Risk and Opportunity Report

The adidas Group continuously explores and develops opportunities to sustain and maximize earnings and also to drive long-term increases in shareholder value. In doing so, we acknowledge that it is necessary to take certain risks to maximize business opportunities. Our risk and opportunity management principles provide the framework for our Group to conduct business in a well-controlled environment.

RISK AND OPPORTUNITY MANAGEMENT PRINCIPLES
The adidas Group is regularly confronted with risks and opportunities which have the potential to negatively or positively impact the Group’s asset value, earnings, cash flow strength, or intangible values such as brand image. We have summarized the most important of these risks and opportunities in this report in three main categories: External and Industry, Strategic and Operational, and Financial.

We define risk as the potential occurrence of external or internal events that may negatively impact our ability to achieve short-term goals or long-term strategies. Risks also include lost or poorly utilized opportunities.

Opportunities are broadly defined as internal and external strategic and operational developments that have the potential to positively impact the Group if properly exploited.

RISK AND OPPORTUNITY MANAGEMENT SYSTEM
To facilitate effective management, we have implemented an integrated management system which focuses on the identification, assessment, treatment, controlling and reporting of risks and opportunities. The key objective of this system is to protect and further grow shareholder value through an opportunity-focused, but risk-aware decision-making framework.

We believe that risk and opportunity management is optimized when risks, risk-compensating measures and opportunities are identified and assessed where they arise, in conjunction with a concerted approach to controlling, aggregating and reporting. Therefore, risk and opportunity management is a Group-wide activity, which utilizes critical day-to-day management insight from local and regional business units. Support and strategic direction is provided by brand and global functions. Centralized risk management is responsible for the alignment of various corporate functions in the risk and opportunity management process and coordinates the involvement of the Executive and Supervisory Boards as necessary. Centralized risk management is also responsible for providing line management with relevant tools and know-how to aggregate and control risks and opportunities utilizing a consistent methodology.

ADIDAS GROUP RISK AND OPPORTUNITY MANAGEMENT SYSTEM

Of significant importance is our Group’s Risk Management Manual, which is available to all Group employees online. The manual outlines the principles, processes, tools, risk areas and key responsibilities within our Group. It also defines reporting requirements and communication timelines. Our Group supplements this top-down, bottom-up approach to risk and opportunity management by employing our Global Internal Audit department to independently assess and appraise operational and internal controls throughout the Group.

The main components of our risk and opportunity management process are:

Risk and opportunity identification: The adidas Group continuously monitors the macroeconomic environment, developments in the sporting goods industry, as well as internal processes to identify risks and opportunities as early as possible. Local and regional business units have primary responsibility for the identification and management of risk and opportunities. Central risk management has defined a catalog of potential risks and opportunities for our Group to assist in the identification process. In addition to the potential financial impacts from changes in the overall macroeconomic, political and social landscape, each business unit actively monitors brand, distribution channel and price point developments in our core sport, leisure lifestyle and sport fusion markets. A key element of the identification process is primary qualitative and quantitative research such as trend scouting, consumer surveys and feedback from our business partners and controlled space network. These efforts are supported by global market research and competitor analysis. Here, secondary material such as NPD Sports Tracking Europe or SportsScan-Info market research data is analyzed and global relationships with independent trend and media agencies such as QRC, ICON Added Value and Trendwatching.com are maintained. Through this process we seek to identify the markets, categories, consumer target groups and product styles which show most potential for future growth at a local, regional and global level. Equally, our analysis focuses on those areas that are at risk of saturation, increased competition or changing consumer tastes.

Risk and opportunity assessment: Identified risks and opportunities are assessed with respect to (1) occurrence probability, and (2) the potential contribution loss or profit, with contribution being defined as operating profit before intra-Group royalties. The occurrence probability of individual risks and opportunities is evaluated on a scale of 0 to 100 % likelihood. In this report, we summarize these findings by utilizing “high”, “medium” or “low” classifications to represent an aggregate likelihood for various risk and opportunity categories. As risks and opportunities have different characteristics, we have defined separate methodologies for assessing the potential financial impact. With respect to risks, the extent of potential loss is measured on a case-by-case basis as the contribution deviation from the most recent forecast under the assumption that the risk fully materializes. This calculation also reflects the effects from risk-compensating measures. In assessing the potential contribution from opportunities, each opportunity is appraised with respect to viability, commerciality, potential risks and the expected profit contribution. This approach is applied to both longer-term strategic prospects but also shorter-term tactical and opportunistic initiatives at both the Group and, more extensively, the brand level.

Risk and opportunity treatment: Risks and opportunities are treated in accordance with the Group’s risk and opportunity management principles and the Risk Management Manual. Line management in cooperation with central risk management and, in exceptional cases, the Executive Board and / or Supervisory Board, decides which individual risks we accept or avoid and those opportunities to pursue or forgo. As part of this process, we also decide on which risk-compensating or transfer measures will be implemented. Similarly, to maximize opportunities, it may be necessary to reduce or limit distribution to protect prices and margins or prolong product lifecycles. In some cases, we also seek to transfer the responsibility or execution for certain risks and opportunities to third parties (e. g. insurance, outsourcing, distribution agreements or brand sub-licensing).

Risk and opportunity monitoring and controlling: A primary objective of our integrated risk and opportunity management system is to increase the transparency of Group risks and opportunities. In addition, we also seek to measure the success of our risk-compensating initiatives. The Group centrally monitors each of these efforts on a frequent basis. In particular, central risk management regularly examines the results of actions taken by operational management to accept, avoid, reduce or transfer risks over time. With respect to opportunities, we regularly monitor the objectives and key performance indicators established during the initial identification and evaluation process. This not only facilitates the validation of opportunities but also allows us to adapt and refine our products, communication and distribution strategy to ongoing developments in our rapidly changing marketplace. In particular, we collaborate with our manufacturing partners and retail customers to evaluate the impact of our growth and efficiency initiatives. Feedback is relayed in a timely manner to product, marketing and controlling functions.

Risk and opportunity aggregation and reporting: Central risk management aggregates Group-wide risks and reports them to the Executive Board on a regular basis. Individual risks are aggregated based on the sum of all assessed risks (sum of occurrence likelihood × potential net loss), taking correlations between individual risks into account. Risks with a likely impact of at least € 1 million on the forecasted full-year contribution are reported to central risk management on a monthly basis. In addition, risks with a likely financial impact of € 5 million or more are required to be reported immediately upon identification to central risk management. Opportunities are aggregated separately as part of the strategic business planning, budgeting and forecasting processes. The realization of risks and opportunities can have a critical impact on our ability to achieve our strategic objectives. Therefore, Management is updated in regular business reviews, but also through ad hoc discussions as appropriate.

CORPORATE RISKS OVERVIEW 

EXTERNAL AND INDUSTRY RISKS

MACROECONOMIC RISKS
Growth of the sporting goods industry is influenced by consumer confidence and consumer spending. Abrupt economic downturns, in particular in regions where the Group is highly represented, therefore pose a significant short-term risk to sales development. To mitigate this risk, the Group strives to balance sales across key global regions and also between developed and emerging markets. In addition, a core element of our performance positioning is the utilization of an extensive global event and partnership portfolio where demand is more predictable and less sensitive to macroeconomic influence.

In 2008, the Group expects global and, in particular, North American economic growth to slow.  see Outlook Similarly, the risk of macroeconomic shocks has increased versus 2007. However, economic expansion in emerging markets, including China, Russia and India, is expected to continue. These markets have overtaken North America and the European Union as the largest contributors to Group revenue growth. Nevertheless, we now assess the likelihood that adverse macroeconomic events could impact our business as medium. The materialization of such events could have a medium negative financial impact on our Group.

CONSUMER DEMAND RISKS
Failure to anticipate and respond to changes in consumer demand is one of the most serious threats to our industry. Consumer demand changes can be sudden and unexpected. Because industry product procurement cycles average 12 to 18 months, the Group faces a risk of short-term revenue loss in cases where it is unable to respond quickly to such changes. Even more critical, however, is the risk of continuously overlooking a new consumer trend or failing to acknowledge its potential magnitude over a sustained period of time.

To mitigate this risk, continually identifying and responding to consumer demand shifts as early as possible is a key responsibility of our brands. In this respect, we utilize extensive primary and secondary research tools as outlined in our risk and opportunity identification process. 

As a leader in our industry, our core brand strategies continue to be focused on influencing rather than reacting to the changing consumer environment. We invest significant resources in research and development to innovate and bring fresh new technologies and designs to market.  see Research and Development In addition, we also seek to create consumer demand for our brands and brand initiatives through extensive marketing, product and brand communication programs. And, we continue to focus on supply chain improvements to speed up concept-to-shelf timelines.  see Global Operations In 2007, we implemented new consumer segmentation strategies at both brand adidas and Reebok and combined Group resources for market research and competitor research. In addition, we increased and focused our marketing working budget spend at Reebok, in line with the future positioning of the brand. We plan further initiatives in this respect in 2008.

Given the broad spectrum of our Group’s product offering, retailer feedback, visibility provided through our order backlogs and other early indicators,  see Internal Group Management System we view the overall risk from consumer demand shifts as unchanged versus the prior year. Changes in consumer demand continue to have a medium likelihood of occurrence and could have a potential medium impact on our Group.

INDUSTRY CONSOLIDATION RISKS
The adidas Group is exposed to risks from market consolidation and strategic alliances amongst competitors and/or retailers. This can result in a reduction of our bargaining power, or harmful competitive behavior such as price wars. Abnormal product discounting and reduced shelf space availability from retailers is the most common outcome of these risks. Sustained promotional pressure in one of the Group’s key markets could threaten the Group’s sales and profitability development.

To moderate this risk, we are committed to maintaining a regionally balanced sales mix and continually adapting the Group’s distribution strategy. In 2007, we employed this strategy by instigating a new adidas distribution policy in the UK. In this market, several years of retail consolidation had led to inadequate product presentation among retailers. As a result, we now offer our top product range to retailers who satisfy more stringent trade policy requirements concerning, for example, the display of product and training of staff. Although this strategy had a short-term negative impact on sales, it significantly improved the brand’s attractiveness to consumers at point-of-sale and led to a strong sales improvement in the fourth quarter of 2007.

Despite a more challenging merger and acquisition environment due to credit market difficulties, we continue to expect further consolidation activity among our competitors and retail partners. This is a result of the strong balance sheets and solid free cash flows within our industry. Therefore, we continue to see risks from market consolidation as having a medium likelihood and a medium potential impact on both Group sales and profitability.

POLITICAL AND REGULATORY RISKS
Political and regulatory risk includes potential losses from expropriation, nationalization, civil unrest, terrorism and significant changes to trade policies. In particular, the adidas Group faces risks arising from sudden increases of import restrictions, import tariffs and duties that could compromise the free flow of goods within the Group and from suppliers. To limit these risks, we utilize a regionally diversified supplier base which allows us to shift production to other countries at an early stage if necessary.  see Global Operations

In 2008, we do not foresee major changes to current trade policies that would have a major adverse effect on our Group. The Memorandum of Understanding between the EU and China which enforced quotas on certain apparel categories expired at the end of 2007. We regard the likelihood of a reintroduction of quotas as low because both parties have agreed on other control mechanisms to manage export growth into the EU. The current apparel quota system between the USA and China remains in place throughout 2008. In October 2008, the European Commission will review its anti-dumping measures on leather shoes imported from countries excluding China and Vietnam. However, we anticipate exceptions for technical athletic footwear, which represents the majority of our footwear product offering, to be maintained with only minor adaptations. Nonetheless, due to the proactive regional diversification of our sourcing portfolio, any unforeseen changes in the new EU legislation would likely have a very minor financial effect on our Group. Similarly, we continue to regard the medium-term risk of further political and regulatory actions as having a low probability of occurrence. However, an unexpected significant change in the political or regulatory environment could have a medium potential financial impact.

LEGAL RISKS
The adidas Group is exposed to the risk of claims and litigation for infringement of third party trademark, patent and other rights. To reduce this risk, new product technologies, designs and names are carefully researched to identify and avoid potential conflicts with the rights of third parties. In February 2006, a major competitor sued the adidas Group for an alleged infringement of patent rights regarding a range of footwear models. This litigation was settled amicably in 2007. Also in 2007, several suppliers and retailers in the athletic footwear industry, including the adidas Group, were sued for infringement of two patents relating to footwear designs. The adidas Group is vigorously contesting the claims in this litigation. We have also strengthened our Intellectual Property department resources to drive further enhancements in our patent portfolio, and in the reviewing and analysis of third party patents.

Due to the safeguards in place, we believe there is a low likelihood of our Group infringing third party trademark or patent rights in a material way. Nevertheless, we continue to believe that litigation could have a medium financial impact on our Group.

RISKS FROM PRODUCT COUNTERFEITING
As popular consumer brands which rely on technological and design innovation as defining characteristics, the Group’s brands are a frequent target for counterfeiting and imitation. Over seven million counterfeit adidas Group products were seized worldwide in 2007 (2006: more than six million). To reduce the loss of sales and the potential reputation damage resulting from counterfeit products sold under our brand names, the adidas Group makes use of extensive legal protection (generally through registration) and works closely with law enforcement authorities, investigators and outside counsel. Although we have stepped up measures such as product security labeling with our authorized suppliers, continued development of these measures remains a high priority for 2008 and beyond.

We regard the likelihood of sustained counterfeiting as high in the short and medium term. However, we believe we have adequate costs budgeted to support our ongoing efforts to successfully combat counterfeiting. We continue to assess the potential risk of counterfeiting to negatively impact our forecasted financial contribution as low.

SOCIAL AND ENVIRONMENTAL RISKS
We have a continuing responsibility to our workers, suppliers and the environment. Malpractice in these areas, in particular human rights violations and dubious employment practices, can have a significant impact on the reputation and operational efficiency of our Group and our suppliers. To limit this risk, we have established workplace standards to which suppliers must conform before and during business relationships with the Group.  see Sustainability Internal inspections of supplier factories verified by extensive independent audits are conducted regularly. In the event of non-compliance with these standards, we develop joint action plans and set deadlines for compliance and further improvement. When these deadlines are not met, business relations are terminated.  see Sustainability, and
 www.adidas-Group.com/sustainability

We expect to further strengthen our supplier monitoring program in 2008. As a result, we continue to regard the risk of social and environmental malpractice as likely in only isolated cases and we believe the potential financial impact is low.

NATURAL RISKS
The adidas Group is exposed to external risks such as natural disasters, epidemics, fire and accidents. Further, physical damage to our own or our suppliers’ premises, production units, warehouses and stock in transit can lead to property damage and business interruption. These risks are mitigated by ample loss prevention measures such as working with reliable suppliers and logistics providers who guarantee high safety standards and disaster recovery plans. In addition to the considerable insurance coverage we have secured, the Group has also implemented contingency plans to minimize potential negative effects.

Our overall assessment of this risk is unchanged versus the prior year. As a result, we believe the likelihood of natural risks is low and expect only minor financial loss after insurance compensation should natural risks materialize. 

STRATEGIC AND OPERATIONAL RISKS

PORTFOLIO INTEGRATION RISKS
The adidas Group is exposed to risks related to the integration of newly acquired businesses. In our ongoing initiatives to integrate the Reebok brand, we face a risk of overestimating potential revenue and cost synergies as well as organizational execution risks. Organizational execution risks relate, for example, to the standardization of functional business processes across the different brands and harmonization of the Group’s IT systems. To mitigate these risks, we implemented a dedicated controlling function in 2006 to continuously oversee our integration activities.

The realization of the projected revenue and cost synergies in 2007, as well as internal transparency on 2008 initiatives, supports our confidence in achieving our medium-term synergy targets.  see Outlook We therefore believe there continues to be a low likelihood of portfolio integration risk occurrence. Due to the magnitude of projected synergies, however, we still regard the potential financial impact of these risks as high.

RISKS FROM LOSS OF BRAND IMAGE
Maintaining and enhancing brand image and reputation through the creation of strong brand identities is crucial for sustaining and driving revenue and profit growth. It is also an important credential as we extend our brands into new categories and regions. The adidas Group faces considerable risk if we are unable to uphold high levels of consumer awareness, affiliation and purchase intent for our brands. To mitigate this risk, we have defined clear mission statements, values and goals for all our brands. These form the foundation of our product and brand communication strategies. We also continually refine our product offering to meet shifts in consumer demand and to contemporize our offering to respond to current trends. Central to all our brand image initiatives is ensuring clear and consistent messaging to our targeted consumer audience, in particular at point-of-sale. Strong brand momentum at adidas and TaylorMade-adidas Golf, as evidenced in improving market research results, gives us confidence that brand image risk in both these segments remains low.

During the past twelve months, we introduced our first post-acquisition initiatives to support our long-term brand image strategy for Reebok. In 2008, we will increase our efforts by launching several new product technologies and a new global brand campaign to improve the overall consumer experience for the Reebok brand.  see Reebok Strategy Nevertheless, due to the current weakness of the brand in North America and the UK, and the possibility that our revitalization initiatives fail to improve brand image in the short term, we view the likelihood of a further reduction in brand image as medium. This could potentially have a high financial impact on the sales and profitability of the Reebok segment.

Aggregating these risks, we continue to believe that brand image risk for the Group has a medium likelihood of occurrence and also a medium potential financial impact on our Group.

OWN-RETAIL RISKS
New adidas, Reebok and Rockport own-retail stores require considerable up-front investment in furniture and fittings as well as ongoing maintenance. In addition, own-retail activities often require longer-term lease or rent commitments. Own retail also employs significantly more personnel in relation to net sales than our wholesale business. The higher portion of fixed costs compared to our wholesale business implies a larger profitability impact in cases of significant sales declines. The Group minimizes this risk by only entering into lease contracts with a duration of less than ten years. Store performance is measured by a retail scorecard consisting of nine quantitative key performance indicators. All shops are ranked by their weighted average score. Underperforming stores are restructured or closed as appropriate.

We continue to believe the likelihood of major closures is medium. However, due to the strong growth of own-retail activities and a rapidly consolidating retail environment, we assess the potential financial impact from these closures, which may also involve impairment charges, as medium.

RISKS FROM RISING INPUT COSTS
Raw material and labor costs account for approximately 70 % of the Group’s cost of sales. Prices of materials such as rubber, which closely correlate with the oil price, are especially subject to the risk of price increases. As our ordering process and price negotiations usually take place around six months in advance of production, our sourcing function has visibility and reaction time to manage and plan for sharp increases in input costs.

To reduce the financial impact on our product margins from higher sourcing costs, we collaborate closely with our vendors to increase efficiency in manufacturing processes and search for new materials. In addition, we have exploited economies of scale from our higher sourcing volume following the Reebok acquisition and are constantly improving production efficiency.  see Global Operations We may also compensate for this risk by increasing the selling prices of our products – although this is subject to the prevailing consumer and retail climate. In addition, in the medium term we have the ability to adapt our sourcing structure to take advantage of more competitive pricing in other locations.

We continue to assess the risks from rising input costs as having a medium likelihood. As a result of the time lag between ordering and production, we believe the short-term financial impacts from input cost increases are low. However, with the sharp oil price increases during 2007, ongoing wage inflation in Asia and increasing freight costs, we believe the potential financial impact from rising input costs has grown for the medium term. This could have a medium financial impact on our profitability beyond 2008.

SUPPLIER DEFAULT RISKS
Over 95 % of our product offering is sourced through independent suppliers mainly located in Asia.  see Global Operations To reduce the risk of business interruptions following a potential supplier default, we work with vendors who demonstrate reliability, quality, innovation and continuous improvement. In addition, we have bought insurance coverage for the risk of business interruptions caused by physical damage to supplier premises. The Group has also significantly reduced the number of independent manufacturers by combining the adidas and Reebok sourcing organizations. This exercise has allowed us to reduce risk by simplifying our sourcing structure, and focusing on the highest-quality suppliers, without compromising our flexibility or competitiveness.

We continue to assess supplier risks as having a low likelihood of occurrence and potential financial impact.

PRODUCT QUALITY RISKS
The adidas Group faces a risk of selling defective product, which may result in injury to consumers and / or image impairment. We mitigate this risk through rigorous testing prior to production, close cooperation with suppliers throughout the manufacturing process, random testing after retail delivery, open communication about defective products and quick settlement of product liability claims when necessary. In 2007, approximately 3,400 FSMK hockey masks which were delivered to retail in Canada, Europe and the USA, were subsequently recalled voluntarily due to a quality issue. The issue arose during subsequent random testing of products after market launch. During these random tests, a hockey puck was aimed at full speed directly at the face masks. Many of the masks dented and the coating chipped slightly. No incidents or injuries were reported before or after the recall.

Our assessment of product quality risk remains unchanged versus the prior year. We regard the likelihood of significant product liability cases or having to conduct wide-scale product recalls as low. As we have insurance protecting us against the financial consequences of significant product liability cases, we also assess the financial impact as low.

CUSTOMER RISKS
Customer risks arise from our dependence on key customers who have the ability to exert bargaining power and can therefore cause considerable margin pressure or cancel orders. These risks exist not only due to the relative size of some of our major customers, but also as a result of our limited ability to impact how they conduct business and the external impacts of the consumer environment in which they operate.

To limit these risks, we utilize a broad distribution strategy which includes our expanding controlled space activities. This enables us to reduce negative consequences that result from sales shortfalls that can occur with key customers. Specifically, no customer at brands adidas, Reebok and TaylorMade-adidas Golf accounted for more than 10 % of brand sales in 2007. In addition, we are proactively cooperating with key retail partners to further optimize sales through innovative point-of- sale initiatives (e.g. our shop-in-shop concepts at Dick’s Sporting Goods).

When necessary, we also restrict the distribution of our brands to protect brand image or product margins, and to streamline supply. For example, in the course of 2007, the Group decided to limit the Reebok product offering to an important mall-based key account in North America who had continually discounted Reebok product. Although we have been strengthening Reebok’s business in other retail channels such as sporting goods, we expect this development will have a significant negative impact on Reebok segment sales in North America throughout 2008. Nevertheless, the Group projects only a low impact on the Group’s overall contribution in 2008 from this action.

Due to the current difficulties at mall-based retailers and the overall economic environment in the USA, we continue to view a strong reduction of business with one of our brands’ biggest retailers as having a medium likelihood of occurrence. Such an event could have a medium financial impact on the sales and profitability of a particular region. However, on a Group level, we continue to view the financial impact from customer risks as low. 

RISKS FROM LOSS OF KEY EVENT OR PROMOTION PARTNERSHIPS
Event and promotion partnerships play an important role in building brand image and generating sales of licensed product. The adidas Group faces the risk of either losing key partnerships or having to accept unfavorable terms due to intensified competition for attractive contracts. To mitigate these inherent risks, we regularly seek to extend our most important partnership agreements before contract expiry. We also regularly include change-of-control clauses as well as non-cash compensation components in contracts to avoid the risk that negotiations are reduced solely to price. In addition, we follow a strategy of broadening the Group’s portfolio of premium partnerships in order to reduce our reliance on single affiliations.

During 2007, we successfully secured long-term contract extensions with a variety of important partners and announced several important new event and multi-year promotion partnership agreements.  see adidas Strategy In 2007, competition for top partnership assets within our industry increased notably. An example of this was an attempt from a major competitor to sign the German Football Federation (DFB). Although we successfully extended our contract with the DFB, we now believe there is a medium likelihood of losing important individual promotion contracts. Nevertheless, given the maturity of our most important contracts, we assess the potential financial impact of this risk to be low in the medium term.

PRODUCT DESIGN AND DEVELOPMENT RISKS
Innovative and attractive products generate strong sales and – more importantly – create a halo effect for other products. The speed with which new product technologies and fresh designs are brought to market is decisive for maintaining competitive advantage. In 2007, all brands generated the majority of their sales with products which had been brought to market over the last 12 to 18 months.  see Research and Development If the adidas Group failed to maintain a strong pipeline of new innovative products over a sustained period of time, we would risk a significant sales decline. We continue to invest in increasing our innovational and design strength. To ensure we can quickly adapt to changing consumer preferences, we focus on streamlining research and development processes to speed up the time to market.

We continue to assess the occurrence probability of this risk, which could potentially have a significant financial impact, as low.

PERSONNEL RISKS
The adidas Group’s future success is highly dependent on our employees and their talents. We thus face the risk of being unable to identify, recruit and retain the most talented people that best meet the specific needs of our Group. To reduce this risk, and enable our employees to make use of their full potential, we strongly engage in developing a motivating working environment. Our goal is to make the adidas Group the “Employer of Choice” within our industry. This is supplemented by offering attractive reward and incentive schemes as well as long-term career opportunities and planning.  see Employees

In 2007, we believe our personnel risks have increased moderately due to (1) growth of our own-retail activities where employee turnover is higher than the Group average, and (2) growth in emerging markets where higher levels of wage inflation increase the volatility of the employment market. Nevertheless, we continue to regard the occurrence likelihood of these risks as low. Should these risks materialize, they could have a medium financial impact on our Group.

Risks from non-compliance
We face the risk that our employees breach rules and standards that guide appropriate and responsible business behavior. In order to successfully manage this risk, the Group Policy Manual was launched at the end of 2006 to provide the framework for basic work procedures and processes. It also includes a newly developed Code of Conduct which stipulates that every employee shall act ethically in compliance with the laws and regulations of the legal systems where they conduct Group business. In 2007, the Group launched a new Code of Conduct e-learning tool as part of our Global Compliance Program to facilitate the ongoing training of our staff in these matters.  see Corporate Governance Report The global roll-out of this tool will be completed in 2008. Participation is mandatory for all employees.

We continue to regard the likelihood of grave misconduct as low. Should they materialize, these risks could have a medium financial impact on the Group.

IT RISKS
A Group-wide breakdown of IT systems or a significant loss of data could result in considerable disruptions to our business. Insufficient project management could delay the execution of projects critical to the Group or make them more expensive than planned. To mitigate system default risk, we review our IT policy on a regular basis and engage in proactive maintenance and business continuity planning. We perform scheduled backups several times a day and one full backup daily, alternating between two different data center locations. In addition, for the central enterprise resource planning system, our contingency solution allows us to quickly switch to a remote site if necessary – without any data loss. System security and reliability are reviewed and tested internally and via external audits on a regular basis. Our target availability of 99.7 % for major IT applications was exceeded in 2007. IT project risks are further mitigated by implementing a proven project methodology for all IT projects and by performing regular risk reviews for all major projects.

We believe the risk of a major IT default continues to be extremely low. Such a default, however, would result in a significant potential financial impact.

FINANCIAL RISKS

CREDIT RISKS
A credit risk arises if a customer or other counterparty to a financial instrument fails to meet its contractual obligations. The adidas Group is exposed to credit risk from its operating activities and from certain financing activities. Credit risks arise principally from accounts receivable and to a lesser extent from other contractual financial obligations such as other financial assets, short-term bank deposits and derivative financial instruments.  see Note 23 Without taking into account any collateral or other credit enhancements, the carrying amount of financial assets represents the maximum exposure to credit risk.

At the end of 2007, there was no relevant concentration of credit risk by type of customer or geography. Instead, our credit risk exposure is mainly influenced by individual customer characteristics. Under the Group’s credit policy, new customers are analyzed for creditworthiness before standard payment and delivery terms and conditions are offered. This review utilizes external ratings from credit agencies. Purchase limits are also established for each customer. Then both creditworthiness and purchase limits are monitored on an ongoing basis. Customers that fail to meet the Group’s minimum creditworthiness are allowed to purchase products only on a pre-payment basis. Other activities to mitigate credit risks, which are employed on a selective basis only, include credit insurances, bank guarantees as well as retention of title clauses.

The Group utilizes allowance accounts for impairments that represent our estimate of incurred credit losses with respect to accounts receivable. The allowance consists of two components: (1) an allowance based on historical experience of unexpected losses established for all receivables based on the ageing structure of receivables past due date, and (2) a specific allowance that relates to individually assessed risk for each specific customer – irrespective of ageing. Allowance accounts are used to record impairment losses unless our Group is satisfied that no recovery of the amount owed is possible; at that point the amount considered irrecoverable is written off against the receivable directly.

At the end of 2007, no customer at either adidas, Reebok or TaylorMade-adidas Golf accounted for more than 10 % of accounts receivable. Allowance for doubtful accounts receivable remained at a similar level of total accounts receivable in 2007 compared to the prior year. Our Days of Sales Outstanding were unchanged compared to the prior year at 58 days. As a result, we believe that our overall credit risk level from customers has remained nearly unchanged despite an increasingly difficult retail environment in many key markets.  see Economic and Sector Development Therefore, we continue to estimate the likelihood and potential financial impact of credit risks from customers as low.

Credit risks from other financial contractual relationships include items such as other financial assets, short-term bank deposits and derivative financial instruments. The adidas Group Treasury department arranges currency and interest rate hedges, and invests cash, with major banks of a high credit standing throughout the world. All banks are rated “A–” or higher in terms of Standard & Poor’s long-term ratings (or a comparable rating from other rating agencies). Foreign-based adidas Group companies are authorized to work with banks rated “BBB+” or higher. Only in exceptional cases are subsidiaries authorized to work with banks rated lower than “BBB+”. To limit risk in these cases, restrictions are clearly stipulated such as maximum cash deposit levels. As a result, we estimate the likelihood and potential financial impact of credit risks from these assets as low. We believe our risk concentration is limited due to the broad distribution of our investment business with a syndicate of approximately 30 banks. In 2007, no bank accounted for more than 17 % of our investment business and the average concentration is 1 %. This leads to a maximum exposure of € 63 million in the event of default of any single bank.

FUTURE CASH OUTFLOWS
€ in millions 

FINANCING AND LIQUIDITY RISKS
Liquidity risks arise from not having the necessary resources available to meet maturing liabilities with regard to timing, volume and currency structure. In addition, the adidas Group faces the risk of having to accept unfavorable financing terms due to liquidity restraints. Our Group’s Treasury department uses an efficient cash management system to manage liquidity risk. At December 31, 2007, Group cash and cash equivalents amounted to € 295 million (2006: € 311 million). Moreover, our Group maintains credit lines and long-term financing arrangements with leading banks, such as a €  2 billion international medium-term syndicated loan facility and a € 2 billion Commercial Paper Program, in order to ensure sufficient liquidity at all times.  see Treasury

Future cash outflows arising from financial liabilities that are recognized in the Consolidated Balance Sheet are presented within the adjacent table. This includes payments to settle obligations from borrowings as well as cash outflows from cash-settled derivatives with negative market values. Financial liabilities that may be settled in advance without penalty are included on the basis of the earliest date of potential repayment. Cash flows for variable-interest liabilities are determined with reference to the conditions at the balance sheet date.

In 2007, we reduced net debt by € 465 million.  see Treasury As a result of this effort, we have reduced our exposure to financing and liquidity risks in 2007. We view these risks as having a low likelihood of occurrence. Nevertheless, failure to maintain liquidity could have a high financial impact on Group performance.

CURRENCY RISKS
Currency risks for the adidas Group are a direct result of multi-currency cash flows within the Group. The biggest single driver behind this risk results from the mismatch of the currencies required for sourcing our products versus the denominations of our sales. The vast majority of our sourcing expenses are in US dollars while sales are denominated in other currencies to a large extent – most notably the euro and the British pound. Since Group companies in the UK are invoiced in euro internally, our main exposures are a US dollar short and a British pound long exposure versus the euro.

In line with IFRS 7 requirements, we have estimated the impact on net income and shareholders’ equity based on changes in our most important currency exchange rates. The calculated impacts mainly result from our hedging practice. The analysis does not include effects that arise from the translation of our foreign entities’ financial statements into the Group’s reporting currency. The sensitivity analysis is based on the net balance sheet exposure, including inter-company balances from monetary assets and liabilities denominated in foreign currencies. Moreover, all currency derivatives were re-evaluated using hypothetical foreign exchange rates to determine the effects on net income and equity. The analysis was performed on the same basis for both 2006 and 2007.

Based on this analysis, a 10 % increase in the euro versus the US dollar at December 31, 2007, would have led to a € 5 million increase in net income. The negative market values of the US dollar hedges would have decreased shareholders’ equity by € 111 million. A 10 % weaker euro at December 31, 2007 would have led to a € 6 million decrease in net income. Shareholders’ equity would have increased by € 130 million. The impacts of fluctuations of the euro against the British pound and other major currencies on net income and shareholders’ equity are also included in accordance with IFRS requirements.

EXPOSURE TO FOREIGN EXCHANGE RISK¹⁾
based on notional amounts, € in millions

1) Rounding differences may arise in totals. 

SENSITIVITY ANALYSIS OF Foreign EXCHANGE RATE CHANGES
€ in millions 

However, many other financial and operational variables that could potentially reduce the effect from currency fluctuations are excluded from the analysis. These include:

Interest rates and all other exchange rates are assumed constant.

Exchange rates are assumed at a year-end value instead of the more relevant sales-weighted average figure, which we utilize internally to better reflect both the seasonality of our business and intra-year currency fluctuations.

The underlying forecasted cash flow exposure (which the hedge instrument mainly relates to) is not required to be revalued in this analysis.

Operational issues, such as potential discounts to key accounts who have high transparency regarding the impacts of currency on our sourcing activities (due to their own private label sourcing efforts), are also excluded from this presentation.

Utilizing a centralized currency risk management system, our Group hedges currency needs for projected sourcing requirements on a rolling 12- to 18-month basis.  see Treasury Our goal is to have the vast majority of our hedging volume secured six months prior to the start of a given season. In rare instances, long-term promotion partnership contracts are hedged beyond the 18-month horizon. The Group also largely hedges balance sheet risks. Due to our strong global position, we are able to minimize currency risk to a large extent by utilizing natural hedges. Nevertheless, our net US dollar exposure calculated for the full current hedging period was roughly € 2.4 billion at year-end 2007, which we hedged using forward contracts, currency options and currency swaps. Our Group’s Treasury Policy allows us to utilize hedging instruments, such as currency options or option combinations, which provide protection while – at the same time – retain the potential to benefit from future favorable exchange rate developments in the financial markets.

The Group increased the proportion of its longer-term hedges in 2007, to strategically utilize the strong euro versus nearly all other major currencies. We also employed a higher rate of forward contracts to reduce option premiums.  see Note 23 As 2008 hedging has almost been completed, it is clear that exchange rates will be more favorable than those of 2007. Correspondingly, we believe that both the level and likelihood of currency risk to our 2008 financial contribution has declined versus the prior year and is low overall.

INTEREST RATE RISKS
Changes in market interest rates affect future interest payments for variable-interest liabilities. As a result, significant interest rate increases can have an adverse effect on the Group’s profitability, liquidity and financial position. The acquisition of Reebok in 2006 led to an increase in interest rate risks due to the higher financing requirements and the resulting higher weighted-average interest rate on the Group’s financing structure.  see Treasury

In line with IFRS 7 requirements, we have analyzed the impact of changes in the Group’s most important interest rates on net income and shareholders’ equity. The effect of interest rate changes on future cash flows is excluded from this analysis. Nevertheless, accrued interest, which is recognized as a liability, has been re-calculated based on the hypothetical market interest rates as at December 31, 2007. Fair values for derivative interest rate instruments accounted for as cash flow hedges were then re-evaluated based on the hypothetical market interest rates with the resulting effects on net income and equity included in the sensitivity analysis. The fair value interest rate risk from private placements that are hedged with fair value hedges was also taken into consideration. However, the effect on the income statement from changes in the fair values of hedged items and hedging instruments attributable to interest rate changes was not material. Exclusions from this analysis are as follows:

Some fixed-rate financial assets, such as commercial paper and certificates of deposit, which our Group values at “fair value through profit or loss” due to the short-term maturity of these instruments. Potential effects due to changes in interest rates are considered immaterial and are not recognized in the sensitivity analysis.

Other fixed-rate financial instruments are measured at amortized cost. Since a change in interest rates would not change the carrying amount of this category of instruments, there is no net income impact and they are excluded from this analysis.

The interest rate sensitivity analysis assumes a parallel shift of the interest yield curve for all currencies and was performed on the same basis for both 2006 and 2007. A 100 basis point increase in interest rates at December 31, 2007 would have increased shareholders’ equity by € 6 million (2006: € 5 million) and decreased net income by € 2 million (2006: € 2 million). A 100 basis point decrease of the interest rates at December 31, 2007 would have resulted in a € 7 million decrease in shareholders’ equity (2006: € 8 million) and a € 2 million increase in net income (2006: € 2 million). 

We believe the IFRS 7 interest rate analysis represents a realistic if rough estimate of our current interest rate risk.

To moderate interest rate risks and maintain financial flexibility, a core tenet of our Group’s financial strategy is to reduce financial leverage (i. e. net debt / shareholders’ equity) to under 50 %. In 2007, we strongly reduced net debt associated with the financing of the Reebok acquisition.  see Treasury Capitalizing on low interest rates at the time of the acquisition, we also strongly increased the share of fixed-rate financing arrangements in early 2006. In 2007, we prioritized our debt reduction activities on variable interest instruments. As a result, fixed-rate financing arrangements accounted for 70 % of our total debt outstanding at December 31, 2007, compared to 65 % in the prior year.  see Treasury

Due to these and various other risk compensation measures, we believe we have made considerable progress on reducing interest rate risks in 2007. Taking the current macroeconomic situation into account, we do not anticipate a significant change in our Group’s average interest rate in 2008. Therefore, we continue to project the likelihood of significant Group interest rate increases, which could have a low financial effect on our contribution, as low.

CORPORATE OPPORTUNITIES OVERVIEW

EXTERNAL AND INDUSTRY OPPORTUNITIES

FAVORABLE MACROECONOMIC AND FISCAL POLICY CHANGES
As a consumer goods company, consumer confidence and spending can impact our sales development. Therefore, better than initially forecasted macroeconomic developments and fiscal policy changes which support private consumption can have a positive impact on our sales and profitability. In addition, legislative changes, e. g. with regard to the taxation of corporate profits, can positively impact Group profitability.

SPORTS PARTICIPATION ON THE RISE
Governments increasingly promote living an active lifestyle to fight obesity and cardiovascular disease. According to the World Health Organization, around 400 million people were considered obese in 2005. Another 1.6 billion more were estimated to be overweight. These numbers are projected to increase to 700 million and 2.3 billion respectively by 2015. Once considered a problem only in affluent nations, obesity is also becoming an issue in countries with low per capita income. This development has serious health consequences and a dramatic effect on health care expenditures. As a result, governments and non-governmental organizations are increasing their efforts to promote a healthy lifestyle and encourage sports participation. Given our strong market position, in particular in categories considered suitable for weight loss such as training, running and swimming, we expect to benefit from this trend.

INCREASING CONSUMER DEMAND FOR FUNCTIONAL APPAREL
Consumer demand for functional apparel has increased significantly in recent years as consumers realize the benefits of functional apparel over traditional cotton sportswear. Improved moisture management, superior ease of motion, and increased comfort are all factors encouraging consumers to switch to high-performance gear. The design and development of functional apparel requires significantly more expertise, product and material research as well as production know-how compared to low-tech apparel. Therefore, only a few companies are able to supply high-end functional apparel. Our resources and our positioning as a sports performance leader enable us to constantly develop innovative products and capitalize on them. For example, adidas is strongly growing in compression apparel. Due to our attractive TechFit™ offering, we achieved strong growth in this category in 2007 and expect to double sales in 2008.

FAST-GROWING WOMEN’S SEGMENT
The women’s sports market is one of the most attractive segments in the sporting goods industry with women accounting for almost half of total spending on athletic footwear. In addition, women also make over 80 % of the purchase decisions for sports apparel for men, women and children. As our Group generates the majority of its revenue in the men’s segment, the women’s category offers potential for further growth. adidas, Reebok and TaylorMade-adidas Golf each address the female consumer in their own distinctive way. With targeted product offerings in both performance and lifestyle, such as the adilibria, Fuse and Clima 365 collections at adidas, the Avon Pink Ribbon collection at Reebok and the Women’s r7® CGB MAX at TaylorMade, all of our brands are well-positioned in the women’s category. Going forward, we will extend and broaden our women’s offering – emphasizing individuality, authenticity and style.

ONGOING FUSION OF SPORT AND LIFESTYLE
The border between pure athletics and lifestyle continues to blur as sport becomes a more integral part in the lives of more and more consumers. People want to be fashionable when engaging in sporting activities without compromising on quality or the latest technological advances. At the same time, performance features and styles are finding their way into products meant for more leisure-oriented use. As the global sports lifestyle market is roughly three times larger than the performance market, this development opens up additional opportunities for our Group and our brands – which already enjoy strong positions in this market. adidas has an authentic sports lifestyle offering and the adidas Sport Style division is targeted to grow overproportionately until at least 2010.  see adidas Strategy Lifestyle products are also an important pillar in Reebok’s brand strategy. We have augmented Reebok’s Classics and music-inspired business with new celebrity partnerships to upgrade and emotionalize the brand’s lifestyle offering. In 2008 and beyond, we will launch new initiatives in this category to capitalize on Reebok’s lifestyle credibility.

EMERGING MARKETS AS LONG-TERM GROWTH DRIVERS
Emerging economies in Asia, Europe and Latin America have consistently grown at stronger rates than more mature markets over the last several years. However, due to economic constraints, sports participation in most of these countries has historically been lower than in industrialized countries. Now, rising real incomes and employment rates as well as positive demographic trends and a growing middle class are fueling these economies – and subsequently our industry. This development is expected to continue for at least three to five years.

European and North American sporting goods brands are often seen as easily accessible, affordable luxury goods. Our Group currently generates around 25 % of sales in emerging markets, which reflects a higher exposure compared to many of our competitors. Further, we believe we have excellent opportunities for further growth, in particular in China and Russia. Supported by our strong portfolio of partnerships, e. g. the NBA, Yao Ming and the China Golf Association in China as well as Andrij Shevchenko and the Russian Basketball Federation in Russia, our strong market positions and our extensive distribution network, we aim to reach sales of € 1 billion in China, while Russia is expected to become our biggest market in terms of sales and profits in Europe by 2010. 

GROWING POPULARITY OF “GREEN” PRODUCTS
Today’s consumers are increasingly concerned about the impact their consumption has on the environment. Therefore, they demand more and more products that are environmentally benign. For many consumers, materials used in footwear and apparel are now expected to be suitable for re-use, while still looking fashionable and stylish. By positioning ourselves in this field within the sports lifestyle segment, we can benefit from the growing demand for environmentally friendly products. In 2008, we are launching the adidas Grün collection within our adidas Sport Style division. The collection consists of footwear and apparel made of organic, untreated or recycled materials such as cork, manila and linen. We expect consumer demand for environmentally friendly products to increase going forward.

STRATEGIC AND OPERATIONAL OPPORTUNITIES

STRONG MARKET POSITIONS WORLDWIDE
The adidas Group has the highest market share in numerous countries around the world. This strong competitive position offers us many advantages in terms of global brand visibility, market power and the ability to effectively expand our position in emerging markets. As a result of our strong partnership portfolio and marketing efforts, consumers around the globe are highly aware of our brands and are receptive to our brand messaging. This makes demand for our products more stable compared to smaller competitors. Hence, many retailers consider our products as core to their offering. The adidas Group is therefore in a strong bargaining position and can compete more effectively for shelf space. Our local market knowledge and marketing power also enable us to quickly react to emerging trends in niche categories such as skateboarding or even enter completely new categories.

MULTI-BRAND APPROACH
We believe there is a natural limit to the audience size a single brand can appeal to, given the diverse tastes and expectations of a highly-fragmented consumer market. Our multi-brand approach provides us with the opportunity to leverage the power of our brands in a more precise and meaningful way.  see Group Strategy We are able to utilize the combined strengths of each brand to compete for a higher percentage of the total market – covering a greater number of consumer needs, price points and demographics.

PERSONALIZATION AND CUSTOMIZATION REPLACING MASS WEAR
Today’s consumers are looking for choice and variety that goes beyond choosing from a wide selection of products. We engage in developing unique and relevant products that fit specific functional and aesthetic requirements.  see Group Strategy adidas, Reebok and TaylorMade-adidas Golf all offer different personalization and customization platforms reflecting each brand’s strategy. Key concepts include the adidas “mi Innovation Center” and Reebok’s “Rbk Custom” online platform. Utilizing the newest body mapping technology, consumers can personalize our most innovative and popular footwear styles to their own fit and performance needs. We believe this technology leads the way in sporting goods retail and have started to roll out “mi Innovation Centers” throughout our concept stores in 2007. “Rbk Custom” is a web-based platform over which consumers can customize footwear. Shoes are then shipped within ten business days. We expect the market for personalized and customized footwear, apparel and hardware to grow strongly and evolve further in the coming years.

BREAKING NEW GROUND IN DISTRIBUTION
The sporting goods retail environment is changing constantly. People increasingly want to get involved with our brands. We have adapted our distribution to cater to this change and have made controlled space initiatives a strategic priority. We will start introducing e-commerce in the Netherlands as a test market for Europe in 2008. We also see opportunities to operate new shop formats in cooperation with other brands. In 2007, we opened the “NHL Powered by Reebok” store in New York, showcasing Reebok’s broad choice of hockey products. Similarly, adidas opened the first European NBA Concept Shop in Istanbul, Turkey. Through initiatives like these, we can more effectively target consumers and involve them emotionally with our products. In our wholesale business, we are increasing our flexibility to utilize changes in consumption behavior as they arise. In 2007, for example, we actively strengthened our North American distribution in the growing sporting goods retail channel. Here, we are able to showcase a much broader choice of our footwear – and particularly apparel products – compared to the athletic specialty channel where industry sales decreased.

TAKING CONTROL OF DISTRIBUTION RIGHTS
Our brands do business in virtually all countries around the world. The majority of our business is done through fully-owned subsidiaries or sales organizations.  see Group Strategy Nevertheless, in some markets, we work with distributors or joint venture partners, in particular at brand Reebok. In doing so, we capitalize on third party expertise in terms of how to best service retailers in those countries. While this strategy can be appropriate in a market’s early development, we strongly believe in having full control over distribution and brand management in more mature markets. Therefore, it is our Group’s strategy to buy back distribution rights for our brands when possible and economically sensible. Over the last several years, we have been very successful in this respect. After having bought back distribution rights for the adidas brand in Japan, Italy and Turkey, we grew significantly in these markets. At Reebok, we have identified the buyback of distribution rights as the single most important revenue synergy potential.  see Outlook In 2007, we realized incremental sales in all countries where Reebok bought back distribution rights. Going forward, we will evaluate potential buyback opportunities on a case-by-case basis, considering opportunities as well as inherent risks from litigation.

COST OPTIMIZATION DRIVES PROFITABILITY IMPROVEMENTS
Continued optimization of key business processes and strict cost control are vital to achieving high profitability and return on invested capital. As a result of the Reebok acquisition, we generate cost synergies that support adidas and Reebok profitability development.  see Outlook Nonetheless, our profit margins continue to be below those of our main competitors. We do, however, see numerous levers for streamlining our cost base going forward. We can further simplify processes across brands and functions to reduce operational inefficiencies owed to the increased complexity of our Group. In North America, we believe we will be able to realize medium-term economies of scale as we continue to integrate adidas and Reebok back-office functions. In addition, we strive to further increase efficiency in our supply chain and make it truly demand- driven. By implementing end-to-end planning processes and improving our replenishment capabilities, we see opportunities to not only better serve our customers but also to further reduce our operating working capital needs.  see Global Operations

FINANCIAL OPPORTUNITIES

FAVORABLE FINANCIAL MARKET CHANGES
Favorable exchange and interest rate developments can potentially have a positive impact on the Group’s financial results. Our Group Treasury department closely monitors the financial markets to identify opportunities.

MANAGEMENT ASSESSMENT OF OVERALL RISK AND OPPORTUNITIES

Central risk management aggregates all risks reported by brand, regional and headquarter functions. Based on the compilation of risks – taking into account the occurrence likelihood and potential financial impact and the current business outlook explained within this report – adidas Group Management does not foresee any individual or aggregate risks which could materially jeopardize the ongoing business health and viability of the Group. In comparison to the prior year, some External and Industry Risks as well as some Strategic and Operational Risks have increased. All Financial Risks have decreased. As a result, Management regards the overall risk likelihood as having increased moderately versus 2007. The potential financial impact from the Group’s overall risk exposure is largely unchanged, due to increased risk-compensating and transfer factors now in place.

This assessment is also supported by the continued positive responses to our financing demands.  see Treasury The adidas Group therefore has not sought an official rating by any of the leading rating agencies.

Management remains confident that the Group’s earning power forms a solid basis for our future business development and provides the necessary resource to pursue the opportunities available to the Group.