Thanks very much, Levi, and good afternoon, ladies and gentlemen. Also a warm welcome from my side to our Q3 2017 results conference call. Our presenters today are our CEO, Kasper Rørsted, and our CFO, Harm Ohlmeyer. Before I will hand over to Kasper and Harm, I will, as always, quickly run through a couple of housekeeping items. Firstly, we have once again a record crowd joining our call today. I would ask you to really limit your questions to two, and also to those of you who are very innovative in asking questions, please stick to that. Thanks very much for that in advance. Secondly, as always, all figures that we will be talking about are currency neutral and will be discussed for our continued activities, unless otherwise stated. With that, I would say we kick it off and over to you, Kasper.
Thank you very much, Sebastian. You know the drill. I will start. Harm will take us through the financial details. We are in execution mode, as you know, executing our strategy. We made a number of progress. TaylorMade and CCM has been sold. The divestitures are now complete. That means from a portfolio standpoint, the only one we have spoken about besides this is our Reebok business that we are in the process of turning around. Our core leadership groups in our company has been established and are being activated. That is the top 20 and the top 120 leaders. Within this community, they are now fully aligned to executing the strategy.
We have also, as indicated or told on previous calls, put an LTI program in place, which is aligned to the targets that you know, aligned to the one KPI, which is EPS. The organization is in full execution mode to ensure that we hit our short and our long-term targets. Both of those have been communicated to you. The quarter was, in any quarter, described by a number of strengths and weaknesses. We continue to see excellent growth in North America and Greater China. The e-com continues to outperform any channel in all the regions. Globally, we saw very robust gross margin improvements reflecting the continued strong brand desire. We also saw strong profitability improvement in the third quarter. There were also areas that we were not as happy with. We saw slower growth in Western Europe due to market and retail slowdown down to 7%.
I would have to say that is still substantially above the overall GDP development and also reflecting a good growth development. Most of you have seen the U.S. basketball allegations. Let me just spend one second on this. While we had another strong quarter in the U.S. with excellent growth, we also are dealing with the basketball allegations. As soon as we learned about the allegations, we immediately, within 24 hours, put the relevant individuals on leave and engaged outside counsel to conduct a thorough investigation of our grassroots and college basketball. The investigation is still underway and will take some time. We are fully cooperating with the authorities. Based on the results, we will take whatever action might be necessary to strengthen our process. We do not expect the situation to have any short or long-term impact on our business.
Basketball makes up a very small percentage of our revenue. Globally, it's 1.7% of our revenue. In the U.S., it's less than 1% of our revenue. While the allegations are serious and we take them serious, we do not expect them to have any business impact. We continue to see a decline in our basketball and our football business, driven by the license decline due to terminations of sponsorship contracts, predominantly the NBA and the Chelsea contract. Our footwear business is growing, and we're still not seeing the limited operating or the operating leverage that we're aiming for. We're making the right decisions to allow that to take place, but it's still too early to see substantial impact on operating leverage. On the P&L developments, our revenue increased 12% on a currency neutral basis and 9% on a euro basis to EUR 5.7 billion.
It's the first time we've had an adidas quarter above EUR 5 billion, so I think it also speaks to the strength of the quarter. The gross margin went up 240 basis points to 50.4% due to more favorable pricing and product mix, and Harm will take you through that in more detail. Operating margin up 270 basis points to 14% margin, supported by an increase in gross margin and operating leverage. The net income from continued operations increased 35%. While we grew the top line 9%, normally we grew the bottom line 34%, a factor of four on the bottom line compared to the top line. The basic EPS increased up to 33%. The key growth areas are North America, Greater China and e-com, which have grown 31%, 28% and 39% respectively.
This is extremely important for us because we have been very consistent in communicating to you that the three most important markets for us globally are North America, which represents 37% of the total sporting goods market; Greater China, which currently represents around 20% of the sporting goods market, but it has a huge long-term opportunity; and the e-com channel, which is in our first nine months, growing more than 50% and is of strategic importance to us in order to create one-to-one relationships, but of course also has fundamental impact on driving our margin up. All three having a profound impact on our third quarter. The adidas brand grew 13%, double-digit growth, on top of 20% increase in the prior year. We saw, as I said, strong double-digit e-com growth in every single market, and our women's business continued to outperform with a strong double-digit sales growth.
Overall, a strong performance on the adidas brand. Sports performance increased 3% with a mixed picture. Running revenue up 16%, driven by 20% growth in footwear, which we're very satisfied with. Training sales grew 6%, reflecting double-digit growth in athletics apparel. The underperformance of the sports performance is predominantly coming from the apparel business, and it's going back to the NBA, the Chelsea, the Euro, and the Copa, which has had a negative impact on us throughout this year. However, let me be very clear on this. Despite what I mentioned here, we are still not happy with the underlying performance in apparel, and it will be an area, and it is an area of focus for us to ensure that we'll get a more satisfactory performance in the apparel area. We're not looking for any excuses in this area.
The Originals business and the Neo business continue to enjoy strong brand heat with a growth of 25%. Originals up 22%, driven by strong double-digit growth in all key regions. The modern franchises, and again, this is a continuation of what we also set for in the second quarter, grow more than 40% and now represent more than half of the Originals footwear business overall. I believe we are getting the balance right between "the older franchises" and the more modern franchises. The Neo business grows 30%, reflecting exceptional improvement in our footwear business. Overall, a continued strong growth of 25% followed a 42% growth in the same quarter last year, on very strong comparables. The Reebok business grew 1%, and let me just pause here for a second.
When we entered the year, and when we reported the first quarter, we were very clear that we would have an unbalanced growth profile of Reebok throughout the entire year. We had a strong growth in the first half, and we were clear in saying we expected a much more modest growth in the second half. We're dealing with two different strategic challenges. One is a growth challenge in the U.S., and an overall profitability challenge for our Reebok business. We have been addressing those very consistently throughout the year through our Muscle Up program. In the U.S., we're making progress on the store closures, which is driving the negative revenue growth number in the U.S. 52 stores will be closed in total, close to 50% of the U.S. stores. So far, we have closed 36 stores, and we have another approximately 15 stores to go.
6 will come in the fourth quarter and 10 in 2018. We expect Reebok North America to return to growth next year. We're satisfied with the progress we're making according to the Muscle Up plan. What we also did was, in order to drive our business in the future, we signed up with Victoria Beckham to unite and drive our women's business, which is a very important part of where Reebok comes from and the business in itself. The overall contribution for Reebok, we're satisfied with the progress we're making, and we're not surprised about the growth profile. It is purely down to the store closures we have in the U.S. With this, I'd like to hand over to Harm, who'll give you the financials in greater detail. Harm, please.
Thanks, Kasper, and good afternoon, ladies and gentlemen. When it comes to the financial highlights, I want to start with the ongoing momentum in the key regions. As Kasper indicated already, we are very satisfied with the momentum that continues in Greater China and North America, and I'm going into more details there in a minute, but I want to talk a little bit about Russia, the decline of 17%. As we indicated at the beginning of the year, we have a store rationalization happening in Russia. Given the sanctions, the overall environment in Russia, originally planned 150 stores to be closed. So far, we have actually closed 140 stores, and we are now estimating for the remainder of the year, we will add some other 60 stores to it. So roughly 200 stores, which is a little bit more than we originally had planned.
The reason for that is we are managing that market based on cash flow relevance, and we want to make sure that we are remaining significantly cash flow positive. That is the number one priority for us. If at any stage, the oil prices would move again or the sanctions are less than they are today, we will be well positioned in Russia to go back to different levels that we are seeing today. When it comes to Western Europe, currency neutral growth of 7%. This indicates growth in most of the key countries, and especially when it comes to the adidas brand, double-digit growth in Originals and Neo. Of course, what Kasper mentioned earlier, football and also the Euro and Chelsea is mainly impacting the European region. That's why we see some of the slower growth in that region.
The Reebok brand growing with 21% currency neutral, driven by running and classics. Also the gross margin, I'm still really happy about given the FX headwind of 120 basis points as being more than offset by pricing improvements. Here I want to be clear again, it's not that we are significantly increasing the prices, it's just that we are establishing different price points. So especially when it comes to Originals or football and running, we are getting to different price points. So as an UltraBoost or an UltraBOOST ATR, the All Terrain, or when it's an NMD or an EQT, we are just getting to different price points. That is a main driver of the gross margin improvements. Hence, also the bottom line, the operating margin, 180 basis points up, is definitely a testament of quality growth also in Western Europe.
When it comes to North America, there's exceptional momentum, especially with the adidas brand. Overall currency neutral growth of 23% in Q3, this comes on top of a 24% growth last year in the same quarter. That is despite the loss of the NBA. This is despite what we are all aware of, a very tough retail environment in the U.S. market. All categories, especially the key categories, running, training, Originals, and Neo are growing more than 20% in Q3. When it comes to the Reebok brand, we are down 22%, and as Kasper mentioned already earlier, we have closed already 40 stores or are in the process of closing 40 stores until the end of the year. There are 10 more to come in 2018.
I want to reiterate again, we are going into a growth pattern in 2018 again for Reebok in the North American market. When it comes to the margin improvements of 240 basis points, it's probably equally impacted as a percentage from both brands. When it comes to the operating margin being up 350 basis points, this is even over proportional impacted by the Reebok brand as a percentage. We are making, as Kasper said, despite the net sales challenges in the U.S. market, we are making good progress on the profitability of the Reebok brand without going into further details. When it comes to Greater China, we are continuing the excellent growth with the currency neutral increase of 28%, led by a 29% currency neutral increase of the adidas brand. This again, driven by training, running, Originals, and Neo.
Also on the Reebok brand, we are up by 9%, driven by training and running. The gross margin, this time slightly down in Q3 by 90 basis points. This again, affects headwinds impacting that. Given the significant growth that we have in Greater China, the team has been able again, to improve the operating margin by 120 basis points, now up to 35.8%. As always and as usual, I have to state that in the midterm, we are still expecting not to keep a level of 35%. I know even my predecessor said that many times, I just want to reiterate that again, that we don't get used to 35% for the foreseeable future. We are very, very pleased with our development in China in Q3. When it comes to Latin America, this is the one market where we continue to see challenges.
Currency neutral sales grew 8% in Q3. adidas slightly ahead of that 8% with 9%, with growth in running, Originals, and Neo. Reebok up 2%, also their growth in training and classics. The fundamental challenge that we have from an overall economic climate, also from a currency point of view, having significant headwind of 260 basis points in Latin America. It has been partly compensated also led to a decline in the operating margin by 100 basis points. We have done significant one-time effects also in some of these markets to get prepared for the future, we are definitely not happy with the operating margin of 13.6% in the quarter. That is definitely something that we are taking very seriously, not just in the first nine months, ongoing in the fourth quarter to get into a better space in 2018 and the years to come.
The highlight of the quarter is definitely the gross margin increase to 50.4%, I want to go in a little more details there. Still an FX headwind of 20 basis points. There's still a headwind from the input cost as well. I have to say the channel mix is pretty much a neutral one as we are growing significantly, especially in China with franchise doors and in the U.S. with wholesale and e-commerce just isn't significant or big enough to have a significant channel impact yet. It's more a neutral element. As I indicated earlier on Europe, it's really the pricing on establishing new price points that gives us the opportunity to show a 50.4% margin. Given the strength of the brand, we are definitely, without going into the details, improving our full price sell-through at all channels as well.
That is definitely contributing to the better margin. There's a slight element of healthier inventory in that margin as well as we are strictly managing our inventories based on our sell-through. This is all contributing to an overall uptick of 260 basis points and net of 240 basis points in the third quarter. This leads to the overall financial results. Again, a 9% increase nominal and 12% currency neutral comes on top of a 17% increase in Q3. I talk about Q4 later on. It's a significant growth over last year. When it comes to the margin, I just mentioned that. Let's focus a little more on operating expenses. Marketing investments grew year-over-year by 8% in absolute terms. As a percentage, it's slightly down by 10 basis points.
We will continue to invest into the brand, as we always said, not just in 2017, but also towards our 2020 guidance. That is definitely something you will see in Q4 to pick up to a different level of percentage over net sales. When it comes to the operating overheads, we are only down by 10 basis points. As I reiterate in every call, we are not happy with the leverage that we are seeing so far. We are still in an investment mode, as you mentioned, with One adidas to drive more standardization and digitization of this company, and to make this one company out of slightly 20 companies in the past.
There's still some investment needed. Especially in my area of responsibility when it comes to one ERP suite into the market, when it comes to standardizing processes, global business service and nontrade procurement. These are things that I'm personally overseeing and driving, not just in 2017, but continue to drive in 2018 to get then more benefits in the second half of 2018 and towards 2019 and 2020 out of these initiatives. Overall, despite the operating overheads that we are not happy about, we have been able to grow our operating profit by 35% and our net income by 35%, which is clearly a high-quality quarter for us. As Kasper indicated, if you grow the bottom line four times faster than the top line, that is definitely something that we give credit to our employees.
When it comes to inventories, there are a lot of numbers that we are reporting on continued operations, discontinued operations, nominal and currency neutral. I believe the most relevant numbers for all of you and for us is the currency neutral number of the continued operations. That's why I want to mention the 16% inventory growth that is indicative of what we plan ahead in the fourth quarter, given our order backlog and the growth in e-commerce and retail. We had a similar number in end of Q3 with 11% and delivering in the third quarter on that. That's reflecting the receivables for 17% up currency neutral and also payables. Overall, most importantly, reflecting the operating working capital average of 20.3%, another 100 basis points improvement compared to the same quarter a year ago.
That is definitely something we continue to drive quarter by quarter based on the seasonality. All right. With that, I would like to hand over to Kasper to explain a little bit the outlook before we go into the questions.
Thank you very much, Harm. Wrapping up this quarter and also speaking about the outlook, let me just remind everybody where we are. We are in the process of fundamentally changing our company through creating the new strategy and building a stronger adidas for the future, driven by a higher level of brand desire and with the following outlook. Getting the right balance between top line and market share growth, gross margin expansion, and operating leverage. We're trying to get that balance right to ensure that we're not looking for growth for the sake of growth, and we're not looking just for profit for the sake of profit. Getting that balance right to ensure that we get to the 2020 guidance, but of course, firstly, deliver upon our annual guidance.
That is what we are in the process of doing, well knowing that 2017 is an important year and 2018 will be equally important. We need to build the right progress throughout the years to come to ensure that we hit our targets for 2020. We expect the sales growth to accelerate in the fourth quarter, and we'll substantially invest in working in marketing activities to drive a number of areas, new launches, ensure that we have the appropriate sales out, but also support the World Cup that will take place in Russia next summer. That means we expect a tick up in growth for the fourth quarter compared to the third quarter. Our outlook for the full year, we're confirming, and that means a sales increase between 17% and 19%.
We expect on the sales increase to probably come in at the low end of the range of the net income within the range. I mentioned what I mentioned. We want to make sure that we get the right balance. The challenge we've had in the past was not so much getting the top line, but it was getting the right balance. I'm guiding you here as we'll probably come in at the low end of the sales range, but we have seen no issue or challenges in the income range. The takeaways from the third quarter was the ongoing momentum in our key growth areas continue, North America, China, and online. We're seeing strong profitability gains reflecting quality of our growth. The full-year outlook, we're confirming.
We're progressing against the 2017 targets that we've communicated and also the 2020 targets that we communicated to all of you earlier this year. We are having a relentless focus on executing on creating the new plan. On the upcoming events, on March 7th, we'll have the full year 2017 results, and we'll also have the full year 2018 outlook. Let me just reiterate what I said exactly a year ago, the guidance will be given in the year that we will be in. 2018 guidance will be given in 2018 and 2019 guidance in 2019. We stated that last year, and that is the way we'll progress. Don't expect any guidance for us today on 2018. You'll receive that guidance upon our full-year results on March 7th.
With this, I'd like to thank you for listening so far, we look forward to the question and answer session.
Thank you. If you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press *1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll take our first question from Fred Speirs with UBS.
Hey, good afternoon. Thanks for taking my question. First question was around the full-year sales guidance, which you've maintained but guide us towards the low end. I'm interested, how did Q3 compare to your initial expectations when you raised that guidance range? What were the main headwinds and disappointments that you hadn't expected? Looking forward to Q4, what are the main factors that you would highlight to drive the acceleration in Q4? Secondly, around Europe, it feels like there's been a bit of a slowdown in the market, and you said it also at retail. Feels like maybe it's becoming a bit more promotional. Just interested in some more detail around that. Which countries are driving that in particular? What's causing that? Are you seeing traffic shifting faster online? Thank you.
Let me start. On the third quarter, we came in at the lower part of our own expectation. There's really two different reasons for this. One was that in Europe, we came in at the low end, predominantly driven by a lower number from France. We saw slower demand in France than originally anticipated. In the U.S., we experienced execution challenges in our distribution structure simply because we have outgrown pretty much all our offices, systems, and structures, and we are addressing this urgently, we probably could have shipped more in the U.S. As you can see, our growth was, on the adidas side, 30%, we're not speaking about low growth.
These were probably the two most important parts that impacted the growth in the third quarter that drove it to the lower end of our expectation, which, of course, also is impacting our fourth quarter. At the same time, as I said, we believe we will be within the range for the lower part. On the fourth quarter, we believe we'll have a very strong quarter. You can see indicative of it will be, if you do what I call guerrilla mathematics, it's 20%-plus growth we expect in the fourth quarter. It's really down to a couple of things, which I mentioned. It's new product launches, it's our continued overall strong business, and it's also the sell-in for the World Cup, where we launched the jerseys this week for a number of countries, and we'll start seeing the impact in the fourth quarter of this year.
Of course, we didn't have that impact last year. That is the way we look upon it. France, a bit lower. The U.S., warehouse issue, simply we're struggling with the success. Fourth quarter, new launches and World Cup.
Just on top of France, any other sort of changes to call out in the European environment?
You have a Nike that continues to be exceptionally promotionally driven. I think you can see that in some of their numbers. I think that has been an ongoing development throughout the year. I think what we stated here was really the relevant ones.
Okay, thank you.
We'll take our next question from Geoff Lowery with Redburn.
Hi, team. Two questions, please. Can you help us understand the phasing of impacts from Chelsea and the NBA from here? Is this the peak quarter in terms of the sales impact of not continuing those relationships? How does it shape from here? Secondly, just picking up on the e-commerce point, clearly you're still growing very strongly, but it has slowed. Was that impacted by the warehousing issues in the U.S., or is a slower rate of growth logical from here?
Let me start with the last question, Harm will take the first. The first answer to your question on our growth rate, yes, of course, the U.S., not slowdown, but execution capability in the warehouse impacted it. I just want to be very consistent. What we're saying here is, if you look upon the guidance that we made back in March, it does indicate that over the coming years, we will not be able to maintain the same growth rate as we had in the past. Just to put it into perspective, if you do a forecast, we will come out, depending on currencies, around EUR 22 billion. Without TaylorMade and without CCM, two years ago, we were at EUR 16, we added EUR six billion to the top line. Continuing to grow with the same relative amount is not going to be realistic.
That was completely, I would say, incorporated in our guidance when we guided back in March. We still feel very comfortable with where we're coming out, and growing a EUR 20 billion company with approximately ±17% is still a, I would say, formidable challenge.
Not bad.
All right, Geoff. When it comes to the Chelsea and the Euro impact, I don't want to go into the details by quarter, what the absolute impact is, because then we get into the game of every quarter, explaining that again and also doing it next year again compared to what we missed this year. So in general, it is definitely the second and third quarter when it comes to Europe and when it comes to Chelsea and the Euro. Overall, we take responsibility what decisions we make and what's the impact on the top line. We care for quality growth, and we're not going to talk about it next year again.
Sure. Thank you.
We'll take our next question from Erinn Murphy with Piper Jaffray.
I had a couple of questions maybe focusing on the North American landscape. Clearly a lot of moving parts here with the competitive landscape. It's been a lot more promotional for some of your peers. I think you, Kasper, already addressed that a little bit. How concerned are you that this competitive landscape, kind of excess inventory, moving away from that pricing could start to encroach on your success in the upcoming quarters?
Of course, competitive behavior impacts overall the market. I think that that is one. Secondly is we will always be in a competitive market. There's no doubt. That it has been more driven by promotional activity than we've seen in the past. Despite that fact, we have now grown in the U.S., with adidas, approximately 30% every year. It does have an impact on the marketplace. There's no doubt that we have significantly gained market share if you look upon our growth rates and those of our competitors. If you look upon trying to get the balance right, we grow 30% and we took our margin up in the U.S. by 3.5 percentage points or 350 basis points. It's getting the right balance of not giving our products away because we're not in the business of giving products away.
Finding that balance. We still feel confident that the U.S. will be accreted to growth for the quarters to come. We still think that we have a long way to go in the U.S. Despite the fact that we've had three or three and a half good years in the U.S., we need to recognize that we are in catch-up mode, and we are not at a market share position that we're aiming at. I believe in previous calls, we have said a minimum market share in a large country should be around 15%, we're not there yet at that stage. I'm actually less concerned about it this stage. I think that we'll continue to have quite a lot of opportunity in the U.S. and penetrate the U.S. market further in the future and also gain market share.
Thank you. That's helpful. Just two follow-ups to that. Could you just walk through where you guys are at right now with % of the product that you sell on full price, particularly in North America, maybe where you were last year, just to help contextualize that? And then on Reebok, when you're done with the reset here in North America, what's the steady run rate of the business from a revenue perspective that we should be looking at for which you can then re-accelerate?
On the full price itself, we don't disclose that number, but it did improve compared to last year. On the question of Reebok, right now, we've been growing Reebok mid-single digits as a brand, and I would assume that in a steady state, that's at least what we should expect. I think that from a Reebok standpoint, in the past, we said we had 16 quarters of consistent growth, but we're not making any money.
Right.
We need to get Reebok to contribute to the value creation of our company. Clearly, that means having a meaningful bottom-line contribution, but also have a top-line contribution. We are not going to chase revenue in the U.S. for the sake of chasing revenue. Reversely, as we indicated, both Harm and I, we will return to revenue growth as our expectation next year, but you should think about it more in the single digits.
Thank you, guys.
Thanks, Erinn.
We'll take our next question from Jürgen Kolb with Kepler Cheuvreux.
Yes. Thank you very much. Just a quick one on the OpEx line. As you indicated that the leverage has not yet kicked in as you may have expected that, when would you expect the OpEx leverage to be a little bit more pronounced as you've discussed? Also on the gross margin development, obviously a very impressive development here. Maybe some expectations as to what you think could be or is doable if we take that a little bit forward. What are the levers that you think you can still work on in order to have the gross margin at this high level? Thank you.
Thanks, Jürgen. The first question on the OpEx line. Yes, even so, we don't see the leverage yet that we all wish to see in the future. There's probably two reasons for it. As I indicated earlier, we are significantly investing in still rolling out our ERP systems into the remaining markets. We are investing into setting up a more professional non-trade procurement team. We're also setting up to build global business services outside of our main locations. That's something we are still investing. By doing that, we are also shifting workforces, and that has some one-time cost. We also had to rationalize the business in Russia and in some of the Latin American markets. Whenever you rationalize or right size the business, you have some one-time effects. These are some one-time effects that we had both in Q2 and Q3.
That's why we don't see the full leverage. Again, these are one-time effects that we have this year and investment into the future of the leverage. There's one single goal that we have, and this is what I take personally on my responsibility also leading the IT team. We want and will build a more scalable business model in the future, and that's where the investments are going into, that we can drive more to the bottom line through the growth that we are experiencing on the top line.
Secondly, on the gross margin, yes, we are very happy where we are, I want to remind everyone again, as successful as we are in Q3 and with our guidance for the full year 2017, our hedging policy is also 18 months out, still nine months ago, we were talking about the risk of going to parity with the US dollar, that's why we continue to hedge and not take any bets. That's why there will not be a lot of tailwind in 2018. It will normalize, but not a lot of tailwind in 2018. 2019 will be a different story, I don't want to talk about it yet. I think we are optimizing the product portfolio. We're getting to the right price points. That's what we are seeing already today.
What we have not seen yet is significant impact of the channel shift because e-commerce is just not, from a size point of view, at the level where we want it to be. The channel impact is more coming towards 2019 and 2020. That's where we should see more benefits. We are very happy with the price points that we're achieving based on the sell-through at these price points as well, and with the discipline that we have from a margin point of view.
Very good. Thank you, guys.
We'll go to our next question from Antoine Belge with HSBC.
Yes. Hi, it's Antoine at HSBC. Three question, if I may. First of all, a bit similar to the question that was asked about the top line, but this time on margin. Were the margin actually above your expectation in Q3? Because not rising the margin guidance, and I know that Q4 is a small quarter, but you only need, I think, around EUR 50 million of EBIT to get there. In particular, in the gross margin, you already reached 50.1% over the first nine months, and I think selling jerseys has always been quite positive for the gross margin. In other words, are you actually sort of reinvesting part of that extra margin into OpEx to, first of all, not leave a bit more room for the outer years?
Second question is, I've noticed an increase in FOB, which is something a bit new, and what is causing exactly that? Here, I'm leaving aside any effects consideration. Finally, I think you had an interest comment about Reebok margin actually increasing even more than the adidas brand margin, and then also, to quote you, I think you said several quarters of not earning anything. Could you confirm that, for instance, in 2016, the EBIT margin of Reebok was between 0%-2% or at least very minimal, so that we can maybe better assess what's the potential going forward from a brand perspective? Thank you.
Let me start with the last question. Reebok was and is loss-making. We believe that that is not what we can be happy with, and we are confident that we can turn that around. On question number 1, I don't think it's appropriate if we change our guidance every quarter upwards or downwards. I think it's important that we hit our annual guidance, and we hit the long-term guidance. There are certain upsides in the fourth quarter, but there are also, as Harm very clearly alluded to, there's a number of investments that we need to make and we want to make, particularly in the brand, but also in other areas of the company to ensure that we build a scalable business model.
That is the way we look upon, we're trying to look upon in the long term, and we would like to become so predictable that we don't change guidance throughout the year. I don't think it's good if we were to do that, and that is also what we would try to strive towards. The annual guidance is the annual guidance. Of course, if there's upside, we'll reflect that, but only with one change. You shouldn't expect a change guidance for the fourth quarter. On the FOB side?
On the FOB, there's no surprise. It's impacting us through input cost, but primarily labor cost, and that's why our sourcing and global operations colleagues are doing their utmost to find the right sourcing base and moving it from China out to Vietnam, to Cambodia, to other places. With the magnitude that we are seeing, it's manageable given the price points that we're achieving right now, as you saw on the overall gross margin guidance. We should expect a continuation of FOB pressure for the years to come, and that needs to be managed, and so far it's being well managed.
Thank you. Maybe just a follow-up on Reebok margins. I understand that it was loss-making and is still. When you look at your 2020 margin target of around 11% for the group, what type of margin does it imply for Reebok at that horizon?
Positive.
All right. Thank you.
That's what you get, Antoine, if you ask more than two questions, right?
Sorry. I won't do it again.
Okay. Thank you.
We'll take our next question from Andreas Inderst with Macquarie.
First one, maybe you can give us a sneak preview for 2018, not necessarily when it comes to top line and bottom line. That's not what I'm expecting. Maybe in terms of product launches besides World Cup. That's my first question. The second question, you mentioned some bottlenecks for the U.S. market when it comes to distribution. How quickly can you actually sort these luxury issues out? Thank you.
Thank you for describing that out of the way, because we think it's a positive problem that we have in the U.S., and Harm will speak about that. I think it would be more appropriate that we discuss launches in 2018 for 2018. We believe we have a solid set of new products coming in, both new products but also products within our existing franchises. We feel comfortable that 2018 should be another year that contributes to the long-term strategy. Besides that, we don't really want to give details of product launches. Too early because, of course, that will then become public knowledge also to our competitors. As you can see, we're confirming our 2020 guidance, and 2018 is an important step for 2020. That will be a step in the right direction. On what you described as the luxury problem. Harm?
Just on the bottlenecks, as you described it, Andreas. First and foremost, Kasper and I have been in Portland just some months back, and all the employees were complaining about not having any parking spots. We said it's also a luxury problem because we are hiring a lot of people to drive the growth in the U.S. It's indeed a luxury problem. On a more serious note, it is a challenge for us the second year in a row with significant growth in the U.S., and we are seeing the warehouse capacity right now significantly impacting our e-com deliveries in the U.S.
It's not as fast as we wish it to be, and of course, it has a sentiment on the consumer and also the on-time and full to our key accounts is not to the level that we used to have in the previous years. That's something we are diligently working on. We are adding another capacity still this year in the U.S. that will ease that problem to some degree. That's a bigger infrastructure plan starting to come into fruition in 2018 and then 2019, which is ensuring a faster delivery to our digital consumers and definitely a more professional delivery to our key accounts and all the partners. Short term, there's some easing coming in November, December. Definitely more significantly it will be in 2018 and 2019 to have in 2019 then a full infrastructure in place again for our targets towards 2020.
Okay. Very good. Maybe one more question. Harm, you mentioned some one-offs in Russia and Latin America in the second and the third quarter this year. Could you quantify that, please?
I'm not going to quantify that, but the one-offs are in the retail closures, of course. Especially when it comes in Russia, when you close 200 stores, you will have an impact on the central administration in Russia as well and that was pretty significant. We are talking about significant workforce that we reduced in Russia. You saw our overall headcounts being below prior year. A similar thing after the World Cup 2014 in Brazil and then the Olympics. It didn't get to the expectations that we had from a top line and then we had to right size the Brazilian organization as well. It's about right sizing retail stores and right sizing the organization that is supporting a not as ambitious growth that we originally expected.
Maybe to add, and I think Harm said it very correctly. We will have quote, unquote, "one-offs every quarter." Because we have them every quarter, they're part of the business. I understand you're looking from the underlying. I'm just saying that there will never be a quarter where we don't have either a special income or a special expense. I think that's just the nature of the business and that's why we start specifying it. We start pulling an element out of the business, which is actually an ongoing element. Of course, we will always address our structures to the market capabilities upwards or downwards because that's the appropriate way of doing it.
I'd probably add to that. Despite the fact of the Chelsea and the Mitchell & Ness divestiture that we had in the second quarter, just assume these are pretty normal quarters that we have in Q2 and Q3 other than Chelsea and Mitchell & Ness and it is what it is. There will be always some one-offs up and down in there, but they're not significant in the overall scheme.
Okay. Thank you.
We'll take our next question from Chiara Battistini with J.P. Morgan.
Good morning. Hi. Thank you for taking my questions. I have two, promise. The first one is just a follow-up on Europe. As we go into next year and forward, should we assume that a high single-digit growth is actually more similar to what we've seen in Q3 is more sustainable going forward rather than a return to the double-digit that we've seen so far in Europe? The second question is on your CapEx guidance, which is up to EUR 1 billion but you've done 50% of that in the nine months. I was wondering what projects you have in Q4 to make up for the other 50%, please. Thank you.
Chiara, thank you for the question. Just to reiterate, we'll give 2018 guidance in 2018 and I think that's the right way of doing it. What we did said is, also in three quarters ago is that we will not be running at the 20% growth rates in the long term because that would then articulate a very different number in 2020. The actual guidance, including growth assumptions for 2018, we will give in March in 2018. Harm, on the CapEx.
Yeah, you definitely caught it right, Chiara. When it comes to the CapEx, similar to the non-existence of the operating overhead leverage, I'm also not happy with the discipline that we have on CapEx spending and similar to the infrastructure challenges that we have in the U.S. that I just talked about. Sometimes we wish we are speeding up some more investments to make decisions faster. That is still something we want to accelerate. With that being said, I also personally doubt that we spend another EUR 500 million in the fourth quarter. We definitely will be significantly below the EUR 1 billion number as CapEx spend for the full year.
Perfect. Maybe if I can just follow up on that then should we expect extra CapEx sort of in 2018. Well, I know you're not going to guide on 2018 but is it just a shift of spending for investments that were supposed to happen in 2017, in 2018?
No, as we said, you can expect roughly another EUR 1 billion in 2018. That's what we always said. 2017 and 2018 are the investment years, and then it's easing to the normalized levels of 3.5% to 4% in 2019 and 2020. Do not expect it significantly shifting in 2018. I would play around with the EUR 1 billion number then.
Okay. That's perfect. Thank you very much.
Thanks.
We'll take our next question from Omar Saad with Evercore.
Thanks for taking my question. I wanted to ask about the DTC comp, which I think decelerated a little bit from a plus 6 trend last quarter to a plus 3. Can you give any color around that regionally, the out-performers and under-performers or by category or Three Stripe versus Originals? Maybe what it would look like ex-Russia, too, because I think Russia is a pretty big DTC market. Details there would be great. Thanks.
Well, Omar, let me take the comps. As reported, we're definitely not happy with the comps that we're seeing, but there are 2 effects to it. One is if I exclude CIS, we have a significant right-sizing and again, the structural challenges that we have, we are getting more in the mid-single digit when it comes to the comp numbers. Secondly, as we indicated in the last call, we are doing a lot of renovation of our stores, and the comp basis is now roughly only 50% of the stores. The stores that we have renovated are actually comping better. Internally, we also look at a like-for-like number that is slightly more positive, and it's more indicative of what we do in retail. Again, we don't want to create a new KPI that we release externally. We want to stick to what we have on comp.
Otherwise, we go back next year again. That's really the direction that we see them.
Got it. Thank you. A follow-up in Europe. I'm wondering, adidas Originals was such a strong trend in Europe earlier than the rest of the world. I'm wondering if you're seeing any sort of shift in the product or style or fashion trends from the demand side in Europe, and if that's a leading indicator for other markets, or is it really just regional macro level issues in Europe? Thank you.
No, on a trend level, we're not seeing any change. It's simply just a sequential regional development on the macro side. There is no overall, I would say, trend change. The trend is still very much in favor of what we're doing. With the increased number of franchises we're bringing into the Originals part of the business, we believe we can also, I would argue, satisfy that demand in the future. You have a different overall macro picture in Europe than we have in certain other regions.
Thank you. That's very helpful color. Appreciate it.
Thank you.
We'll take our next question from John Kernan with Cowen. Sir, your line is open. Please check your mute button.
Can you hear me now, guys?
Yep, now we hear you.
Okay. Sorry about that. Thanks for taking my question. Just back to North America. The operating margin performance has been fantastic all year. You'll probably be at a double-digit segment operating margin this year. I'm just wondering, you haven't even seen the transactional benefits from FX yet that you may see next year. Just wondering how we should think about North American profitability as we head into the fourth quarter of this year, given the competitive environment. Thanks.
I can't really guide you on a fourth quarter operating margin. Of course, what we are doing is, and we've been clear on this, we expect a substantial improvement in North America towards 2020. We've also said that we believe that North America will be slightly dilutive to the overall margin by 2020. We are doing this, I would say, very diligently and carefully and not trying to jack up the margin too quickly because we've been there and done that with very bad results some years ago. It's more building sustainable, I would say, improvement over time. We expect an improvement, of course, a substantial improvement in 2017 compared to 2016. Somewhat in line with what you're seeing, but that's the only guidance I can give.
We want to make certain that we continue sequentially to improve the profitability of the U.S. That's where a big part of the profit that we need to deliver by 2020 is going to come from.
That's helpful. Thank you.
Similar to what I mentioned, I wish, Steven, as the CFO, that we would have invested a little faster in some of the distribution network and then have less leverage on the operating margin. It is what it is. Capturing market share is more important than expanding the operating margin at this stage.
Okay. Very helpful. Just one follow-up question on North America. Incredible 30%+ top-line growth for the adidas brand. How are you segmenting the adidas brand now in the digital space versus the brick-and-mortar wholesale channel, which is obviously seeing quite a bit of disruption? Obviously the adidas app is a big boost to the digital platform. Can you just talk about how you're going to segment the market between digital and then the brick-and-mortar wholesale channel in North America? Thank you.
Well, first and foremost, we're definitely prioritizing our online channel over other channels. There will be some limited early launches on .com as well when it comes to the key franchise that we are launching. That is in a limited way, but that's how we want to create exclusivity on .com and prioritizing it and getting consumers back to .com to drive the growth. Secondly, when it comes to the family footwear business, that's where we're segmenting clearly between Originals and then Core and Neo when it comes to family footwear. That Originals is more for the Foot Locker of this world and the premium fashion accounts. For the family footwear, it's more the Core offering, and that's how we're segmenting it in the physical retail.
Okay, thank you.
We'll go to our next question from Anna Andreeva with Oppenheimer.
Great. Thanks so much. Good afternoon, guys. A couple of questions from us. Following up on North America, did you, by any chance, quantify the missed sales opportunity as a result of the bottleneck? Also, what was the North America comp during the quarter, and how did growth in wholesale parse out between new versus existing distribution? Secondly, on supply chain, can you maybe remind us where you are currently in terms of speed-enabled production, and what are some of the initiatives to get to 50% target by 2020?
Well, let me start with the quantification. Similar to Chelsea or the EUR, we don't really want to quantify what we have missed in sales. Rest assured, given the challenges that we have in infrastructure, we could have shipped more, if we had had another warehouse. It is what it is. We're going to catch up, if not the next quarter, then in 2018. It is what it is, and got to deal with it.
Maybe just before I go to the speed initiatives, I can say, right now we have approximately 20%, and our aim is to take that at 50% and adding different product lines, from footwear into apparel. I really don't want to break down the initiatives, but we believe we are well on the way to ensure that we hit the task we have set ourselves, which will also deliver the margin that we need to get to. I do just want to go back on the North America point and just really stress where we are. We've had three exceptional years in the U.S. We have a positive problem right now on delivery. The reason why we have a delivery problem is, one, of continued exceptionally high demand, coupled with a very strong growth on e-com.
The e-com pushes a bigger stress on distribution than normal wholesale will do. With the change in strategy that we went through last year, with the increase focused on e-com, this is the consequence of it. We believe it's the right business decision. I do want to stress, this is a problem or a challenge that we are very happy to have instead of having the reverse challenge. I believe that we've acted in the right way because moving towards a more one-to-one relationship through digital, even though it does pose more stress into a distribution channel, is long-term the right solution.
With a growth rate of 30% or 31% in the third quarter, I still believe that we can be quite satisfied with the results that we have in the U.S., and also we believe that we can continue to serve the consumer in the appropriate way. That's why Harm said that we've outlined very quickly some short-term solutions, which we're in the process of implementing, and some medium or long-term solutions. We'll continue to be able to serve the market well. I wouldn't overemphasize what could have been done. I think that we are right now quite satisfied with the 31%, and if that meant we had one or two points on the table or in the field, so it might be, but it's still a very strong growth that we have.
Had we built, reversely, a very large infrastructure, then we would have had the margin problem, because then we would have carried different margins. Right now, we need to get this balance right. Overall, the market in the U.S. is a very low growth, if at all, and growing 31% with the adidas brand, we are very satisfied with, and we will take then the problems that come along.
That's very helpful. Appreciate it.
We'll take our next question from John Guy with MainFirst.
Yes, sir. Many thanks, Kasper and Harm. Two questions. Sticking with channel and potential channel volatility going into some markets, namely the North American market next year, especially with what Nike's doing in terms of trying to redefine the retail model and cutting out, as they call it, undifferentiated third parties. How do you see the North American market dealing with potentially a more promotional environment, even more so than what we already see on any incremental markdown, not just for maybe Nike brand, but also any of the other competitor brands? What sort of levers do you think that you can pull over the course of the next 6 to 12 months to mitigate that? I appreciate that you're really going for quality and not obviously quantity, which is what we've seen with the margin. That's my first question.
Let me start with it, Harm could help me answer. I think the best way of mitigating promotional activity is to bring cool products into the marketplace and invest in the brand. I think it sounds very simple, but that is really the core of what we're trying to do in full price and sell-through. Rather create scarcity in the market around certain franchises to ensure that it's going to happen instead of driving a promotional activity. I believe that that is detrimental to a brand if you, over a longer period of time, continue to drive sales through promotional activity. You will see us being careful. It doesn't mean that will never happen. I do believe that the quality of the top line is in the long term more important than driving top-line growth through promotional activity.
New launches, cool products, brand investment, and also in certain areas, scarcity of bringing products into the market. Reversely, I would say deliberately, undeliberately, I think that the scarcity on our Boost products potentially has been good for us, if you look upon it strategically, because it has maintained the Boost and the Ultra Boost products to be a very hot and desired product. When it comes to channel segmentation, Harm, you've been around longer than I have.
I really want to comment too much about what our competition is doing, but all the comments that I heard about a partnership with Amazon or redefining the third-party marketplace is definitely not something that is new, and I fundamentally believe it will not happen overnight. It is definitely a strategic direction, but especially when it comes to Amazon I think it's still more on a pilot or at a limited level. Also, given where we are in the U.S. market with some of the competition, I don't think it's a short term, next quarter or next half, a significant change. It's more strategic intent than anything else. As Kasper said, most importantly, we got to watch our sell-through.
We come up with good products and good marketing campaigns and continue the growth trajectory that we had the last three years, and that's what we are focusing on.
That's great. Thanks. My second question, just around hedging, Harm. Could you just remind us, please, in terms of where we are on hedging rates for this year, and if there's any move going into next year as well, but more importantly this year, just so I've got the hedging down. Bit of a housekeeper, I'm afraid.
Just as I mentioned earlier, our hedging policy is up to 18 months forward, we're not going to take any bets. What we have seen quarter by quarter are some unhedged positions in some markets, where we get benefits or we do get downsides. In the third quarter was more benefits in the unhedged positions. For 2018, clearly, don't expect any headwind, but also don't expect any tailwind given the positions that we have. Again, 2019 will then be a different story as we are entertaining, 160 or wherever we are today. That might be some tailwind then in 2019. 2018, expect that we are remaining where we are today.
You shouldn't see any benefit at all in the second half of 2018? I thought there'd be some.
Well, our hedging policy is we are never hedged 100%, right? You don't know where you're heading.
Yeah.
Depending on our growth rates, we're normally going towards an 80% hedge. There's a 20% variability or some markets where we're not going to hedge. Let's see. It's still far out, but the most relevant currencies, whether it's the pound or the US dollar, then towards the pound or the euro, that's where we are pretty much hedged, and there's not a lot of volatility to be expected, even the second half.
Okay. Thank you very much indeed.
Thanks very much. Levi, we have time for two more questions.
Thank you. We'll take our next question from Julian Easthope with Barclays.
Hi. Thank you. Just one question from me, good afternoon, everyone. You're predominantly still a wholesale business, 75%-80% wholesale. I just wondered if going into Q4, what percentage of the Q4 revenue within wholesale do you actually fully know? Also within that, what flexibility do the retailers have in terms of returns or you helping them out should they get into difficulty in the Q4? Just to sort of have an understanding as to how confident you are about doing the 20%+ growth into the Q4. Thank you.
Julian. Thanks for the question. First and foremost, the split is roughly, on a yearly basis, 75% wholesale, including franchise in China. Let's consider that being wholesale. Otherwise, we need to be more specific on wholesale and franchise. Including franchise in China, it's roughly 75%, then it's 25% D2C. That's a split that we have. It's not fundamentally changed in the fourth quarter, even though the fourth quarter is more a retail quarter for us and the sell-in for our partners happening more in Q3 for their Q4. Maybe it's slightly up but not significantly up in the fourth quarter. When it comes to returns, as we did in the past, we're working with our partners, but we don't have any specific returns policies or whatsoever. We are managing our working capital very tightly.
We are managing based on the sell-through in the marketplace, this is how we sell in based on the sell-through. That's how we manage. There's nothing specific to it, there are definitely no returns policies in the marketplace.
Okay. Of the 75% of wholesale, is that basically booked now to all intents and purposes at this late stage of the year? Or do the orders pattern still come through later on?
Well, for 2017, we definitely have all the orders in the books. There might be some replenishment still, but it's not significant. The end of the quarter is being determined by our direct-to-consumer business but not by our wholesale business. That is pretty much based on delivery. We have the orders. It's just a question how we are converting the orders. That's where things like bottlenecks in the U.S. warehouse come into the game. Even if you have the order, if you can't ship it, you still have the order in your books, and you're not going to ship it. That's really where we are.
Okay. Thank you very much.
We'll take our final question from Piral Dadhania with RBC Capital Markets.
Thanks a lot for taking my question. On a more high-level basis, Kasper, I think you mentioned basketball is only less than 2% of your global revenues now. Appreciate the NBA contracts rolled off, but when we look to North America and levers of future growth, outside of like for like, do you consider basketball to be an area which you would plan to rebuild on the medium-term view? How will apparel feature in your plans for 2018 given the two-year stack run rates for footwear become increasingly more difficult? Thank you.
Thank you for your question. Let me start with the apparel. As I said, I'm not going to give you any guidance for 2018, but I do want to say the following, which I did say during my part of the presentation, that despite the quote unquote, excuses, we're not happy with the performance. There's no doubt that we have to up the game and get a better balance of revenue growth coming from both footwear and apparel than we've done in the past. When we got into trouble in 2013, part of it was driven by a less attractive footwear franchise, and that's why we spent an enormous amount of energy
resources of building a very competitive footwear platform, which I think you will also grant that we've put in place now. Now we need to do the same of apparel and get a better platform than we have today, and I think that would be the appropriate way of answering without giving you 2018 guidance. Right now, it's an uneven growth contributor we're getting from footwear and apparel, despite the one-offs or all the impacts that we have this year. When it comes to the U.S., let me just, before I go to the basketball category, say that pretty much every country around the world where we're present and our big competitor is also present, we have more or less the same position. We're number 1 or they're number 1, it's a 1 or 2 position. In the U.S., it's a dramatically different position.
There's approximately EUR 9 billion of difference between us and our competitor, our neighbor, in the U.S. What I'm saying by that is there are still plenty of growth opportunities in the U.S. irrespective of market segment. That's number 1. Within the market segments that we currently occupy, where we're strong in like running or football or soccer, we also see opportunities for growth because we're coming from a growth profile in the U.S. that in the last couple of years has been more dominated, coming from the Originals side. Going into the traditional American sports, we need to come into those and be more successful than we've been in the past. Basketball definitely belongs to one of those areas of sport that we need to address in a more successful way. That's why it's good to see the growth we're having in our footwear business.
The apparel business is declining, which is NBA-related, but it's still a very minor part of our business. It's 1% of the U.S., so a blip in a quarter you wouldn't even see. We need to have a broader base than we have today. I think it's important that we do it step by step and build meaningful and relevant positions in each of the area of sport where we active in, instead of trying to boil the ocean. I hope that was a meaningful answer to your question.
Yeah. Great. No, it was just in the context of strong momentum in North America for the adidas brand, why not leverage that momentum in categories where you're under-penetrated, like basketball. Very clear. Thank you very much.
Completely agree with your saying that we think that that is one of the options we have, and we need to do that. Of course, with the James Harden signing, I think 18 month ago, that was a step in that direction. Clearly we've not achieved what we'd like to achieve in North America in basketball. Maybe before I hand over to Sebastian, let me just close the point. We'll exit 2017 with a very strong year. We upped the guides in August. It's a very important step in the right direction. Despite the fact that we might come into the low end of the 17%-19%, I would not get overly excited about it. I think that we're making substantial progress against what we're trying to do in the long term, both from a growth standpoint and from a margin expansion standpoint.
In order to do that, we have to build a scalable business model. We have to build a business where we continue to expand our market share position and continue to expand our margin and get into a landscape where we have a competitive margin. That is what we're doing, trying to do every quarter to ensure that we take one step at a time and eventually get away from what you have rightfully criticized us for, was a lower margin business. We, at the same time, also have to grow our market share in a meaningful way.
That is, I hope you can see that what we are striving to do this year, and that's why we'll continue to do what we are doing, deliver on the short term, but also make sure that we can make the appropriate investments so 2018 and 2019 also become good years. Sebastian.
Okay. Thanks very much, Kasper. Thanks very much as well to Harm. Ladies and gentlemen, this completes our conference call for today. As Kasper mentioned before, our next reporting day will be March 7th, 2018, for our 2017 full year results. That's actually also the point when we will provide you with our detailed 2018 guidance. We all look forward to speaking to and seeing many of you over the next couple of weeks and months. If in the meantime, you have any questions, as always, please don't hesitate to reach out to Christian, any other member of the team, or myself. We will always be happy to assist you. With that, I would also like to thank you for participating in our call today. Have a great day, and bye-bye.