Full Year 2012 adidas AG Earnings Conference Call
Mar 07, 2013 AM CET
ADS.DE - adidas AG
Full Year 2012 adidas AG Earnings Conference Call
Mar 07, 2013 / 01:00PM GMT
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Corporate Participants
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* JP 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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* Michael Kuhn
Deutsche Bank - Analyst
* Matthias Eifert
MainFirst Bank - Analyst
* Jurgen Kolb
CAI Cheuvreux - Analyst
* Erwan Rambourg
HSBC - Analyst
* Andreas Inderst
Exane BNP Paribas - Analyst
* John Guy
Berenberg Bank - Analyst
* Andreas Riemann
Commerzbank - Analyst
* Bernd Muell
Landesbank Baden Wurttemberg - Analyst
* Louise Singlehurst
Morgan Stanley - 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 2012 full-year financial results (multiple speakers).
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JP O'Meara, adidas AG - Head of Group IR [2]
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Good afternoon, ladies and gentlemen, and welcome to our 2012 full-year financial results presentation. I am J.P. O'Meara and I head up the investor relations activities here at the adidas Group. During today's presentation Herbert Hainer, adidas Group CEO, and Robin Stalker, Group CFO, will reflect on the achievements of 2012, clarify the impacts from one-off items and discuss the Group's strategic and financial outlook for 2013.
To allow for ease of comparison there are a few things today to bear in mind during our discussion on the figures. Firstly, all sales and revenues related growth rates will be discussed on a currency neutral basis unless otherwise specified. And in addition, all comparisons will be based on the restated 2011 financial results and excluding impairment for 2012. Robin in his remarks will deal specifically with these issues.
So with that in mind let's begin and, as always, let's start with a refresher of the widespread presence and success of our brands and athletes over the past 12 months.
(Video in progress).
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Herbert Hainer, adidas AG - CEO [3]
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So, good afternoon, ladies and gentlemen, here in Herzogenaurach. Good morning to the people who are following us out of the US and the rest of the world. I am very proud to report that 2012 has been another successful year for our Group.
Our dedication to create the unexpected in our products and brands once again sparked consumer excitement all around the world. And this resulted in significant marketshare wins in many of our key categories and markets. And I look forward to sharing some of these great achievements with you this afternoon.
However, 2012 was also not without its challenges. But as you would expect, we have moved swiftly and aggressively to deal with them, meaning we have delivered on our targets for the year and are ready to drive for another year of new records again in 2013. So let me go into more detail.
In 2012 Group sales increased by 6% or 12% in euros to EUR14.9 billion. This means we added EUR1.6 billion in revenues during the year. Our focus on quality growth, which is a key component of our Route 2015 strategy, also ensured our bottom-line again grew significantly faster than the top-line.
The Group's operating margin improved 80 basis points to 8% and earnings per share grew by 29% to EUR3.78, also our highest result ever. Due to the strong operational performance, we finished 2012 with a net cash position of EUR448 million, a fivefold increase compared to a year ago. And this significant cash flow generation once again underpins the trajectory and the value we are unlocking with our Route 2015 strategic business plans.
In terms of growth, despite microeconomic headwinds sales increased in each and every region in 2012. In terms of highlights, without any doubt the standout performer was greater China. Sales for the year increased 15% to a new record level of over EUR1.5 billion with double-digit growth in every quarter.
For many players in our industry China was indeed a challenge in 2012. However, this was mainly due to the specific competitive issues and not because of any lack of interest in sporting goods on the part of the consumer.
You might ask yourself, what is our recipe for success? As part of a rising middle-class our consumer target group in China is maturing at a rapid pace, becoming increasingly discerning and sophisticated. Given the breadth and the depth of our product offering in performance and lifestyle, adidas fits perfectly to this consumer and, on top of our global appeal, we also infuse our brand messages and products with local flair and understanding.
Additionally, we have deepened our already very close relationship with our retail partners who now operate more than 7,500 point of sales across greater China. By ensuring that our business remains constantly in tune with theirs we are able to keep our product offering fresh at the point-of-sale. And this is a clear edge we are enjoying and will continue to enjoy.
Looking forward from our market research we can see that the adidas brand appeal has the most momentum in the Chinese market right now. As a result I'm very confident we will continue to take more marketshare and grow faster than any of our major competitors also in 2013.
Turning to another one of our strategic markets, sales in North America grew 2% in 2012 with brand adidas increasing 9% and TaylorMade-adidas Golf are up 25%. Excluding the impact from the NFL and the NHL license Reebok revenues declined 11% in North America while total group sales excluding the NFL increased by 6%.
Since we began Route 2015 adidas brand sales are up more than one-third, which is well ahead of market growth. In fact, when we look deeper into the adidas numbers our business with our key high school kit relative retail partners was up over 20% in 2012.
Through [originals] in basketball we have created a great place to build on and, quite frankly, when I look at our plans for running we are only just at the beginning of exploiting the tremendous opportunities this market has to offer for our Group.
Speaking of markets with opportunities, in Russia CIS revenues were up 17% in 2012 driven by outstanding comparable store sales growth of 8%. Both adidas and Reebok sales grew at double-digit rates with adidas up 16% and Reebok increasing 20%.
Equally as encouraging was our Group's resilient performance in Western Europe and other Asian markets. Revenues in our home territory were up 3% driven by double-digit growth in the UK and Poland as well as increases in Germany and in France.
In other Asian markets, despite our issues in India, sales in the region increased 7%. This was driven by double-digit growth in South Korea and a strong rebound in Japan where revenues increased 11% as we extended our considerable lead over competitors in that market.
And finally, in Latin America sales increased 8% for the full year driven by strong adidas brand performance where sales were up 13%. Double-digit increases in football and running as well as over 20% growth in owned retail were key to this development.
Turning to our brands, two of our Group's most important values are passion and performance, both of which were at the forefront of many of our 2012 brand and category achievements.
The obvious highlight from 2012 has to be the role adidas played at the year's major sporting events, which spurred adidas brand sales up 10% or 15% in euros to over EUR11.3 billion. In particular the London 2012 Olympic and Paralympic games will surely count amongst the most memorable and inspiring sporting events of our time.
The adidas brand as the official Sportswear partner of the event and of team GB played its role to perfection. It delivered its most comprehensive offering of high-performance products after and contributed significantly to the [emotional] event with the highly acclaimed Take the Stage campaign.
Similarly in Poland and Ukraine standout performances from our teams and players at the UEFA EURO 2012 was another catalyst which truly inspired consumers and fans around the world. They once again reconfirmed adidas as the number one football brand highlighting that our passion for innovation continues to set us apart from the competition.
Be it our iconic (inaudible), the official (inaudible) and Federation jerseys as well as our presence in UEFA champions league, we once again dominated the world's favorite sport achieving a new record level of sales of well above EUR1.7 billion, eclipsing even our own very high expectations.
However, our success was not just limited to the event-related categories. In fact, all other key other adidas categories, be it running, basketball or outdoor, grew at double-digit rates in 2012.
In running sales grew by 13% as the adizero and climber product franchisees continued to drive sales globally. adizero footwear sales increased more than 40% driven by another year of high visibility on the world's major marathon podiums.
On the court our basketball business also gathered pace with our sales growth rate doubling to 22% compared to 11% a year ago. And in particular our D Rose Crazy Light and NBA licensed product drove growth of almost 50% for the category in the strategically important mall-based channel in the US.
And finally, in outdoor sales increased 14% as we continue to make strides towards our Route 2015 goal of EUR500 million revenues. And this was driven again by the highly innovative range of Terrex footwear and apparel.
This passion for innovation leads me to another major highlight of our year, TaylorMade-adidas Golf. With sales up 48% to over EUR1.3 billion in just two years, our golf business has already rocketed past its initial Route 2015 targets and is now more than double the size of its neighbors down the road in Carlsbad. Considering that the golf industry is still relatively stagnant, this is a remarkable testament to TaylorMade-adidas Golf's relentless focus on helping golfers to perform better.
Turning now to Reebok, sales declined 18% in 2012 excluding the impact from the discontinuation of the NFL business and transfer of the NHL-related sales to Reebok CCM Hockey, sales declined by 8%. The brand's gross margin was essentially flat at 35.9%, but is not a bad performance given we had quite some promotional activity to move all toning products during the year.
While we are obviously disappointed with the Reebok results, we have seen the underlying business further stabilize as we accelerated our measures to position Reebok as the fitness brand. In fact, in the first quarter Reebok sales, excluding license revenues, were up 3% driven by 13% growth in classics and almost 40% growth in apparel.
As we announced last April, we discovered commercial irregularities at our Reebok business in India which brought to light a high level of criminal energy and collusion between former employees and external business partners. As promised we have followed up vigorously and swiftly on the matter through a thorough internal and external investigation also with police involvement.
In addition, we have also taken the opportunity to comprehensively review our internal control processes and procedures of governance and compliance with the necessary external expertise at all of our locations around the world.
Robin will take you through more specific details on the matter in his presentation in a few minutes. But let me reiterate quite clearly, noncompliance with our policies has never been and will never be tolerated within our organization.
And as unpleasant as the identified irregularities at Reebok India Company are, I am satisfied we have diligently completed our efforts to uncover all the wrongdoings by simultaneously laying the foundation for a healthy and profitable business for Reebok in India in the future. And here let me reiterate once again our full commitment to the Reebok brand in India.
So that, ladies and gentlemen, wraps up my review of the Group's operational performance in 2012. Despite the cosmetic of the accounting restatements and impairment in our reported figures today, I believe it is important to recognize just how successful our underlying growth and operational performance have been over the past 12 months.
In addition, we have also again demonstrated our ability and long-standing credentials at tackling external and internal challenges with speed and with determination.
Be it the full mitigation of the considerable sourcing cost pressures, the countless hours of vigorous effort to solve the commercial irregularities at Reebok India Company, or the discipline and restraint in managing our business in a persistently uncertain global economy, I am very proud of the passion and the dedication of our employees around the world to tackle these challenges.
And more importantly, all of this was achieved while continuing to stay diligent and focused on ensuring we remain fully on course to deliver our ambitious Route 2015 strategic goals. So I will be back in a few minutes to tell you about what is to come in 2013, but first Robin will take you through all the financials.
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Robin Stalker, adidas AG - CFO [4]
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So, thank you very much, Herbert, and a very good afternoon, ladies and gentlemen. So as you have just heard, 2012 was another successful year for our Group. From an operational perspective we again delivered a robust performance and I will highlight how this has played out throughout the financials of our Group. However, before I come to that, let me provide you with some more clarity on the one-off items contained in our financial results this morning.
As we announced in April 2012, we discovered commercial irregularities at our Reebok business in India which resulted in the termination of the services of the then managing director and chief operating officer. As Herbert said, we have followed up rigorously and swiftly on this matter.
Key findings from our internal investigations include -- inappropriate recognition of sales; a failure to book sales returns and a failure to correctly post credit notes to accounts receivable. This resulted in a significant overstatement of net sales and accounts receivable as well as materially incorrect accounting for inventories and provisions.
During the investigation process the new management also discovered four secret warehouses not disclosed in the official accounting record. The findings of the investigation suggest that the practice of inflating sales and profits had been going on for several years.
As a result of these findings we have restated our accounts in accordance with the IAS 8, which has led to a reduction of net income attributable to shareholders of EUR58 million for 2011 compared to what we had previously reported. In addition, shareholders' equity in the opening balance sheet for 2011 was negatively impacted by EUR153 million to account for the prior year period. Now for further information we have outlined the changes in detail in Note 3 of our 2012 annual report.
The second one-off topic is goodwill impairment. As you know, impairment losses are non-cash in nature and do not affect the adidas Group's financial situation. However, let me spend a few minutes explaining to you why we have done so.
Following our review of the medium-term growth prospects of specific markets and segments as part of our annual impairment test, and taking into account our updated targets for Route 2015 outlined at our investor field trip in September, we came to the conclusion that a few of our cash generating units need to be impaired. The resulting impairment of EUR265 million means we have reduced goodwill on our balance sheet by 17%. In the overall scheme of things the negative impact on total assets is minor at only 2%.
Looking at the specifics, within wholesale cash generating units goodwill impairment losses amounted to EUR106 million in North America, EUR41 million in Latin America, EUR15 million in Brazil and EUR11 million in Iberia. Now the impairment losses were mainly caused by adjusted growth assumptions for the Reebok brand, especially in North America, Latin America and Brazil, and an increase in the country specific discount rates as a result of the euro crisis.
Now in addition, goodwill of EUR68 million allocated to Reebok-CCM Hockey and EUR24 million allocated to Rockport was impaired. These impairment losses are the result of the reevaluation of future growth prospects and, with regard to Rockport, also due to an increase in the discount rate. Again here we have provided full transparency and clarity on this topic in Note 2 of our 2012 annual report.
But now with that, ladies and gentlemen, let me get into the financials. Without deflecting from our great top-line achievements I believe our margin development is again one of the major financial highlights.
The severe pricing pressure we faced in procuring our products from record high raw material costs and wage inflation in 2011 was a significant headwind in each quarter in 2012. In fact, the headwind after supply-chain mitigation amounted to 3.1 percentage points for the fourth quarter and 3.8 percentage points for the full year. Therefore, the 20 basis point improvement in gross margin to 47.7% highlights not only our best-in-class supply chain activities but, more importantly, the strength of our brands and product innovations to take price increases.
In terms of magnitude, the key offsetting factors were -- firstly, price increases, product and engineering efficiencies and a more favorable product mix; secondly, the over proportion of sales growth in our retail segment and emerging markets which carry higher margins; and thirdly, our hedging strategy yielded us a slight positive tailwind in 2012, however, let me point out now that this will reverse in 2013.
Moving on in terms of operating leverage, here we also delivered against one of our key Route 2015 objectives achieving a reduction in our other operating expenses as a percentage of sales of 50 basis points to 41.3%. Now although marketing investments grew 6% to EUR1.8 billion, marketing spend as a percentage of sales declined 60 basis points to 12.1% given the strong top-line development.
By brand adidas marketing investments grew 10% to EUR1.4 billion while spending at Reebok decreased 17% to EUR238 million. As a result 2012 operating profit was up 24% to almost EUR1.2 billion. This translates into an operating margin of 8%, exactly in line with our guidance. For the fourth quarter operating profit increased 49% to EUR26 million.
Turning now to the non-operating items of the P&L, net financial expenses decreased 17% for the full year. A decrease in interest expense of 9% as well as an increase in interest income of 16% were the main contributors to the decline. Negative exchange rate effects were similar compared to the prior year at around EUR7 million.
For the fourth quarter net financial expenses were up 40% as exchange rate variances had a significant influence during the quarter. Excluding these affects, which amounted to a swing of EUR9 million, net interest expenses declined 27% in the quarter.
The effective tax rate for the full year was 29.3%. And as a result of all that, net income attributable to shareholders increased 29% to EUR791 million. For the full year this translates into record earnings per share of EUR3.78, slightly better than the range we guided to in November of EUR3.68 to EUR3.75.
For the fourth quarter we reported a net loss attributed to shareholders of EUR7 million compared to a net income of EUR3 million last year, and this was due to higher income taxes in the quarter as a result of adjustments related to Reebok India.
Now let me spend a few minutes on our segmental performance starting with wholesale. Wholesale revenues grew 2% for the full year with sales increases in all regions except North America. In the fourth quarter Wholesale decreased 4% as growth in greater China, Latin America and other Asian markets was more than offset by declines in other regions.
This decline it was mainly due to the issues we already highlighted in November such as the non-recurrence of the NFL license sales and the prior year major sporting event-related product sell-in. For the full year the wholesale gross margin increased 0.4 percentage points to 40.3% as a result of a more favorable brand sales mix.
Moving over now to the retail segment, currency neutral sales grew 14% to EUR3.4 billion representing 23% of total Group sales for the year. This was driven by a robust comparable store sales growth of 7% which is impressive considering the already strong 14% comp store growth in the prior year. Both adidas and Reebok comp store sales increased 7% each.
In the fourth quarter comparable store sales increased 1%. In particular Russia CIS positively contributed to this development with comp store sales [amounting to 4%]. From a store format perspective concept stores, factory outlets and concession corners all delivered comp store sales increases in the mid-single-digits.
In addition, our sales per square meter continue to improve with store sales per square meter increasing 7% in 2012. Equally pleasing is the continuous improvement of our retail profitability as segment will operating margin improved 20 basis points to 21.5%.
Gross margin in the segment declined 1.7 percentage points during the year with 70 basis points of the decline related to the Russian ruble devaluation versus the US dollar, and the rest due to higher promotional activity given weak retail conditions in many markets particularly in Europe.
However, this was completely obsessed by 1.9 percentage points of operating leverage which drove retail profits for the period up 20% and that, ladies and gentlemen, underpins the great progress we're making on improving our retail operations.
Now the end of the year the retail segment operated 2,446 stores representing a net increase of 62 stores compared to December 2011. Our total selling space also grew versus the prior year and is now over 700,000 square meters.
Now moving on, revenues and other businesses grew 17% in 2012 with particular strength at TaylorMade-adidas Golf up 20%, as Herbert has already mentioned. Sales at Reebok-CCM Hockey and Rockport also grew, increasing 9% and 2% respectively.
For the fourth quarter other businesses grew 7%, mainly a result of the continued momentum at TaylorMade-adidas Golf where revenues grew 15%. This was driven by almost 60% growth in the ions category as a result of the RocketBladez launch.
Full-year gross margin in other businesses decreased 80 basis points to 42.8% driven by lower product margins at Reebok-CCM Hockey where increased sourcing costs as well as the NHL lockout negatively impacted gross margin development. However, due to scale effects segmental operating margin for other businesses increased 40 basis points to 27.4%.
Now moving over to the balance sheet where, ladies and gentlemen, I can again report on some impressive achievements. Despite the growth of our business in 2012 our ratio of operating working capital as a percentage of sales has reached a new record low year-end level of 20.0%, an improvement of 40 basis points compared to the prior year. This very strong performance is better than our original expectation of even a slight increase of this ratio.
At year-end inventories were up only 1% on a currency neutral basis reflecting the Group's strong focus on inventory management throughout 2012. Keeping our markets and channels clean and fresh has been a priority all year; this ensures our brands are well positioned for growth in the upcoming quarters.
Now in 2012 net cash flow generated from operating activities increased 17% to EUR942 million. After cash outflows for financing and investing activity, this allowed us to improve our net cash position by EUR358 million to EUR448 million. This once again demonstrates the strength of our business model and puts us in a superb position to support and invest in the opportunities and growth initiatives of our Route 2015 strategic business plan.
Now in terms of priorities for the use of cash, our capital deployment policies remain unchanged. We will continue to pay down gross borrowings as they mature, of which EUR280 million will be repaid in 2013. To further support Group-wide initiatives in areas such as own retail, infrastructure and IT in 2013 we will increase our capital expenditure to between EUR500 million and EUR550 million.
However, at the same time we reaffirm our commitment to advance direct shareholder returns and the annual dividend is currently our preferred tool for this. Therefore for 2012 we intend to pay a dividend per share of EUR1.35, which is 35% more than in 2011. This represents a payout ratio of 35.7%.
So in conclusion, ladies and gentlemen, in 2012 we have continued to execute in the right way, balancing our desire to grow with a high focus on the quality of that growth. We have again leveraged our scale and tackled our challenges with speed and with diligence. And with that let me now hand you back to Herbert to give you a glimpse into the strategic priorities to continue to drive success in 2013.
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Herbert Hainer, adidas AG - CEO [5]
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Thanks very much, Robin. In the two years since we began our Route 2015 we have achieved quite a lot. As we reported in September, in most cases we have even exceeded our expectations to date. We have delivered robust underlying growth in all of our key attack markets. We have driven double-digit growth in all of our key adidas categories. We have already achieved our targets for TaylorMade after just two years.
We have accelerated swiftly with our controlled space initiatives and already achieved our goal of 45% in 2012. We have held our gross margins essentially flat and increased operating margins while most of our competitors have not. We have grown earnings per share at a compound annual rate of 18% compared to our goal of an average of 15% per annum. And finally, we have generated EUR1.75 billion in cash flow from operations.
This, ladies and gentlemen, is a telltale sign of a group that knows where it is going and, believe me, despite the macro economic pressures, we will continue our trajectory in 2013 and for the remainder of our Route 2015 plan.
Our focus, as Robin has outlined, remains on driving quality and long-term sustainable growth for our brands. And this you will see again in 2013 through a product pipeline packed with game changing innovations, be it in running, be it in basketball, be it in football, in lifestyle or in fitness or golf.
And I say game changing because when you look at some of the examples I am going to share with you now, these are not just updates or tweaks, they are really revolutionary. Take running where all great footwear innovation starts.
In 2013 we're introducing two breakthrough innovations, one of which launched at retail last week, the Energy Boost. In only a few days Boost is already the talk of the trade, seeing higher levels of engagement and enthusiasm than any running product we have ever brought to market before. The sell-through is already outstanding with many of our own shops already sold out.
Why is Boost so special? Because together with our partner, BASF, the world's leading chemicals company, we have created a completely new foam cushioning material that we are convinced over time will obsolete the 20 [plus year] material veteran of our industry EVA foam.
With its distinctive and unique midsole cell structure, Boost provides more energy return than any other foam cushioning material, combining soft comfort with responsive energy for the ultimate running experience. In the heat, in the cold and after countless kilometers it performs more consistently and doesn't lose its cushioning properties like standard EVA foam. But to show you what it really can, let's take a look.
(Video in progress).
For those of you who are here in Herzogenaurach, you will get to try it live later and receive further insights from our adidas sports performance colleagues. Welcome, James and Eric.
Beyond running we also have lots in store in our other categories in 2013. In basketball we will continue to disrupt the market with great new innovations in footwear and apparel as well as by leveraging new assets like John Wall or Ricky Rubio.
During the summer you will already start to see the next great innovation in football as we commence our preparations for the 2014 FIFO World Cup with the Confederations Cup set to ignite football fever in Latin America.
We will also race again in icon building and brand activation. This year we will build core signature collections around several of our superstars including four time Ballon d'Or winner and record-breaking goal scorer Lionel Messi. This week we launched team Messi, a major digital initiative which you will hear more about as we go through the year.
And in terms of digital innovation in general, we will be partnering with Google on an exciting project which will show how creativity and technology can work together to provide consumers with new and innovative ways to engage with our brand.
And we have other major campaigns planned for adidas as well to drive deeper consumer connection, such as a new impactful women's campaign which is called My Girls, and a global originals campaign, Unite All Original. With Originals and Sports Style here we will also see a new milestone in 2013.
In 2012 we broke the EUR3 billion revenue mark for the first time and Sports Style sales increasing 16% or 21% in euro terms to over EUR3.2 billion. Given the growth that we expect from adidas Originals and the adidas NEO label in 2013, this means our adidas Sports Style division on its own will surpass the third-largest player in the sporting goods industry in terms of size this year.
So let me move over to Reebok. As we have now stabilized the business to ensure we drive growth, we will commence a major brand category offensive in fitness in 2013. Our new category approach, which we call the House of Fitness, allows Reebok to engage with consumers regardless of how they choose to stay fit with focuses on five key areas -- fitness training; fitness running; studio activities including yoga, dance and aerobics; walking; as well as classics.
And the positive news when I look back at 2012 these categories, which now represent almost 90% of Reebok's business, grew low-single-digits with fitness training up 30% and classics up 6%. To accelerate this momentum several new footwear and apparel collections will be launched throughout the year.
In running we will introduce three new platforms including (inaudible) and ATV. And in fitness training Reebok will introduce the Reebok Delta apparel collection which takes design inspirations from the cross fit community.
In addition to new products we will activate new exciting partnerships to authenticate and give credibility to Reebok in each category. Renowned yoga instructor, Tara Stiles, the Spartan [race series] of obstacle races and the Red Bull X-Alps adventure race are just a taste of what is to come over the next couple of years.
Bringing it altogether in 2013 the Reebok brand will also speak to the consumer with one voice by launching a new global marketing campaign. The campaign which is called [Lit with] Fire will be the brand's first concerted effort to inspire the fitness consumer to live a life of passion, intent and purpose.
And everything I see so far confirms we are gaining traction for Reebok with retailers and consumers and I fully expect a return to growth for Reebok once we have anniversaried the last of the NFL-related comparisons in the first quarter.
At TaylorMade-adidas Golf our fast-pace of new launches will also continue. The new RocketBladez Irons have already sent our marketshare skywards to over 30% since launch. With new longer metal woods like the R1 and the RocketBallz Stage 2, a major offensive and golf footwear with adizero and the potential for (inaudible) I fully expect the distance between ourselves and our nearest rival to further widen in 2013.
As a group we are therefore very well-positioned to again achieve record sales in 2013. For full-year we expect currency neutral sales to increase at a mid-single-digit rate with growth across all brands, regions and channels.
In terms of phasing, sales growth is expected to be weighted towards the second half of the year, mainly mirroring our product launch schedule, as well as a build up to the FIFA World Cup in 2014.
2013 will also see a step change in the pace of gross margin and operating margin expansion. We expect our gross margin to increase to a level between 48% and 48.5%. Our operating margin will improve considerably in line with our previously announced guidance of approaching 9%. And this in turn will lead to another year of double-digit earnings growth with earnings per share increasing at a rate of 12% to 16% to a level between EUR4.25 and EUR4.40.
So in summary, ladies, it is certainly not by chance that I started my presentation today with the motto, pushing boundaries. Alone from our extraordinary product innovations and great designs, our Group's ability to push boundaries has helped athletes to go faster, hit further and achieve the impossible at the pinnacle of sports for decades.
However, pushing boundaries at our Group definitely goes far beyond this definition. It lives in every aspect of our business. Every day we collectively strive to bring a culture of pushing boundaries to life by constantly motivating and challenging each other to improve.
(Inaudible) is often quoted as saying, strive for perfection; there is always something you can improve. And this is exactly the spirit you will see from our Group over the next 12 months. And this is the edge that will ensure our Group's continued success along Route 2015.
So thank you very much for your attention and now Robin and myself will be happy to answer all your questions.
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Questions and Answers
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JP O'Meara, adidas AG - Head of Group IR [1]
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Thank you, Herbert. For those on the telephone that you may now start registering your questions by pushing star 1 on your touch tone phone. I will give you a few seconds to start registering your calls.
Just want to announce one other thing today -- we have today launched our iPhone app as well as for investor relations, so now it's not just the iPad anymore, we are fully on board. And so, I would like to take the first three sets of questions here in the room so who would like to ask the first question?
So, just come over here, Michael Kuhn. And if you could announce the name of your firm and your own name for your first set of questions. That would also help us out, thanks.
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Michael Kuhn, Deutsche Bank - Analyst [2]
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Michael Kuhn from Deutsche Bank. A few questions from my side. Firstly, on Q4 and some of the effects mentioned, is the 200 basis points gross margin improvement a clean development or are they any special factors that you should consider?
And on like for like and OpEx in Q4 you saw plus 1% in like for like sales and retail like you mentioned NFL and the tough comps. So what would be like a clean number? Could you help us here?
And OpEx on the other hand, up quite substantially. Were there any special effects or what should we expect in terms of OpEx dynamics going forward?
And secondly, you mentioned your CapEx plans of EUR500 million to EUR550 million for the upcoming year, which is quite a considerable increase. Is there any special project included in that or is it just investments on a broad scale? Thank you.
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Robin Stalker, adidas AG - CFO [3]
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Okay, thanks very much, Michael. You know, our fourth quarter is always a little bit difficult to extrapolate because it is a fairly small quarter compared to the other quarters obviously. So no, you can't extrapolate the gross margin unfortunately, 200 basis points is very nice. But there is nothing really significant in one-offs in there.
There is about a 40 basis point impact from the Reebok India and there is a few million, single-digit million impact in the cost source because of that. But, Michael, I think here at the best guidance is to look at what we are saying for 2013. And if we have a pretty good window of margin of 48% to 48.5% and we have also given clear guidance on our operating margin now going up again to approaching the 9 percentage points. So it is at 9.0%.
Second point was about CapEx. It tends to be in our CapEx about a third to retail, a third to some of the infrastructure and a third to the IT. You've seen here -- as you came to [Herzogenaurach] you have seen a few buildings up outside there. We have also got a major warehouse initiative in Northern Germany also (inaudible) in 2013. But there is nothing particular that I would highlight that is different than what we have had in the past.
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Unidentified Audience Member [4]
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(Inaudible - microphone inaccessible)?
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Robin Stalker, adidas AG - CFO [5]
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Well, we're not a very big CapEx company actually. I mean EUR500 million for our sort of size of business I don't believe is very large. And I think our cash flow allows us to keep it at this sort of level. We are definitely not planning on anything significantly different in the future. So I would say that is a good reasonable guidance for the next couple of years.
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JP O'Meara, adidas AG - Head of Group IR [6]
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So let's come here to Mathias and then Juergen.
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Matthias Eifert, MainFirst Bank - Analyst [7]
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Matthias Eifert from MainFirst. First question, do you have -- you said China as an overall market is not that bad, but if I look into what -- how bad competitors are doing I think you have some difficulties. Can you give us some of your insights when you think these difficulties are worked through and then we might be even seeing an acceleration from your side? But I would be happy if you maintained a double-digit growth.
And second question would be you mentioned a second innovation on running this year. Is it another product, that platform similar to Boost or extension of some of the existing ones?
And my third question would be about basketball. Is there any other player showing potential to launch a signature shoe besides (inaudible). I think [injury] of him has also shown that you probably need to broaden the basis of players, not to be too dependent on one guy. Can you give us a bit more insight on that, please?
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Herbert Hainer, adidas AG - CEO [8]
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Yes, thank you very much, Mathias. Let me start with China. As most of you follow us already quite some time, you might remember that in 2009 when after the Olympics in Beijing we ran into problems in the Chinese market, we had a lot of over inventory. I told you already at that time that we will use this opportunity to clean up the market and to build our relationship with the Chinese consumer and the retailer on a complete new platform.
We invested into our retail partners, we put infrastructure in that we could exchange data much faster, which I also told you because then we can read the sell-throughs, we can refill the product, we can steer our inventory much better. And today I think it is safe to say when you ask the key retailers in China, we have the best sell-through rates, therefore they achieve the best margin with our product and they have the lowest inventory.
Of course we have done a lot of marketing activities to stimulate the consumer, as I have said and my presentation. And I definitely do believe that we are doing a better job than many others in the Chinese market in the moment. And you will definitely see continued growth from us in the years ahead, there is no doubt.
Second point was the second innovation in footwear. This is an exciting product which is called SpringBlade and, as you have marketing gurus, especially Eric Liedtke who is running our sports performance division on the adidas side later with you on the Boost side, he definitely can explain to you what SpringBlade is. But it is a complete new technology on the footwear side as well.
And last question was basketball. Yes, you are right. We will further broaden our base with players. It is not only about players but also with players. And as I have said, we have (inaudible) from Reebok to adidas, we have Ricky Rubio onboard and we are still looking for some more players which we bring on board. Obviously we want to have the best one, the young rookies, the stars, this is not as easy, but we definitely strengthen our portfolio.
Don't forget we strengthened our relationship with the NBA into the basketball game with key retailers in the US for basketball. And last but not least, we are bringing out permanently new product as you have seen with the adizero Crazy Lite the D Rose, even he didn't play now for I think it is eight to nine months, we activated him permanently and you have seen the numbers on basketball for 2012.
I mean there is no doubt we need to basketball to be successful for our success in the US and this is what we will further drive. Be not surprised if we will have positive numbers next year again.
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Matthias Eifert, MainFirst Bank - Analyst [9]
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I hope.
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Herbert Hainer, adidas AG - CEO [10]
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I am sure. So, Juergen.
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Jurgen Kolb, CAI Cheuvreux - Analyst [11]
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Jurgen Kolb, Cheuvreux. Three questions, first on Reebok the [Vulcabras] situation in Latin America is that -- or can you update us on that situation? Is there anything negative that might pop up in this year or next year? Maybe an update here.
Secondly, what is your expectation in terms of FX in terms of currency? Because obviously some currencies are playing a little bit of a hiccup here. So what is your expectation there and how much can you control that?
Thirdly, on Boost again, Energy Boost, maybe a little bit of your additional plans in terms of rollout, when will it come to a broader retail format? Your expectations and hopes for additional categories maybe? And also, as the product is probably not yet fully available, the TPU, in terms of profitability is that shoe more attractive for you? I mean the retail price is significantly higher. But is that something where you can also squeeze in some extra 10, 20, 50 basis points?
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Herbert Hainer, adidas AG - CEO [12]
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So, let me start with the first one with Vulcabras. Yes, you know that we have our joint venture partner in Brazil and in Argentina. And this is not always an easy relationship because Vulcabras has definitely some challenges with their own brands and with their own business on the market. Nevertheless we try to work as good as we can.
We are quite successful in Argentina; Brazil is more under pressure. In addition to that, our contract is running out in 2015. So we have a few challenges, but I don't expect any big negative impact in 2013.
Let me just answer the third as well before Robin goes to the FX question. Boost in terms of availability, don't worry, we have a few pairs out for you guys. But don't underestimate it. We want to sell around 1 million pairs of Boost this year. And obviously we have started it in our own stores, as I said. And the rollout will be during the whole year.
And our plan is over the next couple of years to bring Boost, more or less the Boost technology in all of our shoes. It will not be the running category, it will be basketball, it will be training and you will see this category because this is such an advantage to that what is existing on the market. We would be stupid not to further roll it out into other (inaudible) categories as well.
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Robin Stalker, adidas AG - CFO [13]
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Very good question, Jurgen, in terms of currency. I mean this is the world we live in, there's considerable movement in the currency [pairs]. We report in euros obviously and we had some tailwind in 2012 through the appreciation of the euro against some of our trading currencies. But in 2013 I think it may be going a little bit the other way.
The biggest call out here is obviously the Japanese yen, there's been significant pressure on that. But I think at this stage it is a bit early to suggest exactly what the developments are going to be. We keep an eye on it obviously. There is little we can do about the translations where our business is.
In terms of, however, the dollar/euro, we continue to hedge that in terms of our purchasing. And here we have got a hedge rate at the moment for 2013 where we are pretty much fully hedged, which is just above the [132], which is inferior to what we had obviously in 2012 which was [137] to [138]. So that will give us a little bit of a headwind also, but that is obviously in our guidance reflected.
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Herbert Hainer, adidas AG - CEO [14]
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So Juergen, just to remind, I didn't answer the question on the margin of Boost. You know, we are here to make profit and to get to our 9% operating margin we have to earn money with every shoe. So next we will take two sets of questions from the telephone, please.
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Operator [15]
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(Operator Instructions). Erwan Rambourg, HSBC.
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Erwan Rambourg, HSBC - Analyst [16]
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A few questions if I may. Herbert, I think you mentioned to the press that you were expecting TaylorMade to have single-digit growth in 2013. I am just wondering if this is down to the fact that the basis of comparison in terms of growth is tough or if the market overall for golf had toughened?
And related to that, given all the moving parts on Reebok last year and the good performance of adidas, if you had to rank in your view brands in the portfolio for this year in terms of growth, could you give us a sense of what that ranking would be?
Secondly, I was just wondering if you could help us understand when the end of the US pain will happen; i.e. when the sort of one-offs on Reebok will stop weighing. I believe this might be Q2, but I just want to guess -- I just want you to confirm when growth rates will normalize in the US.
And then thirdly, I think you mentioned also to the press that you didn't have in mind any acquisitions in the near future. So I was wondering if we could expect in the future, again all things being equal, the dividend payout to increase. It's already at the sort of high end of your range of 20% to 40%. Can it go beyond that? Thank you.
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Herbert Hainer, adidas AG - CEO [17]
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So let me start with your first question, (inaudible), yes, the single-digit growth is definitely a reflection of the fast growth which we had over the last several years. And as I also said in my presentation, we definitely want to make sure that we have a quality growth. So we don't want to overheat the market, but we definitely do believe with all the new products which we are bringing in we will further grow in top-line and of course driving our profit within (inaudible) to a higher level.
The second one was the ranking of the brands in terms of growth perspective. We want to grow with all the three brands and this year is easy calculating when we're growing with (inaudible) single-digit. And overall we said that we want to grow mid-single-digit. Obviously then the adidas brand has to grow as well because it is the biggest part. But we also have made a commitment that we want to grow the Reebok business in 2013. So you will definitely see all the three brands are growing in 2013.
And then there was a question on acquisition. No, we don't have any plans for acquisition because I definitely do believe that we have still enough work to do with our Reebok brand. And we also do believe that we have enough potential with all our three brands, (inaudible) to further grow to the level what we have given out for our Route 2015 plan.
And as Robin has said already in his presentation, we want to give the money back to the shareholders and within our guidance of 20% to 40%. We are now at 35.7% and this is definitely what we want to continue to give some money back. I think there was --
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Erwan Rambourg, HSBC - Analyst [18]
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Thank you, I just had this question on normalization of growth rates in the US.
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Herbert Hainer, adidas AG - CEO [19]
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Yes, yes, we know, we know. But I just hand over to my dear finance colleague. He is definitely better suited to answer that.
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Robin Stalker, adidas AG - CFO [20]
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Okay, and I think you were asking about the normalization of the Reebok business in America and that's basically because of the NFL contract. On that you will still see some impact on the first quarter. So your assumption is correct that from the second quarter on it should be normalized.
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Erwan Rambourg, HSBC - Analyst [21]
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Thank you very much, thanks.
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Operator [22]
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Andreas Inderst, Exane BNP Paribas.
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Andreas Inderst, Exane BNP Paribas - Analyst [23]
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I have three questions. The first one on Reebok India. After the third quarter you have guided up to EUR70 million one-offs to clean up the market. And I just want to calculate a real clean EBIT margin for full year 2012. Maybe you can help. How much did you spend overall? Was it more than EUR70 million given that you had also -- or that you cut roughly 2% the workforce at Reebok? And that is my first question.
Second question relates to your working capital, nice improvements on the inventory side. Robin, what can we expect going forward from inventory management? What kind of potential do you see to further improve your turns? And maybe you can quantify the impact maybe for the midterm.
And my third question relates to the lifestyle segment, very nice development in the fourth quarter and also the full year. I believe you guide high-single-digit/low-double-digits for 2013.
And on adidas NEO, how is it going here? You have already introduced the collection broadly to the market in emerging markets and North America. How is the store rollout or the test stores going in Germany and what can we expect in terms of roll out in Continental Europe? Thank you.
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Robin Stalker, adidas AG - CFO [24]
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Okay, Andreas, I will take the first two questions and then Herbert will answer the third one. So I know you would love to get it as clean as possible and I can repeat the Reebok India impact in 2012 is about that EUR70 million, it's almost exactly on the EUR70 million. We were just a little bit under that by the third quarter. There was limited impact in the fourth quarter.
But let me make it clear that this 70 million is the difference between what our initial expectations were for the business for the contribution in 2012 in India. And then what actually happened because of our, as you correctly said, clean up efforts in India, we've closed franchisee shops, I think we've closed about 400 shops, we have paid our minimum guarantees. But we have also had obviously a loss of sales and margin from that period. So that was a mixture of many things that clearly impacted our profit and loss in 2012.
In terms of the second question, working capital. Now I guided last year that our operating working capital as a percentage of sales was probably likely to slightly deteriorate or increase in 2012 where we were actually able to do better. I guide again with a little bit of caution that it is getting very difficult to further improve this because as we grow our retail business we do carry inventory a little bit longer obviously.
And so, I am optimistic that we will continue to manage our working capital extremely diligently. But I think at the level of working capital as it is at the moment, 20.0%, that is a pretty good level to just try and maintain.
What I would say however is in the inventory specifically, and we talked about stock turns, although we will carry more inventory, I think there is some opportunity in improving our stock turns particularly when I look at some of our large retailer operations, and here I am referring specifically to Russia.
There are opportunities in our supply chain to further improve the speed of delivery to market, shorten the lead times, presumably keep less inventory on hand. So I am not giving up on it. I think there are still opportunities to improve, but I think I can't promise too much on this area over the next year.
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Herbert Hainer, adidas AG - CEO [25]
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In answering your third question, Andreas, on NEO, obviously we are quite happy with the performance of NEO. As you have seen, 14% growth in 2012, and especially because we are targeting a new consumer group, as you know. So therefore we are quite happy. This is mainly driven by China and by Russia.
But also you asked about the 10 test stores in Germany which we all have opened since summer last year. And we said we will do a test phase of around 12 months. This will end in summer this year, then we will fully review our analysis and all what we have seen and defined the next steps.
I can tell you that overall we are very pleased with the learnings and the performance of the 10 test stores. And it definitely wouldn't be a surprise if we decide to further roll out NEO stores in Europe starting in the second half of 2012.
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Andreas Inderst, Exane BNP Paribas - Analyst [26]
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Okay, maybe coming back to India, the EUR70 million, let's ask the question differently. Because you said it is a difference between initial expectations and what in the end came out. How much of the EUR70 million will you recoup let's say in 2013 and 2014?
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Robin Stalker, adidas AG - CFO [27]
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I knew you would be looking at that. So the thing is it is difficult to say exactly how much that would be. What I obviously will not be repeating in 2013 are the closure of franchisee cost and the restructuring that we did. And we will get some sales back, so some of that EUr70 million presumably will come back.
I don't believe, however, it will be a tremendous amount because the sales volume or the sales expectations that we have for Reebok India 2013 are still a lot lower than what our initial expectations were for Reebok India 2012. So you get a little bit of that EUR70 million back definitely, but not all of it.
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Herbert Hainer, adidas AG - CEO [28]
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Thanks, Andreas, let's move back to the room and, John, you are up next.
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John Guy, Berenberg Bank - Analyst [29]
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Thanks very much, it's John Guy from Berenberg. Just a few questions, please. The first one with regards to the stock up 1% on an FX neutral basis. When you are looking at that well-managed stock are there any specific areas where you think the stock is maybe slightly too high or is that evenly balanced across all the regions? First question.
A second question with regards to not acquisitions but disposals. Is there any comment you can give around potential progress around the disposal of the Reebok Hockey business? I think that you had a few interested parties and was just wondering if there is any update there? Thank you.
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Robin Stalker, adidas AG - CFO [30]
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Okay, I will take the first question. So no, the very good thing about the development of our inventories over the last several quarters now is that it really is across the board. We have been able to install good discipline throughout all of our operating units to keep a focus on it. We are obviously doing a tremendous amount also in the supply chain to become even more efficient in what is already a good supply chain. And so, it is not just one particular area.
I think the area where I would identify some potential improvements, what I just answered in the previous question about those major retail operations where we have rather long supply chains at the moment. And that would be -- Russia would be the key one there.
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Herbert Hainer, adidas AG - CEO [31]
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Yes, (inaudible), you are right, we are always getting interest for part of our business and we definitely had some interested parties looking to our hockey business and we spoke to them. But we haven't got from anyone an offer where we saw this is satisfying to our needs.
And you know that we have quite a lot of innovations that we are bringing to the hockey business be it the RBC sticks which would take over from TaylorMade into the hockey business which is the most sold stick yet.
Maybe the NHL lockout hasn't helped there as well, but we are not under pressure. Therefore we decided no, we stopped the sales process. We will continue to drive our business, make it more profitable and growing and this is the status at the moment. You're welcome.
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JP O'Meara, adidas AG - Head of Group IR [32]
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So, Andreas, next.
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Andreas Riemann, Commerzbank - Analyst [33]
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Hello, Andreas Riemann, Commerzbank. Two questions from my side. In 2014 there will be the next soccer World Cup in Brazil. And the question is are you planning to use as you begin to focus more on Latin America because this is not one of your core regions actually?
And a second one on retail, you closed 260 stores and the question is, how many of the closures are basically opening next door or what are real closures? And given that you are becoming a bigger retailer probably you can collect more data points. Is this number going to come down in the future?
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Herbert Hainer, adidas AG - CEO [34]
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So, in terms of football, obviously this is a big event for us as we are the football brand number one in the world. And as we are the sponsors of the football World Cup and we will have a lot of teams here. Obviously the qualification is not finished yet, but when you just think about Mexico, Argentina out of the Latin America area, Paraguay and so on and so forth. So yes, this will be a big event for us and we will use it to further drive our business in Latin America.
And then you said Latin America is not a core area for us. But Latin America is definitely the area where we grew the fastest in the last 10 years. And this business is relevant for us; there we have a very good market position in most of the countries. And therefore we definitely will use the World Cup in 2014 starting even with the Considerations Cup this year to show to the consumer what we are all about.
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Robin Stalker, adidas AG - CFO [35]
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Andreas, yes you are picking up that we are becoming a much more sophisticated retailer. We are learning a lot obviously about retail. And one of these learnings is that you do need to close stores obviously as soon as you identify they are probably potentially not as profitable as you thought they would be.
And so there may be a number particularly in some of the emerging markets where there has been a larger shop opened in close proximity. But my understanding is that you should expect a continuation of a fine tuning of our platform, we have over 2,400 stores at the moment and closing a couple hundred and opening a couple of them will continue to be part of our management of our retail footprint.
And we're definitely getting more data plans, we're definitely understanding more about where it's appropriate to invest. And we have also a very sophisticated view together with our wholesale guys about our integrated distribution plan for all of our major markets and major cities as to where we want to be in retail or where we want to be in franchising or where we want to be with direct wholesale business.
And so, that is getting more and more sophisticated. But you should continue to expect us to continue -- to be closing stores in the future as well.
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JP O'Meara, adidas AG - Head of Group IR [36]
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Bernd, please.
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Bernd Muell, Landesbank Baden Wurttemberg - Analyst [37]
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Thanks, Bernd Muell, LBBW. Just a question on the gross margin once again. I mean you are guiding for another increase this year and we have briefly talked about the input cost. How do you see things in both? I guess the pressure on labor cost will continue seeing Cambodian workers rejecting pay hikes of 18% recently. So I guess the pressure is on here.
How do you seen material prices evolves in 2013? And do you see, I mean you are guiding for an increase so do you feel that your countermeasures, i.e., accelerated growth in retail and all the other factors that you have explained to us recently, do you see that going strong in 2013 too? Perhaps you can just enlighten us a little bit more on that.
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Robin Stalker, adidas AG - CFO [38]
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So, fundamentally I think we believe in our inventory that we will continue over the next few years to see FOB -- increased pressures on our FOB. I mean the fundamentals both in wages but also raw materials are such that it is likely that rubber or other oil-based derivatives are going to continue to be at this high cost level or maybe even get more expensive. Definitely as you commented yourself on the wages that's clearly the case.
However, for 2013 we don't see through the negotiations with (inaudible) or the visibility we already have for 2013 significant increase in the raw materials. We do see continued pressure on wages. But we are confident that not just through the efforts that we made to continue to be even better in our supply chain, but also through the dynamics of our business and product mix.
As you highlighted, retail growing faster, emerging markets also with higher margins -- that that will overcompensate for whatever those pressures are. But I don't think we can see them going anyway.
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Herbert Hainer, adidas AG - CEO [39]
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Maybe I can add one more point. As we have told you already 18 months ago, we also are looking at all our products, how we can re-engineer them and put more value with lower cost into the business, just the [knitted] footwear piece is one of the initiatives, but we have a lot of others. And they all have helped already in 2012 despite the high cost pressure which we had from the FOB side to keep our margin.
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JP O'Meara, adidas AG - Head of Group IR [40]
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So, operator, we will take our last question today from the telephone, please.
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Operator [41]
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Louise Singlehurst, Morgan Stanley.
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Louise Singlehurst, Morgan Stanley - Analyst [42]
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Two questions for me, please. Just firstly focus on the US market, there's clearly a huge amount of market share for adidas Group when we look at some of the shared data in that market. Can you just talk about the discussions with wholesalers? Are you taking more floor space within those stores?
And when we think about the new launches, i.e. Boost this year, is that incremental or does it start to replace something like the lightweight running that seems to be waning in terms of popularity?
And then my second question it slightly related to that, just thinking about the advertising spend. I was impressed to see that advertising as a percentage of sales slightly came down in 2012. Should we expect that to be ramped up particularly in the US over the next couple of years as you take market share? Thank you.
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Herbert Hainer, adidas AG - CEO [43]
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Let me answer the first question in terms of market share growth in the US and floor space. I mean the one goes with the other in my opinion. When you have seen what we have done the last two years in the US market where we have grown more or less every year double-digit, 9% last year. This means that we are winning shelf space and we are winning the minds and the hearts of the consumer, especially of the high school kids. And this will further help us to drive our sales.
Yes, we are doing more shop-in-shop solutions which -- with key customers in the US especially, in the mall and in the sporting goods channel where we find our high school kids consumer. And this you will see in the future that we will have a stronger presence in the stores through the different categories. And this obviously will help us to get better sales and therefore also better market shares.
In terms of advertising or marketing spend in the US, we definitely do believe that we have found the right formula to spend what is necessary to drive our sales in a qualitative way in the US, which means on the one hand that we drive our sales and build further our business. But we also want to drive our margin in the US and this you see year-by-year getting better. And once again it all comes back to that what we said in the presentation, we went to have quality growth, not just volume.
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JP O'Meara, adidas AG - Head of Group IR [44]
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So, ladies and gentlemen, that completes our conference call for today. Thank you for those who joined on the line, you may now disconnect. And if you get us guys in the room a few seconds to reset, we will start at 3.30 with our adidas performance presentation on [earning]. Our next days will be made free for our Q1 results and thank you very much for coming to Herzogenaurach in person today, we really appreciate that.
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Operator [45]
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That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.
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