On Holding AG (ONON) Earnings Call Transcript & Summary

All right. Good afternoon, everybody. I'm Alex Straton, Morgan Stanley's North America softlines retail and brands analyst. Super pleased to welcome On here to the stage with us, which is a $19 billion market cap business known for their running and footwear. I couldn't believe that market cap number has just been going up recently. It has a very distinctive silhouette as it relates to the footwear. Many of you may recognize. Marc, Martin can model it for you all. So in that vein, I'm joined by Marc and Martin, co-CEOs of the business. Martin also in the CFO role. Thank you so much for joining me here today, guys.

Thanks for having us.

So on format, just to quickly cover logistics. It will be a fireside chat. I'll ask a few of the most topical questions I've heard, then we'll move over to some questions from the audience. And then always my favorite part is covering disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. So that keeps me protected.

Now I'll turn it over to you guys. I want to start with a look back because we're sitting here today, and it's been almost 3 years since you became a public company. So I'm just wondering how has your vision changed now compared to 3 years ago, if you were to sum it all up? And I'll ask you to both of you. Maybe I'll start with you, Marc.

Martin really wants to start. So...

Martin first.

I'll start. I mean, obviously, a lot has changed since then. Just to recap, so we went public in '21. That year, we made EUR 720 million in sales this year, look at EUR 2.3 billion. So On has basically tripled. Now where is this most visible is in the end, in the capabilities that we have built as a team and really how everyone in the team has elevated the way of thinking, the way of managing the business. A lot of great talent have joined ever since and help us to just manage a much more complex business. So I really feel you're inside On, then maybe sales have tripled, but probably complexity has ninefolded. And so the way we can still live in a culture of innovation and excellence. So on the one side, having those huge dreams and bringing them to life and on the other side, really managing millions of shipments every month to our customers, working with key accounts who became larger than many of our countries and just the level of sophistication that is there in the team. That's a big change and gives all the confidence that you can just put more load onto the team into the culture and yes, elevate from here.

And what the culture allows us to do is really to focus on these both elements, innovation and excellence. So we feel part of the secret sauce of On is really that we're able to continue to bring innovations to the market and that we're continuing to push what performance means. At the same time, we can scale the business. And so we can be a home for people who are really good operators. At the same time, we can be a home for people who are creatives and are pushing the frontier of what footwear looks like. And so when you look at our product portfolio over the last 3 years, it's gone from very much being focused around the cloud, which was a large part of our sales. Now it's way more distributed. We're building out the running franchises. We made a lot of progress on the performance all day side. We completely revamped our whole apparel collection. So I think we made a lot of progress on product. Then we focused a lot on being able to bring that innovation to the market. So when you look at our internal processes like factory capabilities, warehouse capabilities, sometimes with some bumps. But overall, it's kind of a long-term journey that we're on to automate more of the business and to build a backbone of a company that can really carry something that is much, much bigger than what it is today. And with that self-confidence from the product and with that confidence from the fact that we're able to execute and we've continuously executed over 3 years comes kind of the freedom to dream. And so the discussions we're having today with the team on what the dreams are versus the discussions we had 3 years ago, they keep on growing. And so I think that's a beautiful position to be in.

So maybe with that same lens, I feel like 3 years ago, we would have been talking about you guys as disrupting the industry. And it feels like heading into this upcoming year, a lot of the big brands are kind of trying to enter your wheelhouse, which is running. So maybe talk to me about how you're thinking about some of these bigger brands now refocusing on this niche that you guys have been able to dominate.

We've -- I think the success of on is that we've tried to create something that wasn't there when we started. So when we started, we very much looked at the space and there was 0 innovation. All the product looked the same. There was a channel that was basically abandoned by big brands. And there was a duopoly in many cases where athletes were looking out for another option who really cares about them and not just like whatever -- whoever pays a bit more, but doesn't really kind of give them the option to be themselves. And so it feels like that's the reason why we entered the space. And since then, they have always been there. Everyone was always more other brands have joined. But we continue to focus on bringing innovation to the market on making the product more sustainable on bringing new silhouettes, on bringing collaborations to life that others don't have. And when we're looking at a product like LightSpray, and how this is pushing manufacturing, how this is pushing -- how materials are used and how this is pushing the performance of products and how we can take some of those learnings and move it also into all day or like more or broader accessible products in the performance run space, I think then we're very confident that a, we have an innovation pipeline ahead of us that will continue to allow On to grow. And b, we've built relationships with our partners and over many years now, and we can create value for them in a premium space. And so this is the playbook that we had in the past, and we are very confident that this will also work in the future.

I want to double-click on that pipeline comment that you made in terms of -- I would love to understand what are you prioritizing in the next year as this market is changing from a pipeline perspective?

So from -- there's -- we're bringing the Cloud 6 to the market. So it's the next iteration of the cloud. This will be in the first quarter. So we're very much looking forward to infusing the product with a lot of collaborations that we're doing. We're bringing additional options to the market. So really looking forward to that part. And when you look at where the product was a few years ago and where it is now, then we've made it more culturally relevant. We've made it younger, but we still kept the older consumer that we have in there, which is great. So really looking forward to bring that to the market. We're going to bring the Cloudrunner and a relaunch of the Cloudrunner in the specialty space. So that's a product that is working really, really well for a very broad use case. And we're really looking forward to bring some iterations of the Cloudsurfer with the Cloudsurfer Max as well, another Max cushioning option into the channel. And then '25 will also be the first time Tim Coppens, who is our Creative Director on apparel has really led the whole apparel collection. So '24 is still a bit of a mix and how that collection has been received by all our partners, but also by some cultural influencers that have already seen it. So we're very excited about that one too.

Perfect. I think that's a nice segue into revenue more broadly. And Martin, I know you guys have put these targets out to get to a little bit over $3.5 billion, I believe, by '26. So can you just elaborate a little bit more on the building blocks, whether that's by geography or channel, product, however you think about it in its most basic way?

Yes. So the goal is to -- or is to double sales compared to '23 number by '26. And the focus is really on the running community and the running vertical. That's our core. At the same time, we have expanded into outdoor, into tennis, into training. Some of them are very young categories for us. So you have an expansion of just the addressable market and the communities that we are relevant in. China is a big focus for us, and we've just been to Shanghai. It's amazing to see how many people start to wear the product and also the -- how many diversity you see in the product. We see China very much as an execution game because we come from such a little base and the product market fit is so strong. So really building own retail stores being more Chinese focused in some of the product development that we do. So China is a big element. We are extremely excited about the success that we have seen in On retail with basically a channel that we only started to have at the end of 2020 and now we operate 50 doors. And yes, most of the stores are living up to the expectations or above. And so we feel this gives us confidence that we can really continue to build that channel as it gives us access to the right customer, not only in the markets where we are already very strong, but also in the markets where there's a lack of premium wholesale distribution. And then we also see the spillover into our D2C e-com channel. And linked to what Marc said, but also linked to our distribution expansion is apparel. And just keep in mind, we are today like 100 million apparel brand. This is a bit the size of on in 2017. So it's nothing, it's super small. But we have proven with footwear that we can bring it from 100 million to a multibillion business. And the same thing is on the agenda here. So investments into the team are super important, but also having owned retail as a key distribution channel goes along with that. So those are the pillars. And at the same time, we are now already developing products for '27. So our focus starts to shift on beyond that time, but it's too early to talk about it.

I want to drill down on one of the pieces that you mentioned, namely DTC. That's been a pretty powerful driver of sales and margin this year. I think some planned, maybe some less planned as you optimized inventory in the supply chain. So can you talk about how you balance DTC versus wholesale mix? And what's like the right type of balance over time between those 2 channels?

We've done a lot of work on developing basically one consumer perspective across the organization. So when we look at the market, we really look at, okay, how do we want to show up in the U.S. as On. And then we have different channels that are executing versus that. And so whereas in the early days, it was very much wholesale and e-comm a little bit separate. Now we're basically having one overarching commercial vision against it with the logic to fulfill a consumer promise wherever you meet on. We've had a lot of learnings this year. So for example, in Q2, we had quite a few issues from a product availability perspective, warehouse perspective. And so then the On e-com channel suffered more because the wholesale channel still had inventory that they could kind of live from. We didn't have it anymore. And so that led to some disruptions in the mix. The positive thing is the consumer still found the product, right? So you didn't have it on our website, but you went to one of our partners. So in the end, we still had additional consumer in on products. And so this also showed how the channels are actually additive if something doesn't work perfectly. And now Q3, Q4, how we're executing against it, we're very, very happy. And we'll continue to be very clear on how do we segment products. I think we've made a lot of progress on having the right product in the right channel at the right time. We'll continue to focus on which are partners where kind of we're already quite established and maybe we see a little bit less growth and who are partners where we can really tap into new communities where we're not so strong yet together with them. So Foot Locker is one example of that. And so this will continue to evolve, and we can continue to build on our own retail strength that we start to develop because every store that we open right now has a positive impact on everyone around that store. So we still see a long way kind of for the brand to continue to grow without cannibalization happening.

I want to focus in on that second part of your answer there, just on wholesale because a very common question I get is about what is the opportunity from here? Are they already in all the doors they're going to be in? How do they expand from here? So can you just elaborate a little bit more on how you think about the wholesale opportunity, if it's the same in the U.S. or different, I think that would be helpful.

Yes. I think it's extremely important to understand. We -- our focus is on long-term durable growth, and we are fully committed to the multichannel distribution network that we have. I think this year we absolutely made a game changer in how many people know the brand and have heard about the brand. And this is due to the big marketing print campaign that we had. the present at the Paris Olympics and all the [Indiscernible]. LightSpray, latest innovation technology. And so if that demand is there it allows us to be super controlled in how many additional retail space and wholesale space do we need in order to maintain a high durable growth. And at the moment, we are in a phase where the there's absolutely no need to push. But at the same time we have a plan and we also have conversations with our wholesale partners on, hey, this is the journey over the next 5 years, how we can grow together. And I think this is exactly where you want to be because you can just focus on the clean, the right parts of the business. I think if you just look at the door count, you miss the right picture. So take Foot Locker, for example, Nike has a EUR 4 billion business at Foot Locker somewhere there. Why shouldn't we dream of having that same business in the future. And at the moment, we are a very small fraction of that. But to be there, it needs the right product. It needs the right community, it needs the right relevance, and that's what we are building. So it's a development that you have -- we expand the communities that basically the brand awareness and that the wholesale partners allow us to capture that together over a long period of time. So what's nonnegotiable for us is to go into wholesale partners that don't live the premium position of the brand. It's not a negotiable for us to lower price points just to be more relevant to partners. So we want to be the most premium performance brand. And -- but we feel we are in a very good position to really play the strength of our channels. But at the same time, we love wholesale and we love that they give us access to new customers. And I think they love us for the premium position that we bring.

Now turning to profitability. Gross margins are outstanding, I think beyond even the targets you had put out at the time of the IPO. So now that you're already there, Martin, can you walk us through how you think about the next couple of years? Like where should those go from here?

I mean the fact that we are there is a bit linked to what I said in the beginning. It's just amazing what the team is able to pull off if you have the right people in the right seats. And so on the one hand side, we see that we have extreme pricing power. We proved this with collaborations like Loewe, where shoes are selling for $400, but we also prove it by the power that we have, especially in our performance products of just elevating price points. And at the same time, we have an extremely strong team on the development and innovation side that is able to engineer innovative products that don't necessarily cost much more. And so we're able to expand our margin. The team is doing a really good job in managing supply-demand, keeping airfreight low, optimizing our network. So I think this puts us in a very -- similar to what I said just now, it puts us in a very strong position to trust that we have a strong margin power. We can invest with confidence into the business. But we feel the 60% plus is a good number. It's a good number because you can't expect that everything is great all the time. I think it gives us also the opportunity to invest into more innovation into sustainability, something that is very important to us. And so we are not just optimizing for margin. But in the long term, this will just pay back and will just increase our strength that we have to drive it. What will really drive margin over time is the D2C share. That's the big driver that is here to stay. So linked to what Marc just said, if we continue to expand in own retail, we expect to see a margin expansion.

Something you hit on a couple of times there was reinvesting against this really strong sales outcome, gross margin outcomes. I don't think you guys have been shy about that. So can you talk about how you think about SG&A maybe near term and then long term, like when we start to see maybe better leverage out of that line item or what your goals are in general as you manage it?

It's SG&A, you got to take SG&A.

So we set out the goal that we have for '26 is 18% plus adjusted EBITDA margin. And I think we are very much marching on that path. We are a little bit ahead. That doesn't mean that we necessarily want to reach the goal earlier because for us, the philosophy is again, durable growth, but also being able to reinvest into the business. So take LightSpray, for example, I think the fact that we are now in a position that we can really invest in a team in capabilities to commercialize the product, to develop the right production processes. That's a good position. We are able to put basically full power behind apparel. We can expand into new markets. And this wouldn't be possible if we want to go too quickly to a too high margin profile. But the business is ready. So similar to what we just discussed on the gross profit margin, it doesn't need changes in the way we do business to get there. It's the discipline over time that will bring us there. We will see leverage in our distribution cost because we are investing in automated solution on distribution side, which will make us much more effective and efficient, especially in single parcel shipments. We pay a lot of attention on not becoming lazy when it comes to processes and becoming fed and inefficient. So this is always a very important part on driving efficiency and making sure that we grow our team a bit lower than ourselves. And then at marketing, I think at the moment, we can dream big. We can do big collaborations, and we want to continue doing this as long as we see the payback. But the sum approved, the payback is there. It's coming. And so yes, that's a bit how we look at the SG&A.

One category that's come up a few times in your responses so far has been apparel. Can you talk about kind of the investment or repositioning you did for that part of the business and then how you think about the opportunity over time?

Yes, we worked -- I think the big insight probably was 3, 4 years ago when kind of we set together and was like, okay, hey, where do we really want apparel to be? And what does it mean in terms of how much time does the team need to spend on apparel. And so then we developed this topic of, okay, let's bring apparel to 10% in a meaningful time frame and then we take it from there, but that means we need to spend 20% of our time on apparel. And ever since we've really upgraded the team. So we've brought in a lot of external people. We've worked a lot in bringing amazing factories on. We worked a lot on the yarn side with the mills and so on. And so we're really focused on being able to bring the same product promise that we have in footwear also to the apparel side. And then with Tim Coppens on the creative side that we don't only have the product benefit, but we also have the design promise that we're giving. And so that you're seeing coming to the market now. So if you look at our collection 3 years ago and if you look at it now, I think it's a huge, huge difference. The consumer response is very, very positive. We worked on fit and sizing. So this was a big topic. This has also had some impact this year on the number. because we had to take some of the old products back and ship new that's out of the picture next year. So then all the products will be there and you fit the new sizing. And then we invested a lot in merchandising and retail capabilities. So we will -- we're building apparel with a D2C lens first. So while our footwear business was very much built together and from the wholesale side and then adding kind of our own e-com in the early days, the apparel business will be built very much with a D2C lens first because that allows us to bring the collections to life in a much, much better way and that just to merchandise the product in a better way so consumers also can feel the benefit.

I want to also talk about stores only because you've mentioned that as a few times. Current footprint, you gave some details, but just so people hear it, again, size of it and then why that was the right path for the brand and how you think about that going forward? What you've learned too would be interesting to hear.

Yes. For us, it was always clear that we don't want to have own retail as a marketing channel. So it needs to be a business channel that is contributing to the overall business. So we have clear top line expectations, sales per square meter expectations, profitability expectations. So we clearly see On retail needs to be superior to wholesale and also on a margin profile. And we both have some experience in On retail. And so we are pretty much aware of the difficulties it can also bring. It's -- it's the first time that we basically have almost more people in retail than in the rest of the company. So a lot of elements that need to come into place. So you need to really find the right locations. And as I said, now 25 stores in -- outside of China, 25 stores in China. We have learned that we are able to do it. We have built a team. We see that at the moment, we are doing extremely well with stores in the size of 400 to 1,000 square meters. So it's like 4,000 to 10,000 square feet. And at the same time, in China, we maybe start a little bit too small. And we see that it almost limits our ability to drive enough sales. So we are now looking into bigger stores. And then the apparel share is at 15% to 25%. So absolutely in a range where we can build on and drive meaningful business out of that. And at the same time, yes, you shouldn't go too fast. You want to maintain a premium position. You don't want to make mistakes in going into a B location because you don't want to wait for an A location. So that's -- again, it's a long-term game. But there's so much confidence behind the team and ourselves to -- that this is a super important additional channel for us, and that was the biggest learning from the last 3 years.

I feel like we've talked a little bit about Americas. You've talked a little bit about China. Can you just give me your view kind of on the Europe opportunity and how that market looks right now? I know you guys have been through some transition from the wholesale footprint standpoint.

Yes. We're very excited about how Europe will contribute to the growth in '25. So I think in '24, you still have the big impact of basically the door closures we did in Germany, Austria and Switzerland, which we feel was the absolutely right thing to do for On. I think the team managed to transition really well. We were able to capture some of those consumers then in our own channel, plus we were able to tap into new audiences with partners like Zalando or ASOS. So I think that's working. '25 will be the first or a year where this impact is basically out. So we'll see Germany, Austria and Switzerland go on a different growth trajectory. We are super excited about the curve or the adoption curve that we see in the U.K. in terms of partnership opportunities we have in terms of who is the consumer that we're winning. And then we have basically the rest of Europe as almost blank space. So if we look at Italy, if we look at Spain, if we look at France, if we look at Eastern European markets, we are still very, very small. And the On store playbook allows to tap into those markets in a different way. So the awareness basically over the Olympics in Paris, I think has almost tripled in a very short amount of time. And we opened the first store in Milano, and it's working even though we were almost not present in Italy, the store is doing well. And so we're very excited about taking that part of Europe now on a different growth curve and being able to spend some of the brand spend, I'll say, in those markets.

One thing I do want to spend a couple of minutes as well is the, definitely a differentiated approach that you are taking. Can you talk about how that came to be the and maybe what it can potentially mean for the brand in the future?

I mean a lot of things sometimes just start with giving an individual the space to have an idea and kind of live their dream and pursue their dream. And so this is how Light started. I hope some of you saw the stories that were out there in media, but also some of the brand material that we did. So it was literally an individual coming up with the idea. And the idea in the end has 3 major benefits that we feel can have a very -- or can have a transform impact on how we do business in the very long run. So one is it allows us basically to establish a different silhouette and an elevated performance. So it's by far the lightest upper execution that's out there, and it's a completely new silhouette. So you have one material, you have no lasers and so on. And with Hellen Obiri varying the product, it also shows that On is very much on the leading edge when it comes to creating innovative performance products for the top athletes. The second thing is it's a very different logic on how we make product because we don't need to source tons of components with a Tier 2 supplier, then bring it to a Tier 1 supplier, then have 100 people that put it together. We basically have the raw material, which is a polymer and we spray the polymer on to the bottom unit. So you can completely rethink the lead time that you have in the industry, you can rethink basically where you produce. So it offers the opportunity to produce much, much closer to the consumer. And then the third element is it allows us to really push on sustainability. So we already now have 75% less CO2 impact on the upper. We're still using material that is not recyclable, but we feel there's a journey to use recyclable and eventually at some point, even circular material. And so that's where we're on. We're in the probably first 5% of the innovation curve. So I think -- please don't think about this as a '25 opportunity. But Martin already spoke about it several times. I think we're here because we're building 2030 and 2031, and we feel this product and the light spray technology is an important element on that journey.

Great. I want to turn more towards the near term. We obviously just hit December just past Black Friday. Holiday is on everyone's mind. So I got to ask just remind us of what your initial view was and anything you're comfortable sharing in terms of how holiday has panned out so far.

Yes. So you have seen we had a super strong Q3, which was really driven by the demand that we have generated during the summer with the initiatives that I already mentioned. Team has done a great job in mitigating some of the disruptions that we had seen on the distribution side, on the warehouse side, which put us in the right position to also fulfill the demand. And this is how we ended the holiday season. So there was a lot of confidence that we can drive a lot of business at full price that the warehouse is ready to supply that. And at the same time we have done a lot of intentional work and also have to right balance between the strength of wholesale business and the strength of our own channels. We also looked at On retail as a very important contributor to the holiday season some say it did a little bit less last year. And we're in the middle of it. What's clearly paying out already is that we see our full-price business growing stronger than our discount business and I think this is exactly what we want to see as a premium brand. So far that demand continues and the warehouse delivers and so all good.

Another topical discussion item here today has been around implications of operating under a new administration, namely tariff tax. Can you just walk us through how you're thinking about what this means for On next year?

I mean we've been doing this for, what is it now, 13 years. So we had the joy of working with the same administration already a few years back. And so I think what we tried to do over time also with COVID is we really looked -- we really minimized the sourcing that comes from China. So On has 0 sourcing coming from China for outside of China. So it's important for us to have sourcing in China for China. So we're working on that. But there's 0 exposure to China also on like the yarn supplies and so on. We diversified a bit away from Vietnam as well. So we produce in Indonesia. We have a supply chain, especially in apparel that a lot comes from Europe as well, Turkey and so on. And one of the nice benefits of being the most premium brand out there is if you have supply and demand under control, you also have a certain pricing power. And so we feel with the sourcing setup that we have and with the brand positioning where we are, whatever happens, we are in a very, very good place to cater to it because we have the pricing power on one side, and we feel we have a sourcing setup that most likely is positively received by the administration right now. And so we're quite confident about On's capabilities to adapt with whatever may come.

Perfect. Super clear. I do -- we have a couple of minutes. I wanted to open it up to the audience, see if there was any questions you guys wanted to ask.

It's a great pleasure to hear you guys. I wanted to ask about the Cloudsurfer and the Cloudsurfer Next. Cloudsurfer retails at $160, the Next is at $150. Normally, when I see a next-generation model, I would assume that the price would go up. Can you talk about the reasons as to why you actually have it $10 less now. And I just wonder if this is going to be sort of thematic when Cloud 6 out and it's going to be $125 instead of $130.

So N doesn't stand for next generation or it maybe stands for next generation in terms of the consumer that we're putting into the product. So in the end, what we're doing, we're building franchises in the run space. And so for us, the key franchises are the Cloudrunner, the Cloudmonster, the Cloudsurfer and the Cloudboom franchise. And we did in those franchises were tearing products. So we have the surfer -- you have to Cloudsurfer Next into Cloudsurfer Max. They come at different price point and the next kind of the next generation is not the next iteration of Cloudsurfer. So this is usually our entry price point to elevated product and we would also tear it differently. so many of our general sporting good doors have Xs to the Cloudsurfer Next. But not to the Cloudsurfer, for example. So, this new logic allows us while terminology the consumer needs a bit to adapt to we understand it. But it should allow us to have a clear proposition towards the consumer in the running space. And then the Cloudsurfer itself gets updated next year and the $150 of the Next gives us the opportunity to place the Surfer at a higher price point next year. So it's actually $10 up and not down, to your question on the Cloudsurfer. So if you want to have the Cloudsurfer at $160 you need to buy one now. It's going to be more expensive.

Perfect. I know we're up on time. Maybe i'll leave it with you guys. Any key message or something that we didn't talk about that you want to highlight.

It's been a very intense and amazing year and so as we're closing out the year we also want to give a thank to the investor community. I think we spent many hours, Martin and [indiscernible] even more but we spent a few hours together. So really appreciate the trust that you're giving us. So it was a pleasure to answer question and tried to bring our message across. And I think sometimes we wish you could see all the things that are happening in the market. So for us being able to spend time in the Middle East, being able to spend time in Southeast Asia, in China, a lot of time in Europe, obviously, a lot of time in the U.S. just kind of shows us a bit where the brand is. And while we're talking a lot about the U.S., we're talking a lot about Sporting Goods and Foot Locker, I think what we see is then the unbelievable opportunity the brand still has in markets like Indonesia, Thailand, you take Saudi Arabia, kind of Dubai, Abu Dhabi and so on. And to see that kind of global brand heat that we're able to generate. I think that gives us a lot of confidence to communicate to you with confidence. And so I think we're taking that into Christmas, and then we're looking forward to many more discussions in '25.

Great. Thanks so much for joining me, guys.