On Holding AG (NYSE:ONON) Q3 2023 Earnings Call Transcript

On Holding AG (NYSE:ONON) Q3 2023 Earnings Call Transcript November 14, 2023

Operator: Hello, and welcome to the On Holding AG Q3 2023 Results Call. [Operator Instructions] I’ll now turn the conference over to Jerrit Peter, Head of Investor Relations. Please go ahead.

Jerrit Peter: Good afternoon, good morning, and thank you for joining On’s 2023 third quarter earnings conference call and webcast. With me today on the call are Executive Co-Chairman and Co-Founder, Caspar Coppetti; CFO and Co-CEO, Martin Hoffmann; and Co-CEO, Marc Maurer. Before we begin, I would like to remind everyone today’s call will contain forward-looking statements within the meaning of the federal securities laws. These forward-looking statements reflect our current expectations and beliefs only, and are subject to certain risks and uncertainties that could cause actual results to differ materially. Please refer to our 20-F filed with the SEC on March 21st for a detailed discussion of such risks and uncertainties.

We will further reference 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 to the most comparable IFRS measures. We will begin with Caspar, followed by Martin, leading through today’s prepared remarks, after which we’re looking forward to opening the call for a Q&A session. With that, I’m very happy to turn over the call to Caspar.

Caspar Coppetti: It is our great pleasure to be here today with you to discuss the results of our thriving business. On continues to have a very strong momentum. In Q3, the outstanding demand for our brand resulted in another record top line quarter with over CHF 480 million net sales. This represents 47% growth year-over-year or even 58% on a constant currency basis. Many of you joined us 6 weeks ago for our Investor Day in Zurich, and we tremendously enjoyed sharing more about On’s unique culture, innovation pipeline and brand vision with you. We aim to be the most premium global sportswear brand, rooted in innovation, design and sustainability. Allow me to share how we have made progress towards this goal in the third quarter.

The On brand is in very high demand and has further gained in popularity and desirability. We’re seeing great success by connecting our celebrity athletes to product innovation. When Ben Shelton stormed to the semifinals at the U.S. Open, for instance, we amplified his skyrocketing popularity through the On brand campaign, Dream On. As announced, we are making strategic shifts in our marketing spending to further build global awareness for On. The headline Dream On Hellen Obiri could also be seen on billboards across New York City in the recent weeks, and Dream On, she did with her dominating win at the marathon, making Hellen the first woman to win Boston and New York in the same season in 34 years. I cannot emphasize enough how important successes like this one are for our brand and for our ambition to become the #1 running brand.

Performance is at the very core of the On brand, and our superior products allow us to command premium prices. More importantly, performance is also a passion across the team. Last month, our Co-Founder, Olivier spent a good week in Boulder to support our local teams during Hellen’s final preparations for New York and the testing of new racing technologies for the upcoming Olympics with the On Athletics Club. And let us share another anecdote with you that illustrates our culture. 10 OAC athletes traveled to New York from Boulder to support Hellen in her race, among them, world-class athlete, Yared Nuguse, who in September won the 1500 meters in the Diamond League Meeting in Zurich. You may not be used to hearing these kind of stories in an earnings call, but we feel that how we achieve our results is just as important as the results themselves.

As shared during the Investor Day, On has a very strong product innovation pipeline. In recent months, we were able to deliver a number of highly successful product launches. Let me name a few. The Cloudeclipse is catering to runners who are looking for a maximum cushioning experience. It is built on our newest patented cushioning platform, CloudTec Phase, which consumers have already adopted so quickly on the Cloudsurfer. And CloudTec Phase isn’t just for running shoes. On’s computer-optimized outsole technology has been adapted for ultimate all-day comfort as well. I am of course talking about the all-new Cloudtilt, which we pre-launched in a hugely successful collaboration with Loewe. Retailing at $490, the model sold out almost entirely within a few days and generated significant traction across our social platforms.

We are excited to see how far the Cloudtilt will go when it becomes more widely available to consumers in February next year. Our design collaboration with JW Anderson and Loewe is a testament to the premium positioning of the On brand, and in particular to On’s apparel range, which will again be featured in the collaboration with Loewe in the coming months. Speaking of apparel, we’ve seen exciting launches in the past weeks and have been very present around the globe with our campaign, RunTogether. Another key innovation milestone in apparel is the Pace Collection, which launches today. It is made from captured carbon emissions, and we are proud to bring On’s CleanCloud technology to apparel for the first time. The strong presence on the tennis court has also increased demand for On’s apparel range, and we look forward to introducing specific tennis performance and lifestyle apparel in spring.

Congratulations to Iga Swiatek for taking the WTA Finals title and returning to world #1. Q3 also marks a milestone in the continuing shift of how we reach our customers. With 55% growth, On’s D2C business has significantly outpaced the wholesale business, which grew 43%. We are very encouraged by the strong performance across both E-com and own retail, which saw store openings in Miami and London Spitalfields in recent weeks. In line with our 3-year plan, we expect D2C to continue to grow faster than wholesale, which will remain an important channel for our business. I’m happy to say that as a brand, we have found the wholesale partners that we want to work with, and going forward, we will focus on deepening these partnerships and jointly delivering an intimate consumer experience across categories through these channels.

As we enter the holiday season and prepare for more product launches to surprise our fans in 2024, we are grateful to share that the On brand has never been stronger than today, and that we never had more reasons to be optimistic about the future trajectory of our business. This is a pivotal moment in our story as we are successfully transforming from a challenger in the running category to a running leader, from a running brand to a multisport brand, from a wholesale-led to a true omnichannel brand, and from a footwear brand to a sportswear brand. With this, I will now hand over to Martin for the detailed discussion of our business and the financials, but not without correcting my earlier mistake of not naming him among the athletic feats of our top athletes.

Congratulations on your finish in the New York Marathon, Martin.

Martin Hoffmann: Thank you, Caspar, and hello to everyone on the call. I still have goosebumps when thinking back to the energy from the amazing crowd along the course in New York City. I was extremely proud and inspired to see so many athletes of On’s Right to Run partners on the course, too. This is what igniting the human spirits for movement is all about. Which is also why we attempt to incorporate a movement session in all interactions with our teams, our partners, and yes, also at our first Investor Day. It was so exciting to welcome many of you to Zurich a few weeks ago. After having completed our IPO process, mostly in a virtual setting, it was great to allow you to experience On firsthand. Similarly, it was very important to us to introduce you to our product team.

We are so grateful for the passionate and talented individuals that are building our dreams with us. We hope you learned a lot about who we are, about the incredible pipeline of products and innovations that are yet to come, and most importantly, that you felt the unique culture at On. For those of you who were not able to join us on the day, the materials as well as a replay of the presentation are available on our Investor Relations website. In addition, before diving into our Q3 results, let me quickly summarize the key elements of our strategy that we outlined at the Investor Day. We aim to be the most premium global sportswear brand. Our first pillar includes 3 strong existing building blocks that we will elevate further. We’ll continue to put a lot of emphasis on running and aim to significantly increase our market share on runners’ bodies.

We intend to benefit from the huge potential around the globe by increasing brand awareness among our core communities. And innovation will continue to be at our core as we focus relentlessly on driving On’s performance credibility and sustainability impact. Our second pillar is focused on investment areas that we will grow aggressively to expand our reach and depth over the coming years. This starts with our ongoing commitment to elevate the power of our premium multichannel distribution to reach our fans globally. We will significantly increase our own retail presence and evolve the channel to contribute meaningfully for our overall business. Finally, we’ll continue to expand our footprint in China at a rapid pace, accelerating market share gains in one of On’s highest growth markets.

The circular consists of new areas to establish our brand with meaningful communities aligned with our vision to be the most premium global sportswear brand. We aim to tap into the training community and light up the tennis court to significantly increase our addressable market. And we will further focus on establishing On as a true sportswear brand known for our full head-to-toe looks across all of our existing and new verticals. With these initiatives, we intend to continue our path of combining high growth with attractive and increasing profitability. This means that by 2026, we aim to double our net sales to at least CHF 3.55 billion, drive our gross profit margin above 60%, and increase our adjusted EBITDA margin to more than 18%. None of this will be easy, but we are extremely excited for what is to come.

As a first step on this journey, and as Caspar mentioned, we are very pleased to say that we started off strong with another outstanding quarter. With this, let me reflect on our Q3 results and our full year outlook and how we view both in the light of our long-term strategy. With net sales reaching CHF 480.5 million, Q3 has been our seventh consecutive record quarter. With 59.9%, we achieved the highest gross profit margin since our IPO. CHF 81.3 million adjusted EBITDA marks another record in the history of the company, exceeding any other quarterly adjusted EBITDA by almost 30%. CHF 58.7 million net profit in the quarter is more than in the whole year of 2022. And we generated a significant positive cash flow. It’s fair to say that Q3 has been our most successful quarter in history across all measures.

The demand for the On brand remains very strong. Our net sales grew by 46.5% versus the prior year period. Due to the ongoing strength of our reporting currency, Swiss francs, the equivalent growth rate at constant currency rates would have been close to 58% or in absolute terms, our reported Q3 top line number would have been over CHF 518 million at last year’s rates. For the second consecutive quarter, D2C outpaced wholesale with a growth of 54.6%, resulting in a D2C share of 34.3% compared to 32.5% in Q3 last year. D2C net sales for the quarter reached CHF 164.7 million. As shared in some details during our Investor Day, we are very excited to see how brand moments such as Ben’s success at the U.S. Open, the wins of our OAC athletes or on a smaller scale, Roger’s recent visit to some of our stores in China are visibly leading to higher brand awareness and ultimately to increase traffic both on and offline.

As mentioned before, own retail will play a larger role in our D2C strategy going forward. The continued success of our stores is further increasing our confidence in this strategic direction. With 26 retail stores operating by the end of Q3, our net sales contribution from own retail more than tripled year-over-year. As Caspar mentioned, over the recent weeks, we successfully opened 2 additional retail stores, one in Miami and the other in London Spitalfields. We’re absolutely thrilled to see the vibrant communities that are gathering around our retail locations. In London, we had about 100 dedicated runners joining us for the first Saturday run out of the store, even in the face of the typical rainy London weather. The high apparel share of 23% in Miami and 19% in London is another validation of the importance of our own retail channel in establishing On as a head-to-toe sportswear brand.

We continue to win many new fans and to tap into new communities through our wholesale channel. Wholesale grew by 42.6% in Q3, reaching CHF 315.7 million. Due to the disruption in our warehouse in the U.S. in Q3 last year and the resulting shift of volume to Q4, this growth rate is slightly elevated. In addition, we did see some early holiday shipments sent out to our partners in the later part of Q3 this year, pulling forward some volumes from Q4. Independently from these one-off effects, we have seen very strong sell-out numbers at our wholesale partners. We are very pleased with the level and the composition of our in-channel inventory. Given these one-offs, looking at wholesale growth for the combined second half of the year will be a more meaningful measure to establish a baseline for wholesale growth going forward.

With that, let me move on to the developments by region. We have achieved strong growth rates globally. Net sales in the Americas grew by 60.5% in Q3, reaching CHF 294.9 million. We are pleased to see that the strong sell-in for the fall/winter ‘23 season coincides with continued sell-out strengths at our partners across the board. Of course, our U.S. business was the most impacted by the operational challenges in the prior year period, again, slightly helping the reported growth rate in Q3 this year. Net sales in the EMEA region reached CHF 144 million in Q3, growing by 19.9% year-over-year. Similar to the previous quarters, we have seen a significantly stronger growth in our D2C channel compared to wholesale. The U.K. remains one of the key growth engines in the region.

The growth is very much performance first, which is very important for us. The validation comes from our recent shoe count along key running routes, where we have seen a strong increase of our market share on runners’ feet. APAC reached net sales of CHF 41.6 million in the third quarter, corresponding to a growth rate of 71.5%. On a relative basis, APAC was the most impacted by the FX shifts versus the prior year. On a constant currency basis, growth in the region would have been over 95%. Overall, growth was broadly distributed across all sub-regions and channels with call-outs for the very strong momentum in Japan as well as the continued strength of our own retail stores in China, in particular, during the Golden Week holiday period. Turning to the performance by product.

Net sales from shoes grew by 47% to CHF 456.9 million. We continue to be encouraged by the strong performance of newer core running blockbusters like the Cloudsurfer and Cloudmonster, and the new generation of Cloud X clearly showcasing the adoption of On in gyms across the globe. The positive brand momentum around the U.S. Open was also demonstrated in an outstanding performance of the Roger family, visible in an elevated growth rate of the franchise in our D2C channels versus the prior year. Apparel grew by 31.8% in the quarter, reaching CHF 20.1 million. As many of you saw a few weeks ago in Zurich, we are very excited about the upcoming collections and innovations that will allow us to further emphasize the differentiation and premiumness of our products.

We are also looking forward to the next generation of our retail store concepts and the role they will play in showcasing our full head-to-toe offerings. The first store to follow this new concept will be our Paris store due to open later this week. Finally, while we slightly scaled back on marketing in Q4 last year, we are running a bigger brand campaign in Q4 this year, centered around our new apparel collection. This includes many highly visible brand moments in key cities around the globe. One of the highlights is our activation at Tottenham Court Road Underground Station in London with daily traffic of over 200,000 people. For the first time since our IPO, we reached a gross profit margin close to our midterm target of 60% plus. Gross profit reached CHF 287.7 million in the quarter, reflecting a gross profit margin of 59.9% and an increase of 280 basis points year-over-year.

This margin increase was driven by a continued high share of full price sales as a result of the premium position of the brand, the increased D2C share and lower freight rates. In addition, we had recorded the last piece of extraordinary airfreight usage in Q3 last year. SG&A expenses, excluding share-based compensation in Q3 [Technical Difficulty] by 46.4% of net sales, up from 44.1% in the same period last year. In particular, distribution expenses remain elevated due to the investment into warehouse automation, which are expected to deliver meaningful scale gains in the future. As a result of the strong net sales, our premium gross profit margin and consciously managed expenses, adjusted EBITDA reached CHF 81.3 million in the quarter, by far the highest in the history of the company and up from CHF 56.3 million in the previous year.

Our adjusted EBITDA margin reached 16.9%, slightly down from the 17.2% in the same period last year. Moving to the balance sheet. Capital expenditures were CHF 8.2 million in Q3 ‘23 or 1.7% of net sales, significantly reduced from the 6.7% of net sales in the same quarter in 2022. In the prior year, the elevated expenses had largely resulted from nonrecurring investments into office build-outs in Zurich and in Portland. Managing our inventory remains a key focus area. In Q3, inventory improved to CHF 424.5 million, a further reduction in comparison to the end of Q1 and Q2, while growing our net sales at the same time. In line with our previous communication, we expect to maintain the current inventory level by year-end. The reduction in inventories also largely drove the overall reduction in net working capital in Q3, contributing to a significant positive cash flow of over CHF 90 million in the quarter.

As a result, net cash increased from CHF 337.1 million at the end of Q2 to CHF 432 million at the end of Q3. As I’ve mentioned, this positive cash flow marks another historical record for On. With that, I would like to move on to our last outlook for the full year of 2023. We are experiencing another incredible year with 3 record quarters and year-to-date growth rate of over 57%, which was driven by winning millions of new fans while connecting even closer with our existing customers. This is most directly reflected in the strong growth of our D2C channel by 57.4%. The growth was further amplified by the very successful expansion of our wholesale network and the important product or rollout with some of the largest global key accounts over the past 12 months to 18 months.

As Caspar mentioned, in many markets, we have found the wholesale partners that we want to work with. While we will continue to expand our presence in existing stores and carefully expand into new locations, new doors will drive less incremental growth compared to previous quarters. In our strategic plan, we outlined our belief in the power of our multichannel distribution and the huge potential of combining all channels in harmony. And ultimately, in our belief to at least double our net sales in the next 3 years, while at the same time, driving a stronger growth in our D2C channels compared to our wholesale channels. We look forward to the final 1.5 months of the year and are heading into the holiday season with confidence in the strength of the On brand and in the strength of our products.

This kicked off strongly during the Double 11 holiday period in China. Despite again, following our no discount policy, we saw an overall year-over-year volume growth of over 70% during the holiday period, clearly indicating the continued brand momentum for On in China. Based on the start of the fourth quarter, our strong Q3 results and our visibility until the end of the year, we are again increasing our net sales ambition for the full year from CHF 1.76 billion to CHF 1.79 billion, implying a full year growth rate of over 46%. Zooming in on the fourth quarter, our net sales outlook implies a Q4 growth rate versus the prior year of 21% on a reported currency basis. In line with our strategy outlined above, we expect to see a more controlled growth of our wholesale sales while converting the high demand for the brand in continued strong D2C sales growth.

As we’ve outlined in our previous quarterly calls, our Q4 growth rate will be further influenced by 3 transitional factors. First, in 2022, we had seen a delay of some order deliveries from Q3 into Q4 due to the disruption of our largest U.S. warehouse as a result of a system update at our 3PL partner. Second, in EMEA, focused on the DACH region, we will be strategically closing around 200 doors at the beginning of the year, which will have an initial impact on our reorders in the fourth quarter. As mentioned on our last call, these stores are mainly comfort stores with a low share of performance business and accounted for around 10% of our EMEA wholesale net sales. Last, primarily due to the strength of the U.S. dollar, but also other impactful currencies compared to the Swiss franc in 2022, we expect another quarter with a strong negative currency impact on our global growth rate.

The 21% anticipated growth rate on a reported basis in Q4 is equivalent to around 30% on a constant currency basis. As a result of our long-term strategy, combined with these temporary effects and timing, we expect our reported wholesale growth in Q4 ‘23 in the area of high single digits. On the other hand, we expect continued strong Q4 growth rates in D2C, closer to what we have seen over the past couple of quarters in that channel. Moving to margins. Our year-to-date gross profit margin of 59.3% reflects the premium position of On. Based on the strong performance in Q3 and the planned strength of our D2C business in Q4, we expect to significantly overachieve our previous full year outlook of 58.5% and increase our full year expectation to at least 59%.

If the environment continues to be favorable, we may even see the full year number drive beyond this threshold. The higher net sales and the stronger gross profit margin will allow us to drive additional investments into building brand awareness in Q4, while maintaining our full year guidance of 15% adjusted EBITDA margin. We continue to think long-term, and we expect these investments to have a positive effect on future sales and ultimately, on our ability to reach our long-term goals, doubling our net sales by 2026, while increasing our gross profit margin above 60% and our adjusted EBITDA margin to more than 18%. Since we publicly announced our strategic plan at the Investor Day, we have spent a lot of time internally to share and discuss our vision at On. Just last week, we hosted our Global Summit, where we introduced our fall/winter ‘24 product collection as well as the 2026 strategic road map to our full internal team.

And we are already experiencing the energy and the enthusiasm across all parts of the organization to build the future. And while we remain intensely focused on bringing this exceptional year across the finish line, we are already looking forward to the many highlights that we expect to achieve on the next steps of our journey. And with that, Caspar, Marc and I would like to open up the session to your questions. Operator, we are ready to begin the Q&A session.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Jim Duffy of Stifel.

Jim Duffy: I have a few questions, I want to start on the fourth quarter guide. The first relates to the state of channel inventories. Previously, you’ve spoken to the North American market having 3 months to 4 months of inventory in the channel. Does that figure still hold or would the earlier sell-in kind of the pull forward of some of the shipments are you now above those levels?

Marc Maurer: Jim, this is Marc speaking. Thank you for your question. So that still holds. So we are very strategically managing that, especially with all our key accounts. We have very good visibility. And in the end, this is also what you see reflected in our gross margin. So we were able to drive a lot of full price sell-through. And so we’re very happy with the inventory position, a lot of fresh inventory that is available at our retailers.

Jim Duffy: Great. And then the fourth quarter, a very important e-commerce quarter. Can you speak to what you’re seeing in e-commerce trends, including customer acquisition, mix, new versus retained customers? I know you had some efforts in social commerce, what you’re seeing in terms of the contributions from social commerce, that would be helpful.

Martin Hoffmann: Yes. Jim, this is Martin. So let me maybe share a bit more insights into the holiday season. So we had a good start into October. We clearly see that we are winning market share in the current environment. Last year was an exceptionally strong holiday season, so significantly above also what we had seen in previous years. We see less enthusiasm this year, and this is also what we hear and see from our retail partners. But at the same time, we continue to grow strongly, and we maintain a full price position. We shared the success in China during the Double 11 season with 70% growth in an environment where the market was flat. And what we see at the moment is fully embedded in our guidance of CHF 1.79 billion, and we believe that this number reflects the current situation quite accurately.

Jim Duffy: Great. Martin, can you maybe give some comments on customer acquisition? Historically, you’ve spoken some about mix of new versus retained customers in your D2C business.

Martin Hoffmann: Yes. So the channel continues to win new customers and to increase market share. So we focus on both acquiring new customers by increasing also brand awareness, but then also working with the customers that we have. We have significantly increased the number of members. So where we have more data and more insights into our fans as well. The holiday season is usually a season where you see the benefits and the fruits from the work throughout the year coming to life. It’s usually not the moment where you acquire a lot of new customers. But as said, we are very happy with how our [ e-com mentioned ] is performing and how it’s supporting our strategy to outperform our wholesale growth with our D2C growth.

Operator: Your next question comes from the line of Jonathan Komp of Baird.

Jonathan Komp: Yes. I want to just follow up. When you look at the fourth quarter revenue guidance, I know you called out some of the transitory factors. Could you maybe just discuss, as you look forward beyond the fourth quarter, if any of those factors will continue outside of the wholesale pullback in Europe? And as you think about next year relative to your long-term mid-20% growth target, do you have any insight today that would support confidence above or below that? And could you, Caspar, maybe talk about the pace of some of the upcoming introductions that you’re most excited about?

Martin Hoffmann: Yes. So maybe let me start with the last one. So we are super excited for ‘24. I think we have a firework of new products coming, a lot of innovation. We have big brand moments planned like the Olympics. So we have outlined our growth aspiration for the next 3 years and doubling our net sales. And as we have done in the past, we will provide an updated guidance on ‘24 in our earnings calls then in March during the full year results. Looking at wholesale and D2C and some of the temporary effects that we now see in Q4, the store closures from EMEA, this is something that will be visible. And we spoke about this that we — that those 200 doors account for around 10% of the EMEA wholesale sales. And so this volume will be going out of the market in — over the next 12 months.

And then we outlined in our Investor Day, our belief in the power of our multichannel distribution and that we see all channels growing that we want to accelerate our expansion in retail, all with the goal to be the most premium performance sportswear brand. And so we expect that all channels are growing, but by controlling the wholesale growth and simply having less incremental new doors, we expect that the increasing brand awareness that we clearly see is converting stronger into the D2C channel. And as a result, we expect a stronger growth in D2C than wholesale, and we expect this to be already quite visible in our Q4 numbers and ultimately being a source for delivering a premium financial profile in the mid and long-term.

Caspar Coppetti: And Jon, Caspar here for your product-related question. There’s many things to be excited about, as you know, you’ve been here for the Investor Day. If you just look at the recent launches in this quarter, the CloudTec Phase platform. So the new Eclipse that we just launched, our Max Cushioning product has done extremely well in early sell-through and it’s becoming one of the favorite running shoes for many. So kind of having a second option there next to the Monster for those that are looking for a very cushion ride is important. And on that same CloudTec Phase platform, the Tilt, which we’ve pre-launched now with the Loewe collaboration, that has exceeded all our expectations. And we are very, very excited about the pending launch in Q1 in ‘24 when the Tilt becomes very widely available to consumers, hopefully, adding another strong silhouette next to Cloudnova, Roger and Cloud.