Earnings Call: H2 2017

Aug 11, 2017

Ladies and gentlemen, good morning. Welcome to the 2017 interim results announcement of Li Ning Company Limited. First of all, let me introduce to you, representatives of the management in attendance today. Executive Director, and acting CEO, Mr. Li Ning. CFO, Mr. Zeng Huafeng. Now I will pass the floor to the management so that they can present to us our operation highlights. Please. Good morning. Thank you and welcome, everyone. Here we are every six months. Financially, we managed to achieve a reported profit of RMB 189 million during the first half of 2017, a growth of RMB 76 million or 67%, compared with first half of 2016. We saw a growth of 11% in our revenues with one percentage point improvement in our gross margin. We also achieved a 20 basis points on expense leverage, notwithstanding our investment in new initiatives. We perpetuated our positive cash flow with operating cash flow increased 94% to RMB 589 million, following the exclusion of Double Happiness from last year. We also continue to accomplish a great improvement in our working capital. Our gross working capital reduced by 14%, while our revenues rose 11%. Our cash conversion cycle further improved to 56 days from 75 days. Operationally, we achieved high single-digit growth in total platform retail sales, including both online and offline. Our channel inventory turnover also improved significantly. We accomplished solid improvements in our retail capabilities, marked by a mid-single-digit growth in same-store sales growth, a four-percentage point improvement in sellout rates of our new products compared with the first half of 2016, as well as a one percentage point improvement in our new product discount. During the first half of 2017, our revenues rose 11% to RMB 4 billion, primarily driven by a 12% growth in the Li Ning brand. As open-to-buy reduction initiative exerted certain impact on our wholesale sell-in and retail sell-through, a low teens top-line growth is reasonable and expected. Our balanced channel strategy has been working well. All three channels achieved persistent growth. Sales revenue from the electronic commerce channel continued to deliver the highest growth amongst others with an increase of 58%. Contribution from the e-commerce channel rose to 19% of the total from the previous 13%. With that, the relative proportion of contributions from the three channels has moved closer to our ideal mix, of which contribution from wholesale moved towards to our target of 40%-45%. On the right-hand side of the slide, you can see our sales of new products aged six months or less continued to improve. Contribution to overall sales from new product rose to 78% from 76%, and our overall discount performance also improved. As far as our same-store sales growth is concerned, our overall SSSG accelerated from flat in the first quarter to high single digit in the second quarter. That drove up our overall SSSG for the first half to mid-single digit. Our offline SSSG had improved from negative to positive in the second quarter. While reduction open-to-buy initiative has a negative impact on the offline SSSG, the favorable result can be seen in the improvement of channel inventory and sellout rate. In addition, with online SSSG up in the positive low 17% level, we believe cannibalization from online sales did have a negative impact on our offline sales. Coming to channel expansion, our total network saw a net decrease of 111 stores since end of last year. We closed more than 350 stores in the first half, the performances of which have failed to meet our benchmarks. In addition, as we are adjusting our channel strategy of which chairman will go into later, we have applied a more rigorous standard for the performance and validity of existing stores while focusing on the scale of the store instead of the number of stores. We are putting more resource on remodeling existing stores to fit our criteria rather than on new openings. For the year, we expect the net decrease in number of stores of our core brand will be partially offset by the growth of our LI-NING YOUNG stores. Therefore, the total number of stores is expected to decline by 100 to 200 for the year. With our expansion strategy in electronic commerce, we achieved a 9% growth in total online and offline sales. It is worth noting that we still achieved a 4% increase in our offline sales in spite of the impact from reduction initiative of Open-to-Buy. This is a solid testimony that our brand is gaining market share. Total wholesale channel saw a 4% increase in revenues. Excluding specialty wholesalers for badminton and soccer, our distributors grew 2% in sell-in compared with a mid-single-digit increase in retail sell-through. A lower sell-in versus sell-through demonstrated our effort in improving accounts receivables and channel inventory. We saw most of our wholesale partners continue our improvements satisfactorily. We expect this momentum to continue as we have already seen orders for the first quarter of 2018 register a high single-digit growth, which is consistent with the trend fostered for 2017, reflecting our tightened Open-to-Buy philosophy. Now, let us take a look at our direct retail. Our directly managed stores saw sales went up by only 6% due to negative SSSG, dragged by probable e-commerce cannibalization. In addition, the team is still under the learning curve on managing the business under a single store ordering model. Our average store count, though, increased 5% compared to first half of 2016. As you can see from the right-hand side of the slide, negative SSSG impacted sales by negative CNY 30 million, which was more than offset by the net increase of CNY 96 million in sales contributed by the net store additions since beginning of 2016. Four wall contribution is at low teens during the period, compared with mid-teens for the same period in 2016, due to a negative SSSG and a higher mix in new stores which have a higher expense ratio. Store productivity and profitability remain the key focus in our direct retail. Our gross margin improved one percentage point during the period, driven by higher mix in direct retail and e-commerce contributing 0.5 percentage point. The improvement in wholesale sell-in discounts due to better mix of new and old products contributing a 0.3 percentage point. The improvement in direct retail sell-through discount due to better discount in new products contributing 0.2 percentage points. We are happy to get back to profitability growth trajectory. The improvement in profitability was primarily driven by the reasonable growth on our top line, coupled with solid improvement in our gross margin, adding CNY 223 million in gross profit. As far as overhead is concerned, we have implemented disciplined control on variable cost. The total sales-related variable cost, such as commissions, direct store expenses, and logistics, increased a total of CNY 125 million, which amounted to 31% of the incremental revenues. This higher than normal expense ratio on variable cost was resulted from the direct retail negative SSSG, as well as a higher mix on new store, as I said earlier, which have a higher expense ratio. Nonetheless, it is still much lower than the gross margin rate. We have rationalized our fixed cost structure as well, offsetting additional investment in A&P and staff cost with the savings on non-critical expenses that allow us a better leverage. Excluding the impact of new investment initiatives, our total operating cost to revenues ratio declined 0.8 percentage point. The favorable net interest income generated by much improved operating cash flow and conversion of convertible bonds has been partially offset by lower equity income from associate and lower government grant, as well as higher tax amount. Our net losses from the three new businesses amounted to CNY 22 million, giving us a net income of CNY 189 million, representing a CNY 76 million or 67% increase from the comparable period in 2016. Our net margin improved to 4.7% during the period, compared with 3.2% for the same period in 2016. Now, moving on to channel inventory. Our channel inventory decreased by mid-single digit while supporting increased store count and a 9% increase in retail sales. Our inventory turnover cycle exhibited an improvement and shortened to 6.3 months. Counting on pure store inventory, the inventory turnover months stood at just 4.1 months. The proportion of inventory aged over six months improved to 33% from 46%. This result validated the positive impact of our open-to-buy reduction initiative. At the company level, our gross inventory was down 4%, and net inventory dropped 3% on the back of the 11% increase in revenues. The proportion of inventory aged over six months period improved by 15 percentage points to 33%, reflecting our success in inventory control. As far as trade receivables were concerned, our gross trade receivables were down by 20% on the back of 11% increase in revenues. The proportion of receivable aged below 90 days improved by 2 percentage points to 54%. Our net receivables were down by 22%, leading to a significant improvement in Days sales outstanding. We are pleased to see that most distributor experience improvements with better sell-through and discounts. As discussed earlier, efficiency is one of the major considerations when it comes to our open-to-buy reduction initiative. The improved receivables condition demonstrate the success of our initiative. Overall, our receivables improved nicely. Yet, there are still a few accounts that require special attention and were given longer timeframe to revitalize. As far as working capital efficiency is concerned, our working capital has further improved to a healthier level. Working capital as a percentage of our revenues declined 7 percentage points to 22%, putting us in a very comfortable financial position to expand our business going forward. We substantially improve our balance sheet and cash flow. Our operating cash flow almost doubled to CNY 589 million. We improved our cash conversion cycle by 19 days to 56 days. We saw our net cash improve by more than CNY 850 million to reach CNY 2.18 billion. Looking back in the first half of 2015 when we set out our target for the working capital improvement initiative, we are pleased to achieve our targets notwithstanding a modest growth in sales during the past two years. In conclusion, we are encouraged with our performance in the first half of 2017. With open-to-buy reduction initiative, we achieved a moderate growth on our top-line sales as expected. We improved our gross margin and implemented disciplined cost control to achieve operational goals. We also recorded significant improvement in our working capital and cash flow. Looking ahead to the second half, various operating initiatives, including product and merchandising planning and refinement, as well as new businesses, will be in place and tested in the market. Hence, there are enough uncertainties that we must remain prudently conservative. We will maintain a strict focus on financial control and business execution as it takes time for the team to move up the learning curve and for the positive impact of the above initiatives to be realized in the result. Chairman will walk you through the details of our business operations and plans. Thank you. Thank you. Ladies and gentlemen, good morning. Good morning. I will briefly go through our operation results and also give you some information concerning our operations. According to the strategies mapped out by our company and with the macro policies of the government, based on these, there had not been a lot of changes. Basically, China is moving towards more sports and there is more encouragement of sports and also exercise, including in marathons and also other sports and competitions. in 2016, according to the country's relevant authorities' data, there had been more participation in such events. This is not just about everyday exercise, but participation in these exercise and sports and competition events. In 2016, it was close to 2.8 million people, and expected by 2020, this number will be over 10 million people. All these go to show the potential of the China sports and exercise market in the future. There is this experiential value for Li Ning products, and at the same time, while we develop these experience, we would also want to grasp this opportunity of raising of experience for the market participants in terms of their exercise experience, their sports products experience, and also their purchasing or shopping experience. Through this, we will be satisfying our customers' needs and their demands, and also to provide a flexible experience according to the differentiated consumption habits of theirs, and at the same time raise a recognition and loyalty for our leading products. There are three main pillars to our strategy for digitalization and raising the all-round experience value for our products. That would be our products channel and also our retail capability. We would want to establish this all-rounded experience and also to strengthen our brand value through this digitalization. We have been continually delivering our digitalization strategy through big data analysis, and we would want to be more increasingly, precisely deliver our products to our customers. Product is still at the core of our strategy. We will be raising the functionality of our products and raising the professional capabilities of the users. Also, we will be getting close to the taste and preference of our customers. It is through functionality that we integrate trendy elements into the design, and therefore differentiate our product assortment and therefore provide to our consumers and customers what they need for each of the scenario in the sports of their choice. China is very big, and taste, preferences or even climate weather are all very different. Therefore, according to the demand for the different areas and regions, we will carry out differentiation of our products assortments and also manage them accordingly. Basically, in terms of channels, we will classify our stores by categories with our own profitability model to match the product planning and assortment that is befitting of the relevant segments and the relevant regions. We will continue to optimize the channels to enhance our retail sales efficiency, and we will be closing down low productivity and loss-making stores in order to raise the profitability overall. In the past, I would say we haven't been doing very well in this regard, therefore, last year or the year before, we have been doing this. But it will take a bit of time and process, and there will be more work to be done. Also, in terms of our stores, we have been upgrading the image and implementing our standard operating procedures. At the same time, we would want to step up with our training for frontline sales and to build sports advisors team so as to reinforce our membership platform. Through this membership platform strengthening, we would want to provide an omni-channel digital marketing. Also to raise our sales. In this chart, you will be able to see 2017 first half, our sales situation for our core categories of products, and you are able to see our sell-through and the mix of our retail sell-through. As I have mentioned earlier, for the categories that we have, on the basis of these core categories, we will be investing more. Here in this chart, you are able to see the results of our investments and also the effectiveness of our investments and our efforts. As you can see, there is an increase from our retail sell-through, in particular in running. It is 26% in increase. Training, 15%. Basketball is 5%. Specifically for running products. According to the needs of the runners, we have come up with a number of for running footwear portfolio. As I have mentioned, the age, culture, level of consumption, habits, behavior are all different for our customers. Therefore, we would want to finely segment these and also to come up with running products that are diversified to meet their needs. At the same time, we come up with long, short lifecycle products. From single products, we have come up with diversified, differentiated footwear portfolio. In the past, there had been a single or a main product, but through this effort, we would want to adjust ourselves. Also, for each season, we would want to come up with a few major products that we would want to push. In particular, for the second quarter of the year, we have come up with Super Light 14, the running shoes. In the 3 months, there had been a sell-out of 56%, and the volume had been over 560,000 pairs. Also, our entry-level running shoes in the second quarter, Speed Star shock absorption shoes. In the 3 months of sale, the sell-out rate was 55% with 220,000 pairs sold. As for basketball products, again, we would want to combine functionality with fashion. Basketball, after all, is a young people, student kind of a sports. For this part, we will have more stories, more culture elements to them. For our products, we would want to dig or to borrow from this trendy, stylish, sports casual, kind of street basketball fashion type, so as to make it attractive for the customers who are basically young and sporty. We would want to make it more playful for them. We have been able to get positive recognition from the young consumers. In the second quarter of the year, we have come up with Sonic V basketball shoes. Through CBA and NBA resources integration for sales, we have raised the Li Ning basketball products to a new level of recognition. For Wade, the NBA player, on the basis of that, we have come up with the Wade series, which are trendy and stylish. We have also used more casual and kind of simple but fashionable kind of design, and to match sports with style. Also, they have been selling very well. As for BADFIVE apparel series for basketball products, again, this is targeted to the young consumers. It is focusing on street basketball fashion. It is playful and very trendy, avant-garde, and it shows a kind of sporty energy. This kind of street basketball fashion is key, and it has been recognized positively by the market. This is a training product. This is using technological elements to boost performance, so it is a kind of new experience for this sports. We have a Super Trainer training shoes, and basically, the design is a one-piece knit. It is breathable, it is flexible, and it is very light. The feeling when you put on these shoes, it is very strong, the feeling that you get. It is very breathable, and it is very flexible, and this is a very important training footwear that we have, and it is very individualistic, full of personality. At the same time, we are coming up with different seasons products. For example, in the winter when it is cold, we have these warm products, including far infrared warm and far infrared products. Also, we have some quick-dry products, AT Dry or AT Dry Freeze. These are the differentiation that we have in the products, so as to provide in warm weather or in the sweaty summer, there are these different training apparel. For training, it is more an individual pursuit for exercise and training, and therefore, in terms of functionality, we have to be even more focused. In our strategy, through the performance, it has shown that the market receives these products very positively. As for sports casual products, we look for uniqueness in colors and also in texture. This is an area that we have to have precision focus, because for sports casual products, it is more about exercise. It is not, as I have mentioned just now, in other functionality, in training or sports. This is more like a everyday behavior, casual design, exercise and sports kind of pursuit. We will be accordingly focusing our products and also our shop design in this direction. There will be accessories, different materials that we use with different colors, and basically, this is about mixing and matching with multicolor and coming up with different experience and different fashion effects. The products have been very positively recognized by our customers. As for channel, as I have mentioned earlier, we continue to upgrade and also develop new channels. In the past, for our channels, I would say the efficiency is not all that high. Sometimes we would very simply talk to our investors, and the investors will continually ask us questions about our channels. In the past, we can say that it has been, to a certain extent, efficient. Today, apart from offline, there is also online purchasing. The channel efficiency, channel convenience, channel attraction, all these will have to be integrated in order to deliver the channel value. That is why, for channel, we have continually been adjusting it and transforming it. Basically, we are coming with stores which are even more efficient, more attractive, and bringing our online customers to our offline stores for purchasing so as to strengthen their experience for our products and also to integrate a kind of integrated value for our brand name, so that there is a cross-selling for online and offline. For 2017 first half, we have been continually putting in efforts to capture certain hot topics and come up with all kinds of marketing events so as to get close to our consumers and to provide them with more diversified experience. For example, the Queen's Day on March 8, and also the Tmall flagship events and Rouge Rabbit in 2017 May, et cetera. We have also mixed them together with our sale events. In the first half of 2017, offline and offline integration, we have been able to create a very good promotional effect. For channel, digitalization is very important. We hope that through accumulating our experience and understanding of our customers, we want to be more precise in our data analysis and to forecast our sales more accurately. Also, we would want to coordinate in a more efficient manner to integrate and to forecast with our supply chain to improve our operational efficiency. This kind of efforts, last year and the year before, we have already started with these systems and efforts from item to item. We have been doing this work in planning for each and every one of our products more accurately in our sales forecast, in our supply chain integration, and the analysis of the data. We have already been able to develop this model and also to raise the overall efficiency of our product planning, our sales forecast, and also operation. On the one hand, we need technology for doing so, and at the same time, we need understanding of our business. Data, information are all there. It is about how you get that information and data. After you have gotten that data and information, how do you analyze it to reach your target? First of all, you have to set a target for your business so that our digitalization and data can feed into that to enhance our efficiency and customer experience. We have already started doing that in the first half of 2017. We have put in more resources. In the second half, we'll put in even more resources in this. In the next year and 2 years, we will continue to do so. This is a very important area of our work going forward. As for our stores, we are categorizing them in an ever more well-defined manner. As I have mentioned earlier, in different areas, regions, sports, and behavior, habits, our customers have different needs. It is important that we well define the different categories of our stores and their location, et cetera. We believe that this is an opportunity for our full category stores, for our category theme stores, to provide this kind of differentiation. In 2017 first half, we have revamped some of our big stores in our key markets to expand them and also to raise their productivity. Especially for our major key markets and also for our full category stores and high-efficiency stores, we have put more emphasis on them, expanded them, and revamped them so that our stores will be as attractive as they had been before. For a number of shops, I would say they have not been performing well. The image and what today's consumers are looking for, I would say there is not a very good match between the two. For us, this year, next year, and the year after, we will be changing our channel, our stores. We have, what, 6,000 stores now? This is a large number of stores, actually. For this kind of volume of stores, to change this and transform this channel to make it attractive and raise the store productivity is actually a big chunk of work. It will not be a simple kind of work. But really, we want to be very well-defined. In the first half of the year, we have already done some work in this direction. In the next page, you will be able to see a few photographs. This is in Shanghai, the River Mall experience store, which is a full category store. Also we have the badminton store. This is a running lab. Basically, these stores, basically integrate the experience of running, basketball, and training, badminton, et cetera, to make it more attractive for these Li Ning customers. Basically, we would want these stores to be fully integrated with full products. But as I have mentioned, this new image and productivity for our experience stores will take time to develop. Even though we have been operating and we have a lot of operational experience, but the market is ever-changing. These 6,000 stores and also our new locations, we will have to see how these stores can fit more precisely the sports that we want to focus on. For example, basketball or running or sports casual, we want to be more well-defined for our category stores. For example, basketball, we will be more focused on the young people who seek expression. In Beijing, Wukesong, the Huaxi Up Store on the left-hand side on the screen, you are able to see a few shots of this store. We want to be a place where young people want to hang out, and this is also where young people will get their basketball products. It is more in line with the everyday lifestyle of the young, of our customers. For each of our category-focused store, we want to be more focused and therefore more efficient and more productive. As I've mentioned earlier, to build these focused large stores will be a main direction of ours. On the one hand, we have these experience stores and also in terms of sales, we are also transforming the channel, the model of our channel before. In the past, for each of our stores, it is around 80 to 120, and for the bigger stores, 200 sq m. But the communication with our customers is already large scale. For example, we already have passed basketball, running, badminton, football, and leisure, et cetera. This is a platform that we have already built, but it's very difficult to show off each of these focuses. As we change the stores, we will be focusing on our larger stores with higher store productivity. As I have mentioned earlier, with time and according to each of the stores' condition and situation, we will go step by step in executing this strategy of ours. That is, focus on their productivity. But basically, if they are selling well, if they are productive, then this is a good platform. This kind of store is the store that we will select for transformation. As for the area, we want to extend these stores to a larger area, to approximately 400 sq m or so, and to be closer to the shopping experience sought by the modern-day consumer. In terms of our categories of products, we would want to enhance the opportunity of effecting sales. We will want to build up the area, increase the square meterage for these larger stores. This will take some time for this kind of transformation, perhaps half a year, one year before we actually see effects, because this is a major piece of transformation work. Well, before, I have already told you that in the next 2 to 3 or 4 years, we'll continue to transform the Li Ning Company, and the main area is in the business model and also in its, as I have mentioned, in the productivity of our stores. As for retail capability, this is a very important area for optimizing our operation platform for retail and to raise our capability in retail. Now, stores, very important for us in the retail operation platform. Well, basically, in terms of our capabilities, our products, in building on each other and also providing an O2O kind of a system is very important for our company. The platform for retail is being optimized with new injection of contents, products. We are basically doing that. In the future, for this platform, we would want to be able to provide more store image enhancement, a better store display, and also for marketing, et cetera, to provide a more precise direction for them. Also, in terms of promotions, we also want to formulate seasonal, regional products and sports-specific and experience-specific kind of marketing and promotional efforts. Also, we want to build on our omni-channel operation and also be able to provide a membership experience and interaction with our members. Also, we would want to establish an all-in-one inventory system for our O2O to implement a direct-to-store kind of delivery. Because after all, in the past, I would say, we have been wholesaling more than anything else. Starting from last year, we have already started with this effort. We will continue with this effort, and more and more, we will be doing this. Also in training of our staff in a stepladder approach, and also not only for retail training, but for each of the positions of our people in terms of their understanding of our products and our customers' need. We would want to train up in that regard as well. As we build our platform, we will be building our ultimate operating standards. These modules and these standards will be the foundation of our company's retail operation. Hopefully, through the building of this operation platform, we will be able to raise our productivity, raise our sales, but of course, that is not built in 1 day. In the future 2 to 3 years, we will have to continually do that to upgrade and enhance the content in this regard. In terms of our capabilities, we will have to continue to strengthen our retail operation as a closed loop in our products, in our stores, in our stock, in our product planning and development, in product sales mix, supply chain relationship, and cash recovery. All these is a loop, a closed loop that we will have to continue to build on using our experience and using our capabilities, which we will enhance continually. This is an introduction about our new efforts. In the first half of the year for our new business progress, it is as follows. There are 3 main categories. Basically, Danskin is 1, and we are ready. For opening of business in terms of our product positioning and the precise positioning of our brand value for the fourth quarter, specific products design and also production of the products. These are all online, on way. The segregation of markets will be in sports casual and also high-end. Also, we also have ballet, because before, this was in dance. Therefore, we have this Dance Fits, Dance Life, Dance Luxe. Also dance, especially for girls. A lot of them are young girls. They like ballet or dance and therefore dance skin will be an urban line that we will be pushing out. In terms of functionality, of course there would be demand, but more it is about a kind of dance play. It is about fashion as well. The series and the clothes, et cetera, it will be meeting the needs of the female sports needs for fashion and for sports. This is the positioning for this product and hopefully in the fourth quarter we will have some test point stores which will be opening up. According to the market response, we will be adjusting our strategy. For LI-NING YOUNG, we are very optimistic about its prospects. I'm not going to talk too much about this. You are all investors with your own insight and information about this young wear. This is about kids wear. Basically, in the past it had been more random. Now that we are doing it ourselves in 3, 5 or 10 years we will be projecting out into this very promising market of LI-NING YOUNG stores. Based on the market, but basically we'll start in the north. There will be 20 stores or so, which will come onto line with product as its core and retail capability as its impetus. In the first half of the year, we have come up with the ordering for 2018 in terms of design, style, materials. We have done some major breakthroughs and the 2018 first quarter trade fair went well. There is another, which is the Li Ning. We are basically continuing with our efforts to improve and optimize the products on this because this is more a leisure kind of a product and there is a difficulty in this. There are a lot of products that can replace it. There is a lot of competition in terms of products itself. How do we in Li Ning be able to optimize our products? This will also take time. As I have mentioned just now, this will take time because the market competition is really much too rich and we will have to analyze and finally decide on how we want to focus our products in order to deliver the kind of effectiveness and efficiency that we seek. In Dalian, Qingdao, Shanghai, Beijing, Nanjing, Hefei, there are already 8 stores which have opened in these cities as of first half of 2017. We will be seeking our direction and seeking the model for our shops before we put in efforts and resources in major ways. These are new businesses of course. We do not have major capabilities here yet and we will be building on them. But of course it will pull down our net profit. Basically CNY 19 million for the first half of the year and for the entire year our expected net profit will still be CNY 18 million to CNY 19 million effect from these three new businesses. The impact from these new businesses of course will not be as efficient as our other lines, but we will continue to build on them and develop these new businesses and to also come up with an energetic Li Ning brand and model for all. Thank you.