong results with comp store sales up 42 percent in the second quarter.” On a recorded basis, sales in the region grew 7.4 percent to €404 million ($554 mm).
In Greater China, “our business continues to go from strength to strength, driven by strong growth in key performance and lifestyle categories,” added Hainer. Comp sales were ahead 18 percent. Recorded sales were up 4.1 percent to €387 million ($531 mm).
In European emerging markets, sales growth was broad based across the various countries with strong double-digit increases in the Middle East and Africa. In Russia/CIS, sales in the quarter were up 13 percent with comp store sales almost on par with the prior year, down 1 percent. Recorded sales were down 1.3 percent to €461 million ($632 mm).
Western Europe continued its rebound, with c-n sales growing 12.6 percent in the quarter, driven by double-digit increases in several key categories with Running, Football and Basketball all growing at rates above 20 percent. Originals and Styles were up 12 percent. By country, Germany, the UK, Spain and Italy all grew at double-digit rates during the quarter. Reported sales were up 13.1 percent to €919 million ($1.26 bn).
North America Group sales were up 1.4 percent on a c-n basis overall. Solid growth of 8 percent from Adidas Brand offset modest declines at Reebok and the 10 percent decline at TaylorMade. Said Hainer, “Football and Running were standout categories, growing 52 percent and 13 percent, respectively. Originals, however, remained challenged, declining at a high single-digit rate. Nonetheless, I am optimistic this trend will improve as new product hits the market later this year and into spring 2015.”
Recorded revenues in North America Group were down 4.3 percent to €790 million ($1.08 bn).
In Other Asian markets, comps inched up 0.2 percent but trends are improving. Sales for Adidas increased 7 percent during the quarter and Reebok continued its strong momentum in the region, growing 20 percent. Its biggest challenge in Asia remains TaylorMade, where sales were down 37 percent in the quarter. Recorded sales were down n 5.0 percent to €504 million ($691 mm).
Q2 WHOLESALE C-N SALES GROW 10.1 PERCENT
In the Wholesale segment (Reebok and Adidas), sales grew 10.1 percent on a c-n basis and added 4.9 percent for the first half. The gains were mainly due to sales growth at Adidas Sports Performance, led by the Football, Running and Training. Sales at Reebok were slightly above the prior-year level driven by sales increases at Fitness Training, Walking and Classics.
Gross margin for the Wholesale segment was up 20 basis points for the quarter and down 20 basis points for the first half as the positive effect from a more favorable product and pricing mix was more than offset by negative currency effects following the devaluation of currencies such as the Argentine peso and the Brazilian real.
In the Retail segment (Reebok and Adidas), sales jumped 22.1 percent on a c-n basis in the quarter and 21.9 percent in the half. Comps accelerated, up 10 percent for the quarter and 9 percent for the half, with growth across all regions and store types. By brand, Adidas comps were up 12 percent for the quarter and 10 percent for the half. Reebok comp store sales remained stable during the quarter and grew 2 percent for the half. E -commerce sales for Adidas and Reebok surged 59 percent in the quarter, bringing the first half to growth of 65 percent.
Retail segment gross margin decreased 4.9 percentage points to 60.5 percent for the quarter and 3 percentage points to 60.2 percent in the half, significantly impacted by its Russia/CIS exposure, as well as currency devaluation in that market. Those two factors accounted for almost 4 percentage points of the decline in Q2 and 2.3 percentage points of the decline in the first half.
Said Hainer, “This was mainly related to an extended period of promotional activity through the summer months, as well as the impact from the year-over-year devaluation of the Russian ruble.”
Across retail and wholesale, Adidas Brand sales grew 14.2 on a c-n basis in the quarter, aided by its sponsorship and successes around the World Cup. Said Hainer. “Sales in the Football category climbed 41 percent, confirming we will reach our aspiration of €2 billion, extending our lead over our major competitor.”
Adidas sold more than 8 million World Cup jerseys, with more than 2 million of the winning German team sold. More than 1 million jerseys each were sold of runner-up Argentina, as well as Mexico and Colombia. The adizero f50 boot ranked as the number one top-scoring boot of the tournament. Said Hainer, “The visibility of Adidas and the commercial success we captured for the brand is a timely reminder of just how effective we can be when we are focused and committed.”
Adidas Running continues its momentum, increasing 16 percent in the quarter with all regions growing at double-digit rates. New silhouettes and price points are supporting the growth. Said Hainer, “Our sell-in in the US and our performance in owned retail were particularly strong, with product launches such as our Pureboost running shoe resonating extremely well with the American consumer.”
Adidas Originals & Sport Style, which missed some trends over the past year, “markedly improved” with Originals returning to growth, up 8 percent globally in the quarter. Said Hainer, “The Originals ZX Flux is taking the market by storm, currently being the number one selling shoe at Foot Locker Europe and I am fully convinced this will evolve into a big commercial opportunity for us. Sport Style maintained its strong growth trajectory, increasing 21 percent in the quarter, driven again by the Adidas NEO label.”
REEBOK BOOSTED BY FITNESS PUSH
Reebok’s c-n sales across wholesale and retail segments grew 9.5 percent, marking its fifth consecutive quarter of growth. Double-digit growth was seen in most regions.
“The quarter was again all about strengthening Reebok's credibility in fitness,” said Hainer. “The brand continued to roll out its new brand mark, the Reebok Delta, and deepen its connection to the fitness community hosting spectacular fitness events and grassroots activities around the globe.”
Those events helped drive Reebok's training business up 26 percent, propelled by the ZSeries and CrossFit Nano, where sell-through rates across all channels exceeded internal expectations. Reebok Classics’ momentum also continued, up 24 percent in the quarter.
In its Other Businesses segment, sales were down 11.4 percent on a c-n basis, driven by a 17.6 percent tumble at TaylorMade. Rockport was off 1.3 percent and Reebok-CCM Hockey inched up 1.0 percent.
Other Businesses segmental gross margin decreased 4.8 percentage points to 38.5 percent in the quarter. For the half, gross margin was down 5.2 percentage points in the segment to 38.8 percent, due mainly to lower product margins at TaylorMade as a result of the highly-promotional environment in golf resulting in ongoing clearance activities.
“The golf industry is weathering an extremely difficult year and, as market leader, this hurts us severely,” said Hainer.
Hainer noted that on a reported basis, adverse currency-fluctuations negatively impacted its top-line result by around €250 million in Q2 and by over €450 million year to date. Gross margins were negatively affected by 60 basis points due to less favorable hedging rates. In addition, gross margin suffered a further 50 basis point negative in Q2 and 30 percent basis points in the half from the devaluation of the Russian ruble. In total, currency impacted its operating profit by over EUR 100 million in the half.
Given the golf, Russia and currency challenges along with the improving momentum seen from Adidas and Reebok, Hainer said Adidas and its board realized it needed “to be more decisive and faster in dealing with our challenges.”
He added, “We must act to strengthen brand leadership to be more impactful in the marketplace and bring more diversity to our earnings streams.”
ORGANIZATIONAL CHANGES TO INCREASE SPEED TO MARKET
First, the plan calls for organizational changes, led by new board members, Eric Liedtke and Roland Auschel, that will become effective from August onwards.
“With this initiative we are transforming our current marketing organization to be more consumer focused, brand driven and agile, with clear empowerment and accountability,” said Hainer. “The new set up empowers our category business units to take responsibility for all marketing processes end to end.”
Key expertise have been added in areas such as concept-to-consumer, innovation and strategy “to ensure we drive our brand agenda more professionally in the marketplace and stay ahead of the game,” Hainer said.
A second push involves heightened investments in its brands to support more balanced growth across categories and regions. Said Hainer, “On this front, this has been one of the shortcomings of our Route 2015 agenda. We won many of our key battles where we had a well-resourced offensive focus. Greater China and NEO are good examples. However, we left our brands exposed to attack in some markets which has cost us market share; Western Europe being an example.”
Its recent partnership announcement with Manchester United, its numerous signings of NBA draft picks this year, and planned notable collaborations starting in September in Originals were cited as an example of its commitment. Added Hainer, “In 2015 we will launch our most ambitious brand campaign yet, which will once and for all tell the world why Adidas is the best sport brand in the world.”
The hike in marketing spend to between 13 percent and 14 percent of sales from its Route 2015 target of 12 percent to 13 percent of sales is expected to be offset by more consistent global growth and tighter overhead leverage. The first quarter of 2015 will detail more about Adidas’ 5-year strategic plan to 2020 in the first quarter of 2015.
“However,” Hainer noted, “we will already begin now in the rest of this year to ensure we sustain the momentum we have in key categories and markets, and here there are several initiatives to look forward to.”
MARKETNG PUSH AROUND KEY CATEGORIES
In Football, a new Predator Instinct boot will build on its World Cup launches while the World Cup success keeps “t the heat on our competitor as the new club football and back-to-school season kicks off.”
Basketball will be supported by its new draft pick signings as well as extending Boost to the category with Crazylight Boost and D Rose 5 Boost. Boost will also be expanded to Baseball, Training, Snowboarding and Kids. Hainer added, “With our new editions and colorways in key running franchises we will also further propel the great momentum we have in Adidas Running during the second half of the year.”
Adidas Training is expected to build on the success this spring of ClimaChill with the launch of ClimaHeat. Adidas Originals will launch new colorways and models for ZX Flux in Q3, as well as photo-based product customization app tied to the shoe. Collections by Rita Ora, Pharrell Williams and Kanye West are expected to all sell well.
Reebok is expected to continue to benefit from its CrossFit and Spartan Race partnerships.
To improve profitability at TaylorMade, Adidas will “carefully look at new launch and introduction timings” with excess inventory remaining in the marketplace. TaylorMade’s overhead will also be aligned to lower expectations. TaylorMade’s moves are expected to impact second-half operating profit by €50 million to €60 million. Said Hainer, “As the dominant market leader, we take this initiative now to secure our lead and to be the first mover in reinvigorating the market. Our innovation pipeline is full and we are set to go whenever we feel the market is ready.”
In Russia, Adidas now plans to add only 80 stores in the market this year compared to its original plan of 150 and a similar figure is planned for 2015. The steps are designed “to reduce risk and protect profit, as well as to drive a faster implementation of new inventory management principles for that market.” The changes are expected to cause an operating profit shortfall of around €50 million in the second half.
“While uncertainty in the market is high right now, we believe this is the right decision for the short term,” said Hainer. “Nevertheless, we remain fully committed to the market. Right now we are very encouraged by increasing brand momentum for both Adidas and Reebok as a result of local marketing investments, as well as improving store operations.”
As a result, sales for the year are now expected to increase at a mid- to high-single-digit rate on a c-n basis in 2014, down from an increase at a high-single-digit rate previously, largely due to TaylorMade.
Gross margin is forecasted to decrease to a level between 48.5 percent and 49.0 percent, down from 49.5 percent to 49.8 percent previously, and compared to 49.3 percent. The shortfall was attributed to lower margins at TaylorMade and in the Retail segment, less favorable hedging rates and adverse currency movements in emerging markets compared to the prior year, as well as increasing labor costs.
Operating expenses as a percentage of sales are expected to increase (as opposed to being flat versus the prior year’s 42.3 percent) due to higher sales and marketing costs. Earnings are expected to now reach €3.10, down from €3.97 and €4.45 previously.
Adidas had over the last several years stated a goal of €17 billion in sales next year as part of its Route 2015 plan and an operating margin of 11 percent. Analysts had already been pegging its 2015 sales level at €15.7 billion even before the warning.
“In summary, while we have delivered notable achievements with our Route 2015 plan, we also accept that we need to lift our game to drive more consistency and dependability in our financial performance,” Hainer concluded. “With momentum returning in key markets, we are taking consequent and necessary decisions now to put the Group on a firmer footing to build for the future. By cleaning up markets, investing with more conviction in our growth opportunities and driving more agility through our new organizational setup, we will return the Group to a higher and more consistent level of earnings growth in the mid to long term.”
