Internal Management System

We are committed to generating shareholder value. We strive to create value by converting sales and profit growth into strong operating cash flow, while at the same time managing our asset base proactively. Our company’s planning and controlling system is therefore designed to provide a variety of tools to assess our current performance and to align future strategic and investment decisions to best utilize commercial and organizational opportunities in the interest of our shareholders. While this focus on creating shareholder value will remain, the launch of our new strategy ‘Own the Game’ for the period until 2025 will have an impact on the internal management system, which will be adjusted accordingly in the course of 2021. See Strategy

Impact of the covid-19 pandemic

In 2020, adidas faced serious challenges arising from the global outbreak of the coronavirus pandemic. Throughout the year, sports events were canceled, a significant number of stores were closed and many of our employees were confined to working from home. We saw a material decline in sales from our physical channels and a corresponding reduction in cash. This unprecedented situation led to a temporary adjustment of our internal management system and required a strong focus on the most important priorities:

  • Ensuring the health and safety of our employees, consumers, wholesale customers and partners.
  • Safeguarding the liquidity of our company through a strict focus on cash flows and financing activities.
  • Doubling down on our e-commerce business to drive net sales and cash generation in times of store closures and reduced retail traffic.

Internal management system designed to drive shareholder value

In order to drive and steer the creation of shareholder value, the company’s Management focuses on a set of major financial Key Performance Indicators (KPIs). Sales and operating profit growth, paired with a focus on management of operating working capital, are the main contributors to operating cash flow improvements. At the same time, value-enhancing capital expenditure benefits future operating profit and cash flow development. In addition, the development of the company’s net income from continued operations position as well as of earnings per share (EPS) is of high importance as it directly drives returns in the interest of our shareholders. Our strong focus on shareholder value creation is reflected in the fact that our Management’s variable compensation is closely linked to the company’s growth in sales, profitability and net income from continued operations. See Compensation Report

Operating margin as major KPI for operational progress

Operating margin (defined as operating profit as a percentage of net sales) is one of our company’s major KPIs to drive and improve our operational performance. It highlights the quality of our top line and operational efficiency. The primary drivers to enhance operating margin are as follows:

  • Sales and gross margin development: Management focuses on identifying and exploiting growth opportunities that not only provide for future top-line improvements, but also have potential to increase our gross margin. Major levers for enhancing our sales and gross margin include:
    • Planning pricing and clearance activities according to market realities.
    • Optimizing our product and channel mix.
    • Improving the quality of distribution, with a particular focus on our direct-to-consumer business.
  • Operating expense control: Management puts high emphasis on tightly controlling operating expenses to leverage sales growth through to the bottom line. This requires a particular focus on ensuring flexibility in the company’s cost base. This flexibility helped us in managing through the covid-19 pandemic in 2020, where we adopted a disciplined approach to both marketing and . More broadly, is one of our largest operating expenses and at the same time one of the most important mechanisms for driving brand desirability and top-line growth sustainably. Therefore, we are committed to improving the efficiency of our marketing investments. This includes concentrating our communication efforts on key global brand initiatives and focusing our promotion spend on well-selected partnerships with top events, leagues, clubs, federations, athletes, and artists. We also aim to increase operational efficiency by tightly managing operating overhead expenses. In this respect, we regularly review our operational structure – harmonizing business processes, standardizing systems, eliminating redundancies, and leveraging the scale of our organization.

Tight cash flow and operating working capital management

In 2020, with at times a large portion of our own as well as our wholesale customers’ store fleet closed, a clear focus on liquidity, cash flow and operating working capital was even more important compared to a normal business environment. This required a close monitoring of the cash and working capital situation and disciplined execution of mitigation measures to manage the company through the crisis. Generally, due to a comparatively low level of fixed assets required in our business, the efficiency of the balance sheet depends to a large degree on our operating working capital management. Operating working capital comprises accounts receivable plus inventories minus accounts payable. See Statement of Financial Position and Statement of Cash Flows

In this context, our key metric is average operating working capital as a percentage of net sales. Monitoring the development of this metric facilitates the measurement of our progress in improving the efficiency of our business cycle.

We strive to proactively manage our inventory levels to meet market demand and ensure fast replenishment. Inventory aging is controlled carefully to reduce inventory obsolescence and to minimize clearance activities. As a result, Inventory Days Lasting (IDL) is monitored and assessed regularly as it measures the average number of days goods remain in inventory before being sold, highlighting the efficiency of capital locked up in products. To optimize capital tied up in accounts receivable, we strive to improve collection efforts in order to reduce the Days of Sales Outstanding (DSO) and improve the aging of accounts receivable. Likewise, we strive to optimize payment terms with our suppliers to best manage our accounts payable.

Capital expenditure targeted to maximize future returns

Improving the effectiveness of capital expenditure is another major lever to maximize our operating cash flow. We control capital expenditure with a top-down, bottom-up approach. In a first step, Management defines focus areas within the framework of our strategy and an overall investment budget based on investment requests from various functions within the organization. Then, in a second step, our operating segments align their initiatives within the scope of assigned priorities and available budget. We evaluate potential return on planned investments utilizing the net present value method. Risk is accounted for, adding a risk premium to the cost of capital, and thus reducing our estimated future earnings streams where appropriate. By means of scenario planning, the sensitivity of investment returns is tested against changes in initial assumptions. For large investment projects, timelines and deviations versus budget are monitored on a monthly basis throughout the course of the project. In addition to optimizing return on investments, we evaluate larger projects upon completion and document learnings for future capital expenditure decisions.

Focus on net income in the interest of our shareholders

Beyond our ambition to maximize operating cash flow, we are committed to a continuous improvement in the company’s bottom line. Management closely monitors the development of both net income from continued operations and earnings per share (EPS) and executes against these two KPIs. Our strong focus on driving sustainable expansion to the company’s bottom line is also reflected in the fact that, as part of the Long-Term Incentive Plan 2018/2020, the variable compensation for our Management is directly linked to the growth of the company’s net income from continued operations.

Non-financial key performance indicators

In addition to the major financial KPIs to assess the performance and operational success of our company, as outlined above, we have identified a set of non-financial KPIs that help us track our progress in areas that are critical for our long-term success but are not directly reflected in the financial statements. These non-financial KPIs are assessed on a regular basis and managed by the respective business functions. Non-financial KPIs which we are closely monitoring include, among others, market share, backlogs and sell-through data as well as our customer delivery performance (On-Time In-Full), employee engagement and a set of KPIs in the area of our sustainability performance.

Net Promoter Score (NPS): Maintaining and enhancing brand desirability through the creation of strong brand identities is crucial for sustaining and driving profitable growth. Therefore, mainly on a market and category level, we invest in primary qualitative and quantitative research such as trend scouting and consumer surveys to determine brand loyalty and brand strength. Measures that are tracked include brand awareness, likeability, and purchase intent.

Furthermore, within the framework of ‘Creating the New’, we have implemented an NPS system, which strengthened our capabilities to more carefully review brand advocacy as NPS tells us how likely it is that consumers will recommend our brands. Our efforts around NPS (both our own NPS as well as the NPS of our major competitors) are driven by an independent agency and monitored by our internal global consumer insights teams on a regular basis. In addition, NPS is measured across many of our own-retail stores as well as our own e-commerce platform.

Given the exceptional circumstances in 2020, NPS has only served as a KPI until the end of the first quarter. Amid a global pandemic and with a new strategic cycle ahead, the company decided to stop gathering NPS data through our external provider.

Market share: To measure the operational performance of our brands relative to our major competitors, we continuously collect, on a market and category level, market share data. The findings provide detailed insights for our senior management team regarding in which markets and categories we have been able to gain market share relative to our peers, enabling us to leverage those insights across the organization. In addition, the results help us to define clear roles and responsibilities for each of our markets and categories within our long-term strategic aspirations, based on their overall positioning within the sporting goods industry. See Management Assessment, AND OUTLOOK

Backlogs and sell-through data: To manage demand planning and better anticipate our future performance, backlogs comprising orders received up to nine months in advance of the actual sale are monitored closely. However, due to the growing share of own retail (including our own e-commerce channel) in our business mix, fluctuating order patterns among our customers as well as an increasing part of our business being realized under significantly shortened lead times, orders received from our retail partners are less indicative of anticipated revenues for adidas compared to the past. Therefore, qualitative feedback from our retail partners on the sell-through success of our products at the point of sale as well as such data received from our own-retail activities is becoming increasingly important.

On-Time In-Full (OTIF): OTIF measures the company’s delivery performance toward customers and our own-retail stores. Managed by our Global Operations function, OTIF assesses to what degree customers received what they ordered and if they received it on time. It helps us to investigate improvement potential in the area of order book management and logistics processes. It therefore also helps us to improve our delivery performance, which is a major aspect when it comes to customer satisfaction. The OTIF assessment covers most of our key markets. See Global Operations

Employee engagement: To measure the level of engagement and motivation of our employees, adidas carries out employee engagement surveys. These surveys aim to provide key insights into how well we, as an employer, are doing in engaging our employees. They thus enable us to develop the right focus and future people strategies across our organization, helping us to create a world-class employee experience and continue to attract and retain top talent. See Our People

Sustainability performance: We have a strong commitment to enhance the social and environmental performance of our company. By doing so, we firmly believe we will not only improve the company’s overall reputation, but also increase its economic value. We therefore follow a comprehensive roadmap with clear targets and regularly track our progress toward these targets. A major focus lies on measuring the environmental footprint of our own sites globally as well as monitoring and rating our supplier factories with regard to social and environmental compliance with our Workplace Standards. We have a strong track record in sustainability disclosure, providing regular updates about our sustainability performance in this Annual Report as well as on our corporate website. See Management Assessment, AND OUTLOOK See Sustainability ADIDAS-GROUP.COM/S/SUSTAINABILITY-REPORTS

Structured performance measurement system

We have developed an extensive performance measurement system, which utilizes a variety of tools to measure the company’s performance. Key performance indicators as well as other important financial metrics are regularly monitored and compared against initial targets as well as rolling forecasts on a monthly basis. When negative deviations exist between actual and target numbers, we perform a detailed analysis to identify and address the cause. If necessary, action plans are implemented to optimize the development of our operating performance. To assess current sales and profitability development, Management continuously analyzes the performance of our operating segments. We also benchmark our financial results with those of our major competitors on a regular basis.

Taking into account year-to-date performance as well as opportunities and risks, the company’s expected full-year financial performance is assessed on a monthly basis. In this respect, backlogs and sell-through data as well as feedback from customers and own-retail stores are also assessed where available. Finally, as a further early indicator for future performance, the results of any relevant recent market and consumer research are assessed as available.

In view of the covid-19 pandemic, the situation required that we adjusted to the greater information needs of senior management within this time of uncertainty through e.g. more frequent forecasts to ensure the quality of decision making. In 2020 overall, our performance management system has proven to be effective.

Operating overhead expenses

Expenses which are not directly attributable to the products or services sold, such as distribution and selling as well as general and administration costs, but not including marketing and point-of-sale expenses.

Marketing expenditure

Expenditure that relates to point-of-sale and marketing investments. While point-of-sale investments include expenses for advertising and promotion initiatives at the point of sale as well as store fittings and furniture, marketing investments relate to sponsorship contracts with teams and individual athletes as well as to advertising, events and other communication activities. Marketing overhead expenses are not included in marketing expenditure.

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