The most expensive year in LEGO's history

The idea

On 1 March 2005, two men in Billund signed the most expensive set of accounts in LEGO's history.

One was Jørgen Vig Knudstorp, a former McKinsey consultant and chief executive since October. The other was Jesper Ovesen, the finance director, who had come from Danske Bank. The first page of the annual report said it without decoration: LEGO was in the most serious financial crisis in its history.

For 66 years LEGO had made money. Every single year. Then came the first loss, in 1998. The next in 2003. And 2004 was worse than both. Management had tried to grow its way out of trouble with computer games, clothes, television and theme parks. The brick had been pushed to the back.

This is the story of the year LEGO stopped growing and started counting. And now the accounts are yours.

How to use the case

Seven key figures, one set of accounts

Key figure 1 of 7 · Earning power

The core breathed. The clean-up cost.

In January 2004 Kjeld Kirk Kristiansen, LEGO's owner, took over the day-to-day running himself. In March came an action plan with one main rule: back to the brick. Computer games and films were handed to partners. The factory in Lättich in Switzerland closed after 30 years. Costs were cut by DKK 1,523 million, a fifth.

Sales fell anyway. LEGO sold toys for DKK 6,704 million in 2004, against DKK 7,196 million the year before. Before the clean-up, the business actually made a small profit of DKK 103 million, after a loss of more than a billion in 2003.

But clean-ups cost money. Factories and machines that were no longer needed were written down by DKK 723 million. Lay-offs and closures cost DKK 502 million. Once those bills were paid, the operating result was DKK −1,122 million.

For comparison, in 2002, the last good year, LEGO had a profit margin of 8.6 per cent.

Key figure 2 of 7 · Fitting the capital to the business

The diet

A company can also get too heavy. LEGO had planned for growth of 8–10 per cent a year. Instead, toy sales fell by more than a quarter. What was left were factories, machines and stock built for a company bigger than the one that actually existed.

So in 2004 LEGO went on a diet. Buildings were put up for sale. The company jet was taken out of service on New Year's Eve 2004. Even the Legoland parks were to be sold. The balance sheet shrank from DKK 10,049 million to DKK 8,089 million in total assets. Of that, DKK 2,432 million was the Legoland parks, which were to be sold the following year.

Revenue was still DKK 6,704 million. Asset turnover shows how many kroner of sales LEGO got out of every krone tied up in the company. The higher the figure, the harder the assets are working.

Key figure 3 of 7 · Profitability · The DuPont pyramid

The top of the pyramid

Now we put the first two figures together. Return on assets answers the board's most important question: what do all the company's assets earn together, before the interest is paid?

The DuPont pyramid shows there are only two roads to a good return on assets. You can earn a lot on every sale, like Ferrari. Or you can sell a lot compared with what you own, like a discount supermarket. The pyramid is written like this: ROA = PM × AT.

LEGO's operating result was DKK −1,122 million, and total assets were DKK 8,089 million. Work out the return on assets directly. Then check it with your figures from chapters 1 and 2 in the pyramid below.

Key figure 4 of 7 · Financing

The price of borrowing

No company lives on its owners' money alone. At the end of 2004, total liabilities and equity were DKK 8,089 million, and equity was DKK 2,948 million. The rest is debt: money that banks, suppliers and others have a claim on. LEGO's financial expenses were DKK 219 million. That same year Danske Bank, LEGO's own bank, stopped lending LEGO any more money, Bloomberg reported.

The interest margin is the difference between what the assets earn (ROA) and what the loans cost (the cost of debt). Think of a grocer who borrows at four per cent to buy goods he sells at a loss. Every borrowed krone hurts twice.

Key figure 5 of 7 · The owners' return

The amplifier

Gearing shows how many kroner of debt stand behind every krone of equity. Use your debt from chapter 4 and equity of DKK 2,948 million. Gearing is an amplifier: it makes a good song louder and a wrong note unbearable.

The owners felt all of it. The result for the year was DKK −1,931 million. Of that, DKK 458 million came from the Legoland parks. A year earlier, equity had been DKK 4,892 million.

Key figure 6 of 7 · Solvency

The cushion

Equity is the company's cushion. It takes the blows before the lenders do. LEGO's cushion had grown thinner year by year: DKK 6,478 million in 2002, DKK 4,892 million in 2003 and DKK 2,948 million at the end of 2004. Total liabilities and equity were DKK 8,089 million.

The owners stepped in. At the end of 2004 their holding company, KIRKBI, turned DKK 800 million of its loan to LEGO into a so-called subordinated loan. It cannot be called in early, and it stands at the back of the queue if things go wrong. So LEGO also showed its equity ratio with the loan counted in.

For comparison, the equity ratio was 51.6 per cent in 2002 and 48.7 per cent in 2003. Many Danish manufacturers sit at 30–40 per cent.

Key figure 7 of 7 · Liquidity

Can the bills be paid on Friday?

A loss is not the same as empty pockets. The write-down of the factories was money spent many years earlier. So DKK 774 million actually came in from operations in 2004, even though the accounts showed a large loss. LEGO used the money to pay down its bank loans.

The current ratio asks: does the company have enough that can quickly become cash to pay the debts due within a year? LEGO's current assets were DKK 3,615 million. That was stock, money owed by the shops, buildings for sale, and only DKK 312 million in cash. Short-term debt was DKK 1,473 million.

Rule of thumb: above 150 per cent is usually reassuring for a manufacturer. But the figure is a snapshot taken on New Year's Eve.

Put it together

The whole pyramid on one page

Write your results into the pyramid. Read it from the bottom up: the business (PM and AT) gives the return on assets. The loans and the gearing decide whether the owners' return ends up better or worse than ROA.

Three last questions

1. Which key figure was the most dangerous for LEGO? Back it up with numbers.
2. Which key figure looked best, and why can it fool you?
3. You are Knudstorp in January 2005. Which figure must improve first, and how?

The lesson

The brick survived. Why?

In 2005 LEGO made money again: DKK 505 million after tax. The Legoland parks were sold for about 375 million euros, and the equity ratio rose to 46.7 per cent. Ten years later LEGO was named the world's most powerful brand. The 2004 accounts explain why.

For teachers: the answer key with Max Noble's calculations and scores is sent on request, so it is not public before the class gets the case.

Sources

Every figure can be traced

LEGO Group, Annual Report 2004: key figures, income statement p. 31, balance sheet pp. 32–33, cash flows p. 34, financial review pp. 22–24, action plan pp. 8–10, subordinated loan from KIRKBI p. 24, company jet and Lättich pp. 8–9
lego.com/cdn/cs/aboutus/assets/blt07abb4b8a3da3f39/Annual_Report_2004_ENG.pdf

LEGO Group, Annual Report 2003: definitions of key figures
lego.com/cdn/cs/aboutus/assets/blte6c97bc4718a1848/Annual_Report_2003_ENG.pdf

LEGO Group, Annual Report 2005: revenue and equity ratio 2005
lego.com/cdn/cs/aboutus/assets/blt6eacf5a8b7af1359/Annual_Report_2005_ENG.pdf

The Guardian via Serious Play Pro: founded 1932, first loss in 1998
seriousplaypro.com/2017/06/04/how-lego-clicked-the-super-brand-that-reinvented-itself

Bloomberg via LUGNET: Danske Bank stopped lending to LEGO in 2004
news.lugnet.com/general/?n=56027

Rework: net profit of DKK 505 million in 2005
resources.rework.com/libraries/leadership-legends/jorgen-vig-knudstorp-leadership

TourMaG: Legoland sold in 2005 for 375 million euros
tourmag.com/La-vente-de-Legoland-donne-naissance-au-2e-groupe-europeen-de-parcs-a-theme_a8670.html

Brand Finance, February 2015: LEGO the world's most powerful brand
brandfinance.com/press-releases/lego-overtakes-ferrari-as-the-worlds-most-powerful-brand

All accounting figures are the LEGO Group's own, in DKK million. The key figures use year-end figures to keep the exercise simple; LEGO itself uses average equity for return on equity. The scene in The idea is built on the signatures in the annual report (Billund, 1 March 2005). The scores, the three lessons and the law are Max Noble's judgement. English edition of No. 0006; the Danish original is the HHX edition.