Earnings Call Transcript - ONON Q3 2021

Operator, Operator

Hello, and a warm welcome to the On Holding AG Third Quarter Twenty Twenty One Results Call. My name is Melissa, and I will be your operator. I would now like to hand the conference call over to Florian Maag, Head Of Investor Relations and Corporate Finance. You may begin.

Florian Maag, Head Of Investor Relations and Corporate Finance

Good afternoon. Good morning and thank you for joining on twenty twenty one in overall conference call and webcast for our third quarter twenty twenty one results. With me today on the call, our Executive Co-Chairman and Co-Founder, Caspar Coppetti; CFO and Co-CEO, Martin Hoffman and Co-CEO, Marc Mauer. For the first part, Caspar and Martin will lead through the prepared statements. Afterwards, we are looking forward to open the call for a Q&A session. Before we begin, I would like to remind everyone that the remarks during today's call may contain forward looking statements regarding future events and financial performance within the meaning of the Federal Securities Laws. These forward statements reflect our current expectations and beliefs only. And top statements are subject to certain risks and uncertainties that could cause actual results to differ materially. Please refer to our final prospectus filed with the Securities and Exchange Commission relating to the company's IPO on September sixteenth twenty twenty one for a detailed discussion of the risks that could cause and actual results to differ materially from those expressed or implied in any forward looking statements made today. Please further note that this call will also contain certain non-IFRS financial measures, such as adjusted EBITDA and adjusted EBITDA margin. One of the company believes, these non-IFRS financial measures will provide useful information for investors, the presentation of this information is not intended to be considered in our isolation or as a substitute for the financial information presented in accordance with IFRS. Please refer to today's release for a reconciliation of our non-IFRS financial measures to the most comparable measures prepared in accordance with the IFRS. With that, I will turn the call over first to Caspar followed by Martin for the prepared remarks.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

A warm welcome to all of you joining us today. We're excited to share with you On's first quarter results as a public company, and we thank you very much for joining this first call following our successful IPO. We are very pleased to announce that Q3 has been the strongest quarter in the history of the company. In terms of net sales, gross profit, and adjusted EBITDA. Global consumer demand for the On brand continues to strongly accelerate as expressed by the fact that all channels reached, and product categories are contributing significantly to On’s hyper-growth. We are thrilled that our brand, which started twelve years ago with the first prototype consisting of cut pieces of rubber from the sole of an old running shoe, has developed into a company that generated net sales of Swiss Franc two hundred eighteen million in this past quarter Q3 twenty one. We see our recent IPO as a steppingstone in our mission to serve more and more people around the world. We invite everyone to join us on this mission to ignite the human spirit through movement, or in short, dream on. We will continue to discover and explore new frontiers, do things differently and build long-term enduring value for all our partners and stakeholders. Given that this is our first earnings call, and some of you may be new to On, we will start with a brief introduction to our history, our core strengths, and growth strategy and shed light on how we made progress in the past quarter. We will then deep dive into our quarterly performance and conclude with an outlook and guidance before opening it to Q&A. On is an innovation company. On was born in the Swiss Alps with one goal: to revolutionize the sensation of running based on the soft landings followed by explosive take-offs, or as we call it, running on clouds. We focus our efforts on three main areas: performance, design, and positive impact. We aspire to increase performance for athletes and everyday consumers, pipeline smart, distinct and sustainability-focused designs to our products. We're happy to report that in the past quarter, On has made strong progress on all three fronts. First, we are proud to have been the official outfitter for the Swiss Olympics and Paralympics teams at the Olympic games in Tokyo. The visibility across the globe, especially for our apparel, led to increased demand and brand awareness. A personal highlight was watching the women's cross-country mountain race where our athletes won both silver and bronze, seeing the full podium in our gear. The Swiss team went on to achieve twenty-seven medals, the best in almost one hundred years. We are also proud that seventeen athletes competed in On products in Tokyo, including five athletes from the On Athletes Club founded only a year ago and based in Boulder, Colorado, along with four athletes from the refugee Olympic team. To enable our athletes to compete at the highest level in long-distance running, we introduced the Cloudboom Echo shortly before the games for both competitors and consumers. This shoe is the pinnacle of our performance running range, featuring CloudTec and ultra-super foam and the carbon speed board. We have already seen many great results by our athletes using this product, including a third place finish by one of our athletes in the Berlin Marathon this past September. On our EBIT performance running segment, we are able to wow consumers and capture market share with the new Cloud Chaser and the Cloud Flyer, which continues to have very strong commitment. Our outstanding design continues to fuel our rapid growth in the performance all-day business driven by the two recently added franchises. We’ve seen that the Signature Formula is developing very well, and Roger Federer recently launched a limited edition, I believe in Boston, which sold out within hours. Both categories are attracting younger, urban, and fashion-conscious consumers and are key pillars in our ambition to be a global pacemaker brand. Third, we are seeing more and more consumers shopping for complete outfits, including our apparel and accessories. In Q3, net sales from apparel products grew more than twice as fast as sales from shoes. We have seen strong demand for exciting new products like the existing partner for protection season, our newly active apparel, and climate-checked items. All of them reflect our passion for technology, design, and sustainability. Last but not least, we are ready to introduce exciting new footwear and apparel products driving performance across multiple segments in Q1 next year. Now, let’s discuss our third focal point of On’s innovation efforts: sustainability. We are highly committed to reducing our footprint as it relates to our climate, and we have committed to some of the most ambitious sustainability targets in the industry. In climate, for example, we are working with science-based targets to reduce our carbon emissions by fifty-five percent through twenty thirty per product that On produces. We are also one of the first brands to join the science-based targets for nature pilot program, going beyond climate and including land, water, forest, and biodiversity. This aspiration is to be both a thought and actual leader for our industry. During the climate summit at COP26 in Glasgow last week, we announced a very ambitious new material: CleanCloud. CleanCloud takes carbon emissions and turns them into EVA. This technology, which we have developed over the last four years, has the potential to be used in the majority of On’s products. We are now working together with technology partners to create the first pairs and scale the technology for mass production. This is a long-term initiative and one of several technologies that On will build in our request to move away from oil-based materials. What sets us apart is our global footprint. Coming from a very small market base in Switzerland, we needed to expand globally from the very beginning. We believe this permits global expansion has been instrumental in driving our net sales CAGR of over eighty-five percent since inception, making On one of the fastest growing scaled athletic shoe companies in the world. We believe this global presence positions us extremely well for future growth within the large global footwear and apparel market. Over the past twelve years, we have built a passionate global community across more than sixty countries. We believe we have opportunities for continued market share gains across the globe. We are in a growth phase in almost all of our international markets and have significant potential to expand our geographic footprint through controlled multichannel growth. Historically, we have been extremely successful entering new markets. For example, we entered the United States in twenty thirteen and grew net sales to Swiss Franc one hundred thirty-six million in the first nine months of twenty twenty, and Swiss Franc two hundred sixty-five million in the nine-month period ended September thirty twenty twenty-one. We entered China in twenty eighteen and grew our net sales in the region by one hundred ninety-nine percent from Swiss Franc one point eight million in twenty nineteen to Swiss Franc five point five million in twenty twenty. In the nine months ended September thirty twenty twenty-one, this number is already at Swiss Franc thirteen point seven million and we are seeing continued strong growth. During Singles Day last week, On’s products sold in our platforms increased by over five hundred percent. We could also see continued growth in wholesale. In distributing these products, we seek to meet runners wherever they are. After starting off selling on our own website and mainly through running stores, our products are now also available in some of the most recognizable general sporting goods and fashion lifestyle retailers in the world, with over eight thousand one hundred stores and value-adding online retailers across more than sixty countries. In Q3, we continued to strengthen our partnership with some of the best global retailers. For example, we launched our first-ever premium retail concept in London, a mini version of our own retail store content. On the lifestyle side, we successfully piloted our collaboration with Foot Locker and a JV at a very selective location. Both pilots have proven that our products resonate strongly with a younger consumer group and we are excited to continue both partnerships while maintaining our premium distribution. The wholesale channel accounted for sixty-four percent of our net sales for the nine-month period ended September thirty twenty-one. With On's community brand awareness growing globally, we have begun to organically scale our DTC channel through onrunning.com and have significantly increased our DTC sales. In September, we opened our own and operated On store in Shenzhen. The DTC channel as a whole, which includes our e-commerce site, flagship store in New York, and other locations in China, represented thirty-six percent of our net sales for the nine-month period ended September thirty twenty-one. We cannot emphasize enough that we consider our DTC and wholesale channels to be highly complementary and brand-enhancing, and we will continue to invest in the expansion across both channels. A review of the Q3 highlights would not be complete without mentioning the great pleasure of ringing the New York Stock Exchange opening bell together with our team to celebrate our initial public offering on September sixteenth. It's an honor to now hand over to the person who has mastered the outcomes for this event: our CFO and Co-CEO, Martin.

Martin Hoffmann, CFO and Co-CEO

Thank you, Caspar. Let's move on to reviewing our financials for the third quarter of twenty twenty-one. As we mentioned in the beginning of today's call, we see accelerating demand for our brands globally. Our Q3 results highlight a strong combination of growth and profitability and the first validation of our business model and our long-term targets. Net sales for the quarter were two hundred eighteen million Swiss Francs, up by sixty-seven point six percent compared to the third quarter last year when running had already been on fire as COVID-19 restrictions were temporarily lifted. So we maintained our strong growth at this elevated level. This growth is driven by the continued success of On’s core strategy, which includes increasing brand awareness, multichannel geographic expansion, and broadening of the product portfolio driven by innovation in design and sustainability. Year-to-date, we achieved net sales of five hundred thirty-three point five million Swiss Francs, a seventy-seven point two percent increase compared to the first nine months of last year and a seventy point one percent CAGR over the past three years, which further validates the strong continued strength of our performance. The demand for our products accelerated across both the wholesale and the direct-to-consumer channels, as well as across all regions and all product categories. As Caspar mentioned, we consider our direct-to-consumer and wholesale channels to be highly complementary. In Q3, we see the strategy being validated by the strong demand in both channels. DTC grew ninety-three percent to seventy-five point seven million Swiss Francs and wholesale net sales increased by fifty-six point seven percent to one hundred forty-two point three million Swiss Francs. Despite the full reopening of retail stores in most key geographies, we see very strong continued engagement from existing customers and the growth of new customers in our DTC channel. For example, in North America, DTC grew one hundred twenty-nine percent and in Asia Pacific, one hundred fifty-two percent. Overall, the contribution of net sales from the direct-to-consumer channel grew to thirty-four point seven percent for the quarter compared to thirty point two percent in the same period last year. We continue to invest in our brands and community by building partnerships with premium wholesale partners. In Q3 twenty twenty-one, consumer demand for the On brand in the wholesale channel increased even further and led to strong growth rates in many of our key accounts. Across both channels, we are seeing strong demand globally, with growth rates in all geographic regions exceeding fifty percent. North America continues to be the growth engine, with a net sales increase of eighty-two point six percent resulting in the United States and Canada being responsible for fifty-one point five percent of total net sales. The continued acceleration of demand in North America is best reflected in the fact that DTC sales grew twice as fast as wholesale. As previously mentioned, we see China as one of the key regional growth drivers, which was showcased by strong triple-digit sales growth in the third quarter. The Asia Pacific region grew by seventy-one point four percent, with significant growth in China somewhat offset by a slowdown in the Australian wholesale market as local lockdowns continued into Q3. In Europe, most markets continue to grow strongly, with an overall regional growth of fifty point three percent. Here it is important to highlight the difference from most other regions, as many European markets faced significant COVID restrictions in Q3 twenty twenty, which had driven higher wholesale sales in the same period last year. The growth across our distribution network is fueled by the successful expansion and development of our innovation-driven products. Across all our product categories and key franchises, the demand is accelerating. Net sales in Q3 twenty twenty-one increased sixty-five point two percent for shoes, one hundred thirty-three percent for apparel, and forty-one point five percent for accessories. For the first time, apparel contributed more than ten million Swiss Francs in one quarter to our overall net sales. Consumer demand is clearly there, and On’s own stores in China for apparel already contribute approximately twenty percent of the sales. Gross profit in the third quarter was one hundred thirty-one point three million Swiss Francs compared to seventy point eight million Swiss Francs in Q3 twenty twenty. Our gross profit margin increased year-over-year from fifty-four point five percent in Q3 twenty to sixty point two percent in Q3 twenty-one. This is fundamentally combined with the strong results we have seen in the previous two quarters and is another validation of our long-term targets. The increase primarily reflects lower customs costs related to the free trade agreement between Vietnam and Europe, lower sourcing costs, and the very low share of airfreight products in Q3. In the first nine months of twenty twenty-one, gross profit increased by ninety point nine percent to three hundred eighteen point five million Swiss Francs, reflecting an improvement in our gross profit margin from fifty-five point four percent to fifty-nine point seven percent. If we exclude our share-based compensation for the moment, SG&A expenses as a percentage of net sales were forty-eight point five percent for Q3 twenty-one compared to thirty-nine point six percent for the same period last year. More comparable year-to-date, SG&A expenses with our share-based compensation were forty-eight point seven percent of net sales for twenty-one compared to forty-five point three percent for the same period last year. This increase is mainly driven by higher investments in digital customer acquisition and demand-creating expenses and the resumption of increased investment activities post-COVID-19 lockdown. In addition, we incurred seven point three million Swiss Francs in IPO transaction costs. Moving on to share-based compensation, which deserves looking at in an isolated manner. Share-based compensation expenses in Q3 twenty-one decreased to two point four million Swiss Francs or one percent of net sales from five point three million Swiss Francs or four point one percent of net sales in the prior year period. This change is primarily due to a one-time transaction in twenty-twenty driven by the strong growth acceleration in the past years and by the successful IPO; we expect to trend approximately seven point five million in additional stock-based awards under our existing equity plan in Q4 twenty twenty-one. Due to the timing of such awards, this impact is not included in our Q3 numbers. Adjusted EBITDA, which excludes share compensation and one-time costs related to the IPO, was thirty-seven point nine million Swiss Francs for the three-month period ended September thirty twenty-one, up from twenty-two point six million Swiss Francs in the prior year period. The EBITDA margin remained consistent year-over-year for the three-month period at seventeen point four percent. Year-to-date, adjusted EBITDA increased by one hundred twenty-one percent from thirty-eight point six million Swiss Francs to eighty point two million Swiss Francs. As a percentage of net sales, adjusted EBITDA increased year-to-date from twelve point eight percent to sixteen percent, further validating our commitment to simultaneously grow net sales and profitability. Shifting to our balance sheet and cash flow, on September fifteenth, and prior to the end of our third quarter, we completed our initial public offering at the New York Stock Exchange. In total, certain selling shareholders sold an aggregate of thirty-five million seven hundred and five thousand class A ordinary shares at a share price of twenty-four dollars. The net proceeds from the IPO for On were six hundred fifteen million Swiss Francs, or six hundred sixty-two million US dollars. This has led to a very strong position of net cash and cash equivalents of six hundred seventy-two point one million Swiss Francs, which will enable us to pursue our ambitious growth plan. Looking ahead, we are confident that demand for our products will remain very strong across all regions, all channels, and all product categories. Before we detail our financial outlook and in order to provide a better understanding of the expected financial performance, we would like to share the recent developments and our short-term outlook regarding the situation in Vietnam and throughout the supply chain. There are two challenges that are connected and that will impact our financial performance in the upcoming quarters. Most significantly, we expect supply constraints and higher airfreight expenses as a result of the recent factory closures in the south of Vietnam. The quantification and mitigation of this impact are being accentuated by volatile freight and distribution costs driven by higher freight and shipping charges and higher warehouse labor expenses. During Q3 twenty twenty-one, our production partners in the south of Vietnam were affected by government COVID-19 closures aimed at curbing the spread of the virus. The impacted factories represent about seventy percent of our production capacity. The closures began in July twenty twenty-one and factories remained closed as of September thirty twenty-one. As of the beginning of October, we have seen a gradual reopening and ramp-up. Our key message today is that all factories are open as of early November and as of this week, are operating at more than eighty percent of our planned production capacity. To put this number into perspective, it is very important to highlight that our planned production capacity was based on the anticipation of continued hypergrowth in twenty twenty-one as well as in twenty twenty-two. To date, the accumulated loss of capacity from the affected region is approximately twelve weeks. To mitigate the impact on our business, we continue to take actions, including the reallocation and prioritization of products across all factory partners and the use of airfreight to balance inventory levels against the strong demand. Additionally, by Q1 next year, we have secured a significant amount of additional production capacity with two new factory partners in Indonesia. We expect the use of airfreight to adversely impact our gross margin by approximately nine hundred to one thousand basis points in Q4 twenty-one and in Q1 twenty-two. We are working closely with our retail partners to maximize the number of products available to our end consumers. These measures include a holistic management of all available inventory and the adjustment of launch dates for new products. We are confident that the supply chain disruptions are temporary, and that our pricing power will allow us to compensate for increased freight and distribution costs in the mid to long term with selective price increases. Turning now to our financial outlook. As this is our first time providing financial guidance to the public market, we would like to briefly explain how it should be approached. Philosophically, we aim to provide prudent yet aspirational guidance that appropriately balances our business potential with the risks or headwinds we face. We will provide guidance for the full year rather than on a quarterly basis, as this is how we steer the business internally and allows us to take a long-term growth perspective. For Q4 twenty-one and fiscal year twenty-two, we are expecting our financial results to be constrained by the aforementioned supply chain challenges. We see demand clearly above the available supply. Given the current uncertainties in the supply chain, we will prioritize top-line growth over profitability in order to protect our retail partners and long-term growth. Now, for the full year twenty twenty-one, we expect net sales of seven hundred ten million Swiss Francs, representing a six-seven percent year-over-year growth. Our outlook reflects the supply restrictions we foresee in the last three months of the year. We have started to airfreight selected products from reopened factories to fulfill demand. Nevertheless, we are still expecting limited product availability in the fourth quarter. Independently of the supply chain disruptions, we have made the strategic decision to shift the launch of our spring-summer seasonal products from Q4 into Q1, resulting in a channel shift in our seasonality. We expect adjusted EBITDA of ninety-two million Swiss Francs, representing an adjusted EBITDA margin of thirteen percent and an year-over-year growth of eighty-five percent. We will continue to have products throughout Q4. Additionally, we will drive investment in premium building with strong investments into returning to physical global major running events such as the New York City Marathon, maximizing marketing during the holiday season, but also continued investments into our team. As previously indicated, we expect to create additional stock-based compensation awards under our existing plans. These awards will vest at the current date, and therefore we will record a material share-based compensation charge of approximately one hundred seventy-three million Swiss Francs in the fourth quarter of twenty twenty-one. This will significantly impact our Q4 adjusted net profit. For twenty twenty-two, we expect an annual dilution from our equity plans of approximately one point five percent. Looking beyond twenty twenty-one, we are very confident that supply chain challenges, especially supply chain constraints, are temporary and that we should fully focus on our long-term growth opportunities. In the first half of twenty twenty-two, we expect net sales to be adversely impacted and final product availability will depend on the continued ramp-up of factory operations and the availability and cost of airfreight capacity. Currently, we expect a return to strong hypergrowth in the second half of the year, projecting at least nine hundred sixty million Swiss Francs in net sales, even though our internal ambition is higher than that. We expect to have better visibility in the new year on how quickly we can access additional capacity and we will revisit our guidance then. To be clear, we are experiencing a transitory supply shortage, not a demand issue. This is not a new situation; for over the last decade, strong demand for the On brand has regularly outpaced supply. We have been able to turn this into an advantage by tightly controlling distribution to ensure sustainable quality growth. In the first half of twenty twenty-two, we will face supply shortages on certain products that exceed our expectations, which may affect consumer access to specific products. However, we believe that in the long run, this will enhance the desirability of the On brand. A tight control of the growth of our SG&A costs in the first half of the year will help caution against rising freight and distribution expenses. Consequently, we expect adjusted EBITDA of one hundred twenty-five million Swiss Francs and to maintain our adjusted EBITDA margin at thirteen percent. As mentioned earlier, to mitigate disruptions across the international supply chain, we will prioritize net sales growth over profitability. In conclusion, we are very proud of our recent performance and excited for the opportunities ahead, but most importantly, we are extremely proud of our global team for their passion in steering On to such incredible speeds and for all the hard work it takes to adapt to a fast-changing environment. Thank you so much.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Thank you for your continued support and trust. Operator, we are ready to begin the Q&A session.

Operator, Operator

Thank you. We'll be taking our first question today from Kimberly Greenberger of Morgan Stanley. Kimberly, over to you.

Kimberly Greenberger, Analyst, Morgan Stanley

Great. Thank you so much. Good afternoon and congratulations on the fantastic quarter right here out of the gate. I wanted to ask about your expansion of factory capacity. I know you were working on diversifying your sourcing base even prior to COVID. But if you just sort of step back and think about the goals you've set for the business over the next two, three, four years, what's your philosophy about how to develop additional factory capacity and diversify your sourcing base in order to maybe at least partially shield from some of the volatility we're seeing concentrated in Vietnam right now? Thanks so much.

Martin Hoffmann, CFO and Co-CEO

Yes, welcome everyone also from my side. This is Martin speaking and thank you so much, Kimberly, for your question. So, I think what we've already started doing some time ago is prioritizing agility over efficiency, and that really has allowed us now to deliver the quarter that we achieved and navigate through some challenges over the last years on both the demand and the supply sides. So, we will continue to build a very agile and nimble sourcing and supply chain environment. What that means is first, we'll try to diversify into more countries, ideally also countries that are closer to our consumers, for example, in Europe or closer to North America, as long as the capabilities are there, and it is meaningful for us to do so. We have pilots running in certain countries. The second thing that we continue to do is dual-source our key styles and key materials. This is another reason why we're able to move volume around pretty quickly. As soon as the factories reopened, we could start at full speed right out of the gate because the materials and components were available. We want to create and continue to create redundancies in our supply chain so we can react to a very fast-changing environment.

Kimberly Greenberger, Analyst, Morgan Stanley

This is very clear, Martin. Thank you so much. I wanted to ask about the wholesale as well, if I could. The wholesale revenue this quarter came in well above our expectations. I'm wondering if you can talk about the additional expansion in wholesale, new partners you've brought on this year, and what you're seeing in terms of demand in that channel. Thanks so much.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Thank you, Kimberly. I'm also going to answer that one. On the wholesale side, the demand we are seeing is coming from our key segments: running, outdoor, and performance. Consumers shop on our website and through our most important wholesale partners, and those partners are looking at the demand very positively with the order book we are seeing for the next six months being what we could have expected. Again, we do face supply constraints in the first month, but we are currently taking orders for the second half of the season. This strong demand is a sought approach on how to expand our wholesale channels and make the right decisions to work with the right partners at the right time. By doing so, we've piloted thirty-two doors in the US and ten doors in Europe. We are seeing very strong results. We will make wholesale decisions that allow us to go after our mission and key targets, one of which is to become the number one brand in running shoes.

Kimberly Greenberger, Analyst, Morgan Stanley

Thanks so much, good luck here.

Operator, Operator

We'll be taking our next question today from Grace Morley of JPMorgan. Grace? Please go ahead.

Grace Morley, Analyst, JPMorgan

Hi, thank you. This is Grace Morley. Thank you for taking my question. I guess firstly, just given the current supply constraints that you are facing, how are you prioritizing the product allocation between your wholesale partners and your direct-to-consumer channel? And then you mentioned your pricing power and potential to implement price increases. Can you comment on whether you are planning any price increases for next year and if you've seen any cost pressures similar to some of your competitors? Thank you.

Martin Hoffmann, CFO and Co-CEO

I will quickly speak to the first point, and then I’ll let Caspar speak to the pricing question. On is a true omnichannel brand, and from a consumer perspective, we want to have the product available for the consumer through their channel of choice. When it comes to our running products, we will treat our key running partners and our own DTC business with equal priority in product allocation across outdoor and performance categories. We also feel that the next few months will present an opportunity to continue to build shelf space with some of our partners, which is one reason we prioritize the top line right now. By doing this, we can secure shelf space with our partners, which can extend well into twenty-two and twenty-three.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

On the pricing increases question, we are a premium brand and we possess significant pricing power in this premium price segment, especially compared to our competitors. Therefore, we are planning selective price increases for spring twenty-two. These will primarily target North America and will affect about forty percent of our volume.

Grace Morley, Analyst, JPMorgan

Great. Thank you. Let me just follow-up with a broader question on the industry. It seems that running footwear seems to be a bright spot across all brands currently. Just wondering what your thoughts are on what is driving that strength. Clearly, you benefited during COVID, but how has it been possible to sustain that strength now that economies are reopening? Thank you.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Thank you, Grace. Running is a habit many of us here probably share. Once you reach the point where you can run two, three, or four times a week, it's hard to let go. It's a great outlet. The habits developed during the pandemic are definitely still relevant today. Let’s also remember that as consumers return to gyms, many also continue to run on treadmills and in other forms outside. Our industry is relatively less exposed to gym returns because running is an integral part of many workouts. So, yes, participation in the sport continues to grow and we are in a strong position to grow alongside it and capture significant market share due to our proactive supply management.

Grace Morley, Analyst, JPMorgan

Perfect, thank you very much.

Operator, Operator

Thank you, Grace. We're now going to move over to Michael Binetti of Credit Suisse. Michael, please go ahead.

Michael Binetti, Analyst, Credit Suisse

Hey. Thank you guys, and congrats on your first public quarter. I just wanted to ask about the new distribution strategy. You mentioned a few stores with Foot Locker and JD, and I know you guys had Product in Foot Locker in the past, but I think that was a long time ago. At the time, the thinking was that you needed to bring more of a fashion component to it. You mentioned several references to lifestyle products earlier. I know you've been investing in the design team and the assets needed to make traction on that part of the business. I’d be curious to hear where you feel you are in that regard and how much opportunity there is in retailers like Foot Locker and JD in the near term. Is that something we could see accelerate significantly driven by lifestyle demand? Thank you.

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Thank you for your question. As you can imagine, over eight years since On was last with Foot Locker, there have been substantial changes, and we feel that by working with partners like Foot Locker and JD is beneficial. First of all, we're starting from a consumer perspective, and we see an opportunity to target even younger consumers. Foot Locker and JD are strong channels for reaching this demographic, and we have the right products for that audience. This resonates extremely well with that consumer base. Secondly, we are attracting a very strong female consumer segment as well and are able to bring that into these channels. Lastly, we are working on product differentiation, so JD and Foot Locker will offer very unique assortments compared to our specialty retailers. We believe that we can efficiently target diverse consumer segments and expect that our premium brand status will resonate well in stores.

Michael Binetti, Analyst, Credit Suisse

If I can ask a follow-up, as you look at next year, I thought it was interesting that you were able to guide sustainable thirteen percent EBITDA margins. That is far off from what we heard during the IPO process about where you thought the business would be next year, but you pointed to heavy gross margin pressure from air freights starting in Q4. I think this is impressive considering you’re guiding flat EBITDA margins. Can you help us think about SG&A versus gross margin next year? How are you building that into your model? Maybe even first half versus the second half, so we can understand some of the dynamics as you go through the supply constraint you pointed to?

Martin Hoffmann, CFO and Co-CEO

Yes, I'm happy to, Michael. Looking at our Q3 results validates our long-term targets. Given Q4 and the first half of next year, we expect those long-term guidance to be impacted by higher-than-average air freight costs, which is the key driver for lower gross profit margin and EBITDA margin. This impact reflects in the thirteen percent guidance we have given for both twenty twenty-one and next year, which also factors in the upside from the planned price increases. As always, we are committed to grow top line and profitability in sync, and we will also cautiously manage our SG&A cost base in light of the current situation and the higher freight costs. However, we have mentioned during the call that especially during the next two quarters, we will prioritize top-line growth over profitability to ensure our consumers can buy our products and our retailers have adequate inventory.

Michael Binetti, Analyst, Credit Suisse

Okay, very helpful. Congrats again, guys, thank you.

Operator, Operator

Thank you, Michael. We'll now be taking our next question from an analyst at UBS. Please proceed with your question.

Unidentified Analyst, Analyst, UBS

Great, thank you so much. Would it be possible to elaborate a little bit on the growth you saw in Europe in the quarter? Was the strength concentrated in some of the countries like Germany, or was it broad-based? Are you seeing increasing momentum in some of the other countries across Europe? Thank you.

Martin Hoffmann, CFO and Co-CEO

Thank you for the question. The good news is we are seeing growth distributed across many countries. The wholesale side is definitely impacted by the lockdowns in the third quarter; however, growth has been very positive in the UK and we are increasing our investments there as it is currently smaller relative to other markets. Germany, Switzerland, and Austria continue to deliver strong results, but we also see significant opportunities in France, where we are implementing several strategies to capture further market share. It is also important to note that our apparel category has been very strong in European markets.

Unidentified Analyst, Analyst, UBS

Great. If I can ask you just about the fiscal twenty-two guidance; based on what you've seen from the stores that you have opened, what is your thought on store growth as we think about the model for twenty-two, and what e-commerce capabilities do you have in place to enhance e-commerce growth all over the world? Thank you.

Martin Hoffmann, CFO and Co-CEO

Let me quickly start on store growth, and maybe Caspar can elaborate more on e-commerce subsequently. The biggest part of our store growth will definitely come from China, as we continue to build our network there. We are already at eight stores, and they are all performing very positively. Along with our partners, we are shaping that environment. Concurrently, we will continue to roll out experiences in key cities globally. You can expect launches in London and other key locations in the U.S., collaborating with revenue-generating retail partners. In terms of e-commerce, we are experiencing significant demand across our regions today, and much of that demand is reflected on our DTC website. The ratio of new customers to existing customers remains stable, indicating that we continue to introduce many new customers to the On brand. The elevated brand awareness, especially in the U.S., now drives more traffic to our website. Looking ahead, we will explore avenues to increase direct traffic to our site without over-relying on major advertising platforms. We also invest in data management strategies to increase the conversion of website visitors into customers and will launch a new store online by the second half of next year.

Unidentified Analyst, Analyst, UBS

Terrific. Thank you so much.

Operator, Operator

Thank you. Our next question goes to Jim Duffy of Stifel. Jim, the floor is yours.

Jim Duffy, Analyst, Stifel

Thank you. Hello, everyone. Congratulations on the terrific quarter and outlook given the challenging backdrop. I hope you can speak in more detail about the product pipeline looking into twenty twenty-two, both key new franchises and important updates from existing franchises. Can you please touch on the influence of any manufacturing disruption on the new release calendar?

Caspar Coppetti, Executive Co-Chairman and Co-Founder

I am happy to talk about the new franchises, and Martin can take the question on the release calendar. We have three business units: running, outdoor, and lifestyle. In running, our goal is to be the number one brand for runners. Therefore, we are launching three exciting new franchises next year that will help us gain broader acceptance and increase our market share to ten percent. The first is the Cloud Runner, launching in spring. It is a supportive, well-cushioned shoe priced at one hundred fifty US dollars. The second is the Cloud Goal, which is the neutral counterpart at the same price point, and we expect this to become our biggest franchise with strong distribution, as we continue to grow brand visibility. The Cloud Monster is our most cushioned product today, and these incremental entries will enhance our existing product offering, which has already proven successful in providing top solutions. In the outdoor category, we have an updated high-performance product that has resonated well, especially in Europe and North America. Lastly, in the lifestyle segment, we're adding two innovative products: the Cloud EC, an ultra-light slip-on made sustainably with only six parts. Last but not least, the Cloud Runner was inspired by our brand's athletic heritage, bringing a fresh silhouette to the lifestyle category.

Martin Hoffmann, CFO and Co-CEO

Thank you, Caspar, for the overview on the footwear side. Let me reiterate that our apparel revenue was up one hundred thirty-three percent, so we also have exciting apparel launches coming up next year, and we foresee all of those to happen on schedule. There’s no impact on our apparel releases from a production perspective. Regarding launch dates, we’re able to proceed with the next iteration of the Cloud in the first quarter as planned. We are also moving ahead with our on running to come as planned in the first quarter. The main impact in terms of timing will be on the Cloud Runner, which will experience a slight delay. We will communicate new launch dates to our key retail partners as soon as they are finalized. Our philosophy remains to ensure that the products we release are most relevant to consumers when they are available. As such, we will prioritize existing products over new launches as they contribute to a significant part of our revenues.

Jim Duffy, Analyst, Stifel

Excellent. Thanks for that detailed overview of the pipeline. Caspar, I find the announcement around CleanCloud incredibly exciting. Can you speak more about the development process, the availability timing, and how you believe that gives you an edge relative to competitors in the marketplace?

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Absolutely. I'm glad that you share our enthusiasm. We have a long-term vision of moving away from oil-based raw materials toward sustainable alternatives. With CleanCloud we are focused on generating new products made from captured carbon. The timeline is challenging and may be fluid, but we aim to ensure that a majority of our products will no longer be oil-based by the end of this decade. For CleanCloud, our timeline will depend on how quickly we can build the network and refine the material usage. This project started about four to five years ago, driven by the insight that companies capturing carbon from the air can create value. We developed the necessary technology and conducted thorough testing in Switzerland, allowing us to access renewable energy throughout the process. We feel close to bringing CleanCloud to scale, and we have two strong partners that we continue to collaborate with to make this vision a reality. Our focus also includes diversifying our supply chain and technologies, not solely relying on a single solution. We want to ensure that we can implement a range of sustainable practices and materials efficiently across our product offerings. Our strategy is to not only set concepts in motion, but to scale quickly and sustainably.

Jim Duffy, Analyst, Stifel

Outstanding stuff. Thank you. Very exciting.

Operator, Operator

Thank you, Jim. We have another question from Jonathan Komp of Baird. Jonathan, please go ahead.

Jonathan Komp, Analyst, Baird

Thank you very much. I want to ask about twenty twenty-two. I know you're guiding revenue to grow thirty-five percent despite the headwinds in the first half. What growth might you have achieved for the year without those constraints, and can you highlight the key drivers you see leading to strong growth in the second half of twenty-two?

Caspar Coppetti, Executive Co-Chairman and Co-Founder

Starting with the second half, as Martin mentioned, we are in discussions with our key accounts about their orders for the second half of the year. From their feedback, we expect this strong demand to continue for the second half. Our partners are placing orders in line with the growth we expect to see. For the first half, we anticipate some constraints due to supply disruptions that will limit our ability to completely fulfill demand, but we are confident this will rebound as soon as supply constraints lift. We anticipate growth rates of around forty to fifty percent in the second half given sustained momentum in the demand.

Jonathan Komp, Analyst, Baird

That's very helpful, thank you. Looking at your business across different categories — running, outdoor, performance all day, or lifestyle — how do you see the long-term dynamics evolving? What might your business look like over time if you were to split it across those broad categories?

Caspar Coppetti, Executive Co-Chairman and Co-Founder

You see, most of our segments are inspired heavily by performance, and this is the foundation of our brand. As an innovation-driven company, we provide solutions across segments that enhance consumers' experiences and abilities in running and other activities. The growing lifestyle segment has seen substantial interest, which encourages us to expand into that category as consumers now expect versatile products. Most of our products can easily transition across activities, allowing for broader appeal in multiple categories and driving strong growth.

Martin Hoffmann, CFO and Co-CEO

As Caspar noted, we remain an innovation company and will prioritize improvements across running and outdoor performance, and we will communicate these advancements to enhance brand perception.

Jonathan Komp, Analyst, Baird

That makes sense, thank you again.

Operator, Operator

Thank you, Jonathan. We're now going to take our question from Cristina Fernandez of Telsey. Cristina, over to you.

Cristina Fernandez, Analyst, Telsey

Thank you. Good afternoon, congratulations on a good first quarter. I wanted to see if you could help think about growth expectations for different regions next year. Any factors in inventory distribution and initiatives you have with your wholesale partners?

Martin Hoffmann, CFO and Co-CEO

Looking at three key markets: North America, Europe, and the Asia-Pacific, North America will continue to be the primary growth driver next year. This is not only in absolute numbers but also in terms of growth rate. Europe has momentum, but growth might be a bit slower than in the US, with room for opportunity in markets like the UK and France. In the Asia-Pacific, significant momentum is driven by China, where we’ve seen incredible sales growth.

Cristina Fernandez, Analyst, Telsey

Great on the distribution. Thank you!