Adidas AG

XETRA:ADS

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the adidas Q1 2018 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Sebastian Steffen. Please go ahead, sir.

[Sebastian Steffen, Vice President of Investor Relations]

Thanks very much, Annette. Thanks very much, to all of you, and good afternoon. Ladies and gentlemen, welcome to our Q1 2018 Results Conference Call. Our presenters today are our CEO, Kasper Rorsted; and Harm Ohlmeyer, our CFO.Before we kick it off with our prepared remarks in a second, which will be followed by a Q&A session, [Operator Instructions] Thank you very much for that. Also as always, I would like to remind you that all figures, unless otherwise stated, will be discussed for our continuing operations. In addition, our revenue development is presented on a currency-neutral basis.And with that, over to you, Kasper.

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Thank you very much, Sebastian, and welcome, everybody. I will go through the business highlights, and I'll turn over to Harm, who will take you through the financial highlights. And I will close with the outlook for the remaining part of the year, and then we'll have a Q&A session that both Harm and I look forward to hopefully conduct to your satisfaction. So let's get started. If you look into the overall quarter, of course, we're going through and reporting on it in a normal way. And from a highlight standpoint, we continue to see strong top line growth, in line with expectations. And when I speak about expectations and we speak about expectations, it's of course aligned with the guidance that we issued in our March results.We see double-digit growth in North America and Asia-Pacific, with a continued very strong China. We're seeing the apparel business accelerate. It's driven by a strong double-digit growth in Athletics. And this is, and I'll take the question upfront, this is not driven by the World Championship. The majority is coming from product outside football. We're seeing a strong gross margin increase, reflecting the high quality of sales despite currency headwinds. And we are seeing strong margin improvements despite significant increase in marketing investment. Upfront, we are investing 12% more in marketing in this quarter, so you can see the leverage is clearly not coming from saving on marketing. The leverage is coming from the starting of the initiatives to create a scale to this model.On the challenges, we're seeing a sales decline in the Emerging Markets and Russia/CIS, reflecting the challenging market conditions, and Harm will go a bit more in detail with that. The footwear business is up single digit, reflecting some challenges for certain franchises. And this is, of course, not new to us. This is the transition from 2 very large franchises, Stan Smith and Superstar, to a set of more franchises, and not all franchises are working equally well. But at the same time, the overall bottom line, footwear is up mid-single digit. The momentum of the Originals business is normalizing. Many of you have in the last set of quarters and years asked how long time is the very, very high growth rate sustainable? And you're seeing we're getting a more balanced growth distribution now from our Originals and sports products. And the concept stores comp are declining, driven by our Russian and CIS business.So if you look and move to the numbers part of our chart, we're seeing revenue increase is 10% currency-neutral and 2% in euro terms. We have seen a strong loss in currencies in the first quarter, which we did guide on, predominantly related to the development of the U.S. dollar and the Chinese currency. The gross margin is up 150 basis points to 50.1% (sic) [51.1%] despite ongoing negative headwinds. And this really goes back to the point that we have spoken about before that we do look for high-quality growth. We are not chasing growth for the sake of chasing growth, and I think that is quite clear in our gross margin here. The operating margin, up 180 basis points to 13.4%, reflecting the gross margin improvements and the overhead leverage. As I said before, we are growing our marketing budget 12%, so we have a negative leverage on our marketing investments, which we believe is the right thing to do, that we're not saving ourselves from a marketing standpoint to the numbers. We're ensuring that we have the right infrastructure and overinvesting in our marketing.Net income from continuing operations increases 17%, and basic EPS from continuing operations, up 16%.Moving on, you can see our 3 strategic growth drivers from '17, also those we expect in '18. adidas North America, up 23%; Greater China, up 26%, so continued very strong momentum in both regions. E-commerce, a slight notch down, growing 27%, reflecting a fairly flattish January and February due to no new releases in January and February. And that's something that we believe that we have to get used to when we look upon quarter-over-quarter. The e-commerce business growth will, in the future, also be highly dependent upon how many launches do you do in a quarter. That's why you see the 27%. But as you can see, overall, North America, 23%; Greater China, 26%; e-commerce, 27%, so fairly strong growth in our 3 strategic areas. Which moves me -- brings me to our brand architecture. We continue to work our brand architecture to ensure that we're appropriately set up. We have our Sport Performance and Sport Inspired, where we're striving to have advanced growth portfolio on this. And of course, we are a sports company, so the focus will continue to be on sports both from an investment standpoint and from an overall majority standpoint, where the revenue comes from [indiscernible] come from sports. And this is predominantly executed through a brand channel.We have now built a new unit core that focuses on the value of consumer across all categories with product that has been specifically designed to the commercial price points. The commercial channel is a huge and largely untapped opportunity for us, especially in the U.S. Average reselling price for a pair of sneakers is around $60. At the same time, we'll remain very disciplined in our segmentation. Core will not interfere with Sport Performance or Originals products in any way. We'll continue to create great brand desirability at the top of the pyramid. Core revenues will be allocated into those respective business units, i.e., revenue with Running -- silhouettes and Running lifestyle-oriented products in Originals. This is an important way of looking upon the market also. While we don't record revenue on this, we want to make sure that we address the entire marketplace but with a differentiated product offering and a differentiated channel. And I think the latter is very important. That means that you will not find our top end and our core products in the same channel. That we've been very clear on from the beginning, and that is also what you will see in the marketplace.Moving on to the adidas brand, growing 11%. So continued strong growth. Our Sport Performance grew 11%, driven by double-digit increases in Football, Training and Running. And Sport Inspired, as you'll probably recall, Originals, is growing 13% due to double-digit growth in both footwear and apparel. So you can see we're now getting a more balanced growth portfolio from Sport and from Sport Inspired. Our women's business continues to grow double digits, now representing 25% of the total adidas brand business.We also continue to see progress in our Reebok business. We increased the profitability by 270 basis points. The revenue declined 3%, mainly due to sales declines in Asia in 2 countries, Korea and Japan. Korea, because of a rapid decline in tourist traffic coming into the city of Seoul; and Japan, similarly because of the profile of the country. We did return North America to growth. It's up 3%. And we're also seeing growth in Western Europe. As I said, robust profitability improvements. Gross margin up 270 basis points to 41.8%. So we are getting closer and closer to the point that we're striving towards, that is returning the Reebok brand into becoming profitable. We are at the same time continuing to invest into the Reebok brand, over proportionately to where we're coming from.Moving on to e-com. E-com grew 27%, driven by double-digit growth in most regions. I did speak about the timing of the product launches. That will continue to in certain quarters be a challenge for us to ensure that we actually have appropriate channel launch, product launches in every quarter, also particularly, when you get to the quarter-over-quarter comparison. We launched the adidas Shopping App, and it's now launched in 8 countries, and we have more than 1.5 million downloads. And we are seeing already now a much higher conversion rate of people using the app versus our normal online channel. We will be continuing to push the global rollout of our adidas app.This is all from my side. At this stage, I'd like to turn over to Harm to give you the financial highlights.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Thank you, Kasper, and good afternoon, ladies and gentlemen. It's a pleasure now to go a little deeper into the market segments. I will spend some time on this chart, going into the smaller markets. And as you can see, this year it's more a mixed bag. So starting with Latin America, up 10%. We are very happy with that development as we went through quite some restructuring in 2017. You might remember, in our portfolio approach, it was not just the divesture of TaylorMade and CCM and the Reebok Muscle Up program, but it was also Brazil and Argentina restructuring. And that's where we see the benefits of that restructuring in 2017, resulting now in 10% top line growth, primarily driven from Argentina, Mexico, but also Brazil. But even more importantly, the operating margin being up 650 basis points. That's why I'm saying portfolio management not just of the brands but also about markets. When I move to Russia, 16% down. And this is, of course, in light of the continuation of the sanctions and the consumer demand that we are seeing, where the consumers clearly are pricing down. But it's also, we closed already 93 stores in Q1, and this is on top of 180 stores that we closed in 2017. And that, of course, is linked to the top line number there as well. But on the other hand, we always said about, it's about safeguarding profitability. And you will see in that segment that the operating margin is actually 720 basis points up, and that is how we managed Russia this time.When it comes to Emerging Markets, it's a mixed bag. Again, there's a continuation of challenge in the Dubai market, so UAE, where we also see similar to Korea, less travel coming in. It's more price-sensitive. And the overall region or segment is a mixed bag. Again, we did some restructuring in Q4 2017 as well, where we merged some of the Dubai area markets, and also that we are getting the benefits of it now in 2018 as we see operating margin being up by 210 basis points.When I go a little deeper into North America, I'm very happy with the continuation of North America being up 21%, led by the adidas brand with 23%, driven by double-digit growth in pretty much all categories. When it comes to the Reebok brand, and that's something that we guided also in March, that we want to go back to growth in the North American market. And you see 3% being driven by Running and Classics. And we would expect discontinuing for the full year to be back in solid growth after some of the profitability measures came in through Muscle Up. Overall, the gross margin decreased by 30 basis points, and this is where I want to highlight some of the challenges that we had last year in the second half about the warehouse constraints. And of course, that led to some transfers of inventories into 2018 that needed to be cleared now in the first quarter. We'll have some continuation in the second quarter as well. That's where we got some impact on the gross margin in the North American market. And that's why we really don't see a leverage on the operating margin, but for the full year, rest assured, we will definitely see leverage from the operating margin in North America as well.When it comes to Asia Pacific, another market that is up 15%, again, driven by the adidas brand, with an increase of 17%, with double-digit growth in Running, Training, Basketball and Originals. And the Reebok brand, as Kasper mentioned already earlier, is down 9% despite a double-digit growth in Greater China. But as Kasper mentioned, declines in Japan which has a more mature demographics, and also South Korea, where we talked about the travel ban towards Seoul. That definitely impacted some of our numbers there. But still, the gross margin being slightly up and the overall operating margin slightly down. But overall, a very stable new segment for us in Asia, again, driven by the 26% growth in Greater China.When it comes to Western Europe, it's slower growth in a very mature market. Currency-neutral, in line with our guidance, mid-single digits for the full year, so 5% growth in Q1. 5% growth also by the adidas brand, driven by Football, partly World Cup impacted, but also Originals, growing in Western Europe. And the Reebok brand increasing by 1% on top of a 25% increase in the previous year.Again, we're talking about quality growth in Europe, so the gross margin is up by 1 percentage points to 45.6% despite certain headwind on the currencies. So definitely, a favorable well pricing mix, and I'm very happy with the margin improvements. And again, based on the significant investments also in the brand, overproportionate, you don't see that gross margin improvement dropping to the operating margin as we pretty much used all the money out of the gross margin to invest into the brand in Western Europe.When we talk about Western Europe, in the first quarter, I also want to mention that the 5% is impacted by World Cup sell-in as well. So when you look forward to Q2, you probably should see a better impact in Russia as the first quarter had more European impact as we sold in most of the jerseys and the ball as well. In Russia, we should see a sequential improvement compared to the first quarter as we start to have pop-up stores during the World Cup event. And again, some heat -- brand heat will be built up in Russia, and to a lesser extent, it will help Europe to grow. That's why if you look at the 5%, it will be impacted by the World Cup in Q1. And that's why I only clearly gave a direction for Q2 that you should expect a slower growth compared to Q1 in the second quarter as the World Cup effect isn't as significant in the second quarter. I also want to highlight one of the more challenging markets that we have in Europe. It's France. And there are 3 factors that I want to mention. One is, as Kasper mentioned earlier, the new franchises that we launched have not worked as well as well as the very mature franchises that we have built over decades. We need to continue to nurture these. And France is a market where we have specifically grown through a product like Stan Smith, potentially overproportionate in some of the key cities, and that couldn't be fully balanced. And lastly, we also have a changing relationship with one of our key accounts, with Decathlon, where we definitely will separate from each other toward 2019. And that is starting in 2018, with the full impact in 2019. And that's the direction that we have for France. But also there, similar to what we had in Argentina and Brazil last year, we have an attack plan in preparation to go back to the right roles in France. When it comes to the second quarter, I also want to mention again that we get to tougher comps from the previous year. In the first quarter, we were up 10%. In the second quarter, we were up 19% last year, and that's what you should keep in mind as well when it comes to August and the results of the second quarter. When it comes to the P&L of the first quarter, I have to say, as a CFO, I've never been happy to see such a P&L. Exactly in the guidance that we mentioned, it was 10% currency neutral. We have also been very clear that the nominal rates will be -- to be managed with the overall company from a cost control and from a working capital control point of view as well. So again, there's a 2% nominal growth. We always made clear that the quality of the growth is important to drop it to the bottom line. That's why I'm very pleased with the gross margin expansion of 150 basis points. Yes, there are still some FX impact in there, especially in Europe. On the other hand, we also did some cleanup on the inventory side in markets like CIS, Emerging Markets and Latin America because that's where we have restructured, and we see some of the benefits of less inventory reserves in these markets. So that is also helping on the gross margin in comparison to Q1 last year.I was made aware that other operating income was quite a question in the morning already. Quite honestly, I have to admit as a CFO, I haven't really looked at these numbers in detail, but rest assured, there are some onetime effects in there as we sold some land and buildings in Europe. There have been some settlements on some legal cases, and there have been some ongoing cleansing of the codes and provisions. So you can definitely look at a EUR 20 million onetime effect. But every quarter, these things will happened. That's why I'm saying I'd rather focus on the marketing investment that's actually 12% up. That is a higher focus for me and making sure that our operating overheads are getting the right leverage. And again, with the marketing working budget up 12% and in absolute terms, roughly EUR 80 million. I am really, really happy to see now the first significant leverage in the operating overheads outside of the other income of 100 basis points. And that's really where my focus is. And all of this leads to an operating profit up by 17% to EUR 746 million, and an operating margin of 13.4%, leading then to net income from continuing operations of EUR 542 million and the basic earnings per share from continuing operations of EUR 2.65.When it comes to working capital, I also want to highlight that the inventories only grew in a currency-neutral basis by 1%. Some of you might think how can we have enough product for Q2 and the quarters to come? Again, as I mentioned earlier, in Russia, Emerging Markets and Latin America, we did some rightsizing. And rest assured we are well prepared for our full year guidance from a product point of view and from an inventory point of view into key markets, Greater China, Western Europe and North America. And this is partly impacted through the restructuring and some of the cleanups that we had in the first half in Emerging Markets and Latin America. But I'm really, really happy with the discipline that I'm seeing. And again, as a CFO, someday, I want to break the 20%. We're getting closer to it. So I'm really, really happy with all my colleagues how we are moving this one forward.Well, on the net cash position, well, you see now the reason why we went out with a share buyback in March. And this is a significant improvement compared to Q1 2017, and we almost hold the position that we had at the end of the year 2017. Again, I think these numbers speak for themselves. That's why I always said in 27 (sic) [ 2017 ], let's generate the problem to generate -- have the cash position then we deal with it, and that's what we announced in March. And that's what you'll see on the next chart, actually, how we used some of the cash on the share buyback. And as we announced in March, it will be up to EUR 3 billion towards 2021 and up to EUR 1 billion in 2018. So we started on March 22. And as of end of April, we already bought back 641,000 shares of adidas, amounting to roughly EUR 130 million. And whoever is interested, that was an average price around 203 and something. And as we promised, we will continue to be in the market every week. And it's not a tactical program. It's a strategic program for the financial health and to return to our investors.With that, I would like to hand over to Kasper again for the outlook overall for the year.

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Thank you very much, Harm. Looking upon 2018, it is a very important milestone to us, the targets we have set ourselves and communicated by 2020. And it's in the context of balancing market share growth and margin improvements. It's important that we get that balance right. Market share with no margin has no value, and margin with no market share has no value. And we're trying to ensure that we keep this balance right all the time. We're focusing on high-quality revenues. We're not chasing revenue for the sake of revenue. And as you could see, which I believe, it also shows the quality of it. We are running with a very low inventory position, which should also speak for the quality of what we're trying to do. So if there were any concerns about excess inventory, that is definitely not the case. We believe we have the product pipeline to support the planned top line expansion that we spoke about for 2018 driving towards the guidance we put into the market.We have, as we said we would do in March, overproportionately in absolute and relative terms, invested in the brands and in products. We'll continue to do so to ensure that we create enough brand heat to drive the company towards 2020 and, of course, beyond 2020.And we're starting to see the leverage of our scale. The business model is still very early days, but you can clearly see that with a 2% nominal growth and a 17% profit growth, you are starting to see some elements coming through. And the bigger or the [indiscernible] element you also should look upon is really the headcount development that we've had a substantial decline in headcount year-over-year. And we've also had headcount decline quarter-over-quarter. So we have this account on payroll end of March compared to end of December and significantly less compared to end of March last year.So we are starting to see the first elements of the scale of the business model. Clearly, we are driving towards margin expansion and overproportionately our income growth, which is, along with our guidance, with a 10% currency-neutral and the 13% to 17% bottom line. That is, of course, the consequence of that because we will get a substantially lower nominal growth coming out due to currency fluctuations or headwinds.2018 is also a year of an event. And one of the biggest or the single biggest sporting event in the world is the FIFA World Cup, that's coming up in 5 weeks' time, which is a tremendous platform for us to present our brand. 12 teams are wearing the adidas equipment, which we are proud of. And of course, we hope that one of our teams are going to win. It's the biggest sporting event in the world and it's a fantastic platform to present our brand. It's driving brand desirability around it -- the world far beyond the football part of it. So the brand impact is, of course, beyond football. We see this as a brand-building event. The direct financial impact is limited, and the football has, over time, relative to the size of the company, become a small event from a financial standpoint but not from a brand standpoint. There is no doubt that the Russian event or the World Cup in Russia does carry lower financial opportunities than the similar event 4 years ago in Brazil. But at the same time, we're looking forward to it. It's going to be a fantastic way of bringing our brand to life globally. Which brings me to the 2018 outlook. We're confirming the outlook, and I'm not going to go through each of the elements. But I just want to say what I said on previous occasions. We strive to have as realistic outlook as possible. We're not striving to give you updates every quarter. Should an update be required, we will do so, but at this stage, we are confirming the outlook. I'll also repeat what Harm has said on a number of roadshows and I have said it and Sebastian Steffen has said. It's that we believe that we will very comfortably hit our bottom line. We think there's more chance on the top line. And we're not going to chase revenue for the sake of chasing revenue, to put this into context.In summary, we have had successful start to 2018, according to plan and according to guidance. We are seeing an ongoing momentum in our strategic growth areas, which are online, North America and China. Although the slowdown in Western Europe Harm spoke to is not a slowdown that we're happy with, but it's a slowdown that we're right now seeing. It has no impact on the guidance for the company. We do expect strong profitability improvements. We have seen them. We can continue to expect them despite the currency headwinds that we have with the particular weak dollar and RMB. And the accelerated marketing investment will continue to support brand and product to ensure that the progress we're making is made and sustainable to the platform. All in all, we are focusing on executing Creating the New, the strategy that we launched 3 years ago. With this, I'd like to call the presentation to a close, and Harm and I look forward to taking the questions for the next approximately 30 minutes.

[Sebastian Steffen, Vice President of Investor Relations]

Annette, we're ready to take the questions now.

[Operator]

[Operator Instructions] We shall take our first question from Fred Speirs of UBS.

[John Frederick Speirs, Director & Research Analyst]

Two questions. The first would actually be around the market environment. I'd be very interested to hear your latest take on the broader environments in the U.S. and Europe and how you feel the level of general promotion activity now is compared to the situation we saw at the start of the year. The second, perhaps, would be on apparel. We saw a good acceleration to mid-teens. You've highlighted in the presentation mainly driven by Athletics. Just interested in whether you're seeing enough encouraging signs that apparel is moving on to a faster growth rhythm. And also by category across the sports, which ones are most promising?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

I will take the apparel, and Harm will take the market. As we've spoken about on previous occasions, we are trying to move or strive to move our apparel business closer to our franchise model, similar to what we're seeing in footwear. And while we're seeing very positive signs here, which is predominantly driven by non-football, and we do this -- we say this deliberately so we don't misguide you. We think we're taking the right steps, but we still think we have a way to go. So we don't think that we are by any means where we need to be. We do not guide on where we think it could be because clearly, what we're looking to do here in line with what we said and in line with our strategy, we want to make sure that when we build businesses to a growth rate, that the growth rate and also the margin of product or the margin of sales also provides profitability for us. So while I'm giving a vague answer, the answer is we are making progress in building franchises. We don't guide on what the future could look like, but clearly, in the last couple of years, the focus was very much on footwear. We are trying to now -- we're striving to see -- the correct English word -- to have a more balanced effort in our company between footwear and apparel. And on the market intensity, I'll hand over to Harm.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, Fred, in general, we don't see much change in 2018 compared to 2017. I mean, the retail environment remains challenging. I would say it's somewhat better in the year as some of the competition is definitely getting somewhat cleaner, so that is definitely a positive. But the retail environment will continue to be challenged through the online business through all the players and through all of the investments that need to be done into the omni-channel environment. Now when it comes to Europe, I would also say the market isn't worse compared to 2017. What we are experiencing right now is after several years of double-digit growth, that some of the key franchises are not being replaceable within 2 seasons with the new franchises, and that's where we need to work through as a brand. And that's why we keep investing into the brand or marketing investment as well. But overall, I would say the overall market environment is, generally speaking, unchanged in both major markets.

[Operator]

We shall take our next question from Antoine Belge of HSBC.

[Antoine Belge, Global of Consumer and Retail Research]

It's Antoine of HSBC. Two questions. First of all, I think you mentioned that in terms of the 2018 guidance, the margin was more or less in the bag but maybe the plan was a bit more challenging. So could you maybe elaborate? And is this leading to those maybe issues about some of the reiteration of some franchise lines? And in which markets are you facing this issue? I think you mentioned France. What about China, for instance? My second question relates to your marketing efforts. I think in the first quarter, your marketing-to-sales ratio was up more than 100 basis points. I understand that then there would be the World Cup, which is going to be costing something. So what is the guidance for marketing-to-sales ratio over the full year and how do you see maybe the 3 remaining quarters?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So let me start with the guidance. I don't think anything is in the bag in May. I think that would be premature. I was giving you a, I would say, self-guidance on how we view it. You can clearly see that North America and China continue with very strong growth, as you can see from the numbers and also from the statements from Harm. But right now, Europe is growing at the low end of the guidance. And that is why when Harm said that we are flattish in Europe in the first half, that is, of course, it's impacting. And we start saying we think that there is more challenge on the top line than the bottom line. That, I think, is the essence of what we're saying. North America and China continue to -- very strong. Europe moving towards a flattish revenue number when you exclude the World Cup impact. We don't -- when it comes to ratio on sales and marketing expenses, we don't guide on that. But what we said very clearly is that we would, in marketing, absolutely and relatively overinvest in 2018. That means in absolute terms, the numbers would be higher. And in relative terms to revenue, the numbers would be higher. That is something we plan to do because we believe that is the right thing. And that is already included in the margin guidance of 10.3% to 10.5%. So it is going to -- in Europe we will overinvest because of the opportunities and also because we think it's the right thing to do for the brand.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

I just would like to add, Antoine, on the gross margin specifically, because a lot of people get excited about the 150 basis points. And again, it's only 1 quarter, and I want to be very clear that we still have 9 months ahead of us. And that is also in comparison to the lowest margin quarter that we had last year. So the comps will be tougher in the next 3 quarters. As I mentioned earlier, it's partly impacted also by the cleanup of some of the inventory in the Emerging Markets and Latin America. That's why I believe it's way too early to give a different guidance. But given the good start on the gross margin and, of course, less headwind in the second half, that's why we feel whatever the top line will be, we're very comfortable about the bottom line. That's all we are saying.

[Operator]

Our next question is from Erinn Murphy of Piper Jaffray.

[Erinn Elisabeth Murphy, Managing Director and Senior Research Analyst]

So I guess, first on the footwear, it's close to an underlying mid-single-digit rate. I was curious if you could kind of help us think about how you're thinking about that line for the year? Are you seeing new units in the channel or new platform that should help accelerate that? Or is that how we should think about this as you're transitioning from some of those older success franchises to some of the new ones? And then my second question is just on the e-commerce. Kind of dovetailing to that, you said you didn't have enough newness or new launches in Q1. Curious on, again, how that -- you expect that channel to grow in the back half. And then, for the adidas app, you're in 8 countries today. What's the outlook for the balance of the year?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Let me start with the 2 additional ones and Harm will do the franchise footwear and apparel. What I said was we didn't launch simply because we're going into a different mode. If you launch products in a brick-and-mortar, you operate with a different frequency. And when we look upon launches, the bigger we become in e-commerce, and of course, when we compare year-over-year, then we'll come into a sequence. If we launch in 1 quarter and we don't launch in the same quarter next year, then you'll have inconsistent growth rates. We do feel comfortable with the growth rates that we have for e-commerce. And as we clearly stated, e-commerce, along with North America and China, will continue to outgrow the rest of the market. So this is simply just learning as we go, and the bigger it comes, of course, the bigger impact it has. We have a very strong roadmap for rolling out the app globally, and you'll see the app coming into Asia this year. But, of course, what we are doing is we take the most relevant markets first. So that's why we started with the U.S. and Europe and we are now moving into China. China, we probably would have liked to do earlier because there is a certain amount of complexity related to the Chinese set-up simply because the digital ecosystem in China is different to anywhere else in the world with the strong presence of Alibaba and Tencent. That will be launched end of the year. So long answer to a short question. The target is to launch, of course, the app in all relevant markets globally.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, And there, on the football side, I mean, of course, we mentioned last year our challenges, our opportunities. We want to grow faster in apparel given the brand strengths, and that has finally happened in Q1. We are very happy with that one. And of course, if you guide 10% overall and apparel is growing above the 10%, then you have a lower number in the footwear. We don't want to give any guidance out there, but we're also convinced that it will be good in 2018 to have an overproportionate growth of apparel. And it's more important for us that the right franchises on the footwear side are lending, are nurtured and are given time to be lasting, so we don't want to overshoot. So I'm very happy that apparel is taking the lion's share in 2018. And on the question on the modern versus iconic franchises in Originals, it's a similar picture to 2017. The vast majority, or more than 50% of the growth, is coming from the modern franchises relative to the iconic ones already in Q1.

[Operator]

Our next question is from Andreas Inderst of Macquarie.

[Andreas Inderst, Senior Equity Analyst]

Andreas Inderst from Macquarie. Two questions from my side. First, Kasper, you highlighted the segmentation strategy. Core versus branded goods. That's nothing new to Europe, at least the way how I see it, and to China. But maybe you can give us a bit more insight what exactly do you plan for the U.S. market. What could be the contribution over time? How much is actually the core channel already in Europe? So just to get a bit of feeling about this strategy. My second question is on Western Europe. You were called out on Bloomberg, I believe, saying that Western Europe should be rather flattish in the second quarter. So now the base is extremely high. I understand that. But for the full year, you still see mid-single-digit growth, which means or implies a significant acceleration, and again, in the second half of the year versus the flattish number in Q2. Just wondering what gives you the confidence for a renewed growth acceleration in Western Europe?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So let's start with core. If you look upon core, we had offers in this category in Europe. If you go to the Deichmann Group, as an example, which is pretty much addressing the EUR 50 to EUR 60 segment, that is a very large segment. And we believe by having the right go-to-market route, it is and will continue to represent a very large opportunity. In the U.S., we have customers like Kohl's, like family channel, that are addressing this segment of the market, and we've never been addressing that. We believe by having a product that has the 3-stripes but, of course, is different to the performance product, and you can't find the performance product in that channel, and vice versa, you can't find the core product in a DICK'S Sporting Goods, we believe that, that is the right way of going. We do not believe it represents any significant risk to the high end of the market. It only does that if you don't have your segmentation strategy on the way. If you look upon China, we have entered the Chinese market coming from the top. The core footwear products or franchises are priced at European or European-plus pricing. And that, of course, gives certain limitation when you want to go broader on China and address more than the Tier 1 and the Tier 2 cities because simply the Chinese consumer cannot afford a lot of the EUR 180 shoe. They can afford a EUR 60 or EUR 70 shoe. Part of that has been addressed through factory outlet. But in order to do it in a more sustainable and a clear way to market when you go into Tier 3, 4 and 5 cities, you got to have the product offering. That's what we are aiming to do with core. So it's just the natural evolution of continuing to grow our business with a differentiated product set so we don't bring wrong products into the wrong channels. When it comes to the European part, I believe that Harm and I are saying the same thing, so I'd like to be clear on we're saying that the growth in the first quarter of 5% was positively impacted by sales of jerseys related to the World Cup. That will happen to a lesser extent in the second quarter, which is why we're moving towards a flattish revenue number for the second quarter. We have not changed the guidance from Europe, and let me be clear on why we do this. We do not want to sit and we are guiding, I think, on 12 different line items. And if we sit and we have to change that then every quarter, we'll have to do an adjustment either on GP1, up or down, on region up or down. When we believe that it has -- we have reached the stage where we believe that it will change, then, of course, we will inform everybody about it. What we are saying is we are confirming the guidance for our company. And should anything different occur, we'll come back and do so. But we're not going to do an update on every element of the 10 every quarter.

[Operator]

Our next question is from Anna Andreeva of Oppenheimer.

[Anna A. Andreeva, Executive Director and Senior Analyst]

Two questions. First, on North America gross margin decline. Could you quantify the amount of the warehouse constraints? Should this be minimized to the second quarter? Or is there any impact still expected in the back half? Also, curious how are promotions during the quarter versus planned? And how should we model gross margins in North America as we go through '18? And then secondly, a follow up on footwear. You mentioned not having enough newness. Is that primarily in Originals? Or did you see some of that in performance as well? And I guess, are you able to accelerate the new release calendar to rectify that?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So let me start with the latter, and here, I need to be very clear. We have not said "not enough newness." That was not the message. The message we are saying is that you need to release in a different frequency when you work online, and we have not done that in the past. We have very often bunch-released. So that means in 1 quarter or in 1 month, we have released 3 or 4 or 5 different pieces of footwear. If you're online, you need to spread your releases differently. I just want to make very clear that we don't leave an impression that there was not enough newness. What we need to do is we need to spread the newness in a different way than we've done before instead of sometimes doing bulk releases. On the U.S. side, I'll hand over to Harm.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, on the gross margin, I don't want to give the details of the impact as we didn't do that last year either to quantify the impact of the warehouse. That's something we've got to manage internally. I just want to try to give more transparency as we did last year. We see warehouse constraints. We still had a successful year in 2017, as you might remember. We are growing, again, 23% in the U.S. despite some of the constraints on the warehouses. We just need to deal with the some of the hangover that we had from last year. But you can definitely model that we'll have an improvement of the gross margin in the North American market. But I don't want to give a guidance for Q2. But Q2 will be less impacted by the current activities that we had in Q1. So I'm not going to promise a sequential improvement every quarter, but definitely, we'll be in positive territory for the full year.

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Well, in the U.S., what we have said very clearly is that we continue to expect an improvement in the margin in the U.S. every year towards around the 20% by 2020. We also expect the U.S. to be slightly dilutive when we reach 2020. But of course, the overall assumption and planning in our modeling is that the profitability will continue to improve annually in the U.S.

[Operator]

Our next question is from John Guy of MainFirst.

[John William George Guy, Managing Director]

I have two questions. First of all, just with regards to Reebok, very strong gross margin performance in the quarter, up 270 basis points compared to the adidas brand, up 60. So something is really starting to happen here. Just a question around the rationalization of Reebok in the U.S. in terms of the outlets. Will that be finished effectively by the end of the first half of 2018? And as Reebok gets back to sort of breakeven, would that have roughly or in excess of the 60 basis points incrementally big impact at the margin for you? My second question is around footwear, and I'm just trying to get a sense of how many pairs of Boosts you're effectively selling. And I can ask the question 2 ways, either a percentage of footwear revenue that is Boost-related in Q1, or out of the over 400 million pairs of shoes, I think, last year, how many millions were effectively Boost-related?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So on the Reebok side, we expect to be more or less finished by our retail closures by the end of the year. There are certain legal constraints in the U.S. because some of the malls, we simply can't get out of. That has no carry effect. What I mean by that is that, frankly, the closure costs would be higher than just letting the lease run out and that's due to the mall situation. So we're fully in line with the profitability improvement that we are expecting in the U.S. on the Reebok side. We don't disclose which impact it will have, but you can be very clear that the 2 things we're trying to achieve on the Reebok side is one, get Reebok back into black territory in profitability; and secondly, invest heavily in the brand. And we're doing both at the same time, and we feel, I would say, comfortably, and I don't mean this in an arrogant way. We feel confident that we can achieve what we are aiming to achieve on getting Reebok into positive territory. On the Boost side, I'll hand over -- on the footwear side, I'll hand over to Harm.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, I don't want to disclose any details on the Boost side, of course, but again, we still see solid growth. And I just want to mention just as Boost was impacted in that category, so the Running footwear category is growing 16%. That probably gives you a rough indication. But there I would like to leave it.

[Operator]

Our next question is from John Kernan of Cowen.

[John David Kernan, Managing Director and Senior Research Analyst]

So just on gross margin, obviously, strong performance in Q1 on top of very strong performance at the end of 2017. I'm just wondering, it still seems like you have pricing and mix working to your benefit. What is the incremental deceleration in kind of the gross margin improvement as 2018 goes on to get to the 30 basis points overall for the year?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Well, there are 2 factors, John. One, as I mentioned earlier, we had, on a comparison, we had more inventory challenge in some of the Emerging Markets and Latin America, and we have less inventory allowance in Q1 that has an impact in gross margin in Q1. But yes, you're right there. Pricing and channel benefit as well in Q1. But as we mentioned earlier, we are confident about the bottom line, the net income. We are less confident about the top line. And we always said we want to work with our partners and use some of the gross margin to drive the top line in the right way. And that's why we want to keep the flexibility for the full year and then working with margin in the right way.

[Operator]

Our next question is from Jurgen Kolb of Kepler Cheuvreux.

[Jurgen Kolb, Analyst]

The part that you mentioned, the more commercially oriented product range, I was wondering how high the share of your current business is in this category at this point in time. And what do you think the market potential is in this more commercial-oriented price range? And then secondly, on France, you broke up or you're about to break up with Decathlon. What is your plan in place in order to cover up for the lost business with Decathlon? Is this predominantly going into retail? Or what's your plan for France going forward?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

Let me start with the first question related to our core business. We believe there's substantial opportunity to be had in this area by doing it the right way, and I think by doing it the right way is applying the discipline in that we don't ship product that we'll not make money on. The reason why it's so important to build the scale of the business model is that you can actually add products with a lower gross margin and still have a bottom line improvement because of the scalability. And that's what you're going to start seeing over time in China, which we have said over many years, you should expect China to have a contribution [indiscernible] goes down, but of course, overall, the margin will go up, too. We think there's a substantial element or a substantial opportunity in this segment moving forward. This part is still by [indiscernible] the minority of the business we do today. So a lot of the business we're going to do in this area will be new business. This is also necessary for us to long-term grow in North America. In North America, we have been at the very $100-plus price point with pretty much all footwear. While this has been very good in establishing the brand and getting us a double-digit market share, and we'll continue to push here, this market segment does give us certain limitations on how long we can grow. So we need to continue to push the technical side of our products, the technical running, the high-end Boost shoes, et cetera. But we've got to get it balanced in where the sweet spot of the market is without jeopardizing the other half.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, on the Decathlon, Jurgen, it's definitely we believe, similar to our take -- the analogy to the U.S. I mean, when Sports Authority went out of business, I don't think the market felt it at all, and it was consumed by other players. And I mean, Decathlon is not going out of business. They're a strong player, of course, in Europe. But I think it can be through some of the buying groups, some of our retail piece, but it definitely goes partly online as well. And that's the direction that we're going. I mean, it will definitely feed our online drive as well.

[Operator]

Our next question is from Jonathan Komp of Baird.

[Jonathan Robert Komp, Senior Research Analyst]

I want to follow up on the discussion about the franchises. And it sounds like there's a little more volatility in the success rate that you're seeing. And I just want to ask more directly kind of, number one, which franchises in the newer ones are working? Which ones aren't? And then when you look at the root causes of some of the change in performance, do you think it's brand heat? Do you think it's design? Is it the competition? Like what do you attribute the change in the performance to?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So before we go there, let me just start by commenting on where we're coming from. We're coming from extremely high comparisons. We just reported a 10% currency-neutral quarter, so it's not a quarter where we have lost market share. I want to put that into context that not all franchises work equally well. I think it's natural. What we're seeing is that we had a period where 3 very, very strong franchises were working full steam at almost an unnatural point. When you look upon some of the franchises we just launched like the Solar Boost, the Commander, the Yung, the [ Sabaco ], the Harden, many of these franchises are very successful. But they are not as successful to the same level as a Superstar or a Stan Smith, and I think that is what we're seeing. We're seeing [indiscernible] starting to pick up. We're clearly seeing [indiscernible] didn't meet all our expectations. And I don't think this is anything unnatural because that was included in the guidance. So of course, we go look upon and say where does a launch work and where doesn't it work? But I just want to caution everybody and say I don't know any company where you have 100% hit rate in all the franchises. And right now, we believe that with the guidance we have of 10%, that reflects a fairly good -- gives a good indication of the success rate that we have and should give us right now, maybe with the exception of Europe, market share gain in any market we actually have been, including the U.S. and China.

[Operator]

Our next question is from Volker Bosse of Baader Bank.

[Volker Bosse, Co]

Two questions from my side. First on e-com, so where do you stand in regards to implementing the full side of multi-channel functionalities as well as in regard to building partnerships with market-leading marketplaces? So where do you see room for improvement in that aspect? And the second question would be on Reebok. Good to see Reebok back to growth in North America. But could you give us a bit more color on what's going to happen for the rest of the year in Asia-Pacific and Latin America? How do you see the momentum there having the Q1 shortfall in the books?

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

Yes, just on the e-commerce side, it's Harm speaking here. So we keep rolling out the omni-channel capabilities. We are pretty much done. We started in Russia already 2 years back. We are full up and running in Europe and also in the U.S. We are now looking at what are the opportunities in Asia as we build One Asia. That's where you can expect something in the second half already. But in the 2 major markets, North America and Europe, largely complete from an omni-channel point of view. When it comes to partner programs, we start rolling out these to more partners, but this is still limited to Europe and North America, not to any other markets. And that's where we want to optimize that omni-channel play with these partners first because it's a new business model, not just for us but also for our partners. And that needs to be optimized. That needs to be nurtured as well. So from a partner model point of view, it's clearly focused on Europe and North America only.

[Operator]

Our next question is from...

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

On the Reebok side -- excuse me, on the Reebok side, excuse me, we expect a more positive development in Asia by the end of the year. Clearly, our business in Korea, which has historically been a very, very strong business in Korea, it's been one of the biggest Reebok countries globally, has been severely impacted by the overall market slowdown in Asia. So we are looking upon it country by country. I think that what we're trying to do is move Reebok towards a balanced growth that gives the appropriate delivery on profitability. Of course, we had not hoped that we will come into having a negative revenue stream in Korea or Japan, but we're working with Reebok. Reebok seems to be a difficult child to raise. But I can say the primary purpose has been to reach for profitability in Reebok. And I think that you're seeing the progress we're making here. And that means that in 1 quarter, we might have a country that doesn't perform much to the standard that we want, but we are across the board, and it goes for adidas and for Reebok, we are restraining ourselves from doing anything where we push product for the sake of pushing product. And that I do want to stress in this call. This goes for adidas and it goes for Reebok. We are not pushing product for the sake of pushing product. We want to have a balanced picture of market share gain and margin gain. And that might give us [ insight ] as it goes into negative territory and this context for Reebok within a quarter because we will not do short-term things to just drive revenue for the sake of driving revenue.

[Operator]

The final question is from Simon Irwin of Crédit Suisse.

[Simon William George Irwin, Director]

Quickly then, in Europe, was there any difference between your wholesale and your direct-to-consumer? I.e., is there any kind of weather impact or kind of overall economic slowdown impact within those numbers? Or do you think that's representative of the market? And secondly, you said you only really -- you're going to have 2 launches later in the quarter with the Deerupt and Arkyn. Will these have a bigger impact in 2Q? Or are they by nature much smaller franchises and smaller volumes at a group level?

[Kasper Bo Rorsted, CEO & Member of Executive Board]

So I think that one should always be careful by using the weather because we don't use the weather when things are going well, so we're not going to use the weather when things don't go well. So I wouldn't put that into account. And we think that we'll have a more balanced launch kind of in the second quarter than we had in the first quarter. But right now, we're telling you the way we see the picture. As I said, it does not change the guidance for us on a company level. We'll give you some more detail from Harm's side.

[Harm Ohlmeyer, CFO, Labor Director & Member of Executive Board]

This is on the channel side. It's pretty much balanced, but I can definitely confirm that e-commerce is still the fastest-growing channel also in Europe. But again, it's a very balanced picture. There's nothing that is an outlier there. But e-commerce remains the fastest-growing channel also in Europe.

[Sebastian Steffen, Vice President of Investor Relations]

Okay, Simon, thanks very much. Thanks very much, Annette. Thanks very much, Kasper and Harm. And thanks very much also to all of you for staying so disciplined on my 2-question request. This completes our conference call for today. As you know, our next reporting day will be on August 9, 2018, following Q2 results. We all look forward to speaking to and seeing many of you over the next couple of weeks and months during the various road shows and conferences. If in the meantime, which I would assume is the case, you have any questions, as always, please don't hesitate to reach out to any member of the IR team. As you know, we will always be happy to assist you. And with that, thanks again for participating in our call today, and have a good day. Bye-bye.

[Operator]

Ladies and gentlemen, thank you for your participation. You may now disconnect.