Q3 2012 adidas AG Earnings Conference Call
Nov 08, 2012 AM CET
ADS.DE - adidas AG
Q3 2012 adidas AG Earnings Conference Call
Nov 08, 2012 / 02:00PM GMT
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Corporate Participants
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* John-Paul O'Meara
adidas AG - Head of Group IR
* Herbert Hainer
adidas AG - CEO
* Robin Stalker
adidas AG - CFO
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Conference Call Participants
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* Andreas Inderst
Exane BNP Paribas - Analyst
* Jurgen Kolb
Cheuvreux - Analyst
* Matthias Eifert
Mainfirst - Analyst
* Julian Easthope
Barclays - Analyst
* Louise Singlehurst
Morgan Stanley - Analyst
* Michael Kuhn
Deutsche Bank - Analyst
* Chiara Battistini
JPMorgan - Analyst
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Presentation
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Operator [1]
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Good day and welcome to the adidas Group conference call for the nine months 2012 financial results. Today's conference is being recorded. At this time, I would like to turn the conference over to John-Paul O'Meara. Please go ahead, sir.
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John-Paul O'Meara, adidas AG - Head of Group IR [2]
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Thank you, Operator. And good afternoon, ladies and gentlemen. I'm JP O'Meara and I head up the IR activities here at the adidas Group. Today our presenters would be Herbert Hainer, Group CEO and Robin Stalker, Group CFO. And they will be covering our strong financial performance so far this year, as well as giving you some insight into the various initiatives we have planned to keep momentum going for the remainder of 2012 and into a very exciting 2013. So, with that, over to you, Herbert.
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Herbert Hainer, adidas AG - CEO [3]
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Yes, thanks, JP. And good afternoon, ladies and gentlemen. I'm very pleased to report today another set of robust and record financial results for our Group.
For the first nine months, currency-neutral sales increased 8% or 14% in euros in over EUR11.5 billion with growth across all geographical areas. Through proactive gross margin management and disciplined control of our operating costs, we were able to achieve an operating margin improvement of 40 basis points to 10.1%. And as a result, Group net income in earnings per share have jumped 22% to EUR798 million and EUR3.82 respectively.
We again had many highlights in the third quarter, but there are three real outstands. Firstly, it is the power and the global strength of the adidas brand where we enjoyed 10% currency-neutral growth.
The second is our gross margin performance, which increased 30 basis points despite continuing pressures from input costs. This allowed us for the seventh consecutive quarter to grow our bottom line, both fastest in sales and at a double-digit rate being 14% for the quarter.
And thirdly, we continued our industry leading inventory management, which resulted in another quarter of sequential decline as inventories were down 1% currency-neutral compared to the prior year period.
These strong results continued to be a reflection of our relentless focus on driving quality and sustainable top line growth. Unlike many in our industry, we have not only preserved, but created opportunities to improve and grow our margin. And we have done so without the need to sacrifice important investments into our brand and infrastructure critical to sustaining our future success. And this is clearly one of the key strengths of our Route 2015 strategy.
Our powerful global reach and brand appeal is reflected in the strong and broad based sales growth seen in all of our geographic areas in the first nine months. In particular, our key attack markets of North America, which is up 5%, Greater China, which is up 16% and Russia CIS, which is up 17%, have once again delivered significant category and market share victories. And even in Western Europe, where we were able to grow Group sales by 4%, which is impressive, given the recent economic challenges.
Our performance also in the first nine months also reflects our dedication to creating the industry's most desirable brands, which we are doing by consistently driving product innovation, brand authentication and investment.
So let's have a look at our brand achievements for the period. Starting with adidas, the momentum we are currently enjoying with the adidas brand is unprecedented in the last decades. With sales increasing 10% currency-neutral in the third quarter and 12% year to date we have marked our 10th consecutive quarter of double-digit growth for the brand. There is a rapid double-digit rate in all regions with exception of Western Europe, which increased 7%.
All around the world, the brand was front and center in the summer of sports, be it the success of our corporation with Team GB at the Olympic games, where they won 65 medals. Andy Murray's first Grand Slam victory at the US Open and Olympic gold in Wimbledon. And our success on the world marathon stage, which includes Geoffrey Mutai and Mary Keitany being crowned 2011-2012 World Marathon Majors Series Champions.
And these are just some of the inspirational athlete achievements that continue to inspire and showcase to the consumer why adidas is the best performance sports brand in the world.
This is also fully underlined in the diversity of the brand's growth by category. All of our key performance categories, be it football, running, basketball, outdoor, as well as adidas' Sport Style have grown at strong double-digit rates this year. And our innovation led growth is reflected in the brands' gross margin, which was up a healthy 70 basis points in the third quarter.
In football, our year-to-date sales are up 17% currency-neutral and at a high single-digit rate in the quarter as we built on our dominance at the UEFA EURO 2012. During the quarter, the Predator and the key football club apparel launches, such as Chelsea, Bayern Munich and Real Madrid have all seen year-over-year increases of over 20%.
In running, our gross rate accelerated in the third quarter with sales rising 17% driven by the continued success of our adiZero and Clima franchises. In addition, several new introductions, such as the adiZero adios 2 two racing shoe, the Kanadia trail shoe and our Supernova technical apparel all received industry awards during the period, highlighting the strengths of our offering across the full breadth of the running market.
In basketball, sales also accelerated in the third quarter, growing 30% within North America, even up almost 60%. And this we fueled by strong footwear sales, driven the Rose 3 and the Crazy Light 2, as well as strong growth in apparel as we anniversary last year's NBA lockout.
And finally, it goes without saying that our connection to the lifestyle consumer is only getting deeper. Sales increased 23% currency-neutral in the third quarter, driven by double-digit growth at adidas Originals and at adidas NEO label. A particular highlight was the strong reception to our all Originals Represent campaign, which resonates strongly in the back-to-school period all around the world.
Now moving over to Reebok. The reported sales declined 25% currency-neutral in the quarter and 20% year-to-date. If we exclude the impact from our cleanup of Reebok India and our decision to discontinue the NFL license and the reporting change of the NHL business from Reebok to Reebok-CCM Hockey, revenues declined 6% in the quarter. While this is still by no means satisfactory, it is an improvement in trends compared to the second quarter decline of 10%.
This confirms what I told you back in August, that we do encouraging signs for the brand, particularly in markets led by our own retail and control space initiatives. In fact, comparable store sales globally are up 11% in the third quarter. In addition, I also now believe we can call out that our Classic business is moving into a sustainable upward trend. Reebok Classic sales were up double-digit in the third quarter, supported by strong new product introductions, such as those with new brand ambassador Alicia Keys.
Finally, let me wrap up my comments on the period with a review of TaylorMade-adidas Golf. Sales in the first nine months increased 21% currency-neutral. In the third quarter, sales increased 4% currency-neutral with strong double-digit growth in North America and in metalwoods, offset by lower sales in Europe and in irons due to the timing of this year's product launches.
Our strength in innovation has once again shown through on this year's six major professional golf tours with TaylorMade drivers winning 49 events already. Also, several of our Tour Staff pros played starring roles in the Ryder Cup matches, including Dustin Johnson, Justin Rose, Sergio Garcia and ultimate hero, Martin Kaymer.
So ladies and gentlemen, this completes my review of the period. I will be back in a few moments to talk about the rest of the year and some initial flavor on 2013. But before that, let me hand over to Robin, who will discuss the third quarter financials and business developments in more detail with you.
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Robin Stalker, adidas AG - CFO [4]
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Great, thanks very much, Herbert. And good afternoon, ladies and gentlemen.
As you've just heard, our Group is having another excellent year, both operationally and financially. My comments today, I want to focus on three topics. Firstly, a look at our third quarter top line performance trends by region and channel, also adjusting for this year's one-time items. Secondly, the reasons for the strong development of our gross and operating margins and finally, our continued progress and discipline in balance sheet and cash management.
In the third quarter, currency-neutral sales increased 4%, or 11% in euro terms, to EUR4.2 billion with every region, except North America, posting sales gains. If we exclude the impacts from the NFL license and Reebok India, sales for the Group in the quarter increased 7% currency-neutral.
In Western Europe, despite the widely commented macroeconomic challenges in many parts of the region, Group sales grew 1%. This was primarily a result of strong sales growth in the UK, France and Poland, which offset declines in the Southern European markets. Both the UK and Poland saw very strong results as we benefited from tremendous brand visibility during the major sports events with currency-neutral revenues gaining 19% in the UK and 27% in Poland.
In European emerging markets, Group sales increased at 19% currency-neutral. This strong performance was mainly driven by Russia CIS, where revenues were up 21% currency-neutral, again driven by strong comparable store sales growth of 14%.
In North America, Q3 Group sales decreased 5% on a currency-neutral basis, mainly as a result of sales declines at Reebok, which more than offset sales growth of 11% at adidas and 13% growth at TaylorMade-adidas Golf.
In Greater China, currency-neutral sales increased 11% with double-digit growth at both adidas and Reebok. Comparable store sales at all of our sub labels are very strong and in particular, the highlight for this quarter was the adidas NEO label, which saw double-digit comps driven by our first ever fully integrated campaign, featuring two of Asia's biggest youth icons, Eddie Peng and Angelababy.
In other Asian markets, Group revenues were up 1% driven by strong growth in Japan and South Korea, which was partly offset by the negative consequences related to Reebok India. Excluding these effects, sales growth for the region would have been up 6% for the quarter and 13% year-to-date.
Finally, in Latin America, adidas Group sales accelerated significantly in the third quarter, increasing 16% on a currency-neutral basis. Double-digit sales growth, both at adidas and in other businesses, more than offset revenue declines at Reebok.
Now moving on to profitability. We continue to be rewarded for our hard work and strategic focus on driving quality sales growth. Similar to previous quarters, the Group faced challenges from higher input costs. In fact, the total negative impact was 2.5 percentage points in the third quarter, which we were able to fully mitigate, delivering a margin increase of 30 basis points for the period.
The key drivers to achieving this expansion are similar to those outlined in our recent earnings calls. Firstly and most importantly, price increases, product engineering efficiencies and a more favorable product and regional sales mix. Secondly, the over-proportionate sales growth in our retail segment which carries higher margins. And lastly, our hedging strategy yields us a slight positive tailwind, however, I would like to add here that we expect this to reverse and become a headwind in 2013.
Now for the first nine months, that means we are now closing in on our target of a gross margin of around a prior year level of 47.5% with year-to-date gross margin now down only 40 basis points. By the way, for the nine-month period, input cost pressures were a 4.1 percentage point negative.
Moving now below the gross profit line, we continue to make very good progress towards one of our key Route 2015 goals and that's leveraging our growth and operational scale to drive operating expense leverage.
For the quarter and year-to-date, other operating expenses increased 14% and 13% respectively. As a percentage of sales, other operating expenses were up 0.7 percentage points in the third quarter, however year-to-date, they decreased 0.5 percentage points. Thereof, sales and marketing working budget expenditures increased 9% for the third quarter and 8% for the first nine months. As a percentage of sales, sales and marketing working budget was 10.8% for the third quarter and 11.7% for the first nine months.
Group operating profit increased 19% in the first nine months to a new record nine-months level of EUR1.2 billion. This translates into an operating margin of 10.1%, up 40 basis points. In the third quarter, operating margin expanded 10 basis points to 11.8%.
Turning now to the non-operating items of the P&L, net financial expenses decreased 25% in the first nine months compared to a year ago. This mainly reflects a 22% increase in interest income and a 60% decline in negative exchange rate effects. Lower interest expenses also contributed to this development.
The tax rate for the first nine months increased a slight 40 basis points to 27.8%, which is due to a less favorable regional earnings mix and fully in line with our guidance of the tax rate increase to 28.5% for the full-year. As a result, net income attributable to shareholders for the nine months increased 22% to EUR798 million, a new first nine months record mark for the adidas Group which translates into basic and diluted EPS of EUR3.82.
Third quarter net income attributed to shareholders as well as basic and diluted earnings per share increased 14% to EUR344 million and EUR1.64 respectively.
Now by segment, currency-neutral wholesale revenues reflect in the third quarter an increased 4% in the first nine months, as sales growth at adidas more than offset revenue declines at Reebok. Gross margin for the segment was up 0.9 percentage points for the quarter to 41.3% and is now down only 50 basis points year-to-date. Price increases, as well as a more favorable product and regional mix helped to more than offset the headwinds from input costs in the third quarter.
In the retail segment, comparable store sales growth continued to be a key driver for segmental revenues, contributing 9% of the 15% currency-neutral growth for the quarter. For the first nine months, comp store sales also expanded 9% currency-neutral while total segment sales grew 16% currency-neutral.
By brand, currency-neutral adidas comp store sales increased 8% in Q3 and 9% in the first nine months, while Reebok comp store sales grew a very healthy 11% and 9% for the quarter in the year-to-date period respectively. Sales from e-commerce were also very strong, growing 63% in the third quarter and 65% year-to-date. Retail gross margin decreased 3.3 percentage points to 59.0% for the third quarter and decreased 2.2 percentage points to 61.0% in the first nine months. Increased promotional activities, as well as the devaluation of the Russian ruble versus the US dollar, were the main factors contributing to margin declines.
Coming now to the segmental operating margin for retail, we continue to make strides towards becoming a world-class retailer. Despite the decrease in the retail gross margin, segmental operating margin for the third quarter declined only 1.4 percentage points to 21.8% and by 0.1 percentage points to 21.6% for the first nine months.
Now in terms of store development, at the end of the third quarter, we operated 2,466 stores, a net increase of 65 stores or 3% versus the prior year in level of 2,401. During the first nine months, we opened 262 new stores and closed 197 stores while 52 stores were remodeled. Now our remodeling and store upgrade efforts continue to yield significant benefits. For example, during the quarter, we reopened the adidas brand Concept store on Hankow Road in Hong Kong, where after the store renovation, we are seeing impressive results. In the first trading days after its reopening, sales increased 47% versus the previous year and traffic was up 9%.
Now finally coming to the other business segment, this is certainly one of the highlights of our first nine-month's performance. Currency-neutral revenues grew 7% in Q3 and 20% year-to-date, driven by strong sales increases of Taylormade-adidas Golf and Reebok-CCM hockey.
In euro terms, sales for other businesses grew 18% during the quarter to EUR486 million and 30% in the first nine months to EUR1.6 billion. Since June, the consolidation of Adams Golf added EUR23 million of sales.
The segmental quarterly gross margin decreased 0.2 percentage points to 42.7%, but the first nine months gross margin was down 0.5 percentage points to 44.0%, mainly as a result of lower product margins at Rockport and Reebok-CCM Hockey. Improvements at TaylorMade-adidas Golf partially helped to offset these negatives.
Now, ladies and gentlemen, I'd like to discuss our balance sheet and cash flow development and I am again particularly proud of the further progress we achieved in the quarter. Our conservative approach towards managing risk and our disciplined control of our inventories is certainly justified and we continue to be rewarded for pursuing this focus.
Our inventory growth rate has once again declined compared to the prior quarter decreasing 1% on a currency-neutral basis. This is in stark contrast to most of our major competitors where inventory growth rates continue to be at much higher levels. As a result, we were also able to further decrease operating working capital as a percentage of sales by 0.4 percentage points to a record low of 20.5%.
The combination of our tight control of working capital with our strong operational performance led to significant cash flow generation for the period. This is reflected in the 55% year-over-year decline in net debt from EUR750 million to a level of only EUR337 million.
Taking all of our results together, we once again have seen a strong increase in our equity ratio, which is up 2.7 percentage points to 49.6%.
Now looking out to the remainder of the year, we have made some small adjustments to our full-year guidance. We've slightly reduced our sales outlook to high single-digit currency-neutral growth from approaching 10%, which mainly relates to lower sales expectations at Reebok after the first nine-months performance, as well as negative impacts due to the ongoing NHL lockout. Our gross and operating margin guidance for the year, as well as our earnings per share guidance obviously remains unchanged.
Finally, given our strong inventory management, we expect operating working capital as a percentage of sales to be around the prior year level, compared to our earlier expectations of a moderate increase. This means we will deliver not only record P&L results, but also record cash flows from operations this year, which will be ahead of our original expectation.
So ladies and gentlemen, on that very positive note this concludes my comments for today. Now back to Herbert to take you through our key initiatives and to give an update on our initiatives for the remainder of the year and some indications of what to expect from us in 2013.
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Herbert Hainer, adidas AG - CEO [5]
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Thanks, Robin. Let me tell you, ladies and gentlemen, that never in my time as CEO of the adidas Group have I seen momentum like we have today. We can definitely look forward to the remainder of the year and 2013 with confidence and with ambition.
While there is still a lot of macroeconomic uncertainty, both positive and negative, we have done all the right things and we will continue to do so also in the fourth quarter to give our Group the perfect platform for a strong competitive attack in 2013.
In terms of our expectations for Q4, where our priority will continue to be on ensuring markets and channels stay lean and fresh, there are also a few things to bear in mind. Firstly, we will anniversary the sell-in of high-margin event related products for the Olympic and Paralympic games and the UEFA EURO 2012, particularly here in Europe.
Secondly, we will continue to see negative impact on Reebok from the NFL license termination with Q4 being one of the peak quarters of the negatives.
Thirdly, as Robin mentioned already, the player lockout in the NHL will negatively affect our fourth quarter results, also in one of its most important quarters.
And finally, we will see the last of the Reebok India negatives as we finalize our cleanup efforts.
If you add all of that up, that is a material headwind for our smallest quarter. Each of these accounts for a low double-digit million impact on profit totaling as much as EUR50 million. But nevertheless, given the strong momentum in our key Route 2015 growth categories, we expect to be able to offset many of these headwinds as you can see by the reiteration of our guidance.
So what are the positive things going on that will fuel our underlying success over the holiday period? Firstly on the product side we have some significant new introductions. Here are few examples. In basketball we launched the Rose 3 basketball shoe on October 4th at the $160 US dollar price point, 45% higher than its predecessor the Rose 2. And since it's launch, it has enjoyed double-digit sales through each week. To remember one of our most successful campaigns in history, the Rose Return, which has had 18.5 million digital views already. This clearly highlights the broad appeal of this very special NBA icon.
Another example of great products just out is in football. Yesterday evening we introduced the new adidas adiZero f50 football boot, which was worn for the first time by the world's best player, Lionel Messi last night in the Champions League Game between Barcelona and Celtic.
And last but not least, Taylormade-adidas Golf has unveiled it's latest and most remarkable golf irons to date, RocketBladez, inspired by the distance enhancing benefits of the Rocketballz fairway woods and the rescue clubs, this is certain to be another consumer hit when it starts at retail at the end of November.
In terms of our channels, in wholesale we are piloting some of our latest shop-in-shop initiatives before ramp-up next year. For example, in the US, we began our new adidas Home Court program with Dick's at the end of last week. And with Sports Chalet, we have already have 20 new Reebok Fit Hub shop-in-shops in place and the early results of both programs are very encouraging.
In own retail for Q4, it is all about driving holiday traffic and conversion in our stores. Here, not only do we have our most comprehensive winter wear offering to date, but also for the first time ever we will have a fully integrated global in-store and online Christmas campaign which launches at the end of November.
So as you can see, across the Group there is plenty going on to ensure a highly successful end to the year. But after such a great year 2012, what can we look forward to in 2013? Well, let me put it simply, an even better year.
We will continue in the same direction and with the same determination as we have done all through the first years of Route 2015 -- staying focused, implementing with excellence and, above all placing the consumer front and center in every decision we make.
We will create the unexpected, by bringing more game-changing innovation and freshness in more categories than any of our competitors. In particular, we will bring one game-changing revolution to market in spring which I am certain will shake up the entire running market.
In addition, you will see us continue to deepen the emotional connection between our brands and our consumers, becoming an even greater part of their lives through best-in-class brand activation on the field of play, on the street and in social media. You will see this again on every major stage, be that the NBA All-Star Weekend in Houston, Texas, the UEFA Champions League final in London, the IAAF World Championship in Moscow or as we kick off for the FIFA World Cup 2014 at next summer's FIFA Confederations Cup in Brazil.
And you will see fantastic new brands and product collaborations with key promotional partners, such as the Derrick Rose logo and collection in basketball, our new exciting partnership with Justin Bieber for the adidas NEO label, Yoga rebel Tara Stiles with Reebok and Alicia Keys for Reebok Classics.
These are the types of opportunities and initiatives that make our Group unique. They are part of a formula that is rich in content, comprehensive to the globally relevant, and focused to maximize and grow earnings and cash flow.
I can already confirm that we expect to deliver another year of record financial performance in 2013. This will come predominantly from operating margin expansion, where we expect to achieve a level of around 9% in 2013, as well as from sales growth. This will yield another year of significant double-digit earnings growth, which I am sure you will agree, is the telltale sign of a high-performing company.
So with that, ladies and gentlemen, thank you for your attention. And Robin and I are happy now to take all your questions.
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Questions and Answers
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Operator [1]
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(Operator Instructions) Andreas Inderst, Exane BNP Paribas.
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Andreas Inderst, Exane BNP Paribas - Analyst [2]
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I have a couple of questions. The first one on inventory management. Excellent development here. Robin, maybe you can elaborate a bit more. How come that you are so much better than competition right now? You mentioned the focus on inventory management, but what exactly are you doing? And what are the prospects for 2013 on inventory management?
The second question is on cash flow. Extremely good development here as well. In terms of utilization of cash, what can we expect in terms of dividends, share buybacks or acquisitions? Maybe you can give us a hint here.
My third question is on the oneoffs related to India. Can you quantify the oneoffs for Q3, please?
And then my final question on 2013 on the sales growth, what you expect. Are you happy with the consensus forecasted for 5%, 6% growth rate?
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Robin Stalker, adidas AG - CFO [3]
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I'll take the first couple of questions. I'm not sure I can specifically identify what the competitors are doing with inventory, but I can say what we are doing. And we are over the last years really concerned that we have a good visibility on our inventory, that we have a focus on clearing the inventory as quickly as possible. And you may also see that we proactively have to take tradeoff positions in this respect and sometimes clear and achieve lower margins just to make sure that we do have very clean inventories. And perhaps one of the best examples compared to competitors, you look at our performance in China, and one of the reasons we're very well positioned in China is that we took decisions in 2009 to go deeper into clean up and to maintain a very current inventory in that region.
So, we will continue to keep everybody focused on that and I think that will also help us over time to increase our stock terms and therefore obviously further our use of cash and our cash flow generally.
Apropos the use of cash, no, there's not change in the guidance that we've given over the last year. Our first priority is to continue to generate good cash to pay down the debt. Secondly, we have said that we will continue to invest in our operations. And we have got a -- what we believe a very good policy dividend policy and you have seen us slightly increase our dividend over the last couple of years. And you may anticipate us increasing that in the future. We have still some room to go within our guidance. We have no plans for any sort of major acquisition or any sort of buyback at this stage.
Your third question was about India. Reebok India and the oneoff hits this year. Gave guidance earlier in the year that we're expecting the oneoff charge this year to be around the EUR70 million. Year-to-date at the end of the third quarter we've probably got about EUR60 million in there and we've probably got another EUR10 million to EUR15 million to go in the fourth quarter.
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Herbert Hainer, adidas AG - CEO [4]
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Andreas, your fourth question was about sales increase in 2013. You can be sure that our deep desire is to first grow our business in 2013 as I have already said in my little speech. But bear with us when we have final results presentation in beginning of March. We'll give you all the details to that.
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Operator [5]
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Jurgen Kolb, Cheuvreux.
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Jurgen Kolb, Cheuvreux - Analyst [6]
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Again, on the inventory side, a very strong performance indeed. Any concerns that there might be in the next quarters the need to ramp-up your inventory side? Or is that a level you think you can continue on a sustainable basis?
And then again, the raw material impact in the third quarter, another 250 basis points. The trend is obviously improving, but how could you -- or how do you see the next quarters trending from that perspective? Maybe also looking into the first half of 2013.
And sorry if I may have missed it, but the gross margin for the Group in Q3, excluding India, how did that develop there?
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Robin Stalker, adidas AG - CFO [7]
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Look, with the inventory no, we're quite confident we can sustain this. We, as I said to Andreas' question, we're trying to improve our stock turns here. And so we're getting more efficient in our inventory. But we definitely also want to make the sale, but we're not anticipating that we have to see that we increase inventory. We want to maintain it at this good level
In terms of FOB, yes, you've seen that this quarter the trend's been better. And although for the full nine months we're still suffering something like over 400 basis points negative impact because of the FOBs.
It is getting better, we would anticipate that this will be a smaller impact in the future quarters, particularly because we're starting then to anniversary or do the comp with the significant increases of the beginning of 2012. So look to this to be something that is not the headwind in the future that it has been in the last few months.
And in terms of the gross margin impact from Reebok India, it's minimal, if at all anything on the Group basis. But in terms of the Reebok segment, it's about 1.2, 1.3 percentage points from the gross margin.
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Jurgen Kolb, Cheuvreux - Analyst [8]
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Allow me please one add-on question regarding Southern Europe. How do you see the situation there, specifically the three core markets, Italy, Spain and France, the current trends that you're noticing there?
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Herbert Hainer, adidas AG - CEO [9]
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Yes, Jurgen, the Southern European countries you mentioned, they're definitely still challenging. But on the other hand, as you have seen, also during the summer months, we are able to excite the consumer speed on the European Championship with the Spanish national team, (inaudible) Real Madrid and a lot of others. So therefore on the one hand it's, as I said, it's challenging, but on the other hand I think we have been quite successful to motivate the consumer to go into the stores and buy our product. And this is what we will continue to do.
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Operator [10]
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Matthias Eifert, Mainfirst.
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Matthias Eifert Mainfirst - Analyst [11]
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First question for myself would be could you help us to understand page 20 in your presentation, how to reconcile the 5% increase you are mentioning there? I don't know if that is referring to North America because I think Q3 sales were actually declining there. That would my first question.
Second question is extremely exciting about basketball of adidas in North America up nearly 60%. Are there any other categories that didn't perform as good as you expected it? And if so, what would that be? And do you have any measures to kind of improve that going forward?
And my third question would be also about the gross margin, a bit more on a longer-term perspective. Do you think we ever will get back to this kind of levels we have seen at the adidas brand in the wholesale business of 46% in 2008? Or is it just not possible anymore due to, I don't know, continuously increasing labor costs and or maybe a mixed change or something like that? Can you put that into perspective please?
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Robin Stalker, adidas AG - CFO [12]
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So, Matthias, just for a little clarification point, we're upside year-to-date in the US (inaudible).
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Herbert Hainer, adidas AG - CEO [13]
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Your second question, Matthias, was on the basketball or are there categories which are not performing as well. I mean as I said in my speech, I'm very pleased with be it running, be it football, be it basketball, be it outdoor or the adidas style business was originally. If I would have to pick one within the adidas world, then it would be tennis, which was not as successful as all the others. But you know tennis is not the biggest category. But overall I must say I am very pleased with the development of the adidas brand.
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Matthias Eifert Mainfirst - Analyst [14]
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And then for North America in particular?
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Herbert Hainer, adidas AG - CEO [15]
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Yes, in North America in particular it's basketball, it's football, it's Original, it's apparel, these are the main categories.
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Robin Stalker, adidas AG - CFO [16]
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And Matthias, we like challenges and we therefore believe there's still opportunity to improve gross margin, although I think we've given you over the previous years good guidance in terms of where that's coming from. I mean there is this development in the mix, in the regional mix and obviously also in our channel mix. I mean the retail margin obviously being higher than the wholesale margin and the faster growth of retail that certainly helps us.
And don't forget also that one of the major opportunities we have in further improving our margin is improving the gross margin of the Reebok brand and as that improves, clearly that helps also the total group market.
So we're optimistic, but no specific guidance on that at this stage.
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Operator [17]
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Julian Easthope, Barclays.
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Julian Easthope, Barclays - Analyst [18]
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Just three questions if I may. The first one from marketing spend. I see for the first nine months you're down about 70 basis points in terms of percentage of sales. Is that going to be a step change in marketing spend from this point forward and we're looking now at sort of 12% and a bit rather than 13%. Or is there likely to be a sort of margin headwind on marketing spend for next year?
The second question I have is on the interest charge. You've now got EUR1 billion in the CB and the bonds. And you still have some private placement. So I just wondered if the bonds was going to be used to pay down those private placements early or what is the actual average interest charge of the gross debt, if possible?
And just lastly, a clarification on Reebok. Are we expecting therefore with the NFL contract being big in the fourth quarter of this year, another quarter that's going to be down sort of 25% caused by the NFL and NHL contracts as well?
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Herbert Hainer, adidas AG - CEO [19]
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Julian, let me start with the first question, the marketing working that should know this is definitely not a step change. As we, I think I have said it already several times, I don't see there's a cost in terms of investment. This is just pure timing effect and as we told you, we are spending around 12% to 13% to activate our consumer sentiment and I think we do it in a fairly professional way.
When you look what our campaign says, I said just before the originals all in campaign. How much consumer excitement they create. So, but the answer is that no, there is no step change.
And the last question on Reebok, yes this is definitely correct. The CNFL in the last quarter is the biggest quarter. This will ultimately influence our performance for Reebok in the fourth quarter and the decrease will be around that number.
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Robin Stalker, adidas AG - CFO [20]
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And in terms of the interest charge, you're right, we have obviously have a gross debt, we have no plans at the moment to change that structure. And in the convertible bond over here we have to, from an accounting point of view, also reflect this as a cost at a normal bond rate. We bifurcate obviously. You may remember the coupon of that is 0.25%. We have a very good practical financing rate, but obviously through the accounting of that if they go through the P&L more expensively.
If I look at the gross, borrowing average would probably be close to 5% at the moment.
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Operator [21]
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Louise Singlehurst, Morgan Stanley.
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Louise Singlehurst, Morgan Stanley - Analyst [22]
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A couple of questions for me, please if I may. Firstly on Europe, obviously there's been a slowdown in Q3, not at all a surprise. But can you talk about the end consumer, if there's any difference there in terms of pricing demand or if it's just footfall.
Secondly on China, given the problems all the domestic brands are having, you are clearly outperforming significantly in that market at the moment. Can you just talk about plans to push out to lower tier cities and does the current difficulties with the domestic environment prevent you from going as fast as you'd like to in those lower tier cities? I suppose I'm really trying to find out whether we should expect an acceleration in the growth for 2013.
And then thirdly, back on the balance sheet again and thinking about what Nike's been up to in terms of exiting some non-core or smaller brands, were there any plans like for Rockport or the hockey business or any changes that you can expect to see with the portfolio added as Group?
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Herbert Hainer, adidas AG - CEO [23]
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Let me start with the first question. Europe and the consumer. Yes, we definitely see in some countries, as we have spoken before really, especially in the Southern Europe, that the consumer is a little bit more price sensitive. But on the other hand, as we have done over the last years, by bringing in new innovative product, this helps us to raise our prices.
I have just given the example before in America with the road shoes, but we have similar examples here in Europe with our football boots, the f50, which I mentioned, the new one with Lionel Messi with the new jerseys (inaudible). And as Robin said before, having a clear inventory really helps us to put our prices into the market and not downgrade and reduce the prices for faster sales. Therefore this keeps our margin, but this also keeps the reputation and the image for our brand and I think with (inaudible) we're doing a better job than many of competitors here in that respect.
And the second question to China. Yes, we will first continue to lower tier cities, but with all the respect to build a sustainable and healthy business, as I have told you already the last three years. If you remember after 2008 and 2009 where I said yes, we will clean up the market first. We will install information systems with our key franchise. As you said, we know exactly what the consumer is doing in the stores that we can put in fresh products and we don't have over inventories. And I think it's also fair to say that we have been quite successful with this underlying success, which we have in China.
Honestly, I don't see any difference to that practice in the future and this will mean that we will further continue to grow in China and we will expand also with all the respect that we monitor the market quite carefully in 2013 to lower tier cities.
And the third question I think was to smaller businesses. I mean as you can imagine, we always get -- or have been approached by companies to want to buy the one or the other thing from our product portfolio. Yet I can confirm that we have been approached in the near future for our hockey business and we are in discussions, but we haven't taken a final decision yet.
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Louise Singlehurst, Morgan Stanley - Analyst [24]
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Actually just a quick follow-up on NEO as well. Obviously that's doing very well for you in China. Good thing for all those Justin Bieber fans out there I'm sure. But in terms of the global rollout, is there anything else beyond Germany? You've got plans for that label?
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Herbert Hainer, adidas AG - CEO [25]
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Yes, we have NEO and more (inaudible) than just in China. We have it in Russia, we have it in some of our emerging markets. But we said for the core of European, but always mean the five countries, be it UK, Germany, France, Spain and Italy.
We first want to test it in Germany. We took Germany as a test market because we think this is a highly competitive market. We have said 10 stores opened as we told you. We will take 12 months as we said, so this means middle of next year we definitely are in a better position and then we decide how we will do the first rollout.
But I also can tell you that the first indications that we have from our stores here in Germany are quite positive. Does not mean that all the 10 stores are booming, but 7 out of the 10 are doing very well. One or two we have to look how we improve. And one that is not performing to the level which we thought, but this is exactly honestly what we wanted because we want to learn what is working and what doesn't work before we then do the rollout.
But we definitely will give you to that much more details next year when we speak about the first expansion of NEO.
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Operator [26]
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Michael Kuhn, Deutsche Bank.
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Michael Kuhn, Deutsche Bank - Analyst [27]
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Also essentially three questions from my side. Firstly, on other businesses here the operating margin was down 2.3 percentage points in the third quarter. Would be interested what's the reason behind that and whether it had to do with the Adams inclusion. And that context, one clarification context, I think the figure of EUR23 million was mentioned. Was that the first time sales consolidation of Adams in the third quarter?
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Robin Stalker, adidas AG - CFO [28]
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The figure line outs for Adams is the -- for the total for the year we said from June, so there was a bit in the second quarter also, but it was minimal obviously. And the margin deterioration in the -- it was pretty small, but it is largely because of the Rockport margin.
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Michael Kuhn, Deutsche Bank - Analyst [29]
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Then second question on hedging. So what you said currently in terms of your dollar hedge rate. And could you explain a little more what you're referring to when you said that hedging might turn into a headwind?
And then finally on current trading, for the -- I mean would be interested whether you see any, let's say substantial changes in trends among the regions or whether you would say that the environment is let's say fairly stable?
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Robin Stalker, adidas AG - CFO [30]
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Firstly, what I said with the gross margin is it gave us a little bit of a tailwind in the third quarter but it was only about 30 basis points. So it's not very much. And I think we'll see that flip the other side as we go into 2013.
But overall, the hedging will be a slightly more negative figure for us in 2013 because our hedge rate at the moment, 2013's around about the 132. And we were over 136 to 137 basically for 2012. So there's a deterioration there.
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Herbert Hainer, adidas AG - CEO [31]
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And in terms of your third question, current trading. I mean the latest news obviously I get from our own stores and what I can see is that we are doing very well in China, in the US. Russia is doing okay. Also the biggest part of Europe is okay, but as we have said already Southern Europe has more challenges than the rest.
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Operator [32]
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Chiara Battistini, JPMorgan.
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Chiara Battistini, JPMorgan - Analyst [33]
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A couple of questions from me, please. As top line is slowing down in the second half of this year and comes for the first half of next year will be particularly tough. Shall we expect the 2013 top line development more weighted towards the second half? And that would be my first question.
And then on the other operating income, I see that that was up 131% in Q3 compared to 44% in Q1 and 32% in Q2. So I was wondering if that included any oneoff? And this significantly boosted the Group EBIT margin in Q3 and what the Group EBIT margin would have been excluding those oneoffs.
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Robin Stalker, adidas AG - CFO [34]
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I'll take the second question on the operating income. Don't just look at the percentages. I mean I know the percentage is high, but look at the absolute. We're talking about EUR20 million, EUR30 million or something a year. This is always other income, there's always a collection of various things. And this particular period we've got insurance claim payments. We've also got release of various accruals. But you'll see that going up and down quarter over quarter. So I don't think it has any significant figure. I definitely can't (inaudible) for the percentage for you, but I don't think it's significant.
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Herbert Hainer, adidas AG - CEO [35]
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We had some noise on the telephone. Can you shortly repeat the first question because we didn't understand it quite clear.
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Chiara Battistini, JPMorgan - Analyst [36]
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Sure, I was wondering given that in the second half of this year we are seeing a top line growing slower than in the first half. And in the first half of next year you will have very tough comps given events in 2012. I was wondering if the development of the 2013 top line will be more weighted towards the second half of the year so we should expect a slower growth in the first half and then a pickup in the second half or it will be more equally balanced?
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Herbert Hainer, adidas AG - CEO [37]
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Yes, obviously the comps in the first half next year will be tougher because of the events, but on the other hand, please have in mind that we have proven over the last, I think five, six years that we are quite capable in the so-called in-between years to push our product initiatives and therefore drive sales.
And as we have indicated already, we do believe we have a game changing innovation, which we'll bring up in spring next year on the running market and a lot of other initiatives. So you definitely will see us growing our business also in the first half next year.
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John-Paul O'Meara, adidas AG - Head of Group IR [38]
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So, ladies and gentlemen, that completes our call for today. Our next reporting date will be March 7, 2013 when we give out our full-year results. I'd like to also remind you for those who haven't already downloaded our app, we have a new investor relations media app available with lots of extra information to help you continue to follow all of the great things going on at the brand. And other than that, we wish you all a happy holiday period and look forward to talking to you in the New Year.
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