Earnings Call Transcript - ONON Q4 2022

Operator, Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome and thank you for joining the On Holding AG Q4 2022 Results Call. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. Please follow the operator's instructions. It’s my pleasure and I’d now like to turn the conference over to Jerrit Peter. Please go ahead.

Jerrit Peter, Executive Co-Chairman

Good afternoon, good morning, and thank you for joining On's 2022 fourth quarter and full year 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 Hoffman; and Co-CEO, Marc Maurer. Before we begin, I would like to remind everyone that today's call will contain forward statements regarding future events and performance within the meaning of 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 earlier this morning for 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 reconciliation to the most comparable IFRS measures. We will begin with David followed by Martin leading us 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, Executive Co-Chairman

Thank you very much. And welcome everyone to our fourth quarter results update call. The last three months of our first full financial year as a public company saw an exceptionally strong finish to an exceptional year. It is fair to say that at the time of the IPO, we didn't expect that we would already have beaten the CHF 1 billion net sales mark so comprehensively in 2022. So it fills me with a huge sense of pride to stand here 18 months later on behalf of the On team to speak to a variety of successful fourth quarter that brought us to more than CHF 1.2 billion in net sales for 2022, delivering a year-over-year growth of 69% versus 2021. Since the IPO, we've often spoken about our philosophy that has guided us since we started, driving growth while at the same time staying focused on efficiency and driving profitability. So it makes us even prouder of the team’s achievement of finishing our first full year as a public company in a profitable way with a net income of CHF 57.7 million. We are so grateful to everyone that has shaped On with us over the past 13 years and set the foundation for this amazing achievement. Finishing the year with such an outstanding Q4 is the perfect testament to the great work our team continues to do and an indicator of the continued momentum and the great opportunity that lies ahead of us. With net sales of CHF 367 million, and the growth rate of 92%, the quarter came in significantly ahead of even our own high expectations. Demand for the brand across all regions, categories, and channels remains extremely strong, and we are excited that we were able to enter 2023 in such a great position. By switching our URL to on.com, we've also made it even easier for consumers to find our iconic brand online. And we truly believe we are setting ourselves up for our best year yet. I'd say it is both in terms of the strong momentum that we have seen in the first months of the year, and as well as the industry odds. If you look at the normalization of operations, the last three years of the pandemic roller coaster have been a huge challenge, and have put our teams and operations to the test. The factory closures in Q3 of 2021 meant a very tight inventory position at the end of 2021 and early 2022 as well as elevated air freight usage, particularly in the first half of 2022. Along with the industry, we have seen tight production capacities at factory partners, disruptions of global trade lines, increased sea freight lead times, as well as macro challenges. We were additionally challenged by our induced warehouse disruption in the third quarter of 2022. Martin will provide some additional perspectives on how these elements come into play in our financial review as well as outlook for 2023, but it is safe to say we are very confident and excited to be heading into a year of increasingly normalized operations where we can focus even more on driving our brand and continuing to build a community of athletes, fans, and innovators, and an exceptional team that is excited to be part of the next phase of On. But before we move to the detailed financial review of the fourth quarter, I want to take a few minutes to focus on three areas that are fueling the ongoing momentum we see around the brand as we move into 2023, namely, the way we are bidding and running our ambitious move into tennis and our growing popularity amongst younger consumers. So let's start with running. It's clear to see that 2022 was a huge year for us with the introduction of the Cloudrunner, CloudGo, and Cloudmonster, we added three major silhouettes that have been strongly supporting our ongoing market share increase on runner's feet. We can see this very clearly in our proprietary run account data, where in particular the Cloudmonster and Cloudrunner are positively over-indexing with regards to their visibility on the running routes versus their contribution to sales. This, of course, further establishes our credibility as a brand rooted in performance, a key strategic priority for us. We are excited to play our part in fueling run culture and amplifying it with storytelling and content around the amazing sport of running. For example, with initiatives such as our new global event series On Track Nights, which we announced in January, set to begin in May with the Trackfast, in Los Angeles. These events held at different track meets around the globe will have their unique local flavor but all champion a fresh community-focused festival feel approach to track racing. We also made running more inclusive thanks to our Right to Run social impact partnerships program. Right to Run brings together grassroots communities and organizations to make an impact in the realms of safety, access, adherence, and inclusion in running and movement. We continue to expand the program and now partner with 17 organizations globally, helping us achieve our ambition of reaching 100,000 community members. Another way we fuel the run culture, and the key component of ON's mission to ignite human spirits through movement is the ON Athletics Club, an incredibly inspiring group of young track and field talents with tremendous potential and big dreams. Just last month, we announced the launch of the Do Shania division of the OAC, and together with their counterparts in the U.S. and Europe, we look forward to supporting the next chapter of track and field champions as they set their sights on the Paris 2024 Olympics. While many On athletes are working towards their first Olympic games, we are extremely excited to have added a reigning Olympic champion to our roster. Triathlon gold medalist at the Tokyo Olympics, Kristian Blummenfelt, has joined us with the ambition to defend his title in Paris next year. Alongside Kristian and IRONMAN World Champion, Gustav Iden, who joined On in 2022, we also announced the signing of two more triathletes in January, reigning female IRONMAN World Champion Chelsea Sodaro and fellow superstar triathlete Paula Findlay. All our OAC team members and On athletes across running, trail, and triathlon have in common the belief and knowledge that our products put them in a position to win at the highest levels of performance. They know that the forefront of innovation has the success of our athletes as its number one priority. Just look at some of the amazing achievements of our athletes recently. This past weekend, we saw Helen Obiri cruise to victory in the New York Half Marathon with a new course record. At last month's Minerals Games, one of the most important indoor track events of the season, On had 13 athletes competing, a significant jump versus the four we had last year. And those athletes delivered career-best performances including seven national records and wins for Alicia Monson in the women's 3000 meter race and Jero Nougues in the Summers Smile. This runner form continued when On athlete Helen Bekele won the Osaka Marathon in February. We look forward to seeing our Pinnacle products on the feet of many more runners in the near future. That's why we'll be making these products available to the broader market, for example, commercially launching the new generation Cloudboom Echo 3 which has been on the feet of our most successful athletes in Elite Competitions in recent months. Our next phase of innovation for the everyday runner is about to shake the market up too. Two days from now, we will officially launch the all new Cloudsurfer which features our new cushioning technology called CloudTec Phase. This evolution of On’s existing technology was generated using computer-optimized technology called Finite Element Analysis, which simulates the effects of structures and materials of the human body to minimize stresses and provide a whole new running sensation. Innovation within the Cloudsurfer is here to make waves, and we've seen waves of positive feedback even ahead of the official launch. Early media reviews have been hugely positive with testers describing being blown away by the new CloudTec Phase cushioning, calling it their favorite road running shoe of the year, and heralding the Cloudsurfer as an impressive step change for all. Our innovations are not just reserved for footwear. Back in February, we kicked off our spring-summer ‘23 season with a focus on our full head-to-toe offering by introducing our latest apparel collection. The supporting campaign was centered around the message to feel nothing, so you can feel everything, shining a spotlight on our innovative lightweight and high-tech materials. But coming to my second point, it's not just the road of running where we've been making waves. Yesterday, we made our ambitions clear for tennis when we announced the signings of two of the sport's most exciting talents to our roster of top-ranked tennis professionals. The women's world number one ranked player, Iga Świątek from Poland, and America’s newest sensation, Ben Shelton, for whom On is the 20-year-old first ever multi-year sponsor. Going forward, those players will be wearing the Company's newly developed “On” collection of our professional competition and custom editions of the Roger Pro. The competition tennis shoe has been Swiss engineered and designed individually for and in close collaboration with both players, Roger Federer, and the Lightning innovation team at On Labs to meet the demands of their individual style of play. With an eye on the future, On has also signed the 16-year-old Brazilian player, João Fonseca, who recently made his ATP main-draw debut at the 2023 Rio Open after some hugely impressive achievements on the Junior circuit. With a potent mix of inspirational athletes and innovative head-to-toe products, we truly believe that tennis can play a key role in fueling the next stage of On’s growth. Coming to my third point, as we further build the brand in the performance run space and expand across categories, we see that our new product innovations lead us to new customer groups. Highly visible technology and innovation in shoes and apparel is increasingly embraced by younger consumers, from trendsetting teenagers in the U.K. to many young On fans in gyms and on the streets across the U.S. This is one reason why we have used our most popular shoe, the Cloud, as our starting base and have reimagined its CloudTec to activate with lower weights and smaller feet. The result is the Cloud Play, On’s first kids' shoe, and the Cloud Sky, our first shoe for teens and pre-teens. Our commitment to put performance at the forefront of every new product also starts with the smallest ones. That's why we work together with two leading universities in the field of children's biometrics to tune the Cloud and make sure the shoes help kids' feet grow in the very best conditions. As a small added benefit, Martin, Marc, and I are now finally able to fulfill our own kids’ wishes that we've been hearing about for many years by getting them into a pair of On. And believe me, we have been hearing these wishes a lot. It’s our mission to promote movement among kids and teenagers from a young age to build the love for sports and relationships with On for a lifetime. With that as an introduction, I'm very pleased to hand over to Martin for the Q4 financial review and our outlook for 2023.

Martin Hoffman, CFO and Co-CEO

Thank you, David, and hello everyone from my side. 2022 was definitely a super exciting year with so many highlights. Not just as a parent of young children that can now explore the world in On products, but even more for someone who loves sport and movement, who believes in sustainability, but most importantly, for a member of an amazing, diverse, and inspiring team. The On team has grown from 1,150 to 1,700 during 2022, now representing 79 different nationalities. Our outstanding achievements are the result of this team and all our global partners and their energy and drive to challenge the status quo on a daily basis. Having exceeded CHF 1.2 billion in net sales for the full year, with a 68.7% increase compared to ’21 makes us extremely proud. As David mentioned, being able to convert the strong sales to a bottom line profit of CHF 57.7 million further validates our ability to build a high growth brand while increasing profitability as a result of our strategic and operational progress. Q4 has been exceptionally strong and another record quarter with CHF 366.8 million in net sales. In North America, Q4 net sales include some catch-up effect from Q3 following the warehouse disruptions we had back then. But ultimately the strong demand that we are seeing continues to exceed our expectations across all regions and channels. Consequently, the 91.9% Q4 net sales growth year-over-year results from the strength of the brand that we built in 2022 combined with improved product availability following a further normalization of product supply in our warehouse operations. In Q4 2021, we were unable to fulfill all the demand due to supply shortages and low inventory levels as a result of the factory closures in Vietnam during the third and fourth quarter of ‘21. This effect was more significant in the European numbers where we had even less inventory buffer than elsewhere going into Q4 ‘21. At the same time, we had lower wholesale sales in Q4 2021 as key markets, such as Europe and various cities in China were impacted by repeated COVID-19 related shopping restrictions. Driven by these impacts in ‘21, wholesale has grown even stronger than DTC in Q4 2022. Wholesale sales more than doubled year-over-year growing by 104.3% to CHF 217.3 million. These strong numbers are backed up by the underlying demand and sales through our wholesale partners. In Foot Locker, for example, Q4 was by far our strongest sellout quarter in history. With the same numbers of doors as in Q3, units sold increased by over 50% quarter-over-quarter, supported by the continued demand amongst younger consumers for products such as the Cloudnova. For the full year 2022, we achieved 73.1% growth in wholesale. We were able to drive significant same-store growth with new and existing products by being disciplined about expanding our door network in our own markets from around 8,000 doors to 9,200 doors over the 12 months period. With the focus on our premium position, we continue to manage the channel carefully and closed over 200 doors that we considered less additive to the positioning of the brand. The strength of our premium products rooted in innovation, design, and sustainability is even more directly reflected in the demand we have seen in our DTC business, resulting in a 76.4% growth in Q4 versus the prior year period. While others in the market were discounting, we have achieved our strong growth with a very high share of full-price sales. We continue to build strong direct connections with our customers and invest in our DTC capabilities to drive stronger growth of our DTC channel compared to wholesale. We also completed the rollout of our new website and purchased our new domain on.com, which will allow us to attract and convert even more fans online. We are also thrilled to drive the successful expansion of our own retail store formats. Just a few weeks ago, we opened our largest store to-date, On Regent Street in London, and it has outperformed our expectations ever since. We're so grateful to see how the London run community came together on the opening night to celebrate a milestone. The London store has further validated our multichannel strategy, driving a visible increase of visitors both to our website and at our retail partners. Already in the first week, apparel sales in the London store exceeded sales in any other location in the U.K., which we see as an additional showcase for the head-to-toe strengths of our own channels and highlights the opportunity we have in apparel. Reflecting on the full year of 2022, we were able to build on the significantly elevated base of our DTC channel during the pandemic and drive 61.4% DTC growth in 2022. The number of visitors to our website in 2022 increased from 102 million to 143 million year-over-year. Our e-commerce capabilities and direct customer connections will be long-term assets for On and our journey of profitable growth. Moving on to our regional performance. Our continued success in building a global brand is reflected in the strong growth across all regions. In Europe, after a muted start to the year, net sales returned to strong growth in the past quarters, including the 80.6% increase to CHF 79.6 million in the fourth quarter. The great start of the London store in Q1 confirms that momentum in the U.K., one of our fastest-growing markets in recent quarters. Net sales have almost tripled in the U.K., and net sales in Germany and Austria also grew strongly between 40% and 50% respectively. In North America, after a temporary slowdown in Q3 caused by the warehouse disruption, our business reaccelerated in the fourth quarter with a growth rate of 81.5% accounting for CHF 242.1 million. In Q4, DTC grew even stronger than wholesalers. This confirms both our ability to drive an overproportionate DTC growth as well as the selective expansion of our wholesale network. The Asia Pacific region doubled year-over-year to CHF 21.6 million, reflecting very strong momentum in Japan, Australia, and China. Finally, the rest of the world grew from CHF 3 million in Q4 ’21 to CHF 23.4 million in Q4 ‘22, largely reflecting our entrance into several distributor markets in Latin America during the course of 2022. If you look back at the full year of 2022 from a regional perspective, it's great to see how all regions have contributed to drive net sales well above the CHF 1 billion mark. Of course, the incredible and continued momentum of our largest market, North America, has contributed the most in absolute terms. North America accounted for over 60% of our net sales in 2022 and will continue to be our growth engine going forward. In 2022, we further amplified our relationship and trust with many key retail partners, and we are looking forward to grow our combined businesses. Even with this incredible growth, we still see ample opportunities for higher penetration in many areas of the U.S., and we will continue to calibrate and selectively expand our footprint with wholesale partners to ensure we are present in the most meaningful doors that support our growth and brand positioning. From a much smaller base, APAC grew by 87.7% for the full year and contributed 6.6% of net sales, despite the ongoing lockdowns in China. Thinking about the very strong momentum in China, Japan, and Australia as well as our upcoming expansion into South Korea, we're extremely excited about the huge growth opportunity out of what is still a very underpenetrated region for us. The more than four times year-over-year net sales increase in our rest of the world region shows how we are only just getting started in many areas of the world. This fact is equally true for our most mature region. Growth in Europe was 36.1% for the full year, but this does not take into account that many markets are in a very early stage of growth and increasingly picking up momentum. I mentioned the U.K. as an example, but this is also true for other sizable markets such as France, Spain, and Italy that have only recently started being taken in-house. If we switch over to products, the strong momentum of our key footwear franchises continued throughout the fourth quarter, resulting in 96.7% growth. We continue to gain market share in the running community especially with the Cloudmonster, Cloudrunner, and CloudGo. At the same time, the Cloudnova is winning more and more younger fans. In Q4, we launched the new CloudX, another key franchise that resonates strongly with the fitness community and continues to win market shares in gyms around the world. The CloudX is also our most sold product in China. On apparel, we further executed on our strategy, both from a product and distribution perspective. Compared to Q4 ‘21, we launched fewer new products in Q4 ‘22, which led to a comparatively lower growth rate of 15.4%. As David mentioned, we have continued to focus on showcasing On as a head-to-toe brand and will be very focused on the apparel business throughout 2023 and beyond. For the full year, shoes grew at 70.9% and apparel at 30.2%. The growth was well-balanced across all three product categories: performance running, performance outdoor, and performance all day. In the fourth quarter, gross profit reached CHF 214.6 million compared to CHF 111.8 million in the same period in 2021. The gross profit margin of 58.5% significantly improved compared to 57.1% in Q3 and 55.1% in Q2. Compared to Q4 ‘21, gross profit margin remained unchanged despite a strong headwind of 280 basis points from unfavorable currency movements. As expected, after almost 12 months of highly inflated air freight usage, we were able to return to sea freight as the main mode of shipment in Q4. SG&A expenses excluding share-based compensation dropped significantly from 59.2% of net sales in the fourth quarter of ‘21 to 45.1% in Q4 2022. A further proof of our ability to scale in a profitable way and manage our cost base actively. During the holiday season, our brand strength and word of mouth drove a high level of organic traffic, which allowed us to achieve significantly higher net sales with a similar absolute marketing spend compared to the same quarter in the prior year. Other savings as a percentage of net sales were on distribution and general and administration expense, largely as a result of mix and scale gains. As announced in our last quarterly update, share-based compensation in the fourth quarter decreased materially year-over-year from CHF 176.2 million to CHF 34.4 million. The 2021 expense had been elevated as a result of our IPO with considerable amounts of long-term awards that had vested in connection with the listing at elevated share price levels in Q4 2021. With 2.8% of net sales, share-based compensation in 2022 is more in line with our future expectations. As a result of the strong net sales, adjusted EBITDA for Q4 exceeded our expectations and reached CHF 61.8 million up from CHF 11.2 million last year. The corresponding adjusted EBITDA margin increased from 5.9% to 16.8%. For the full year of 2022, our adjusted EBITDA reached CHF 165.3 million and a corresponding adjusted EBITDA margin of 13.5%, well ahead of our previous guidance both in absolute and relative terms. As you are aware, this full year margin reflects considerable extraordinary air freight usage, particularly in the first three quarters of 2022. Moving on to our balance sheet. Capital expenditure of CHF 33.6 million in Q4 netted to CHF 83 million for the full year 2022 or 6.8% of net sales. A significant increase versus 2021, mainly due to important investments into our new offices in Zurich and Portland and ultimately into our team and our culture. Despite the continued expansion of our retail network, we expect to reduce CapEx in 2023 to our long-term range of around 3.5% to 4.5% of net sales. Our ability to meet high customer demand with a strong product supply has led to our very strong growth in Q4. We had early signs at the end of Q3 for this further acceleration of demand as well as strong orders for 2023 and we were able to further increase the production output with our factory partners. In anticipation of strong momentum and demand in the first half of 2023, we further strengthened our inventory position to CHF 395.6 million as of December ‘22, a considerable increase versus the prior year low point following the factory shutdowns. Nevertheless, there are dynamics that led to this peak inventory position being somewhat higher than it ideally would be. In 2022, our production orders factored in a higher level of security margin for tight production capacity of factory partners and for volatile sea freight lead times. A faster than expected normalization of both factors has led to a higher than expected cumulated inflow of inventory. We have already adjusted our production plans going forward in order to reflect the shorter lead times. As a result, we expect to maintain the current absolute inventory levels as of Q2 despite the continued expected strong growth rates. At the end of Q1, we expect a higher inventory level, including first products for the fall-winter season. Overall, as the additional inflow is driven by current and future season products, our inventory remains very fresh and sets us up to drive a continued high share of full-price sales in 2023, while creating scarcity at the same time. Finally, turning to cash and liquidity. Our year-end cash balance of CHF 371 million, together with our available credit line of CHF 160 million, puts us in a strong position to continue supporting our ongoing growth plans. With that, I'm excited to look ahead and present you our outlook for 2023. Let me start by reiterating our guidance philosophy. We aim to provide prudent yet aspirational guidance that appropriately reflects our belief and optimism in the On brands and the opportunities we see while taking into account potential risks and externalities. We'll continue to provide guidance primarily on a full-year basis rather than quarterly, reflecting the way we steer our business towards long-term success. The focus continues to be on our mission to build a brand that is set up for the long-term by emphasizing high quality, durable, and profitable growth. When I speak to our expectations for the first quarter specifically, this marks an exception to this rule. Given where we stand in the quarter, we believe it is appropriate to give you an update on what we expect to achieve in Q1. We plan to launch exciting new innovative and sustainable products across all categories while further growing our existing blockbuster franchises. We will establish closer and more direct connections with our fans and elevate the brand experience for our most loyal customers. Our new website and retail formats allow more fans to discover On through our DTC channel and drive a higher DTC share. In addition to the recent London launch, we are looking forward to rolling out our next owned retail locations in Miami and Williamsburg, New York. Both will likely open their doors in the second or third quarter. Simultaneously, we will further expand our international footprint, with the conversion of important markets like Italy and Korea from distributor to owned markets. We will carefully expand our presence in wholesale, with the goal to reach the relevant customer communities through the right retail partners. With a focus on the Paris Olympics in 2024, we will further invest in our athletes’ team, both in talents and in product innovation and will further strengthen our core and operational backbone to drive efficiency and scalability. We're excited that the normalization of the supply situation will allow us to focus more resources on building the future. But most importantly, we are looking forward to continuing developing our high-performing team and our culture. We closed 2022 on a high and the first month of ‘23 has been off to a great start, strongly supporting our optimism and excitement for the year. As you will have seen in our release this morning, we anticipate reaching at least CHF 1.7 billion for the full year 2023 corresponding to year-over-year growth of 39%. This number includes around 300 basis points headwinds from the current currency environment and reflects the currency-neutral growth rate of 42%. This full year number is around 30% higher than our aspiration back in September 21 before the IPO, a further testament to the great achievements that our team has accomplished since then. We have been off to a great start in 2023, with ongoing very strong momentum across all regions and product groups and we expect our Q1 net sales to land around CHF 380 million or 61% above last year, maybe even higher. As a result of the strong first quarter momentum and the comparably heavy supply disruptions that we faced primarily in the first half of 2022, we anticipate a higher growth rate of high 40s in the first half of 2023, with a slowdown to mid-30s in the back half of the year. Based on current momentum and pre-orders for the fall-winter season, we see an opportunity to achieve even higher growth rates in the second half, but we remain prudent in light of the many risks in the current macroeconomic environment. Despite the strong growth of net sales this year, we do not expect a meaningful further increase in our absolute inventory position throughout the year. Depending on phasing, we may see modestly higher or lower inventory levels in the quarters, but over the course of the full year this will allow us to choose our net working capital balance relative to net sales and improve our cash flow. Turning to margins. As we have already seen in Q4, we foresee a more normalized supply chain situation in 2023, and consequently a significant reduction in the use of air freight along with lower freight rates. We expect to resume our path towards our mid-term gross margin target of 60% and currently anticipate a full year 2023 gross profit margin of around 58.5%. We are committed to continue our focus on efficiency and profitable growth and plan a further increase in our adjusted EBITDA margin to 15% for the full year 2023, representing a 54% increase in absolute adjusted EBITDA. The continued maturity in key markets and higher efficiencies across key processes are expected to drive future scale gains in SG&A. During the course of 2022, we intentionally held back on marketing spend to offset some of the additional air freight expenses. To further increase brand awareness for On and to drive our DTC business, we plan to reinvest some of the scale gains and raise marketing spend in 2023 back to around 12% to 12.5% of net sales. We also expect temporarily higher distribution expenses as a result of expanding our global warehouse capacity and several automation projects that are set to drive cost efficiencies in the years to come. As mentioned, we expect the reduction of net working capital relative to net sales and also lower relative CapEx investments following the completion of our main build-outs. We will also be expanding our existing credit line with the closing of a new facility during Q2 or Q3. Our momentum and outlook reflect all the achievements and progress we made in 2022. Today, On is a very different company than a year ago. We have further elevated our brands and our reach to set ourselves up for ongoing success and market share gains. We have reached new customer communities through our multi-channel approach and our ability to tell the story of running and run culture. We have strengthened our operational backbone and further professionalized our processes and brought our digital platform to the next level. All of this makes the opportunity for 2023 and beyond even larger than ever. The foundation is the belief in our mission, to ignite the human spirit through movement and to dream On. Thank you so much for being a part of this journey with us. With that, we'd like to open up the session to your questions.

Operator, Operator

Ladies and gentlemen, at this time we will begin the question-and-answer session. Please follow the operator's instructions. We have the first question from Alex Straton from Morgan Stanley. Please go ahead, sir.

Alex Straton, Analyst

Great. Congrats on another great quarter, guys. I have two quick questions for you. First, just on the revenue guidance for the year. Can you talk about the underlying assumptions by channel and geography? And then secondly, it piqued my interest when you mentioned that you kind of walked away from a number of wholesale doors. Can you just talk about the rationale and how you assess that on an ongoing basis? Thanks a lot.

Operator, Operator

Ladies and gentlemen, please stay on the line. One moment, please.

Martin Hoffman, CFO and Co-CEO

Hey, sorry, I think we had a technical problem here. But hopefully we're back now. So Alex, thank you for your question. I will take the first one, Martin here, and Marc will take the second one. So, as you have seen, we had very strong momentum in Q4 in all regions and we foresee that the growth is driven by all regions. Of course, North America, in absolute terms, will drive the majority of the growth. I think we are in a good position to exceed CHF 1 billion of sales in North America alone. Then Europe, you have seen that we had an 80% growth in Q4, and we see continued momentum also in the first quarter. A lot of the markets where we have a relatively low market share are driving growth, like the U.K., France, Spain, Italy, along with many fresh products that will come into the dark region. And really in China and Asia, we are super positive in light of the post-pandemic area. So, we can fully execute on our plan to continue growth in China and expand our retail network there. A lot of traffic is coming back into the retail stores in recent weeks, giving us positivity for high growth rates in the APAC region.

Marc Maurer, Co-CEO

Yes. Hi, Alex. You should see this because we're having this beautiful technical setup here, and now we're pausing an iPhone around to answer your questions. I hope you can hear us well. So, on the channel focus, I think we keep on speaking about this. We want to reach our consumers and provide them with an elevated experience through our DTC channel. So that's also why we're expanding the retail network, but also through our most important wholesale partners. We will continue to focus on the partners that we feel can help elevate the brand, which means we will continue to close doors that are a bit less additive to the positioning of the brand, mainly doors that focus on comfort and prime shoes. We've done that in the U.S. and will also start to do it a bit more in other regions, especially in Europe.

Alex Straton, Analyst

Thanks a lot.

Jim Duffy, Analyst

Well, thank you. Let me start by complimenting the team on the execution through the pandemic and related disruptions, excellent work. My first line of questioning is about operating expense budgeting. Martin, with the step up to CHF 1.7 billion in 2023, can you speak to where you see leverage opportunities? If I heard you correctly, you plan to reinvest about two points into marketing. Where do you see G&A expense? Are there opportunities for leverage over the real estate investments you made in 2022 in the new offices? And what's the state of your investments in apparel infrastructure? Thank you.

Martin Hoffman, CFO and Co-CEO

Okay. Thank you, Jim. I will speak about the expenses, and then David can speak a little more on the apparel side. It's important that we see a normalization of the supply chain. The excessive use of air freight we had this year is the biggest upside potential that we have and that is reflected in our gross profit guidance. At the same time, we still have high growth aspirations and will continue to invest in the business to be able to handle and further scale from that while focusing on scale gains and further efficiency. We will reinvest some of the upside and savings from air freight back into marketing for very different reasons. First, to install On as a head-to-toe brand in customer minds, but also to drive a higher DTC share in the future. At the same time, we will also invest a bit more on the distribution side because we have some double costs for a temporary period by expanding our warehouses, with a clear goal to automate our warehouse and drive efficiency in the future, bringing our distribution costs below the current level. There are also already opportunities baked in, as we have started projects to outsource our delivery, and we are seeing scale gains in markets that become more mature like North America and European markets. We are committed to drive higher profitability if we exceed our sales goals and the guidance we have given, allowing some of that additional upside to flow through the P&L as well.

Jim Duffy, Analyst

Martin, can you maybe provide some insights?

Martin Hoffman, CFO and Co-CEO

Go ahead.

Jim Duffy, Analyst

I just wanted to ask a follow-up to that. Could you please speak specifically to the G&A line? Would you expect to leverage the G&A line? You made big investments in real estate in 2022. And I believe you've been making many investments in the apparel infrastructure; would you expect to leverage those in 2023?

Martin Hoffman, CFO and Co-CEO

Yes, a lot of the build out in our new offices is reflected in the CapEx expenses that were significantly higher than our long-term aspirations of around 3.5% to 4.5% of net sales. Of course, utilizing the new offices to a higher extent by growing our team and our sales will also create efficiencies. Many of our efficiencies will come from growing our team at a slower pace than our net sales growth. In 2022, we grew our team by about 50%, while net sales grew over 60%, and next year we plan to add around 400 people, resulting in significant economies of scale.

David Allemann, Executive Co-Chairman

And Jim, when it comes to apparel, it’s a multiyear journey for us to become a sportswear brand, and we feel that all the right pieces are falling into place. It’s fantastic to see that our apparel lineup resonates with our communities, especially in our own retail stores where the share is growing. We are investing in additional talent with key hires in the apparel space. It will take some time for this to flow through the collections and for you to see the full scope of that. But we are working towards being a global sportswear brand and will spend more time on apparel in ‘23 to further drive this business. Core investments in talents and upper funnel campaigns will increasingly build our sportswear brand.

Jim Duffy, Analyst

Thank you.

Tom Nikic, Analyst

Hi, thanks for taking my question. I think obviously you've made good headway in some of the bigger sneaker retailers, especially in the U.S. with Foot Locker and Dick's Sporting Goods. Can you give us an update on the number of doors with those retailers and where you expect to be at the end of 2022 and where you expect to get in 2023?

Marc Maurer, Co-CEO

Yes. With Foot Locker at the end of Q4, we were at 160 doors. Just want to give you an example also of the success we're seeing and the feedback we're having from some of those partners. So, with Foot Locker in Q4, we had our highest sellout quarter ever. We had a 59% unit increase over Q3, which was the second highest quarter, driving the expansion. We don't want to give an exact number on where we're going to be by the end of ‘23 because it will depend on how many consumers we can sustainably reach with the products that we make available. So you can expect all the partners to continue to grow, but the speed of growth will depend on how fast we can bring an elevated brand experience to life. Then at JD, we stood at 166 stores globally by the end of Q4. Dick's Sporting Goods really only started in January ‘23. We had few Dick stores and seven Public Land stores by the end of ‘22, and we're currently in 58 doors with Dick's Sporting Goods and expect that number to increase to around 150 doors towards the end of 2023. With Fleet Feet, we are currently at 275 stores. We are very happy about the growth that we are seeing, especially as it plays into our core running community.

Tom Nikic, Analyst

Great. Thank you very much and best of luck for continuing to progress this year.

Operator, Operator

The next question comes from Cristina Fernández from Telsey. Please go ahead, ma'am.

Cristina Fernández, Analyst

Good morning and congratulations on the amazing performance in the fourth quarter. I had two questions related to products and distribution. One, how much brand momentum are you seeing in the new customers coming into the brand buying core franchises like Cloud 5 versus the new products launched in the last year? And the second question is regarding the distribution of new products like tennis and kids; will that follow similar wholesale partners that you’ve had previously, or is that mainly going to be on the DTC channel?

Marc Maurer, Co-CEO

Thanks for that. In Q4, 65% of the growth came from new products, and 35% came from existing products. When we look at new products, the CloudGo, Cloudmonster, and Cloudrunner are resonating really well with consumers, allowing us to be very positive for 2023. We also have strong preorders for the fall-winter season on the Cloudnova, targeting younger consumers. Comparing it historically, we're reducing dependency on the Cloud and bringing the right consumer into the right product through the right channel. Regarding tennis and kids, we will focus on tennis distribution through a couple of wholesale partners catering exclusively to that community, as well as through our DTC channel. For kids, we will have a stronger focus on DTC with a few selected partners like Nordstrom.

Cristina Fernández, Analyst

Yes. Thank you.

Abbie Zvejnieks, Analyst

Great. Thanks for taking my question. Regarding reducing dependency on Cloud, does that dynamic change in the near-term with the elevated inventory position? Are there categories where that inventory position is more elevated than others? Thank you.

Marc Maurer, Co-CEO

It's important to understand that the increase in inventory is very much intentional, driven by the growth and momentum we see. This increase has occurred in areas where we foresee the strongest growth and where our products see the strongest demand. The inventory is in line with our demand plans and what we see in the preorders for the current quarter. We expect that a lot of this inventory will continue to drive a high share of full-price sales.

Abbie Zvejnieks, Analyst

Great. That's helpful. One more question on converting select international markets to owned versus distributor. Are there significant changes on the P&L from a growth or operating margin perspective that we should think about, or are those just smaller impacts?

Marc Maurer, Co-CEO

For next year, the impact is relatively small, as it’s about building these markets. We mentioned Korea, which is a very important market in the Asian region, and Italy in Europe. The impact will be relatively small both from a conversion effect and from a sales increase effect.

Michael Binetti, Analyst

Hey, guys. Thanks for taking our question. I'll add my congrats on a great quarter. Obviously, there's not much to pick out in the quarter. The results were well ahead of what we thought we'd see. I am curious if you could unpack the gross margin a bit in the fourth quarter and help us connect it to the longer term. If I heard correctly, you're lapping about CHF 7 million in air freight from last year, so about 370 basis points of a tailwind.

Marc Maurer, Co-CEO

If we compare Q4 versus Q4 last year, our gross margin stayed stable. This year, we had about CHF 37 million of additional air freight, which we don't foresee for next year. That's in the range of about 200 to 300 basis points of upside. Importantly, we still want to be prudent and on the conservative side with our guidance. Currently, we expect the 2023 gross profit margin to be FX neutral, so no impact from that side. We continue to build for the future and focus on operational efficiencies, extensions of the supply chain, and our processes which will define growth rates in the future.

Jonathan Komp, Analyst

Yes, hi. Thank you. I want to follow up on the order book and the pre-book visibility that you're seeing. Could you discuss the drivers of the current growth? In the second half of 2022, you had very successful product launches and strong growth rates. What is driving your continued growth? Also, could you talk about your roadmap in the performance running business as we approach the Olympics next year?

Marc Maurer, Co-CEO

The growth in preorders is coming from the core launch side, so we have the Cloudmonster, Cloudrunner, and CloudGo together, with an 80% preorder increase year-over-year. The Cloudnova has a 70% preorder increase over the previous year. We are very confident from our running product portfolio for the fall-winter season. We are also launching new iterations of our existing running blockbusters, and the upcoming Cloudboom Echo 3 has already been used by our pro athletes in races. We aim to cover all performance needs from accessible running products to the absolute pinnacle of performance running for the Olympics.

David Allemann, Executive Co-Chairman

If you think about Q4 last year, half of all the growth came from our new running products. We're also launching new iterations of existing blockbusters that will innovate further. The 2024 Olympic Games will showcase our wide range of products as we prepare for that banner year.

Marc Maurer, Co-CEO

The performance all day business is growing alongside performance running. We aim to lead with performance in our products and want to establish ourselves as the number one brand under our seat. We feel there's an opportunity ahead of us that we're not penetrating yet, especially in the fitness community with upcoming products targeting those consumers.

Jay Sole, Analyst

Great. Thanks for the commentary on product innovation and position in the performance categories. I want to ask about tennis. Can you share your ambitions in the category, market size and growth potential, both in terms of footwear and apparel? Also, based on initial reads from your new store in London, how confident are you in a broader rollout of this store format?

Marc Maurer, Co-CEO

We have been waiting for this opportunity, and we are super excited to have Iga and Ben join our journey. Our goal is to bring our innovation and authenticity into the tennis world. The tennis market is sizable but relatively small compared to running. However, we're seeing a strong influence of tennis on all-day usage from both a footwear and apparel perspective. Our Roger franchise is resonating with consumers strongly and is set to grow further.

David Allemann, Executive Co-Chairman

Our own retail stores are not just about transactions, they're about inspiration. Our Regent Street store is performing four times better in revenue than our first store in New York. There are visible lines in front of the Regent Street store, which demonstrates our retail model's sustainability. We will focus on key locations for retail, not opening thousands of stores worldwide but rather being selective. In China, we are moving towards a faster retail expansion.</s>

Sam Poser, Analyst

Thank you for taking my questions. In 2023, how should we view wholesale growth versus direct-to-consumer revenue growth? Also, what is the optimum inventory turn you envision moving forward?

Marc Maurer, Co-CEO

We should think about growth similarly to how we thought about it for ‘22 or ‘21 before COVID. We're focused on reaching the right consumers through the right channels, hence, we don't want to give exact numbers on doors. We're focused on managing sales closely. We're also able to reach many new consumers through our DTC channel and drive a strong DTC share.

Martin Hoffman, CFO and Co-CEO

This is very much a function of the growth we are expecting. Inventory levels have been around 30% of net sales, but we were at 37% at year-end, slightly above. This is how we may look into the future.

Operator, Operator

Ladies and gentlemen, that was our last question for today. The conference is now concluded, and you may disconnect your telephone. Thank you very much for joining and have a pleasant day. Goodbye.