The Adidas-Ye divorce is going to cost the German athleticwear company half of its projected 2022 profit.
In reporting third-quarter earnings, Adidas cut its full-year net income expectations from preliminary projections made just one month ago. It now forecasts 250 million euros ($250.8 million), down from a target of around 500 million euros ($501.6 million).
Adidas also expects currency-neutral revenues for the full year to grow at a low-single-digit rate in 2022, down from the mid-single-digit rate it had anticipated last month.
For the third quarter, Adidas’ currency-neutral revenues increased 4 percent, with reported revenue jumping 11 percent to 6.41 billion euros ($6.43 billion) from 5.75 billion euros ($5.77 billion) in the 2021 period.
Net income from continuing operations came in at 66 million euros ($66.2 million), plummeting from 479 million euros ($480.2 million) a year ago, thanks in large part to several one-off costs totaling almost 300 million euros ($300.7 million)—nearly half of which is related to the company’s exit from Russia after it invaded Ukraine.
In a Nutshell: Adidas’ public split with the Ye, the artist formerly known as Kanye West, has been a significant bump in the road leading to more questions than answers about the sportswear company’s future. The company is looking to start fresh in 2023, poaching Puma CEO Bjørn Gulden as its new CEO effective Jan. 1 to replace the outgoing Kasper Rørsted.
But Adidas will have to maneuver through the holiday season before looking ahead to the new year.
In an analyst call, chief financial officer and soon-to-be interim CEO Harm Ohlmeyer did not confirm what Adidas plans to do with all of the unsold Yeezy merchandise that’s piled up after it terminated the partnership, only acknowledging that the Nike rival has multiple options, and will have a more concrete answer “when the time is right.”
“We need to take our time to review what are the best options, and there are several options that we’re working through,” Ohlmeyer said. “It’s a dedicated team working on this, but rest assured we have pulled back the remaining net sales in November and December.”
Ohlmeyer said that Adidas has enough inventory currently planned for 2023 that would be able to compensate for a shortfall in sales resulting from the Yeezy termination, if necessary. Adidas also expects to save roughly 300 million euros ($301.5 million) in royalty payments and marketing fees by discontinuing its relationship with Ye.
Rebranding some Yeezy shoes is not out of the question either. Although he did not explicitly confirm that Adidas would rerelease Yeezy shoes under its own branding, Ohlmeyer noted that the athleticwear giant still owns all the intellectual property rights to the shoe designs and colorways.
“It’s our IP, it’s our product. We do not own the Yeezy name, so we believe interesting plans are coming to fruition in 2023 and that’s what we’re working to,” Ohlmeyer said.
Inventories increased 72 percent to 6.32 billion euros ($6.35 billion) as of Sept. 30, up from 3.66 billion euros ($3.69 billion) in the year-ago date. On a currency-neutral basis, inventories were up 63 percent versus the prior year.
The heightened inventory reflects slower consumer demand in major Western markets since the beginning of September, but most of the increase was driven by higher product and freight costs, a different order pattern as a result of longer lead times within the company’s supply chain as well as lower prior year comparables due to last year’s impact from the factory lockdowns in Vietnam.
Ohlmeyer delivered some good news by saying that inventory has peaked, and is expected to decline going forward including “meaningful inventory reduction” by the end of the 2023 first quarter. Inventory should return to normal levels by the second quarter.
It plans to accomplish this largely in North America and Europe by using aggressive discounts to clear excess inventory, cut overall buying volume for the spring/summer 2023 season, trim planned purchases for more than 1,000 factory outlets to give the stores more shelf space, and repurpose existing and evergreen and carryover products.
“[In Europe,] we are now only operating with around 10 percent planned buys for affected outlets compared to around 50 percent in a normalized environment,” Ohlmeyer said. “We have reduced our overall buying volume for spring/summer 2023 already significantly compared to the fall/winter 2022 season.”
Adidas has already implemented inventory takebacks in China to clear excess inventory in the market throughout the year amid slumping sales in the region. In the third quarter alone, Adidas shifted 200 million euros ($201.2-million) in goods from its retail partners to its own factory outlets to fulfill demand in the country.
Third-quarter gross margin declined by 100 basis points (1 percentage point) to 49.1 percent from 50.1 percent in the year-ago period, with higher discounting, higher product costs and freight expenses offsetting the broad-based price increases and favorable currency effects.
Adidas’ gross margin is now expected to be around 47 percent in 2022, with forecasts for operating margin to be roughly 2.5 percent.
As part of its turnaround attempt, Adidas established a “business improvement program” designed to stabilize profitability in 2023. Several initiatives aim to mitigate cost increases resulting from the inflationary pressure across the company’s value chain as well as unfavorable currency movements.
In total, the program, which will result in one-off costs of roughly 50 million euros ($50.1 million) in the fourth quarter, is expected to compensate cost headwinds of up to 500 million euros ($501.2 million) in 2023. In addition, it is expected to deliver a positive profit contribution of around 200 million euros ($200.5 million) next year.
Net Sales: Adidas saw third-quarter revenue jump 11 percent to 6.41 billion euros ($6.43 billion) from 5.75 billion euros ($5.77 billion) in the 2021 period. Currency-neutral revenues increased 4 percent.
From a regional perspective, revenue growth was driven by the company’s Western markets and APAC, which combined continued to grow at a 12 percent rate. Revenues in North America increased 8 percent during the quarter, driven by a double-digit increase in the company’s DTC channel
Even when accounting for the Russia/CIS exit, which cost more than 100 million euros ($100.4 million) in revenue in the quarter, EMEA revenue grew 7 percent. Revenue growth in APAC and Latin America, reached 15 percent and 51 percent respectively, year over year.
In contrast, the company’s top-line development in Greater China continues to be severely impacted by the ongoing zero-Covid restrictions and the 200-million-euro ($201.2-million) in inventory takebacks. While Adidas’ own retail revenues in the market increased 7 percent in the third quarter, the takebacks resulted in a total revenue decline of 27 percent in China during the three-month period.
By channel, DTC saw currency-neutral sales grew 6 percent year-on-year. Excluding Russia/CIS, revenues in the company’s own distribution channels were up at a double-digit rate.
Within DTC, the company’s e-commerce revenues increased 8 percent, driven by “strong double-digit increases in EMEA, North America and Latin America.”
Wholesale revenues during the quarter increased 3 percent, impacted by the inventory takebacks in Greater China.
Net Earnings: Net income from continuing operations came in at 66 million euros ($66.2 million), down from 479 million euros ($480.2 million) a year ago. Basic earnings per share (EPS) from continuing operations were 0.34 euros (34 cents) in the third quarter, compared to 2.34 euros ($2.35) in the 2021 period.
Alongside the Russia exit, non-recurring costs also were related to accelerated cash pooling in high inflationary countries, a recently settled legal dispute with Nike as well as higher provisions for customs-related risks.
Operating profit at the Three Stripes reached 564 million euros ($565.2 million), reflecting an operating margin of 8.8 percent of sales. This is a decrease from the 672 million euros ($673.4 million reeled in during the year-ago quarter, at 11.7 percent of sales.
CFO’s Take: Ohlmeyer said he expects another 200 million euros ($201.2 million) in inventory takebacks in China for the fourth quarter, and shared where Adidas needs to improve in the market going forward.
“Local lifestyle influencers are still hesitant to collaborate with Western brands. We have been highly dependent on lifestyle influencers historically, making us more exposed to the sudden loss of followers last year,” Ohlmeyer said. “While we continue to make huge progress in our digital capabilities, activities and reach, our ability to interact directly with the Chinese consumer—which is particularly important nowadays—is somewhat more limited.”
The soon-to-be interim CEO said Adidas is moving away from its previous activation model centered on lifestyle influencers, and will instead focus on fostering membership at the local community level and building its sports partner portfolio.