Reebok International Ltd. continues to find ways to post positive numbers on a quarterly basis. In the second quarter, the company capitalized on a combination of one-time charges in the prior-year period and the acquisition of The Hockey Company to generate both top- and bottom-line improvements. But with the anniversary period of the THC deal now behind them, the company turned to the sale of the Ralph Lauren Footwear business back to Ralph Lauren to post a solid bottom line increase for the third quarter.
The third quarter 2005 results were positively impacted by an after-tax gain of $49 million from the sale of the Ralph Lauren Footwear business, while $2.5 million of costs related to “certain legal and other expenses” associated with the proposed merger with adidas cut into the bottom line.
Management also said that operating results were affected by the integration of The Hockey Company into the Reebok Brand and from the impact of a changing landscape at Footlocker, Inc., where Classics have slowed in favor of performance product and the retailer makes moves to reduce inventory levels over the balance of 2005. The decline in the Foot Locker business was blamed for roughly $46 million of the total company sales decrease and an $18 million impact to pre-tax earnings for Q3.
Excluding the after-tax gain from the RLFW sale and charges associated with the adidas merger, net income would have declined nearly 13% to $71.2 million for the period, despite solid improvement in the gross margin line. At issue was the sharp decline in revenues during the period, somewhat from the divestiture of the RLFW business, but mostly from big declines in both domestic and international footwear sales for the Reebok brand.
Paul Fireman, RIL chairman and CEO, said that Q3 was “certainly an eventful and unusual quarter” for the company due to the adidas merger deal announced in August. He said the deal has created “some retailer uncertainty” about the brand in the short-term and that has impacted the company's sales and order intake in the quarter, “particularly with certain mall-based retailers in the U.S.” In the quarterly conference call with analysts, Fireman also appeared to suggest that consumers may be moving away from the mall and into other channels.
“I'm not suggesting they have a significant problem,” said Fireman, referring to the mall retailers, “it's just that the compression of price, a lot of promotional activity, is not where theyre best served.” He pointed to an improved business at TSA and other sporting goods retailers, suggesting “it appears that's where customers are going to.”
He said they (Reebok) were working to increase their business in the sporting goods channel, but also saw increased opportunities in the mid-market and family footwear channels.
CFO Ken Watchmaker said the Classics business in the U.S. was essentially flat for the nine-month YTD period excluding the Foot Locker impact. Including Foot Locker, sales of performance products increased by 8% for the same period, albeit off of a smaller base.
On the THC side, the company saw a ramp up in hockey sales in the quarter, but the integration effort was a drag on the bottom-line. Reebok is consolidating multiple warehouses in Canada into its new distribution facility in St. Laurent, but they have “encountered some startup problems” in the new facility that have caused some difficulty in shipping current THC orders.
Management said there was approximately $15 million of open THC orders at the end of the quarter that they were not able to fulfill until October or beyond due to capacity restraints.
They also said they were incurring duplicate costs related to redundancies and excess payroll costs in connection with the start-up and wind-down of the facility.
“There has been a high degree of fan interest in the NHL and we believe the 2005/2006 season will stimulate a renewed interest in hockey and greater demand for our products,” said Fireman.
Keeping in mind that the THC business is now folded into the Reebok brand numbers, and the ramp up in hockey sales that came with the start of an NHL season this year that never happened last year, the actual Reebok brand business is clearly in one of its cyclical downturns right now.
While the sale of RLFW, the integration of THC, the shift away from Classics, and the decline in business to Foot Locker, Inc. would appear to be enough to explain away most of the business decline, the company also felt it necessary to blame Hurricanes Katrina and Rita for softness in the period. A company press release said the U.S. market had become more promotional in response to the hurricanes and related economic factors such as rising energy costs.
Reebok said the decline in its U.S. footwear backlog was “primarily the result” of its open order position with Foot Locker and “certain other mall-based retailers.” The companys open order position with Foot Locker over the next six months accounts for over 80% of the U.S. footwear backlog decline.
As he did during last quarters call, Watchmaker said that their current sales outlook for the U.S. footwear business in fourth quarter is “better than the backlog declines would indicate.” He said that backlog of Reebok's U.S. branded apparel increased, but the gain was more than offset by a decline in the licensed apparel backlog.
Last quarter, Watchmaker stressed that futures were less of an indicator of forward-looking results than in the past after the company reported that backlog at the end of the second period was up just 0.5%. SEW can only assume that he expected the fill-in business to make up the difference in the Q3 results, but it now appears that the at-once to cancel ratio has swung back in the other direction.
This quarter, Watchmaker said they changed their booking programs in licensed to “create more of a chase business” in an effort to “reduce cancellation and improve retail performance.” Order backlogs for NFL and NHL apparel are in positive territory for the next six months, but the overall licensed business took a hit from weakness in the NBA Swingman business, which Reebok took over from Nike this year as part of their exclusive NBA deal. Watchmaker indicated that the market was still working through the older inventory.
In Europe, Reebok said the overall sales decline in the quarter was primarily in the U.K., France, and Italy, but they felt that recent management changes in the French and Italian markets will begin to “positively impact future performance in these regions.” The retail environment in Europe was said to be “challenging and promotional,” with average selling prices continuing to decline across the region.
The companys factory outlet business saw comps decline 7.5% for the period, which management attributed to “the energy crisis.”
>>> No real impact to the business here as the offer on the table from adidas keeps RBK shares artificially high, but one has to wonder what the Germans are thinking
>>> Its a good thing only external factors are at work here. Otherwise, adidas might get skittish…
|Reebok International, LTD|
|Third Quarter Results|
|(in $ millions)||Quarter Sales||Backlog|