Earnings Call: H2 2020

Mar 19, 2021

Investors, friends, good morning. Welcome to Li Ning Company Limited's 2020 annual results announcement. This meeting will be conducted on webcast and conference call. On the webcast link, you can also read the PPT slides. We offer floor language and simultaneous interpretation. This afternoon, this webcast will be uploaded to the website. May I introduce to you our management, Executive Director and CEO, Mr. Li Ning, Joint CEO, Mr. Qian Wei, and Mr. Terence Tsang, CFO. Our CFO, Mr. Tsang, will first present a financial review. Then Mr. Li Ning will introduce to you our strategic direction. After that, Mr. Qian will talk about the group's operation achievements, followed by Q&A session. Now, may I pass the floor to the management? Welcome, everyone. First off, I would want to highlight the fact that all discussion we are going to have in this presentation exclude the impact of the one-off non-operating income in the amount of CNY 234 million recorded during 2019. Financially, as discussed before, while we are not exempt from the negative impact COVID-19 has been created to the business, we are confident of achieving net profit margin improvement even under the impact of the COVID-19 because of our scalable cost structure, our continued elevated brand positioning, and what we have done in advance of the COVID-19. Consequently, we were able to achieve a net profit margin improvement of 260 basis points to reach 11.7% with our revenues up 4.2%. Such improvement was mainly driven by 2.6 points in expense ratio reduction, as well as increase in government grant and interest income while holding our gross margin flat under a very promotional retail environment. As expected, our operating cash flow declined 21%, but the key is we were able to achieve positive operating cash flow in the amount of CNY 2.76 billion, even with the COVID-19 impacting negatively on the retail sell-through. As a result, our net cash increased 25% to CNY 7.44 billion compared to same period last year. In addition, we were able to maintain continued improvement in working capital structure even under such time. Our gross average working capital was down 11%, while revenues went up by over 4%. Our cash conversion cycle further improved by six days to 20 days. Operationally, the continual improvement we made has mitigated some of the negative impact from the COVID-19. Specifically, we achieved a low single-digit growth for total platform retail sell-through, including both online and offline channels for the Li Ning core brand. Our channel inventory increased mid-single digit, relatively in line with our sell-through increase, thus maintaining our channel inventory turnover with an improved aging structure. Our offline new product performance impacted by the challenge and promotional retail environment down low single digit, driven by volume decline. Average selling price registered a mid-single digit increase, notwithstanding a very promotional retail environment. New product six-month sell-out rates declined by over four points, while three-month sell-out rates down approximately one point as compared to the same period of 2019 on a weighted average basis. The improved three-month trend versus that of six months was resulted from Q4 products with a high single-digit improvement in sell-out rates over Q4 of 2019 products during the first three-month selling period. Clearly, you can see the operation challenge resulted from COVID-19 had improved a lot during second half of the year. Now, let's take a look at the revenues. During 2020, our revenues rose 4.2% with mid-single-digit growth in apparel and footwear, as well as a low teens growth in accessories. Our balanced channel strategy for Li Ning core between wholesale and the direct-to-consumer channels, which also known as the DTC, has played a very important part at times like this. Specifically, it balanced the risk between channel and financial as well as working capital and P&L. The electronic commerce channel continued its growing trend over the past few years with sales revenue rose 30%, driving its contribution to 29% of the total from the previous 24%. Our wholesale revenues grew 1% with revenue mix decline one point to 48%. Direct retail declined 10% and this revenue mix dropped four points to 23% of total Li Ning core business. Nonetheless, the DTC, which is the direct-to-consumer segment Increase its mix by one point to 52% of the Li Ning core brand revenues, giving us a balanced channel penetration. On the right-hand side of the slide, you can see that our sell-through from new products category aged six months or less improved by one point to 79%. Nonetheless, this is still an area of opportunity for us, as a healthy retailer should be at the mid-80s level. Coming to the same-store sales performance, as there is no offline store that opened throughout Q1, hence, we will just discuss the Q2 to Q4 performance. Our overall same-store sales increased mid-single digit during Q2 to Q4 of the year. Our offline SSSG stood at mid-single digit decline, driven by mid-single digit decrease in both direct retail and wholesale channel. Meanwhile, our online SSSG accelerated to low 30s growth from Q2 to Q4. As you can see, the business has gradually rebounded during second half of the year. As far as our channel strategy is concerned, the number of stores for total platform decreased by 617 as compared to end of 2019. Of the decline, Li Ning core brand accounted for 537, and Li-Ning Young made up the remaining 80 drop in store counts during the last 12 months. Due to the COVID-19 impact, we have accelerated the store closing rhythm and delayed somewhat the store opening schedule. In addition, our channel strategy for Core Li-Ning is to continue on expansion of bigger and high-productivity store. So even with high single-digit decline in store count, our selling square footage actually went up by high single digit in end of the year. From the sell-through standpoint, as you can imagine, due to the COVID-19, our offline channels experienced the first decline in the recent years, drop of 5%. And with the positive contribution from consistent e-commerce expansion strategy driving a low 30s growth, the total online and offline sell-through able to remain in the positive territory of 1%. Our offline channel decline is all driven by unit decrease, as our average selling price, also known as ASP, actually went up low single digit even with such heavy promotion environment. As mentioned during last year presentation, we have a low teens increase in our MSRP or tag price for the 2020 new products, which enable us to mitigate some extent of the deepened discount on both new and old products impact to our sell-through amount. Wholesale of Li-Ning brand, excluding international and Li-Ning Young, saw a 1% increase, but the number of stores decreased 394 over the same period last year. With high single-digit decrease in selling square footage. Excluding specialty wholesalers for badminton and soccer, our sell-in was down low single digit, due primarily to lower revenues from the old product sell-in. New products revenues were basically flat as high single-digit increase in our new product MSRP was offset by high single-digit decline in new product unit sell-in. On the right-hand side of this slide, you can see our core wholesaler sell-through declined low single digit, which corresponded to the sell-in volume. As we always said during the past few years, we manage our wholesale business with a sell-through focus, and we will keep striving to maintain the balance between sell-in and sell-through to ensure channel inventory is in a healthy state. Once the short-term negative impact is worked through the channel as happened in the first half. Moving on to retail channel. The revenues of directly managed stores declined by 10%. The recovery started in the last four months of the year is not enough to make up the 24% decline in the first half. While the comparable ending store count declined 11%, or 143 stores, as mentioned above with the big store expansion strategy, the selling square footage actually went up high single digit. On the right-hand side of the slide, you can see there are two main negative drivers to the direct store revenues. First is the SSSG stores, which saw a negative CNY 303 million decline. But if you look at the store revenue of these SSSG stores in February and March of 2020, during which when most of these stores were closed because of the initial outbreak of COVID-19, already accounted for CNY 290 million decline. Secondly, the closure of around 550 stores during 2019 and 2020 also accounted for CNY 473 million revenues decline. With separation of our direct store operation team and single store operating model comes a stricter standard for store closure. Hence, the number of store closure has been accelerated. We try to mitigate the negative impact on store profitability resulted from the 10% sales decline and gross margin erosion due to the heavier discount environment through managing our controllable expense and negotiate on the fixed rental expenses. As a result, our store profit margin reduced from high teens to low teens in the comparable period. Turning to gross margin. Our gross margin remained flat, notwithstanding a very promotional environment. The major drivers were improvement in wholesale gross margin that was attributable to mid-single digit increase in our initial markup over costs, which also known as IMU. In addition, the improvement of new and old product mix in our selling revenues also drive the increase. Together, they contribute 1.2 percentage points. As said in our prior discussions, our old product clearance is more prioritized in our direct retail channel. Hence, some of the positive margin impact from our new/old mix in our wholesale sell-in is offset in our direct retail channel. Speaking of retail, heavier discounts on both new and old product sell-through for our direct retail negatively impact 0.7 percentage points. Dilution in channel mix due to higher decline in revenues from direct retail, which has the highest gross margin deducting 0.5 percentage point. Reduction in inventory provision due to lower inventory and better aging structure as well as lower R&D cost, adding 0.3 percentage point. Inventory optimization initiative in other wholesale business units, deducting 0.3 percentage point. Now, let me walk you through the profitability analysis. Driven by small increase in revenues and flat gross margin rate, we saw a CNY 289 million addition in gross profit. As far as expenses are concerned, we carried out disciplined cost control on variable cost to ensure better leverages. This is even more important when revenue growth is challenged by the COVID-19. As you can see from the slide, the total sales-related variable costs such as commission, direct store expenses, as well as logistic costs increased a total of CNY 108 million, representing 18.4% of incremental revenues, which is reasonable considering negative SSSG environment. With the cost control initiative we put in place, the platform expenses decreased CNY 156 million, driven primarily by staff cost as well as travel and entertainment expense reduction. Our advertising and promotion expenses decreased CNY 47 million and stand at 8.9% of revenues, down from the 9.6% of revenues in 2019. Other income and interest increased CNY 240 million, mainly due to increase in government grant and increase in interest income due to higher net cash during the comparable period. As a result, our operating margin improved from 11.4% in 2019 to 15.2% in 2020 after adjusted for the one-off non-operating goodwill provision in 2019. Consequently, our net margin improved by 2.6 percentage points to 11.7% from 9.1% in 2019. Moving on to channel inventory. Our channel inventory increased mid-single digit in relative to a low single-digit increase in retail sell-through. As you can see, we have been able to mitigate most of the negative impact on channel inventory caused by the COVID-19. Consequently, our inventory turnover cycle remained flat at 4.2 months as compared to 2019. Our efforts is more evidence if you look at the aging. Moving to company inventory. At the company level, our gross inventory declined 5% compared to a 4% increase in revenues. The proportion of inventory aged over six months declined one percentage point to 28% from 29% in the comparable period last year. This result validated the effectiveness of our inventory control, particularly at times like this. This improved balance and aging structure provides a good base for recovery in the coming year. Having said that, we believe there is room for improvement in our retail merchandising flow to further improve our inventory structure. As far as trade receivables are concerned, our gross trade receivables decreased by 1%, and relative to the 4% revenue growth, leading to continued improvement in our day sales outstanding, even with the impact of COVID-19. While the channel sell-through trend has improved, we still will be monitoring the wholesaler sell-through recovery trend and make sure enough support is granted. But as you can see, we have sufficient resource, both financially and operationally. As far as working capital efficiency is concerned, our working capital remained at a very healthy level. Gross average working capital was down by 11% to support 4% growth in revenue. The working capital as a percentage of our revenue further declined by one point to 8%, giving us sufficient resource to capitalize on the full recovery. The COVID-19 impact on our retail sell-through is negative and has taken a toll on our operating cash flow. Nonetheless, while declined approximately 21% compared to same period last year, we managed to achieve positive operating cash flow of CNY 2.76 billion. Consequently, our net cash improved by CNY 1.48 billion to CNY 7.44 billion compared to CNY 5.96 billion at the same period last year. Because of this healthy cash balance, the board of directors has recommended dividend of approximately CNY 510 million or CNY 0.2046 per share upon shareholders' approval. This represents 30% payout ratio on the net income. Thus, we will continue to invest in our business expansion with channels and categories. In addition, we will be making further appropriate investment in our brand elevation and operations to support a consistent, healthy business growth as well as to capitalize on the ample growth opportunities in this market, particularly at the current state of economy. Looking back on 2020, we are pleased with our financial performance, notwithstanding with such a severe impact to the retail landscape. As said in the beginning, our continued operation improvement has mitigated a certain extent of the negative impact caused by the COVID-19. As seen in this closed-loop slide, clearly, our offline retail sell-through was negatively impacted, but we have been able to continue improvement in our inventory, cash conversion, as well as working capital structure. As set throughout last year, there are things that we have done before the outbreak that allow us to weather through the COVID-19 with continued financial performance. Collectively, those factors allow us to deliver a satisfactory profit and loss statement, strong balance sheet with healthy working capital. Of course, while the COVID-19 is under good control in China and business is in steady recovery trend, but it is far from totally over in impacting our daily lives and economy, particularly on a global perspective. Hence, we're taking a proven balanced approach for 2021 between capitalize on the recovery under still somewhat uncertain macro environment as well as resuming investment in our brand and operations. We're looking at the mid-20s top-line growth and a net profit margin improvement of around 100 basis points. If you look at a two-year span from 2019, this represents over 350 basis points improvement in our net profit margin. Now, Chairman will walk you through our strategic direction. Thank you. Thank you, Terence. Good morning. Let me go through our company's direction. In 2020, the economy and the industry was under short-term pressure because of COVID-19. However, the pandemic is gradually under control, and people's health awareness is strengthening. The sports industry sees wide development opportunities and state policy stimulates domestic consumption. I believe that mainland sports brand will see a lot of opportunities and room for achievement. Our company has promoted its business development strategy and also deepened the strategy of single brand, multi-category, and multi-channels developments. We are committed to becoming a world-class professional sports brand and recognized by the world. In terms of the sales performance, the whole platform retail of the five core categories recovered from the decline of 11% in the first half of the year to the positive growth of the whole year. The retail obviously rose steadily in the second half of the year. The sports fashion category showed a strong resilience and recorded a 23% growth. Running and training are greatly impacted by the pandemic. But compared with the first half of the year, there is still an obvious recovery trend in the second half. The pandemic situation is under control and domestic market gradually recovered, so we are full of confidence in the long-term development of Li Ning brand. In terms of the products, basketball category is based on professionalism, focusing on the basketball shoes IP, such as Way of Wade 8, Yushuai, and applying high-end technology, such as Li Ning, and to strengthen the actual performance of products and create high-quality product reputation. At the same time, we continue to promote street basketball and fashion culture in order to reach more young consumers. In terms of marketing, we signed contracts with NBA stars and CBA talents to increase exposure of products in professional competitions. We also link with cross-border resources to increase the topic, the marketing, and enhance the market popularity. In terms of running, we constantly expand the metrics of running shoes to provide excellent product experience for professional and mass runners. We build core professional running shoes IP and deploy high-end professional product lines such as the Feidian, Speed and Jueying, and steadily accumulate professional reputation of running category. For the general category, we have introduced various types of running shoes, such as protection and jogging. At the same time, we pursue innovation, seek balance and breakthroughs in the professional and pioneer trends, and launch fashionable running shoes with professional performance such as Ranger, et cetera. In respect of training, we focus on functional sports and enhance product experience through technology innovation. We also lay out the females training market and develop this market, take women's fitness as the core, and improve women's product metrics. We continue to innovate, upgrade the technology of windproof and splash proof, and deal with all-weather training. We continue to upgrade the star IP, Unbounded series, of training categories to create professional strength. In sports fashion, we create the Evergreen Classic series and continuously enrich product packages and mix, and also to explore the female market, arrange the women's products and topics in the market, and reach more women consumers. We continue to build Li Ning brand in China and sign up high-quality artists and celebrities to increase product exposures and expand brand influence by using the fan base of those celebrities. In terms of brand marketing, we continue to build professional resources metrics and strengthen brand professional attributes. Basketball category continues to deepen the cooperation with the contracted players, and in the future, it is expected we will have more collaboration with those contracted players. In terms of running, we deepen our plan of marathon resources and sign international marathon professional players and increase the professionalism and exposure of running shoes. In badminton, we signed international badminton players and it strengthen the professional reputation of badminton category through the endorsement of professional athletes. In terms of the brand linkage, we launched a number of cross-border products, including LINE FRIENDS and the kung fu star Jackie Chan and a Japanese pioneer artist, Haji Sorayama, which achieved a high-quality exposure. The brand linkage is not only one of the ways to improve sales and reputation, but also a channel for us to convey brand spirit and attitude. We try to convey Li Ning brand's values to the outside world through different cooperation and attract like-minded people and continuously expand brand influence. On the 30th anniversary of establishment of our brand, although we are impacted by the pandemic, we are not bound by the pandemic. When the International Fashion Week was temporarily suspended, we moved the show to Dunhuang, the starting point of the Silk Road, with the significance of civilization blending. This Dunhuang Fashion Week broke the outside world's inherent concept of fashion show, and this is avant-garde design set up against the historical Dunhuang sceneries and made the audience shine and let us see the potential of Li-Ning brand. In the future, we will continue to make breakthroughs on the road and to make the next 30 years more exciting. Next, I want to invite CEO Qian Wei to introduce company's operation progress. Thank you. Good morning. I'm Qian Wei. Today, I will give you a summary of reports on the key strategies and the business progress in 2020. In 2020, in response to the uncertain impact of the pandemic, the company's business was adjusted to focus on increasing revenue, expenditure reduction, inventory control and the profits insurance and also, the increasing of the profit margin. In this impact, we strive to open up new sources, seize every opportunity to generate income, and also to make a solid preparation for our future development. For the cost reduction, we control unnecessary and inefficient expenses. We also reassess business requirements from the perspective of concentration, and the abandonment of the business, and adjusted cost of budget. For the inventory, we managed and digest the whole inventory rhythm, and to ensure the actual inventory was within the controllable range at the end of the year. In 2020, the company achieved satisfactory results in revenue stabilization, cost control, and inventory control, which was mentioned in Terence's report before, so I won't repeat it here. Next page, please. In terms of business, we continue to explore in R&D, innovation, supply chain and commodity management channels, e-commerce and retail operation, and we achieved initial sound results, and which laid this solid foundation of our confidence. At the same time, in terms of organizational culture, we adjusted this structure for future development and reshape this management culture and promote the business efficiency. I will explain these one by one. First is about R&D and innovation. We will carry out the product innovation around demand of professional sports. We will also have to improve from the passive production to the proactive production. In 2020, we continue to improve the technical platform of professional products, including this competitiveness of our products. In terms of the talents, we want to attract the top-notch talents to our team and to strengthen our competitiveness. In 2020, we continue to improve the technical platform, including some key technologies and materials and structures. In some key categories such as running and basketball, we maintain the innovation development. In the future, we will increase investment in R&D, establish and improve the R&D management, and strengthen the construction of R&D professionals, and establish the differentiated leading technology advantages. In the aspect of a supply chain, we define the supply chain strategy of changing a passive production into active production. In 2020, around the supply chain capability and quality, cost delivery and the supplier metrics, we optimized the overall supply chain. In terms of the quality strength, the awareness of the quality control has been raised. We will also strengthen the management of supply chains. For our resources, the supplier metrics were established. For the last year, the main material types of our shoe products decreased by high double digits, and the number of shoe material supplies decreased from 99 to 81. The variety of clothing materials decreased by low double digits, and the number of service suppliers decreased from 166 to 109. In the future, we will strengthen the collaboration between supply chain and sales and commodities, and build an active supply chain to meet business needs. For the commodities, we improve the commodity planning system and inventory management to realize commodity management efficiency. At the same time, we promote the commodity management function of the headquarters platform and strengthen the commodity management operation capability. For the specific implementation, we implement the commodity sales plan with different stores and the marketing, as well as the review, and optimize through monthly, weekly, and cross-departments meetings. In 2020, the width of our products decreased and the depth of our products increased. The width decreased by 20%-30%, and the depth increased by 30%. Commodity efficiency was optimized, and the business contribution was improved, and the business growth was driven by commodities as the core. For the overall product of shoes, accounted for over 50%, up more than 3% year-on-year growth. The new clothing products accounted for over 30% and up 4% year-on-year. In the future, we will implement the sales plans with commodities as the core, and also improve the commodity operation and its efficiency. In terms of channels, we are clear about the strategy of expanding high quality and profitable stores, and integrated the functions of the channel expansion, store design, and the store construction in the whole link. Also implement the closure of some stores and all the things based on this channel management process. For the implementation, we continue to promote the opening of larger stores and strictly control of the profitability, accelerate the closure of loss-making stores and stop losses in time. At the same time, we carry out the research project of store image and promote Li-Ning's brand image in some terminal stores. During last year, through the opening of new large stores and accelerating the closure of inefficient and loss-making stores, the overall number of channels decreased, but the average area and the total selling area were improved. We see the Li-Ning brand in China, by the end of 2020, the number of large good stores decreased, but the total sales area increased by medium digits year-on-year. In the future, we will continue to establish the channel layout and to support the development of our brands and realize the profit of a single store and formulate the channel based on different levels of market. I will talk about e-commerce. E-commerce business is an important business support in 2020, and under this background, we are more clear about the strategy of large-scale e-commerce business and focusing on different communication. We also strengthen the integration of online and offline business. We follow up the performance progress through the weekly meeting of e-commerce business and establish cross-functional communication between the online and offline business synergy. In addition, we also carry out channel certification and the integration of e-commerce, and constantly standardize the operation order of those online channels. For example, we created Dunhuang Fashion Week, and this also improved our sales. In 2020, the e-commerce's focus is on the sales growth, and we will also promote the offline and online integration. The specific figures are introduced in Terry's report, so I won't repeat it here. This year, we will strengthen the e-commerce, but at the same time, we will also emphasize the synergy of the online and offline business and to create Li-Ning the big e-commerce economic environment. This is an omni-channel operation. In terms of the retail operation, we continue to adhere to the business strategy with the commodities and the stores, as well as the efficiency. We pay attention to the performance to single store and operation. We will also analyze this of a single store operation and the turnover rates and the joint rates. We will also make some reviews on the implement check. For this part, we integrate commodities and the retail operations. We implement the sales toolkits and establish the sales front-line proposals and the follow-up solutions, and implement this P&L review and the rectification mechanism. Promote the standardization of the operation business. In 2020, although the income of offline channels were greatly impacted, but through strengthening the retail operation, the turnover rate and also the joint rate continued to increase. During the year, the overall joint rates increased by double digits. According to the store data, this overall transaction rate is increased by about 13%, and our retail operation centers are constantly optimized. Next page is about our organizational culture. For our organizational culture, we optimize the structure and adjusted this division of functions. Also optimize our management culture and business thinking. We strengthened our channels functions as well. We set up the sales function headquarters and also R&D. In order to increase the management efficiency, we optimize the report channels to ensure the efficiency and smoothness of business communication. In order to ensure the coordination of work, we promote the cross-departmental and cross-system coordination. Those method also improve our communication within the group. In addition, in order to convey the corporate management culture and the business thinking to all our employees, the company also sets the live video broadcast of a CEO. We will continue to improve our functions and strengthen our management and professional abilities, establish a retail talent training system, and achieve the same goal and centralize the team management. Last but not least, I want to talk about our future trends and direction. In the future, we will continue to adhere to Li-Ning's business development strategy, which is proved to be the correct direction, then continue to strengthen the company's core competitiveness and achieve the muscle-type enterprise, establish an enterprise management and operation system for sustainable development. At the same time, we will promote transformation from wholesale to retail operation mode, focusing on consumers, markets, and the goods in the stores. At the same time, we constantly pursue efficiency optimization in commodity operation and retail store operation, channel, cost, and organizational structure, and to maintain our sustainable growth and sustainable to increase our profitability. That's all. Thank you.