Adidas Q3 Boosted By North America And China

Adidas reported third-quarter sales jumped 12 percent on a currency-neutral basis, led by North America, China and its global e-commerce business.

On a conference call with analysts, CEO Kasper Rorsted noted that the Adidas brand, which grew 13.6 percent on a currency-neutral basis in the quarter, was led by growth of 31 percent in North America, 28 percent in Greater China and 39 percent across global e-commerce.

Said Rorsted, “This is extremely important for us because we have been very consistent in communicating to you that the three most important markets for us, globally, are North America, which represent 37 percent of the total sporting goods market; Greater China, which currently represents around 20 percent of the sporting goods market, but it has a huge long-term opportunity; and the eCom channel, which is in our first 9-months grew more than 50 percent and is of strategic importance to us, in order to create a one-to-one relationships, but of course, also has fundamental impact on driving our margins up. So, all three having a profound impact on our third quarter.”

Still, he seemed more pleased that profits are improving at a much faster rate than the top-line. The 34 percent gain in earnings from continuing operations marked nearly four times the improvement of the 9 percent reported sales growth seen in the quarter. Gross margins improved 240 basis points while operating margin was up 270 basis points.

Rorsted has made improving profitability a priority. In its last fiscal year, operating margins at Adidas were 7.7 percent versus 14.2 percent for Nike.

While much has been made about the market share gains Adidas is making against its key competitors in North America and elsewhere, the goal is “getting the right balance between” top-line gains, gross margin expansion and operating leverage. Said Rorsted, “The challenges we’ve had in the past was not so much getting the top line, but it was getting the right balance.”

Rorsted noted that both sales and margins are helped by establishing a “higher level of brand desire” for the Adidas brand.

Harm Ohlmeyer, CFO, noted that the gross margin improvement was not led by significantly increasing prices, but establishing “new price points” due to heightened demand for the Adidas brand.

Added Ohlmeyer, “Given the strengths of the brand, we are definitely, without going into the details, improving our full price sell-through at all channels as well, and that is definitely contributing to the better margin. There is a slight element of healthier inventory in that margin as well, as we are strictly managing our inventories based on our sell-through.”

Still, Rorsted noted some areas the company is “not as happy with.”

This includes limited operating-overhead leverage despite the significant top-line growth, although slow progress is being seen. He elaborated, “Our footwear business is growing, and we are still not seeing the limits of upgrading the operating leverage that we’re aiming for. We are making the right decisions to allow this to take place, but it is still too early to see substantial impact on operating leverage.”

He also pointed to Western Europe, where growth slowed to 7 percent due largely to retail slowdown. The termination of its deal with Premier League champions Chelsea is also leading to an overall decline in its global football business.

While Adidas overall had “another strong quarter in U.S. with excellent growth,” the U.S. college basketball recruiting scandal also caused the company to react quickly.

“As soon as we learned about allocation, we immediately, within 24 hours, put the relevant individuals on leave and engaged outside counsel to conduct a thorough investigation of our grassroots and college basketball,” said Rorsted. “The investigation is still underway and will take some time. We are fully cooperating with authorities. Based on the results, we will take whatever action might be necessary to strengthen our process. We do not expect the situation to have a short- or long-term impact on our business.”

He noted that basketball makes up only 1.7 percent of its overall revenue and is less than 1 percent of its U.S. revenue. Added Rorsted, “So, while the allegations are serious, and we are taking them seriously, we do not expect them to have any business impact.”

The basketball category overall is down due to the transfer of the NBA contract from Adidas to Nike.

Among its brands, Adidas brand’s sales on a global basis in the quarter jumped 13.2 percent on a currency-neutral basis (9.7 percent reported) to €5.09 billion. The currency-neutral gain was on top of a 20 percent increase in the same period a year ago.

Strong double-digit e-commerce growth was seen in every single market, and its woman’s business continued to outperform with a strong double-digit sales growth.

Sport Performance for the Adidas brand increased 3 percent. Running climbed 16 percent, driven by 20 percent growth in footwear. Training grew 6 percent, reflecting double-digit growth in athletics apparel. The underperformance of Sport Performance was predominantly from apparel, which was impacted in part by NBA, the exit from its Chelsea contract and currency headwinds. Despite the external challenges, Rorsted said the company is “still not happy with the underlying performance in apparel and it will be an area and is an area of focus for us to ensure that we’ll get a more satisfactory performance. So, we are not looking for any excuses.”

The Originals and Neo businesses grew a combined 25 percent on top of 42 percent growth in the same quarter last year. Originals was up 22 percent, driven by a strong double-digit growth in all key regions. The modern franchises grew more than 40 percent and now represent more than half of the Originals footwear business overall, in line with a goal of becoming more balanced between older and newer models. Neo grew 30 percent, reflecting ”exceptional improvement” in footwear

Reebok’s global sales inched up 0.6 percent on a currency-neutral basis (off 1.6 percent reported) to €485 million. Rorsted that the company had previously noted that it expected Reebok to show strong growth in the first half followed by “much more modest growth” in the second half as it undergoes a transition. Rorsted said the brand is facing “a growth challenge in the U.S. and an overall profitability challenge.” In the U.S., Reebok is closing 52 stores, including 36 already closed this year. Six more are set to close in the fourth quarter and 10 in 2018.

Said Rorsted, “We expect Reebok North America to return to growth in next year. We are satisfied with the progress we are making according to the Muscle Up plan.”

Rorsted also noted that Reebok earlier this week signed Victoria Beckham “to unite and drive our women’s business,” which he said was “very important” in part because it’s “where Reebok comes from.”

By region, sales in North America overall grew 22.7 percent on a currency-neutral basis (18.5 percent reported) to €1.1 billion. The currency-neutral gain is on top of a 24 percent gain last year.

The 31 percent hike on a currency-neutral basis for the Adidas brand came despite the loss of the NBA contract and “a very tough retail environment in the U.S,” said Ohlmeyer. All categories, especially the key categories of running, training, Originals and Neo, expanded more than 20 percent in Q3. Reebok’s sales fell 22 percent in the quarter due to the store closings.

Gross margins in the North America region improved 240 basis points and operating margins added 350 basis points with both the Adidas brand and Reebok showing improvement. Ohlmeyer said the company is “making good progress on the profitability” of Reebok in the U.S.

The other star region was Greater China, which saw sales grow 28.3 percent currency-neutral (23.1 percent reported) to €1.01 billion. The gains were led by the 29 percent currency-neutral increase of the Adidas brand, driven again by training, running, Originals and Neo. Reebok added 9 percent, driven by training and running. Gross margin was down 90 basis points due to currency headwinds and operating margins improved 120 basis points, to 35.8 percent, due to the strong top-line momentum in the region.

In Latin America, sales rose 8.4 percent on a currency-neutral basis (3 percent reported) to €502 million. Adidas brand sales grew 9 percent with growth in running, Originals and Neo. Reebok inched up 2 percent, led by training and Classics. Weaker economies, in part due to currency headwinds, led to a 260 basis point decline in gross margins in Latin America and a decline in operating margin by 100 basis points. Ohlmeyer said that while the period included “significant one-time effects,” “we are definitely not happy with operating margin of 13.6 percent in the quarter. That is definitely something that we are taking very seriously.”

In Western Europe, sales were up 7.4 percent on a currency-neutral basis to €1.66 billion with growth in most key countries especially for the Adidas brand, which saw double-digit growth in Originals and Neo. Football was down due to the loss of its Chelsea contract and weakness in the euro is causing slower growth in the region. Reebok climbed 21 percent currency-neutral in Western Europe, driven by running and Classics. Gross margins were up 120 basis points due to pricing actions with operating margins gaining 180 basis points was seen as “definitely a testament of quality growth,” said the CFO.

In the Russia/CIS region, sales were down 16.7 percent on a currency-neutral basis (11.1 percent reported) to €173 million due to store rationalization efforts that had been announced earlier in the year. The company had planned to close 150 doors. It has closed 140 so far this year and now in total expects to close 200 this year. Said Ohlmeyer, “We are managing that market based on cash flow relevance and we want to make sure that we have remaining significant cash flow positive, that is the #1 priority for us. If at any stage, the oil prices would move again, or the sanctions are less than they are today, we will be well positioned in Russia to go back to different levels that we are seeing today.”

In its remaining regions, sales in Japan improved 2.7 percent to €243 million but were down 8.2 percent on a reported basis. Sales in the MEAA region were up 5.5 percent currency-neutral (0.8 percent reported) to €801 million.

The company’s gross margin increased 240 basis points to 50.4 percent, mainly due to the positive effects from a better pricing and product mix, which more than offset higher input costs as well as unfavorable currency developments.

Other operating expenses increased 8.5 percent to €2.13 billion, reflecting an increase in expenditure for point-of-sale and marketing investments as well as operating overhead expenditure. As a percentage of sales, however, other operating expenses decreased 10 basis points 37.5 percent. Operating profit grew 34.5 percent to €795 million.

Net income from continuing operations was up 34.9 percent to €549 million. Losses from discontinued operations mainly related to the divestiture of the TaylorMade and CCM Hockey amounted to €22 million, about equal to €20 million the prior year. As a result, net income increased 36.3 percent to €526 million.

Adidas confirmed its guidance for the year. Its outlook was previously increased with the announcement of its preliminary second quarter results on July 27.

Sales are expected to increase at a rate between 17 percent and 19 percent on a currency-neutral basis. Net income from continuing operations is projected to increase at a rate between 26 percent and 28 percent to a level between €1.360 billion and €1.390 billion.

Gross margin is projected to increase of up to 0.8 percentage points to a level of up to 50.0 percent. Other operating expenses as a percentage of sales are forecasted to be below the prior year level of 42.7 percent. Operating profit is expected to increase between 24 percent and 26 percent of sales.

Photo courtesy Adidas