Adidas AG

XETRA:ADS

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the adidas AG Q3 2020 Conference Call. [Operator Instructions] And I would now like to turn the conference over to Sebastian Steffen, Head of Investor Relations. Please go ahead.

[Sebastian Steffen, Senior Vice President of Investor Relations]

Thanks very much, Hailey, and good afternoon or good morning, and welcome to our third quarter 2020 results conference call. First of all, I would express -- would like to express that we highly appreciate you our flexibility as we had to move forward this call due to a regular senior management meeting that is taking place later today. As you can imagine, we have to hold this meeting virtually and in order to allow colleagues from around the world to join, we need to start right after this call. So thanks very much for your flexibility. Our presenters in today's call will be our CEO, Kasper Rorsted; and our CFO, Harm Ohlmeyer. We will kick it off in a second with the prepared remarks from Kasper and Harm, followed by the Q&A session. During the Q&A session, I would again ask you to limit your questions to 2 to allow as many people as possible to ask their questions. And since we don't have that much time today, I would now like to hand it over to Kasper.

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

Thank you very much, Sebastian. First, I will provide you with a high level of where we stand. Then we'll review our business and financials in the third quarter, and then Harm will give you an update on how we continue to operate and deal with uncertainties and opportunities. And at the end, we'll take a look at our current trading outlook, and of course, take you through our product pipeline and answer any questions you might have. The good part is that sport finally came back and our athletes are again winning on the pitch, whether it's Bayern Munich taking the Champions League, Dominic Thiem taking the U.S. open, All Black's [ team ] defeating Australia, or having Peres, not only setting one, but setting 2 half marathon records in our new adizero Adios pro shoe really shows sport is back, but also shows our commitment to where we came from, football and running, this is where adidas was born. When sport returned, we also were better able to connect with the consumers. Whether it's through our home team campaign with a second chapter on social media, where we've had more than 0.5 billion views and ready for sport or on our online site, where our consumers who connect have a much higher intent to buy than the average -- than the average or it's Ready for Sport that showed how we can successfully combine brand and commercial opportunities. So the importance of sport is back is not simply underestimated, of course, we want the fans back in the stadium also. And we're also connecting at the grassroots levels. The amateur game is also returning, which is important for every individual around the world that does sport outdoor and indoor. And in order to support amateurs at all levels in Europe, we've donated more than 150,000 kits to set up 10,000 teams across Europe. This is our pledge to bring amateur football back and change lives through the power of sport. We're also excited to have Amanda joined at the beginning of 2021. Amanda will become our new Executive Board member responsible for Global HR. She's held executives -- numerous executive positions for different divisions and companies, among others, BNP Paribas and JPMorgan. She has more than 24 years of HR experience in global organizations, and we're delighted that she's taken the opportunity to come to adidas and help us move our overall HR agenda forward. Within our agenda, it's also about creating lasting change. And in July, we set clear commitments to fight racism and accelerate inclusion globally. In August, we relaunched our internal Fairplay code of conduct to strengthen our connection to integrity. In September, we held our first global day of inclusion for all employees to engage, reflect and learn about the topic. On this day, I personally discussed the importance of inclusion with Olympic champions Edward Moses. And throughout Q4, all employees are completing a 30-hour diversity and inclusion training which shows the seriousness of our commitment to creating lasting change within our company. It was also great to see that we were ranked the best place to work by -- as a sports company, by Forbes. We are the highest ranked sports company on the sports, Forbes World's Best Employers 2020 list. Ranking is based on response to the pandemic and scores of image financials, talent development, gender equality and sustainability. So immensely proud moment for us to top the list as the best sports company to work for. Which brings me to the business. A big part of the business is, of course, the products that we sell and deliver to our consumers. Whether it's our Superstar that saw amazing growth of 68% in the past quarter, also driven by relationship with Beyoncé, the relaunch of our ZX and the ZX 2K Boost, the launch of our A Jersey clubs, whether it's Manchester, Arsenal, Bayern Munich, Real Madrid or Juventus, all getting the excitement back on football, ZX -- football boot, the MYSHELTER outdoor proposition or the Reebok legacy, where we saw strong income performance with 100% sell-through on the initial launch. So bringing the right products to the consumer. As you can see, which I did mention for those shoes -- most of all of us -- most of us grew up with Lego and having a collaboration with an iconic toy manufacturer, gave an enormous resonance on the brand side, both for Lego and for adidas. We also saw the positive store opening trend continue throughout the third quarter. When we last reported, 92% of our stores were opened at the end of July. At the time, we expected the store opening trends to remain positive. And this assumption has proven right. Store opening rate remained above 90% and stood at 96% at the end of the third quarter. Some of that reversed in recent weeks. More about that later when I discuss the outlook. But overall, an improvement throughout the third quarter as we anticipated, which also lowered the third quarter in the context that we're putting it into here. We have a clear focus in this uncertain environment and arriving at a healthy inventory level at the year-end, and generating profitable sell-through of our products and being disciplined about wholesale sell-in. This helped improve our position or going in position in '21 and has clearly paid off in now the third quarter. The inventories were materially reduced during the quarter with more than EUR 500 million with a reasonable level of discounting. E-com continued to increase with 53% with a double-digit increase in full price, driving 13% growth in D2C. What we continue to see is that the retail traffic is significant below prior year and has recently slightly weakened, again, more about that later. And of course, the risk of further lockdowns requires a disciplined stance on both orders and shipment. I do want to say in this context. That we've done our utmost to manage our P&L and balance sheet in a balanced and a prudent way to make sure that we protect the company in the utmost way and more -- have taken cautious decisions when it comes to our balance sheet and our P&L than aggressive decisions, as nobody can know us, neither us nor you, where this will take us. And that has been the focus throughout the third quarter. We saw the P&L showed strong and profitable recovery in Q3. The revenue declined 3% in the third quarter. So that means almost staying at previous level. And if you take an opening rate of our stores of 96% in to account, assume that it's similar for wholesale and have less traffic. It's very much in line with what you would call normal trading. But let me be very clear, we could have easily delivered an even better topline performance, but we stayed true to our very prudent approach, and we'll continue to do so. Growth in D2C, which was 13%, reflect a strong demand for our products, but we kept our disciplined stance to sell-in, which weighted on the wholesale business, which was negative. This might have a negative impact on our topline development in 2020, but it is the right thing to do to ensure that we have the best position going into 2021. We saw a EUR 1.1 billion improvement in operating profit versus prior quarter, and we saw a 30 percentage points growth improvement compared to prior quarter. Harm will take you through that in later detail, but it was a substantial improvement quarter-over-quarter. When we look upon our strategic growth areas, adidas North America came in at minus 1%, generated positive growth in the first 2 months of the quarter, and for obvious reasons, we did not see any going back-to-school sales because nobody or very few went back-to-school. A positive impact from pent-up demand and physical stimulus then faded in the month of September. We saw Greater China at minus 5%. We saw double-digit growth in our D2C business, driven by both our own retail and e-com, despite physical traffic still significantly below in the prior year. And I know there's been questions around this. I just want to reiterate, we have seen very strong double-digit growth in our D2C business. What we have done is we've seen the franchise business lag due to our cautious approach to sell-in in order to focus on healthy inventory levels. And we do expect china to be back to healthy growth in the fourth quarter. E-com up 51% despite a store opening rate of more than 90%, and we saw exceptional growth in e-com continue. As mentioned before, we achieved this growth with a significant higher full price sell-through in e-com compared to Q2. Our e-com continues to drive profitable growth, nearly 150 million creative club members at the end of the third quarter. That meant we added 70 million in the last...

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

Nine Months.

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

Nine months, yes, excuse me. So 70 million in the last 9 months. So an enormous growth in our member base. Members account for 2/3 of e-comm sales and known consumer is much more profitable consumer, but more on the value of members later, confirmed that we launched in the U.S. and also China, which are predominantly for exclusive product drops. When it comes to our 2 brands, the adidas brand saw growth in Originals of 4% and running at 2%. Our Originals footwear were up mid-single digits, and made exceptional growth of the Superstar franchise, with our growth in running as our iconic UltraBOOST franchise continue to grow at high single-digit rates even throughout the pandemic. Our Reebok brand was down 7%. Reebok has a lower exposure to the running or outdoor category, which is predominantly where we've seen our growth coming in the sporting category. Reebok also has a high exposure to North America, a market that so far has recovered more slowly than Europe. While we're speaking about Reebok, let me just say that we are aware of the media coverage over the last weeks. I ask for your understanding, but would like to say right away, that as a matter of company policy, we will not be commenting on rumors or speculations. What I can tell you is that we continue to work on our 2025 strategic business plan, which we will be presenting to you in March next year. With that, I'll hand over to Harm.

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

Thank you, Kasper, and good morning, good afternoon, everyone on the call, ladies and gentlemen. As always, let's start with an overview of some segments. And look at the world map, illustrates our strong recovery in Q3, with currency-neutral sales in Russia, CIS and Europe, already returning back to growth with plus 11% and 4%, respectively. In North America, we've recorded a slight top line decline of 1%, with positive sales growth over the first 2 months of the quarter as consumer spending was temporarily supported by fiscal stimulus. So operating margin increase of nearly 6 percentage points in North America resulted from gross margin improvements due to less use of air freight, which was needed last year to mitigate the impact of the supply chain shortages, as well as strict cost control during the quarter. Sales in Asia Pacific declined by 7%, with Greater China recording a 5% decrease. As already mentioned, in China, we achieved double-digit growth in D2C with 33%, which underlines the strong sell-through of our product. At the same time, however, the franchise business lagged due to our disciplined approach to sell-in. As Kasper mentioned, we project China to return to growth in Q4, while we maintain our clear focus on healthy inventories and profitable sell-through. This might have an adverse impact on our revenue development in the short term, but it helps us protect the brand and improves our market position going into 2021. In Latin America it was minus 13% and Emerging Markets was minus 10%. The overall environment remained challenging as the pandemic continued to disrupt operations, and several stores remained closed. Let's take a look at the P&L. So the topline was facing translation headwinds throughout the second half. In Q3, we recorded a negative translation impact of 4 percentage points, mainly due to the weaker U.S. dollar. As you can see from FX spot rates this headwind will persist in Q4, and we are not going to feel any significant benefit from it in gross margin before late '21 and going into '22, given our hedging policy, 12 to 18 months out. Our gross margin was down only 2.1 percentage point to a level of 50%. As expected, a favorable channel and market mix was offset by negative currencies and the promotional environment in more details to follow-on a separate slide. Operating expenses were down 11% as a result of strict cost control. Marketing was down 23% as we continue to suspend marketing that would be ineffective due to social distancing, but we remain very visible through our social channels. We, of course, also continue to double down on digital marketing in order to remain connected with consumers, add members into our ecosystem and support our growth in e-commerce. Operating overhead decreased 5% as lower business related expenses offset increased logistics costs resulting from the continued exceptional growth in e-commerce. We have achieved a fast return to double-digit operating margin. Operating profit of EUR 794 million reflects a margin of 13.3%, just 3 months after Q2, having been maybe the most challenging quarter in our history. Now let's take a more detailed look at the gross margin development in Q3. Similar to Q2, lower sourcing cost and the more favorable channel and market mix, primarily due to the ongoing exceptional e-com growth had a positive impact on our gross margin in the quarter. And I want to be very clear that we also had no positive impact of any onetime effects in the third quarter, and there was no reversal of any accruals from the previous quarters. So it's a -- clearly an underlying consideration. These positive effects were more than offset by negative currency developments and a less favorable pricing mix. And while the promotional activity continued to weigh on our margin development in Q3 and the negative impact from discounting was significantly lower compared to Q2. This is a direct result of our focus on healthy inventories, profitable sell-through and disciplined sell-in. These principles will continue to guide us through Q4 and lead to a further moderation of promotional activity. We are expecting our gross margin to be around the prior year level in Q4 despite continued FX headwinds. Let's take a look at our operating profit recovery. So let me look at the comparison of Q2 to Q3. Operating profit of EUR 794 million in Q3 marks an improvement of more than EUR 1.1 billion compared to the second quarter. We achieved this by strict cost control throughout Q3 and were able to avoid deleverage on the back of a declining topline. The P&L development in the third quarter is a clear proof point of our operational flexibility. Following the P&L discussions, let's now look at the balance sheet. Net debt amounted to EUR 1.1 billion at quarter end. While this represents a deterioration compared to the net cash position 1-year ago, the net debt position is still modest in historical context, and is up only EUR 300 million towards the end of Q2. And our equity ratio remains solid at over 30%. Turning to operating working capital. The average operating working capital as percentage of sales increased to 23.2%. Inventories were up 35% currency-neutral year-over-year. This increase still reflects the inevitable lower-than-expected product sell-through caused by the broad-based store closures during the first half of the year as well as traffic below prior year levels after stores reopened. Compared to the end of Q2, we reduced inventory by 10%, or more importantly, by EUR 500 million as our inventory normalization is progressing exactly according to plan. I will further speak about the inventory development on a separate slide. Receivables were down 14% currency-neutral year-over-year, reflecting a continued emphasis on cash collections. Payables were down 26% currency-neutral as our payment terms with vendors are also normalizing, given more comfortable liquidity position.Now let's take a deeper look at our operational setup. So as we execute through the coronavirus pandemic, we continue to strike the balance between short-term challenges and long-term opportunities. Let me reiterate that the health and safety of our people and communities remains our top priority, of course, even more so, as cases are on the rise again. We will cover 4 additional priorities in this section. First, the operation flexibility. I will give you an update on inventories as we work towards a normalized inventory level by year-end. Then the financial flexibility, and I'm going to provide you an overview about the steps we took to increase our financial flexibility at favorable conditions. And then, thirdly, about digital opportunities, and Kasper will then explain how we leveraged our digital ecosystem and how we drove membership and profitable growth. And at the last but not least, Kasper will walk you through the latest developments in our D2C business and show how we actively drive the channel shift to build direct relationships with the consumers, both online and off-line. So let's start with our inventory provision -- position. As you know, we had an inventory buildup of around EUR 1.1 billion during the first half of the year when the impact from the pandemic was the worst, and more than 70% of our stores were closed at the peak. In the third quarter, we reduced inventories by more than EUR 500 million. So already worked through roughly half of the inventory buildup. We have done so with a reasonable level of discounting, as you can tell from the 14 percentage points higher full price share in our e-com business in Q3. We continue to execute on our proven plan and are confident to arrive at a largely normalized inventory level by year-end. Let's remind ourselves what our game plan was to finish at a normalized inventory level. First, we are flexibly driving our product pipeline. We continue to launch products in an agile way, exciting about the most successful launch to market at short notice to adapt to changing market conditions. In many cases, we are executing fully digital. Product launches now with a digital ecosystem continue to be well received by consumers. We doubled down on e-comm to ensure we serve consumers in the best possible way during these lockdown in Spring and keep ramping up. Thirdly, in addition, we are making increased use of our factory outlets around the world. And fourthly, as presented in Q4, we will leverage the current sales events, whether it's Singles Day in China, whether it's in the CyberWeek or what we also did with a digital dedicated theme to our members to our credit club members and this is the success of online as off-line. Let's go by our cash position. Our cash position at the end of Q3 improved by around EUR 1.2 billion compared to June 30, mainly due to the following financing activities. As our operating working capital needs peaked during the summer months, we had drawn down EUR 500 million of the KfW facility in July in order to keep full financial flexibility and maintained a certain liquidity buffer at any point in time given prevailing uncertainties. We also received the proceeds from placing Eurobonds in an amount of EUR 1 billion at the beginning of September and our first transaction as an investment-grade rate issuer. This takes our total cash position to EUR 3.2 billion at the end of September. Please be aware that we received the proceeds from our EUR 500 million sustainability bond in the beginning of October. So this cash inflow did not fall to the balance sheet in the third quarter. I want to take a moment to give you a consolidated view of the steps taken to further optimize our capital and cost. We issued investment-grade bonds in an amount of EUR 1.5 billion overall at very favorable conditions. As announced earlier today, we have also secured a new EUR 1.5 billion syndicated loan facility with several of our partner banks. The new loan facility will run until 2025 with the syndicate of partner banks with Deutsche Bank and HSBC as lead arrangers. This brings the total of our recent financing activities to EUR 3 billion and led us to replace the syndicated loan facility under participation of KfW with immediate effect. The EUR 500 million portion drawn in July was already paid back in October, including interest and fees, which had been agreed at customary market conditions. The KfW facility was crucial as a safety net in April when other sources of financing were unavailable. I would like to thank, again, the German government for its rapid support and giving certainty, not just to 60,000 employees, but also to many of our partners, whether these are suppliers or vendors that we work through the crisis. While uncertainties prevailed, we are now facing them with a considerably strengthened financial profile, hence, do not need the KfW facility as an additional safety net anymore. To summarize, let's look at this timeline and everything that we have accomplished on the financing side in just a few months. We entered 2020 with a strong financial profile before facing an unprecedented situation that pose challenges even for healthy companies like ours. Fast forward today -- to today, we are investment-grade rated and have issued bonds at favorable conditions as well as secured a new syndicated loan with our partner banks. Having replaced the KfW facility, we have total available liquidity of EUR 3.6 billion and can access capital markets for additional liquidity at all times, thanks to our strong investment-grade credit ratings, I'm proud of what we have achieved in such a short period of time. And now let me hand over to Kasper again to take you through the digital and the D2C opportunities.

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

Thank you very much, Harm. Before I go into the membership part of our digital portfolio for you. Let me just give you a couple of numbers, which I think are interesting to reflect upon. This year, we'll come up with a number in e-com substantially above EUR 4 billion. When we started [ 2016 ], our number was EUR 600 million. With a number north of EUR 4 billion, our e-com business alone would make us a top 5 sport brand globally. When we started our membership programs, only 12 months ago, we only had 50 million. Now we have 150 million. We are seeing an enormous increase across the board, whether on digital business, whether it's a membership, whether it's a transaction on our .com or within our portfolio. And the reason why it is so important for the members is that they are the heart of our digital opportunity because they are the most loyal customer, and they help us drive profitability growth at scale. You can see the numbers growth I just spoke about when I came to members. Members have a 20% higher average order value than non members. However, they do not only spend more, they also shop more frequently and have a 60% higher average order frequency compared to non members. With a Net Promoter Score above 7C, we know they're completely committed to our brand and our programs. In total, members have a 2x -- 2.4x higher lifetime value compared to nonmembers. And with our unique app ecosystem, we're doing a lot to attract even more consumers and keep them engaged. We are now the only sport brand that rewards members for both physical and purchasing activity through our app ecosystem. Running and training apps acquire membership points when working out, and in the adidas app, in our newly launched CONFIRMED app we reward purchases for the physical exercise that you have done. Let me give you another example of how we drive membership. In October, we had created a club week, our first festival for members only. Though we get various events in place to engage existing members, incentivize new members to sign up, we provide exclusive interviews with some of our most prominent athletes like Karlie Kloss or Paul Pogba, to name a few, and behind the scenes videos. We had over 30 raffles for members to win unique products, we had limited edition releases with more than 70 new designs for our members, and the result speaks for themselves. Not only did we acquire 2 million new members within just a week, we also generate revenue of nearly EUR 100 million during the week over achieving a revenue target by more than 40%. And we not look at the digital opportunity in isolation, but take a D2C view across online and off-line. We sharpened the storytelling in our stores, which was another important driver of the D2C leg we have covered in the third quarter. As an example, we boost the sell-out of our Clean Classics collection with product displays made from recycled materials and gesture-controlled screens in our stores. In this way, we explained our sustainability story and the commitment to end plastic waste to our consumers with impact. We also keep investing in physical stores in relevant locations. In London, we opened a new Originals flagship store in one of London's most creative boroughs. In a time of uncertainty, the Carnaby store is designed to bring people together, showcase products and celebrate our heritage. And as such, it will be integral part of our new city ecosystem and help to drive engagement with our London consumer. I can only encourage many of you who live in London to come and see the store when it opens up again when the closedown is over, but it is a unique investment into London again following our flagship store that we opened just a year ago on Oxford Street.As the corona pandemic still evokes restrictions, let me now provide you with an update on global own retail traffic and conversion trends as observed during the third quarter. And you should probably assume that our trend is not far away from that of our partners. Our efforts to revitalize retail continued to improve traffic in stores throughout the third quarter. However, traffic still remains below the prior year level due to social distancing guidelines, which have become even stricter in recent weeks, leading to a stabilization of traffic trends in October.In November, we have even started to see a slight deterioration of traffic in open stores as stricter social distancing guidelines were put in place, particularly in Europe. On the other hand, conversion rates continue to remain elevated compared to prior year level, as consumers that visit stores tend to have a clear plans. And let me just stay here for a second and say the following. We are one of the first who've been clear on what's happening in the market because it's happening now, we wouldn't have said that three weeks ago. But for everyone, when you have closed down, it impacts all kinds of stores, ours and others. And when you see stores closed over the weekend, like in Italy, it has an impact on adidas, like it has on everybody else. And I want to make certain that I bring this across. This is not an adidas-specific point. This is what happens when stores closes down. And, of course, what we do expect is a subsequent take-up on the retail, [ now ] on the e-com side.Within this environment, we are actually driving the channel shift towards our D2C business. As a result, our D2C share year-to-date is up 10 percentage points compared to prior year and have now reached a level of 40%. Establishing direct relationships to consumers across both digital and physical touch points provides us with insights as well as opportunities for profitable growth. At the same time, we're exiting thousands of non-strategic wholesale accounts, particularly in the US, to win with the winners, but not only in the US. At the same time, we are scaling our effective and cost-efficient self-service model for more and more our remaining wholesale partners.The best way to drive D2C is, of course, through strong products, and we have that in our pipeline. But again, we are driving a fundamental shift in the business model within adidas, and corona has accelerated that shift that will help us gain more control of our business moving forward, but of course also drive higher margins through a end-to-end business to the consumer, which brings me to the outlook.But before I go there, I do want to speak about our products because we sell products to consumers that love sport and love athleisure. We continue to innovate along many dimensions. With FUTURECRAFT.STRUNG, we brought our 4D technology into textiles to create a lightweight upper made out of a single piece of material. This is the first kind of prototype in our industry combining athlete data, additive manufacturing, and robotics. It's another breakthrough for us, but of course also for our consumers.When it comes to Reebok, we have had many breakthroughs in terms of sustainability. The latest one comes from the Reebok brand, and that's the introduction of Forever Floatride Grow. This is a plant-based running shoe with an eucalyptus tree upper as we continue to innovate in fabrics and in materials.And when we look upon the ZK 2K Boost (sic) [ZX 2K Boost], we continue to leverage our product archive by combining iconic styles and Boost technology to win in the lifestyle running category. After having successfully launched or pre-launched the 2X 2K Boost (sic) [ZX 2K Boost] with the selective drops, we now provide and scale the franchise along a global blockbuster campaign.And within the global Ready for Sport campaign, we activate COLD.RDY, the fourth and final apparel launch of our new apparel performance collection. Winter is just around the corner, and COLD.RDY keeps our consumers warm and comfortable in harsh conditions. And more than ever, it is important to have the right products at the right time. And with gyms closing down across the world, people were – increasingly continue to exercise outdoor, and having the right winter material for our consumers to exercise outdoor will allow us to win.In Ninja, our collaborative approach to innovation also comes to life with our e-gaming activity with Ninja, one of the most popular e-gamers out there. With early access to Creators Club members, the CHASE THE SPARK collection inspires consumers to chase the things they're passionate about, as Ninja does with e-gaming. Another example of our current collaboration is one with Disney, which yield a series of limited Star Wars releases across the several major footwear franchises.And finally, IVY PARK; we could not be more excited about the release of the second IVY PARK collection and the blockbuster campaign THIS IS MY PARK with Beyoncé. The collection includes apparel, featuring inclusive sizing and gender-neutral performance gear, footwear and accessories. The launch of the full collection resulted in outstanding media coverage and great consumer engagement, leading to complete sellout in the US within only 24 hours.We have many more hype releases that drive brand desire also coming and, of course, also with Beyoncé. Our product Superstar launched in September was more than 30 times oversubscribed. And YEEZY remains in high demand with strong sell-through. Over the course of the fourth quarter, we plan 113 drops, so more than one drop a day, ensuring excitement around the brand will remain high throughout the period.We are seeing stores in part of Europe closing again as everybody else. We continue to successfully execute our product launches since the start of the fourth quarter. Recently, new lockdowns in Europe led to store closures, reducing our store opening rate in this market to approximately 60%. Our global store opening rate is between 92% and 93% as of today, down from 96% at the end of the third quarter. In addition, stricter distancing guidelines have a negative impact on traffic in our stores in Europe that are open.While we're on track for growth in Q4 when new lockdowns in Europe came, the fourth quarter started well in October and we were on track to return to growth in Q4. Then case numbers accelerated dramatically and new lockdowns came into effect in parts of Europe, weighing on our store opening rate and the traffic in open stores.As a result, our top line is now predicted to develop similar to Q4 as it did in Q3, implying a low to mid-single-digit currency neutral revenue decline. This is against a strong comparable base as of last Q4 sales, which were supported by first product introductions related to the Euro 2020 and early shipments due to a different timing of Chinese New Year. If you were to adjust for those two, we would be on or above of the performance in the fourth quarter this year compared to last year. Last year, the fourth quarter growth was 19%.Despite these difficult comps, revenue would have returned to growth in absence of new lockdowns in Europe. As Harm already mentioned, our focus on profitable sell-through and disciplined sell-in is expected to lead to a Q4 gross margin that is flat year-over-year. As a result, we expect Q4 operating profit to between €100 million and €200 million.The key assumptions upon which we based our guidance is that we don't see any additional major lockdown coming into effect; specifically assumes that more than 90% of the company's global store fleet will remain operational through Q4; and it also assumes that traffic will not materially deteriorate from the levels experiencing in the quarter so far.While 2020 have brought a lot of challenges along, it's also made us a better company. We're moving our company fundamentally forward in our cultural evolution. We are operationally becoming much, much better when it comes to sourcing, sell-in and campaign and product launches. We've not only strengthened our P&L, but also our balance sheet, and our direct-to-consumer business has taken a huge step forward from a 30% share of the business to a 40% share of the business.And let me kindly remind you of our upcoming Investor & Media Day on March 10, 2021. We'll provide you with an update on our strategic priorities and ambitions for 2025. It's unlikely that we'll be able to host you in Herzo, but we'll make sure to turn this into an insightful virtual event.And with this, I'd like to come to the conclusion and summary. Our top and bottom line are very close to previous years, despite the fact that we've managed our business very prudently in the third quarter. We will continue to focus on healthy inventories, profitable sell-through and disciplined sell-in in a prudent setup.Finally, we are on track towards normalized inventories by the year-end level, and our financial flexibility has dramatically increased at very favorable terms. We're better positioned for the short-term uncertainty and long-term growth drivers. And at the end, what stands in front of everything else is the health and safety of our employees and partners that will continue to remain top priority for us as a company.And with this, we'll take your questions.

[Operator]

[Operator Instructions] And the first question comes from the line of Antoine Belge of HSBC.

[Antoine Belge, Global of Consumer and Retail Research]

Antoine at HSBC. Can you hear me?

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

Yes, we can hear you loud and clear Antoine.

[Antoine Belge, Global of Consumer and Retail Research]

So 2 questions. Maybe the first 1 is on China. I think you mentioned why you restrained the sell-in in Q3. Can you elaborate a little bit more on the market conditions there? I think you mentioned that there are still a lot of inventories. To what extent it is an industry-wide issue? And to what extent do you think that maybe you also have too many inventories of your own products? And my second question relates to marketing. I think the marketing expenses were down 23% in Q3, with sales only 3%. So what could be the a pattern in terms of the recovery in the amount you're spending? And also in Q3, do you believe that you've been spending less than competitors? Or more or less, you maintain your own share of voice?

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

On China, China is and will continue to remain a healthy market with growth, and it also grew in the third quarter. For Obvious reasons, there are excess inventory for everybody. But as you can see, we grew and we had strong double-digit growth in our D2C channel in the third quarter. We did restrain the sell-ins to our franchise partners. We do expect return to growth in the fourth quarter. So overall, the fundamentals in China remain very strong. We are seeing right now, the first indications of 11/11, and we are seeing healthy growth in that environment also. So it is a market "normalization" that's happening where everybody is getting rid of excess inventory, they do it in different ways. But the underlying fundamentals in China remain very strong. And that's why we also predict growth also in the fourth quarter.

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

Just Antoine on an on your question on the marketing being 23% down. Of course, we spent significantly in the second quarter. And then in lieu of no major events, like no Olympics, no European championship, there was limited reason to spend to tremendously in Q3. We also took a deep dive into the marketing by line item, drove a lot of efficiency and spending smarter as well in the third quarter. And rest assured, we will start spending in Q4 as sport is coming back to the pitch. At least outside of some European countries, but we are positive about the fourth quarter, and we keep investing for the sustainable growth of this company.

[Operator]

The next question is from Geoff Lowery of Redburn.

[Geoff Lowery, Partner of Non]

Could you talk a little afternoon event, could you talk a little bit more about your performance in Europe in Q3? And how you would have been thinking about the outlook in the absence of lockdowns? And joined up with that, how do you think about your buy for next year given the uncertainty over whether there's euros, whether there's Olympics, how do you approach that uncertainty at this juncture?

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

Geoff, yes, thanks for the question. Clearly, we would have expected growth also going into the fourth quarter for Europe. We had a good trajectory in Q3. We had a tremendous achievement in October as well, returning back to growth or continue the growth pattern in Europe. But again, and then the lockdown came in. But definitely, very clearly, a good trajectory in October and very positive development in Europe. And it would have been back to growth overall in the fourth quarter. We're not going to comment on what we are going to buy for Spring/Summer '21 or Fall/Winter '21. But rest assured, we are a growth company and we want to return back to growth in '21 and of course, the buy needs to be seen in comparison how we finish at a reasonable level at year-end with inventories. And -- but we have no reason to be too cautious going into '21 as we are a growth company, and that's what you will see in '21.

[Geoff Lowery, Partner of Non]

Okay, understood. And does the softer Q4 than we might have expected a month ago impact on your ability to get inventories where you want them by year-end? Or are there mitigating measures you can make to still deliver normalized inventories?

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

No, definitely not in a material way. And what we are seeing right now, of course, we are utilizing the commercial events, whether, it's single days as we speak and then there's still the side where we're coming. So we're absolutely on plan and will not impact our year-end inventory in a material way.

[Operator]

The next question is from Jurgen Kolb of Kepler Cheuvreux.

[Jurgen Kolb, Analyst]

Two questions. With the refinancing of your KfW loan, what's your stance in terms of resuming your dividend payments and maybe even the share buyback program? And I think, Kasper, you mentioned that this whole online development actually is fundamentally shifting your business. Maybe you can elaborate a little bit more on what that means really for the entire organization and where this share of online business can go to, given on the current trajectory that you're seeing in these marketplaces?

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

Thanks, Jurgen. The refinancing of KfW, of course, as we just terminated the contract as we speak, it's not the right time to talk about dividends yet. But of course, as you know, historically, we always had been very consistent in our dividend policy, but we have a clear logic. We have a clear financial policy. And then whenever there's extra cash, we will turn it back to the investors. And again, this could be through dividends and share buyback in the future. But today, it's not the time to talk about it.

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

When it comes to the digital growth, I think the positive thing we have seen is we've seen a dramatic acceleration, not only in the business that we have achieved through D2C and digital. But also to the underlying infrastructure that we have built this year because we have taken resources from all parts of the company and strengthen our technology platform that we built. We've built new apps, we reallocated several hundred people -- 700 people from other parts of the organization into e-com. We reallocated several hundred people from other parts of the organization into e-com.So, if you look upon and try to think about 2025, you can rest assure that the D2C side of our business will play a very important role and, of course, the starting point has now been dramatically improved because our starting point is 10 times – 10 points higher than it was a year ago. I'm not going to try to model that through for you, but as you would understand it, it has material upside for us through running a D2C model. It might imply higher operating overheads, but it does imply substantially higher margins. And then you can see in the third quarter also that we are coming out with a margin almost at previous year level, I think it's 70 basis points away from previous year. So, it is for us as a company a strategic very, very important step and it's accelerating our move to D2C probably with a two- to three-year horizon.

[Operator]

The next question is from Graham Renwick of Berenberg.

[Graham Ian Renwick, Analyst]

Just 2, please. First, on trading. I just wondered to what extent your growth in Q3 may have been constrained by the order cancellations you made earlier in the crisis, particularly on new product launches, do you find yourself in a position where the consumer demand recovered a lot faster than you expected and wholesale partners were demanding higher volumes of fresh product that you perhaps weren't able to fully satisfy? I think Nike flagged constraints in the period, given cancellations earlier in the year and some peers who didn't cancel performed a bit stronger. And then secondly, on discounts and inventories. I just wanted to square the fact that you have significantly reduced the level of discounting in Q3, and you're guiding to flat gross margins in Q4, which is positive, but you still have a high inventory levels to clear across Q4. Of the EUR 500 million remaining excess stock, I just wondered how much of that we plan to repurpose and hold into next year to sell at full price? And of the remaining stock, do you largely expect to clear that all through commercial events such as Singles Day and Black Friday, where you would have to have build up stock to discount anyway even in a normal year? So I guess, overall, is it fair to say that you're expecting the final EUR 500 million of excess stock to be cleared with much more limited impact to margins and perhaps the first EUR 500 million of excess stock, and that's what gives you confident in that flat gross margin guidance for Q4?

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

Well, thanks, Graham, for the 2 very well-articulated questions with a lot of sub questions within the questions. But the first one is definitely, there have been no constraints from a supply point of view in Q3. And to be very clear again, we could have grown in that quarter, if we wanted to. But we are very disciplined in the sell-in, and we want to make sure that we remain in a pull model and not shipping in more relative to the inventories that we have seen at our franchisees in China [ although we ] have been very disciplined, of course, help our margin, not just in Q3 but also in Q4. When it comes to the inventories, that's a minimal part that we will repurpose going into '21. There will be some [ surge ] to federation jerseys. There will be some Olympic products, but the majority of the products will be cleared through the commercial events that I just talked about, whether it's Singles Day or CyberWeek or Double 12 and other events that we have during the course of the next 6 to 7 weeks, we have actually done tremendous progress already in October, which, of course, can't disclose, but we are, again, right on plan. We will sell a lot in our more than 1,000 factory outlets. And this is getting better inventory for them as well because it's fresh product from either Spring/Summer '20 or partly even Fall/Winter '20. So also there, you shouldn't see a margin drag by placing these or selling these products because these are commercial events have accepted the prior year as well. Of course, we make them a little bigger as the overall industry is still clearing inventory. But we remain very disciplined. And again, for us, it's not about delivering the quarter or the top line, it's the overall P&L that matters for us, and that's why you see a positive development of the gross margin as well from Q3 into Q4.

[Operator]

The next question is from Cedric Lecasble of MainFirst.

[Cedric Lecasble, Research Analyst]

Cedric Lecasble from Stifel now. I have 2 additional questions. The first 1 to square up the gross margin in Q4. Should we understand that the regional mix in Q4 will play a strong impact on your gross margin component that you didn't have in Q3 with Europe and North America outperforming Asia? And as far as FX headwind is concerned, should we consider the same kind of headwind in 4Q than in 3Q on the gross margin? And the second question is on your SGA trend. You are forecasting similar topline trends, should we model similar SG&A trends? You had cost overall overheads down approximately 5%. Should we expect that to be similar in Q4?

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

Well, 3 questions there, Cedric. First, on the gross margin. No. I mean, the regional mix should not play a significant factor. I mean, again, we are returning inventory back to growth in China, but there's significant Singles Day as well in that number. And we have -- we will see good growth in the 1 or the other market as well. So do not expect a significant marketing mix. On FX, it's similar to -- in Q4, what we had in Q3. There might be some minor impact of Spring/Summer '21 billing rates or hedging already going into Q4, but it's minor. So assume it's a similar impact in Q4 than is Q3. When it comes to the operating expenses or the SG&A line overall, as we had more certainty, how we are going out of the crisis, with what you've seen in Q3 already and our guidance for Q4, we start investing more diligently, again, whether it's on the marketing side or also into project or catching up on some of the IT projects that we have delayed or canceled that we get ready for '21. And again, we are and we will remain a growth company, and that's what we're getting prepared for already in Q4.

[Operator]

The next question is from Adam Cochrane of Citi.

[Adam Gareth Cochrane, Director]

Two questions for me. As you look at the costs and the efficiencies that you've managed to do across the organization in the last 6 months. Is there any bits of those which can be permanently taken out, a change in the way that you do business either head office or in-country that we can sort of use as a way to think about a higher-margin maybe as we look forward? And then secondly, you talked about the wholesale self-service for some of your partners. Can you just explain a bit more what that is, please?

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

I'll take the 2 questions. If you look upon [ what the outcome ] -- come back in the near-term is, of course, are all of the T&E costs, that's simply not going to come back. Secondly, as we took a decision not to do any restructuring throughout the crisis because we believe that returning back to growth is actually a better way of managing the relative cost. And frankly, the timing and the cost of taking people out is not justifiable when we know that we are going to return back to growth. What we are seeing is we are seeing a fundamental shift in our D2C business. And that then drives a different cost profile. So you will see costs coming in, partly in the operating overhead and the shipping cost because of the handling costs and the digital costs. So you might see -- or you probably will see operating -- less operating overheads leverage moving forward, you will see expansion on the gross margin due to the D2C business and subsequent expansion of the overall margin. And that has been accelerated throughout the COVID. So if you look upon the overall cost profile, you're not going to see bigger changes there, but you are going to see mix channel changes how we conduct our business. That was number one. Number 2 was.

[Adam Gareth Cochrane, Director]

Wholesale click.

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

Yes. Yes, the wholesale. What we've done over the last many years is, how we just engaged with the wholesale partners through a digital setup, so providing them a catalog, whereby they order, so you don't have access to sales reps anymore, you order directly from a predefined set of products. We preselect products to different wholesale partners. And that, of course, will continue to expand rolling out globally. And in parallel, we are reducing the number of point of sales. We are with wholesale partners who we do not deem to be competitive moving forward. And that is, of course, being then cannibalized by our own or D2C business. But the biggest change is really the D2C business and the change it has within our company.

[Adam Gareth Cochrane, Director]

On that, in terms of the efficiency point, I suppose of thinking some companies have talked about they've taken time out of their supply chain by using digital meeting, digital production rather than physical sales reps. You're doing all these things as well, I presume.

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

Yes. I'm sorry for not going there. Yes. What we are doing is digital creation. So we have an interim creation of our products. We start with digital catalogs. So if you were to look upon and if you took a big U.S. partner of ours, when we do the sell-in of course, everything is through digital catalogs. And that, of course, you take not only time out of the equation, you also take the entire sampling out and sampling is a substantial amount. It's double-digit millions of samples in expense you have every year. So you take sample cost out and you put a completely different speed into the model. So the end-to-end digital element of it fundamentally changes the way we not only manufacture product or design products, bring design to factories, but also do sell-in to our wholesale community across the board. And if you -- by the way, if you go online right now, you look upon how we market our product in a 3D setup, how we get sizing much better through digital tools. So it's totally different now than it was 2 or 3 years ago. Look for the storytelling of Beyoncé in our website, totally different than we ever done.

[Operator]

The next question is from Ed Aubin of Morgan Stanley.

[Edouard Aubin, Head of Luxury Goods]

Just -- so 2 questions for me, one on DTC in the U.S. again and one on YEEZY. So your main competitor in the U.S. has announced, I guess, its intention to accelerate substantially it's move to DTC and rationalize its wholesale network. So how much oxygen will that provide to adidas in terms of shelf space in the U.S. going forward? And related to that, how do you intend to balance, as you just said, Kasper, potentially the increase in wholesale sales in the U.S. with your overall focus on the -- on DTC and better control of your distribution? The second question is on YEEZY. So, I guess, Kanye West signed an agreement with Gap over the summer? To what extent will that impact supply at adidas going forward? And I guess given Gap's lower price point in general, could that kind of cheapen the -- or impact the halo effect of YEEZY on the adidas foot range?

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

So I wouldn't call it shelf-space oxygen, I would call it shelf space. I think this is the fine terms to walk is -- I look upon relative or absolute terms, I think that with the winners of the brick-and-mortars, if you take the JDs of this world to mention one or more, of course, we want to continue to push our shelf space within these customers because they also have a digital business. And categorize them only as brick-and-mortar would be wrong. So, it's a mix between absolute and relative, of course, it will give us some opportunity. But I think that the big challenge is to restrain from going into the wholesale accounts that has a limited lifespan, and that is what we're doing at this stage, limiting ourselves, we're getting out of those.And we have probably, as aggressively as our competitor in the US, grown our D2C business. I don't think there's a lot of difference. Right now if I take the digital business into account from our wholesale partners, I think that we are very much neck to neck, if we are not leading. So, in this space, we can definitely measure ourselves against the best. But it's just being very, I would say, disciplined around which shelf space do you want, because if you go in and get tempted to take something that has a very short-term lifespan, it doesn't really help you. So, we're looking upon the absolute size of the D2C business and the relative size, and it's going to be mix of both.When it comes to the YEEZY brand, we have exclusivity for footwear. We actually have seen absolutely no impact or negative impact from the relationship that Kanye has with Gap. We are very happy that he is engaged in that relationship. It's a relationship between him and Gap. And our relationship with Kanye has been extremely successful this year and continue to be so. And there's absolutely no impact or crossover impact between the apparel and the footwear side.

[Sebastian Steffen, Senior Vice President of Investor Relations]

Hailey, we'll have time for 2 more questions.

[Operator]

The next question is from Warwick Okines of Exane BNP Paribas.

[Alexander Richard Edward Okines, Research Analyst]

I've got 2 questions. Actually, the first is also on wholesale accounts. In the slide deck, you mentioned the exit of nonstrategic wholesale accounts. Can you just give us some help to understand the pace or scale of this or how much your thinking has developed this year? And then, Kasper, back in August, you said you thought that you had the best product pipeline that you'd had for 3 years. Do you think you're seeing the benefits to brand HEAT from this yet? Or is it still too early to really see the benefits?

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

So on the first one, we'll give you a very clear indication when we meet in March and where we think our D2C business can go to -- as you can see, it's growing 10% points just this year, but we'll give you an indication where we believe that's going to be. I'm still very convinced about the quality of our products. We have 113 hype drops. I don't think that we are exploring our hype drops well enough because this is the amount of drops we have, I'm not -- I don't think we're seeing the full benefit of the products we have today. But right now, if you do a lineup, as I said, I still believe that we have the best product lineup for the last 3 years. And that is also when we go through the hype drops, either of those we already had in the third quarter of those we've have now in the fourth quarter. We have seen a higher oversubscription to hype drops than we've seen in the last 3 years, and that is, of course, substantiating my point. I don't think it's fully recognized at this stage. Also because I think the consumer right now is a more frequent consumer than we've seen in the past where the consumer tends to shop online and doing a lot of promotional shopping online. But I'm still very confident that we will get back into a very solid growth rate in 2021, not only because of the products we're carrying in and the pipeline that we have, but also because of the inventory positions and the prudence of our P&L and the balance sheet that we actually deal with.

[Operator]

The next question is from John Kernan of Cowen.

[John David Kernan, MD & Senior Research Analyst]

Yes. I just wanted to go back to the theme of sport and how do you think sport -- global sport in general is set up for 2021? And how you're positioned within the theme of sport and the recovery in team sports and also global professional sports as we go in -- through the year with the potential for the Olympics to be a major catalyst as well?

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

So my guess is as good as yours. There's no doubt that the sports fan is deeply frustrated because he or she can't go to the stadium, and that has an impact whether you sell t-shirts or hoodies or whatever you sell or merchandising around it. The highest likelihood is, and I'm speaking with as much or a little background noise as you do is, until we have a sustainable vaccine in place, you're going to have constraints of people going and getting access to stadiums. And if you go to the Euro or the Olympics, the participation of fans in stadiums will totally depend upon or solely depend upon the health and safety of that. So as soon as that comes back, of course, we're going to see a huge, I would say, push not only in engagement around the brand because that's where it really substantiated the brand, but of course, also the commercial opportunity. That's true for adidas, that's true for others. Until then, what you'll continue to see is people using our product in outdoor activities, so on safe environment. But of course, the big game changer is going to be to get the fans back into the stadiums outdoor, indoor and start enjoying sport in an environment with thousands and thousands of fans. And that's only going to happen, I believe, when you have a vaccine, and you could see what happened in the market yesterday when Pfizer gave the first signs of hope, and that seems to be materializing sometime next year. And in closing, my case is as good as yours when that's going to create a safe environment. But that's upside for us, by the way, if you look upon it. That's why we feel comfortable and get optimistic about 2021.

[John David Kernan, MD & Senior Research Analyst]

Certainly something I look forward to. And then maybe just one quick follow-up on the confidence of your wholesale partners as we head into Spring/Summer season 2021. In general, health and wellness was a category that won during COVID-19, I'm just wondering how the confidence of some of these wholesale partners rebuild their books for the first half of 2021, how that confidence is playing out?

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

Right now, very strong. I was in contact with our 5 of our largest customers over the last 4 days, very confident and strong, of course. Right now, from a financial standpoint, our bad debt position provisions were proven to be almost over prudent, and we see a very strong position from the Foot Lockers or the JDs of this world going in. Of course, they're impacted by the, I would say, temporary closedowns or lockdowns right now in Europe. But overall, the confidence level has been quite high.

[Sebastian Steffen, Senior Vice President of Investor Relations]

Thanks very much, John. Thanks very much, Kasper and Harm. Ladies and gentlemen, this concludes our Q3 results conference call. You've heard it from Kasper, and let me again remind you of our upcoming Investor and Media Day on March 10, 2021. Unfortunately, it looks like we will not be able to welcome you physically here on our campus in Herzo. Instead, we are planning to connect with you in a virtual way on that day, something that has worked quite well over the last couple of months. So please save this date and mark your calendars accordingly. A formal invitation will, of course, follow early next year. In that spirit, if you have any further questions today, tomorrow, next week or over the next couple of months, at least, don't hesitate to reach out to Adrian, Christophe or myself. And that leaves me again, thanking you for the participation, for your flexibility, saying bye-bye and most importantly, in these days, stay safe and take care. All the best. Bye-bye.

[Operator]

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.