On Holding AG (NYSE:ONON) Q3 2022 Earnings Call Transcript

On Holding AG (NYSE:ONON) Q3 2022 Earnings Call Transcript November 16, 2022

Operator: Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the On Holding AG Q3 2022 Results Call. I would now like to turn the conference over to Jerrit Peter. Please go ahead.

Jerrit Peter: Good afternoon, good morning, and thank you for joining On’s 2022 third quarter earnings conference call and webcast. With me today on the call are Executive Co-Chairman and Co-Founder, David Allemann; CFO and Co-CEO, Martin Hoffmann; and Co-CEO, Marc Maurer. Before we begin, I would like to remind everyone that the remarks during today’s call will contain forward-looking statements regarding future events and performance within the meaning of the federal securities laws. These forward-looking statements reflect our current expectations and beliefs only and such statements are subject to certain risks and uncertainties that could cause actual results to differ materially. Please refer to our 20-F filed with the Securities and Exchange Commission on March 18 for a detailed discussion of such risks and uncertainties.

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Please further note that this call will also contain certain non-IFRS financial measures, such as adjusted EBITDA and adjusted EBITDA margin. These measures are not intended to be considered in isolation or as a substitute for the financial information presented in accordance with IFRS. Please refer to today’s release for a reconciliation of non-IFRS financial measures to the most comparable measures prepared in accordance with IFRS. We will begin with David followed by Martin leading through today’s prepared remarks, after which we are looking forward to opening the call for a Q&A session. With that, I’m very happy to turn over the call to David.

David Allemann: Thank you very much, and a warm welcome from here in Zurich to everyone around the globe joining us today. I’m delighted to be here to speak about another outstanding quarter, and the exciting recent progress and developments at On. As you will have seen in our release this morning, net sales for the third quarter increased by more than 50% to CHF 328 million, our strongest quarter in history. This makes On a CHF 1 billion net sales company. We’re looking at the 12 months leading up to the end of September, and it allows us to increase our full year outlook. During our last earnings call, we talked about how we are focusing on building a company that is set up for durable growth with the goal of being the #1 brand on runner’s bodies.

Today, I delve deeper into the strength of the Young brand and our most recent innovation achievements, before handing over to Martin for a detailed review of our third quarter financial performance, and details on the outlook for the rest of the year. 12 years ago, On started from out of nowhere and has built a powerful grassroots movement of millions within a few short years. It fills me with pride that we continue to inspire and attract a record amount of new runners to On. There is simply an incredible amount of momentum around On right now, and I want to focus on 3 of the key areas that are driving this growth and setting us up for sustained success. Firstly, we are expanding the reach of the brand like never before. On has seen a record number of visitors coming to our website, with almost 10 million sessions per month recorded so far this year.

Our Instagram followers just crossed the 1 million and engagement is high. We are attracting new consumers every day due to our ability to drive awareness and then meet their individual needs once we have gained their attention. We are doing this in a number of ways, not least, via are our highly successful omnichannel approach. Our strategy connects us with consumers when and where they want to shop, either via our own physical and digital stores, wholesale partners or immersive digital platforms. In September, we began piloting a fully redesigned website designed to deliver a richer, more immersive shopping experience. The pilot and AP testing in the U.K. has delivered great results and we cannot wait to roll it out globally in the coming months for all of our fans to enjoy.

We’re also partnering with external digital platforms such as the WeChat e-commerce mini program in China. Chinese consumers can now seamlessly shop for On products without ever leaving the WeChat ecosystem. Our increasing brand visibility is also driven by powerful marketing campaigns that resonates with our core community and reach a new breed of useful runners. Runners who are inspired by an emerging run culture that elevates running to a lifestyle. The seed of this culture was planted during the pandemic and new habits have now been formed. These campaigns are hugely distinctive and impactful. During the Berlin Marathon, you couldn’t escape our brand as we took over hundreds of key out-of-home sites across the city to support our Dream On campaign.

We also partnered with the city’s music festival to provide our unique take on how running inspires creativity. And during the run — the New York City Marathon, runners joined us at 0.2, an immersive exhibition that explore the magical mind space that can only be accessed through running. October also saw the hotly anticipated second lower times On collection of performance footwear. It launched too much fanfare, particularly in the APAC region, where it was heavily featured in influential style media, such as Vogue Japan. Hydro choosing to build the brand is also contributing to our momentum, namely by staying true to our focus of performance innovation. I’m thrilled to see how our newest performance product like the Cloudmonster, the Cloudrunner and the CloudGo are resonating with runners in a major way, becoming the fastest-growing product lines at our retail partners.

These styles are now driving volume for us, not only in running specialty doors, but also in general sporting goods channels like big sporting goods. Crucially, our running shoes that resonate so well with consumers are powered by the very same technology you see on the feet of our successful professional athletes and the On Athletics Club, our lead track and field team. Athletes like the Norwegian titled Gustav Iden, who won the men’s Ironman World Championship in Hawaii in October. He delivered an unbelievable performance with the new course record. But not only did Gustav set new overall course record, we played a part in Gustav running a course record marathon to finish off the race and secure the win in a On shoe specifically created to meet his needs.

Of course, this groundswell of professional athletes wanting to wear our innovative products influence its runners to choose On shoes for their daily runs and workouts. This was on full display around the New York Marathon, where our New York City store locked the strongest 2 days in history. Our product innovations aren’t just confined to footwear. The potential of our apparel business has never been greater. We’re doubling down on apparels and have recently made a number of key investments to strengthen our design and development team. In the last few months, we have also seen a great response from our community to new apparel products such as the Luma’s collection of hi-vis reflective running gear and our latest sports bra line. And just last week, we had our global meeting where our team and key partners were introduced to our next lineup of products that we will bring to market in the fall/winter ’23 season.

We surprised the team with 3 all new footwear silhouettes and many new and exciting apparel pieces. As you know, brand and product desire builds lasting relationships with our consumers and turns them into eventualists. We also create long-term partnerships with retailers to ensure we do everything we can to serve and inspire consumers together. But of course, we can’t speak about lasting meaningful relationships without mentioning Roger Federer. Our partnership with Roger has never been an athlete endorsement deal. Instead, he has long been a partner, investor and co-entrepreneur of ours. He plays a truly instrumental role in the development of the Roger line and the Roger Pro tennis shoe, acting as a role model to all of his own teammates at the same time.

Like many sports fans, we have heavy hearts when Roger announced his retirement from the professional tennis game. But I’m delighted to say that he will now spend even more time with us to expand the professional On tennis business and our performance product offering as a whole. My last and final point brings me to durable growth, not just for On, but for our planet. We are making fast progress in innovations that drive a circular future. For us, durable growth means growing responsibly. As a brand born in the Swiss Alps, nature is our home and where we run. Our sustainability mission has always remained the same, namely, to make high-performance products with the lowest possible footprint and engineered for circularity. We focus on 3 core areas: recycle, reuse and reduce.

On recent calls, we provided updates on breakthroughs we made against the first 2 ambitions, namely our cyclone subscription model. Today, I’d like to focus on the third area, carbon capture. I’m delighted to say that Q3 was when we finally realized our dream of reducing carbon impact when we unveiled the first ever shoe made from carbon emissions with our clean cloud material. This makes on the first company in the footwear industry to use carbon emissions as a primary raw material for a shoe’s midsole, a huge milestone for the sports industry and something that seemed almost impossible when we first started developing it 5 years ago. CleanCloud will go from proof of concept to commercialization. Our ambition is to bring the technology to as many consumers as possible in the near future.

Also notable sustainability achievements in the quarter included the introduction of Onward, our first-ever platform to shop and trade in preowned gear for On, customers and products stay with us longer. Onward is currently available in the U.S., and we’re looking forward to see how our first foray into the resale market develops in the coming months. To summarize, we are incredibly pleased of the progress we have made over the past 12 months and are extremely excited for the next steps we’ll take on our mission to decouple On’s resource consumption from our strong growth. With that, it’s my pleasure to hand over to Martin for the Q3 financial review and updated outlook for the full year. Martin, please.

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Martin Hoffmann: Thank you, David, and hello, everyone, joining our call today. Q3 has been another record quarter for On. Our net sales growth of 50.4% to CHF 328 million has been stronger than expected, and another step on our journey towards durable growth. Those of you who have followed us since the IPO know that why net sales growth is important to us, we are just as focused on expanding on profitability. By further reducing the airfreight share and despite foreign exchange headwinds, we have achieved a record adjusted EBITDA of CHF 56.3 million, an adjusted EBITDA margin of 17.2% in the quarter. The strong results validate a continued high demand for our brand globally. At the same time, they validate our ability to scale and professional life along all parts of the business.

David mentioned some of the factors that have driven our record sales. The success of our products, our expanding collaboration with wholesale partners, and our progress to connect even more intensely with our customers. The high demand that we are experiencing has challenged our logistics network. While our supply chain teams across the globe have done an exceptional job to cope with the record volumes, in mid-August, we experienced temporary constraints in our U.S. East Coast warehouse caused by a system upgrade by our 3PL partner. So our team worked fast, and the situation has been remedied. We were not able to fulfill all the demand we had in the U.S., especially in D2C, where we lost some sales due to longer delivery times and higher cancellation rates.

In addition, the strength of the U.S. dollar, in conjunction with the weakness of the euro in ratio to our reporting currency Swiss francs, had a significant negative impact on our gross profit margin, and our adjusted EBITDA margin of 250 basis points compared to the third quarter last year. On total net sales, currency developments are mostly neutral, while regional sales are impacted. So even in spite of these headwinds, we delivered record results, which is a testament to our strong brand momentum and high-quality team-based execution. Now let me review the strong quarterly financial performance in more detail. We, again, saw a well-balanced growth between channels, regions and product verticals. We continue to win market share at existing retail partners, while selectively expanding our distribution to reach the right customers, which helped to drive an increase of net sales and wholesale of 55.6% versus a very strong prior year period.

As announced, we started to pilot at 8 big sporting goods locations and are extremely happy how On has resonated as a head-to-toe brand with apparel and accessories, driving nearly 20% of the units sold. On footwear, is certainly showing that it can drive our mission to reach every runner. Styles such as the Cloudultra, Cloudmonster and Cloudrunner have been large volume drivers during the pilot phase. We have also increased our door count with Footlocker to 150 doors in the U.S. in connection with the fall/winter ’22 season launch, which came together with very strong numbers in Q3, and excellent sell-through during the back-to-school season. We continue to follow our strategy of seeking presence in the highest quality doors, tightly managing stock levels and, whenever possible, showcasing the trends and designated On shop-in-shop areas.

A great example is our partnership with Nordstrom, where we opened 12 dedicated On shops in September. Overall, our wholesale door count in our own markets, that means excluding distributor markets, stands at 9,050 doors as of the end of Q3 versus 8,000 doors at the beginning of the year, reflecting a strong organic growth within existing stores through both existing and new products, while expanding distribution in a very controlled way. Moving over to direct-to-consumer, where net sales grew by 40.7% in the quarter. Without the constraints in our U.S. warehouse, we would have been able to achieve even more sales growth in D2C. Our D2C growth is well balanced and driven by the strong demand from both our existing customer groups as well as a large number of first-time purchasers that are frequently only just discovering the brand.

As David mentioned, we are also very excited about the ongoing rollout and the potential of our new online experience to further increase the engagement with our fans. We are also continuously investing in our data infrastructure to connect more directly with our customers. Last week, I had the opportunity to visit our newest On retail store that just opened in Los Angeles, at Bolivar in Venice. The customer response has been incredibly strong, and we have heard many times that this is one of the nicest stores in this Street. Like many of our other locations, it is not only a store, but also a launch pad for our running communities. Our next location is outside of China will be in London and Miami, for which we are looking at the openings early next year.

In China, the traffic to our On retail stores has surged back after the larger scale lockdowns in Q2 and has also significantly increased versus the prior year comparable periods. For example, our existing Beijing store saw a 40% increase in traffic in the month of August versus the prior year period. At the same time, we opened 4 additional stores in China since early September, there are 2 in Shanghai, 1 in Beijing and 1 in Chengdu. The China retail stores also continue to be a showcase of the opportunity we have in apparel when we can actively drive our merchandising. Our existing store in Shenzhen, as an example, even reached a 30% apparel share in Q3. Overall, considering the aforementioned dynamics in the quarter, our D2C share was 32.5% versus 34.7% in the prior year period.

Then moving on to the developments by region. Q3 net sales in North America grew 57.1% to CHF 176.3 million, driven by the strong demand for our full product line across all retail partners and direct channels. As mentioned before, we would have had even more demand from our D2C customers in the region that we were unable to fulfill due to the temporary warehouse constraints. Net sales growth in Europe accelerated compared to Q2, and we achieved CHF 116.5 million, 31.8% year-over-year growth despite the considerable FX headwinds from a strong Swiss franc versus the euro and British pound. Demand in most key markets continues to be strong, and we are very happy to have extremely strong partners in the region as we continue our growth path. With the expansion of JD, we saw record monthly sell-through of footwear in September, which helped the U.K. to double net sales year-over-year in Q3.

And we are excited to say that Q3 also marked the successful launch with Footlocker in Europe, both in selected stores and online. Finally, Q3 also means marathon season in Europe, and we were very present in the weeks leading up to the marathon in London and Berlin, with this year’s spring campaign showcasing the power of running to ignite the human spirit. Marc and I, of course, are amongst the big believers in this power. And so I will admit Marc did so considerably faster than I. I’m happy to share that we both crossed the finish line in Berlin with smile still on our faces, alongside many of our On teammates, friends and partners. Net sales in Asia Pacific grew 85.2% to CHF 24.2 million, driven by the strong rebound in China following the prolonged lockdowns in Q2 as well as the continued momentum in Japan and Australia.

Despite some occasional local lockdowns, China posted a year-over-year growth rate of 90% in Q3. This momentum also extends beyond Q3. For Double 11, the biggest online shopping festival in China, On was selected as the only new sportwear brand to be featured online and offline with Tmall in the buildup to the event. Our co-branded design featuring the Cloudmonster was highly visible in major subway and bus stations across all major cities as well as digitally for the 3 weeks leading up to Double 11. This, together with our strong brand momentum led to an increase of over 135% in terms of items sold versus the prior year Double 11 period. With a total of 7 new On retail stores opening in China in half year 2, and considerable traction on our new WeChat mini program launched in October, we expect China to be a continued growth driver for us for the years to come.

Finally, our Rest of World net sales increased 150% to CHF 11 million. As announced in previous calls, we have successfully built a network of new distributor partners across Latin America. In addition, we are also seeing a very strong demand increase in the Middle East. Turning to our performance by product category. Net sales On shoes grew 51.6%. In August, we launched the CloudGo, which, together, with the Cloudmonster and the Cloudrunner, has completed our line of reinvented performance running products that have driven significant market share gains for us. We expanded our collection of undyed products to the Cloud 5 and also the Cloudnova, and we are excited to showcase these blockbuster franchises in their most sustainable execution today.

As we all celebrate Roger’s amazing career, we also expand the Roger Line to a new mid-top version and of course, celebrated Roger’s last official tournament, with Roger Laver Cup limited edition, which caused long lines at the on stand during that event in London. Apparel grew by 32.4% to CHF 15.2 million. Similar to last quarter, still slightly below our expectations, but we continue to build the foundation for future success by investing into our internal capabilities, our product assortment and the experience for our customers. Gross profit reached CHF 187.4 million in the third quarter compared to CHF 131.3 million in the previous year period, representing a gross margin of 57.1% versus 60.2% in Q3 ’21. As expected, we used additional airfreight to fulfill more of the high demand for some of our new products.

But overall, in Q3, we further reduced the reliance on airfreight, and we are now in a more normalized position, which helped drive continued sequential improvement on gross margin versus Q1 and Q2. Besides the planned impact of airfreight, we have experienced pressure on our margin from the lower D2C share as a result of the warehouse constraints and, even more importantly, from the negative year-over-year FX development mentioned earlier. SG&A expenses, excluding share-based compensation and last year’s one-off transaction costs related to IPO were 44.1% of net sales in Q3 this year, reduced from 46.4% in the same period last year. While we continue to invest in all parts of the business, we are also driving efficiencies and economies of scale.

Adjusted EBITDA reached CHF 56.3 million in the quarter, exceeding CHF 50 million for the first time in our history. This was up from CHF 37.9 million in the previous year, which, at that time, had been the highest quarterly EBITDA to date. The adjusted EBITDA margin of 17.2% decreased slightly from 17.4% in Q3 ’21, largely due to the gross margin impact mentioned earlier, but was considerably up from the 10.8% in the last quarter. Now moving to our balance sheet. Capital expenditures were CHF 22 million in Q3 ’22 or 6.7% of net sales, largely consisting of investments into the buildouts of our offices in Zurich and Portland into new On retail stores as well as IT infrastructure. Let me go into a bit more detail when it comes to our inventory position.

Inventory increased by CHF 45.7 million or 21.1% compared to the end of June, and by CHF 118.2 million or 82% compared to the end of the third quarter last year, which, a year ago, as you remember, was unseasonably low due to COVID-induced factory shutdowns. If we exclude in-transit inventory, which has been significantly reduced due to the reliance on airfreight between September last year and middle of this year, the inventory growth quite closely followed our net sales growth. We are currently in a much better position to execute the demand for the upcoming holiday season than a year ago, but inventory levels were at a low point. The inventory in transit and in our warehouses has been produced to fulfill the existing orders on books, which should stay in Q4 and in early Q1.

Driven by the higher working capital and the CapEx investments, net cash at the end of Q3 reduced CHF 493 million from CHF 557.7 million at the end of the second quarter. Our strong balance sheet allows us to pursue our ambitious growth plans and upcoming investments. Finally, towards our path of becoming a much larger company in the future, I’m very pleased to announce that we have secured the capacity with a third party to build a highly automated fulfillment center in Atlanta. This warehouse will provide additional capacity as of early next year and will replace our existing East Coast warehouse by 2025. By then, the automation will significantly decrease our handling costs and dependency on manual labor, offering an opportunity for further SG&A leverage and continued increase of our D2C business.

This contract is secured by a bank guarantee and, consequently, by dedicated cash balance. Let’s look into our future logistics setup. It’s a great transition to speak about our financial outlook for the rest of the year ’22 and into 2023. A very exciting and successful year is coming to the end, and we are planning to close the year on a high note. Based on the strong performance in Q3, we are once again raising our net sales outlook for 2022 by CHF 25 million from CHF 1.1 billion to CHF 1.125 billion, which includes the confidence in our ability to drive the stronger fourth quarter than assumed in our previous guidance. This new top line reflects a strong full year growth of 55% compared to 52% in our previous guidance. The increased outlook considers a few aspects that I would like to point out.

First, the temporary constraints in our Atlanta warehouse are behind us, and we are approaching the important holiday season with a strong momentum. While we have a strong inventory position, we may see out-of-stock situations on some fast-moving styles, which we see as an important element in driving positive scarcity. Importantly, our long product life cycles allow us to remain focused on full price sales. Given the good momentum and supply situation, we are now in a position to fully normalize the use of airfreight and do not expect an extraordinary impact in Q4. Second, we continue to see a strong demand for On products, and October was off to a very good start for the quarter. We’re staying in close contact with our retail partners, and analyze our extensive customer data to carefully observe the macro and microeconomic developments.

Our order book for Q4 and for the first half of next year confirm our strong outlook, and we are planning the business for continued strong growth. We’re also focused on ensuring we stay disciplined and controlled in our cost structure to ensure we are driving durable long-term growth. Third, we expect continued margin pressure from the combination of a strong U.S. dollar and a weak euro, both compared to our reporting currency Swiss francs. The executed price increases in the U.S. and the planned increases in Europe as of early next year offset some of the compression. For 2022, we are increasing our adjusted EBITDA target for the full year to CHF 148 million, reconfirming our goal of an adjusted EBITDA margin of 13.2% for the year, even at the elevated top line outlook and despite the additional challenges described beforehand.

Finally, as we have previously mentioned, due to the structure of our pre-IPO equity plans, we will see the majority of the 2022 share-based compensation expenses in Q4. At the current share price level of USD 17 to USD 21, we anticipate a charge of around CHF 35 million to CHF 50 million. Each dollar higher or lower than the current share price at the time of granting in early December would then cause the share-based compensation charge to change by roughly plus/minus CHF 3.5 million. Over the past weeks, we have spent a lot of time with our senior leadership team to shape an aligned vision for the years to come. Our order book for the first half of ’23, the current demand we are seeing, and the much-improved supply environment put us in a strong position to drive continued strong and durable growth, both in Q4 and beyond.

They also allow us to approach the year cautiously to protect the position of the brand even in the current uncertain macroeconomic environment. Notably, we are committed to further increase our absolute and relative profitability with a constant focus on efficiency and improvement of adjusted EBITDA. David listed some of the most exciting initiatives around our brands in the last month. They ultimately led to the strongest quarter in our history and an elevated outlook to close the year on a high. And we remain fully focused on accomplishing in these last few months. All of this would not be possible without our culture and the team that is standing behind it. Our new offices around the world became an incredible source of energy. We can’t be thankful enough to everyone in the team for building a culture of high performance, while also focusing on everyone’s wellbeing.

One of my highlights every month is to talk to our new starters and to share our history as a starting point 2-day or 3-day-long onboarding journey. Because to understand our past, it’s essential to shape our future and to dream on. With that, David, Marc and I like to open up the session to your questions. Operator, we are ready to begin the Q&A session.

Q&A Session

Operator: The first question is coming from Jay Sole from UBS.

Jay Sole: Great. David, you mentioned a lot of innovation that companies delivered over the last quarter, Cloudmonster, the CleanCloud. Can you just talk about the new product pipeline and the innovation that you have planned for next year? Do you see this robust as it’s been over the last few quarters? And can you talk about the kind of investments you’re continuing to make in product innovation to drive the brand forward?

David Allemann: Very much — very happy to talk about that because our goal is to be the #1 brand on runners’ bodies over time. And so it’s super important that we continue to invest in innovation. And you’ve seen that in the past that we regularly launch new technology platforms. Now you also see how we’re working closely together with athletes. So just look at what our collaboration with Gustav Iden athlete, but also for many, many other athletes On Athletics Club to name some — to name a group that also got an incredible followership around our core running consumer. Now for next year, and I think we mentioned that also in the previous call, we are introducing a whole new technology platform, which is Cloud X 3, which was developed computer assisted, so that we choose the very best form factor to give you the perfect price.

And so that’s just the next iteration of how innovation comes out of On. And like we mentioned here as well that the foams that we are using in shoes for our athletes and also the Speedboard is can be actually fully bio-based. You see that in the Cyclon. In Cyclon, we will be use very, very advanced foams, and advanced Speedboard, and its fully bio-based and recyclable. So you also see that we can combine high performance for athletes, but at the same time, also achieve our goal of circularity.

Jay Sole: Got it. And then maybe, Martin, if I can follow-up, just one other one. Can you just talk about the impact that the warehouse constraints had on sales in terms of like a number? And then also at the same time, within Europe, how much did FX weigh on the growth rate in terms of like basis points?

Martin Hoffmann: So the impact of the various constraints was mainly on direct-to-consumer because the omni sale channel traditionally has inventory so the impact there was less immediate. We would have seen a higher D2C share, if we wouldn’t have seen those constraints. They really lasted for about half of the quarter. So the share of our D2C business would have been more in line with what we have seen in the past. To the question on the FX impact on our regions, if you would look at basically the 2 key regions on a rate of last year, then the growth rate in Europe would be more around 41%, and the growth rate in the U.S. about 49%, or North America.

Operator: The next question is coming from Jon Komp from Baird.

Jon Komp : Martin, if I can follow-up. Could you talk a little bit more about what’s performing your top line revenue growth assumptions in the fourth quarter? And since you commented directionally on the order book into the first half of 2023, could you just maybe frame up sort of what you’re seeing in terms of qualitatively the growth and the reaction from your wholesale partners, and how we should view that — those comments in the context of sustaining good top line growth here?