On Holding AG

especially in DTC, where we lost some sales due to longer delivery times and higher cancellation rates. In addition, the strength of the US dollar in conjunction with the weakness of the euro in ratio to our reporting currency, Swiss francs, had a significant negative impact on our cross-profit margin and our adjusted EBITDA margin of 250 basis points compared to the third quarter last year. On total net sales, currency developments are mostly neutral, while regional sales are impacted. So even in spite of these headwinds, we delivered record results, which is a testament to our strong brand momentum and high-quality team-based execution. Now let me review the strong quarterly financial performance in more detail. We again saw well-balanced growth between channels, regions, and product verticals. We continue to win market share at existing retail partners while selectively expanding our distribution to reach the right customers, which helps to drive an increase of net sales and wholesale of 55.6% versus a very strong prior year period. As announced, we started to pilot at eight Dick's Sporting Goods locations and are extremely happy how ON has resonated as a head-to-toe brand with apparel and accessories driving nearly 20% of the units sold. On footwear, DIX is certainly showing that it can drive our mission to reach every runner. Styles such as the Cloud Ultra, Cloud Monster, and Cloud Runner have been large volume drivers during the pilot phase. We have also increased our door count with Foot Locker to 150 doors in the US in connection with the fall-winter 22 season launch. which came together with very strong numbers in Q3 and excellent sell-through during the back-to-school season. We continue to follow our strategy of seeking presence in the highest quality doors, tightly managing stock levels, and whenever possible, showcasing the brand in designated on-shop-and-shop areas. A great example is our partnership with Nordstrom. where we opened 12 dedicated on shops in September. Overall, our wholesale door count in our own markets, that means excluding distributor markets, stands at 9,050 doors as of the end of Q3, versus 8,000 doors at the beginning of the year, reflecting a strong organic growth within existing stores through both existing and new products, while expanding distribution in a very controlled way. Moving over to direct-to-consumer, where net sales grew by 40.7% in the quarter. Without the constraints in our US warehouse, we would have been able to achieve even more sales growth in D2C. Our D2C growth is well-balanced and driven by the strong demand from both our existing customer groups, as well as a large number of first-time purchasers that are frequently only just discovering the brand. As David mentioned, we are also very excited about the ongoing rollout and the potential of our new online experience to further increase the engagement with our fans. We are also continuously investing in our data infrastructure to connect more directly with our customers. Last week, I had the opportunity to visit our newest own retail store that just opened in Los Angeles at Ebertini Boulevard in Venice. The customer response has been incredibly strong, and we have heard many times that this is one of the nicest stores in this vibrant street. Like many of our other locations, it is not only a store, but also a launchpad for our running communities. Our next locations outside of China will be in London and Miami. for which we are looking at openings early next year. In China, the traffic to our own retail stores has surged back after the larger scale lockdown in Q2 and has also significantly increased versus the prior year comparable periods. For example, our existing Beijing store saw a 40% increase in traffic in the month of August versus the prior year period. At the same time, We opened four additional stores in China since early September. There are two in Shanghai, one in Beijing, and one in Chengdu. The China retail stores also continue to be a showcase of the opportunity we have in apparel when we can actively drive our merchandising. Our existing store in Shenzhen, as an example, even reached a 30% apparel share in Q3. Overall, considering the aforementioned dynamics in the quarter, Our DTC share was 32.5% versus 34.7% in the prior year period. Then moving on to the developments by region. Q3 net sales in North America grew 57.1% to 176.3 million Swiss francs, driven by the strong demand for our full product line across all retail partners and direct channels. As mentioned before, we would have had even more demand from our D2C customers in the region that we were unable to fulfill due to the temporary warehouse constraints. Net sales growth in Europe accelerated compared to Q2, and we achieved 116.5 million Swiss francs. 31.8 year-over-year growth, despite the considerable FX headwinds from a strong Swiss franc versus the Euro and British pound. Demand in most key markets continues to be strong, and we are very happy to have extremely strong partners in the region as we continue our growth path. With the expansion of JD, we saw record monthly sales through our footwear in September, which helped the UK to double net sales year over year in Q3. And we are excited to say that Q3 also marked a successful launch with Foot Locker in Europe, both in selected stores and online. Finally, Q3 also means marathon season in Europe. And we were very present in the weeks leading up to the marathons in London and Berlin, with this year's sprint campaign showcasing the power of running to ignite the human spirit. Mark and I, of course, are amongst the big believers in this power. And so I will admit Mark did so considerably faster than I. I'm happy to share that we both crossed the finish line in Berlin with smiles still on our faces, alongside many of our own teammates, fans, and partners. Net sales in Asia Pacific grew 85.2% to 24.2 million Swiss francs, driven by the strong rebound in China following the prolonged lockdowns in Q2, as well as the continued momentum in Japan and Australia. Despite some occasional local lockdowns, China posted a year-over-year growth rate of 90% in Q3. This momentum also extends beyond Q3. For Double Eleven, the biggest online shopping festival in China, ON was selected as the only new sportwear brand to be featured online and offline with team oil in the build-up to the event. Our co-branded design featuring the Cloud Monster was highly visible in major subway and bus stations across all major cities as well as digitally for the three weeks leading up to double 11. this together with our strong brand momentum led to an increase of over 135 percent in terms of items sold versus the prior year double 11 period with a total of seven new own retail stores opening in china in half year two and consider traction on our new WeChat mini program launched in October, we expect China to be a continued growth driver for us for the years to come. Finally, our rest of world net sales increased 150% to 11 million Swiss francs. As announced in previous calls, we have successfully built a network of new distributor partners across Latin America. In addition, we are also seeing a very strong demand increase in the Middle East. Turning to our performance by product category. Net sales from shoes grew 51.6%. In August, we launched the Cloud Go, which together with the Cloud Monster and the Cloud Runner has completed our line of reinvented performance running products that have driven significant market share gains for all. We expanded our collection of undyed products to the Cloud 5 and also the Cloud Nova. And we are excited to showcase these blockbuster franchises in their most sustainable execution today. As we all celebrate Roger's amazing career, we also expand the Roger line to a new mid-top version. And of course, celebrated Roger's last official tournament with a Roger Labor Cup Limited Edition, which caused long lines at the on-stand during that event in London. Apparel crew by 32.4% to 15.2 million Swiss francs. Similar to last quarter, still slightly below our expectations. But we continue to build the foundation for future success by investing into our internal capabilities, our product assortment, and the experience for our customers. Cross-profit reached 187.4 million in the third quarter. compared to 131.3 million in the previous year period, representing a cross margin of 57.1% versus 60.2% in Q3 21. As expected, we used additional air freight to fulfill more of the high demand for some of our new products. But overall, in Q3, we further reduced the reliance on air freight, and we are now in a more normalized position. which helped drive continued sequential improvement on cross-margin versus Q1 and Q2. Besides the planned impact of air freight, we have experienced pressure on our margin from the lower DTC share as a result of the warehouse constraints and, even more importantly, from the negative year-over-year ethics development mentioned earlier. SG&A expenses excluding share-based compensation And last year's one-off transaction costs related to the IPO were 44.1% of net sales in Q3 this year, reduced from 46.4% in the same period last year. While we continue to invest in all parts of the business, we are also driving efficiencies and economies of scale. Adjusted EBITDA reached 56.3 million in the quarter, exceeding 50 million Swiss francs for the first time in our history. This was up from 37.9 million Swiss francs in the previous year, which at that time had been the highest quarterly EBITDA to date. The adjusted EBITDA margin of 72 percent decreased slightly from 17.4 percent in Q3 21, largely due to the gross margin impacts mentioned earlier, but was considerably up from the 10.8 percent in the last quarter. Now moving to our balance sheet. Capital expenditures were 22 million Swiss francs in Q3 22, or 6.7% of net sales, largely consisting of investments into the build-outs of our offices in Zurich and Portland, into new own retail stores, as well as IT infrastructure. Let me go into a bit more detail when it comes to our inventory position. Inventory increased by 45.7 million Swiss francs or 21.1% compared to the end of June, and by 118.2 million or 82% compared to the end of the third quarter last year, which a year ago, as you remember, was unseasonably low due to COVID-induced factory shutdowns. If we exclude in-transit inventory, which had been significantly reduced due to the reliance on air freight between September last year and mid of this year. The inventory growth quite closely followed our net sales growth. We are currently in a much better position to execute the demand for the upcoming holiday season than a year ago, when inventory levels were at a low point. The inventory in transit and in our warehouses has been produced to fulfill the existing orders on books with ship dates in Q4 and in early Q1. Driven by the higher working capital and the capex investments, net cash at the end of Q3 reduced 493 million from 557.7 million at the end of the second quarter. Our strong balance sheet allows us to pursue our ambitious growth plans and upcoming investments. Finally, towards our path of becoming a much larger company in the future, I'm very pleased to announce that we have secured the capacity with a third party to build a highly automated fulfillment center in Atlanta. This new warehouse will provide additional capacity as of early next year and will replace our existing East Coast warehouse by 2025. By then, the automation will significantly decrease our handling costs and dependency on manual labor. offering an opportunity for further SG&A leverage and continued increase of our D2C business. This contract is secured by a bank guarantee and consequently by a dedicated cash balance. This look into our future logistics setup is a great transition to speak about our financial outlook for the rest of the year 2022 and into 2023. A very exciting and successful year is coming to the end, and we are planning to close the year on a high note. Based on the strong performance in Q3, we are once again rising our net sales outlook for 2022 by 25 million, from 1.1 billion to 1.125 billion, which includes the confidence in our ability to drive a stronger fourth quarter than assumed in our previous guidance. This new top line reflects a strong full year growth of 55% compared to 52% in our previous guidance. The increased outlook considers a few aspects that I would like to point out. First, the temporary constraints in our Atlanta warehouse are behind us, and we are approaching the important holiday season with a strong momentum. While we have a strong inventory position, we may see out-of-stock situations on some fast-moving styles, which we see as an important element in driving positive scarcity. Importantly, our long product life cycles allow us to remain focused on full price sales. Given the good momentum and supply situation, we are now in a position to fully normalize the use of air freight and do not expect an extraordinary impact in Q4. Second, we continue to see a strong demand for on-products and October was off to a very good start for the quarter. We're staying in close contact with our retail partners and analyze our extensive customer data to carefully observe the macro and micro economic developments. Our order book for Q4 and for the first half of next year confirm our strong outlook and we are clearly planning the business for continued strong growth. We also focused on ensuring we stay disciplined and controlled in our cost structure to ensure we are driving durable long-term growth. Third, we expect continued margin pressure from the combination of a strong US dollar and a weak euro, both compared to our reporting currencies with strengths. The executed price increases in the US and the planned increases in Europe as of early next year offset some of the compressions. For 2022, we are increasing our adjusted EBITDA target for the full year to 148 million, reconfirming our goal of an adjusted EBITDA margin of 13.2% for the year, even at the elevated top line outlook and despite the additional challenges described beforehand. Finally, as we have previously mentioned, and due to the structure of our pre-IPO equity plans, we will see the majority of the 2022 share-based compensation expenses in Q4. At the current share price level of 17 to 21 US dollar, we anticipate the charge of around 35 to 50 million Swiss francs. Each dollar higher or lower than the current share price at the time of granting in early December would then cause the share-based compensation charge to change by roughly plus minus 3.5 million Swiss francs. Over the past weeks, we have spent a lot of time with our senior leadership team to shape and align tuition for the years to come. Our order book for the first half of 23, the current demand we are seeing and the much improved supply environment put us in a strong position to drive continued strong and durable growth, both in Q4 and beyond. They also allow us to approach the year cautiously. to protect the position of the brand even in the current uncertain macroeconomic environment. Notably, we are committed to further increase our absolute and relative profitability with a constant focus on efficiency and improvement of adjusted EBITDA. David listed some of the most exciting initiatives around our brand in the last month. They ultimately led to the strongest quarter in our history. and an elevated outlook to close the year on a high. And we remain fully focused on accomplishing that in these last few months. All of this would not be possible without our culture and the team that is standing behind it. Our new offices around the world became an incredible source of energy. We can't be thankful enough to everyone in the team for building a culture of high performance, while also focusing on everyone's well-being. One of my highlights every month is to talk to our new starters and to share our history as a starting point to their three-day long onboarding journey. Because to understand our past is essential to shape our future and to dream on. With that, David, Mark, and I would like to open up the session to your questions. Operator, we are ready to begin the Q&A session.

Ladies and gentlemen, at this time, we will begin the question and answer session. Anyone who wishes to ask a question may press star followed by one on their touch-tone telephone. If you wish to remove yourself from the question queue, you may press star followed by two. If you are using speaker equipment today, please lift the handset. before making your selections. Anyone who has a question may press star followed by one at this time.

One moment for the first question, please. The first question is coming from J Soul from UBS.