Earnings Call: H2 2012

Mar 26, 2013

Good morning, everyone. Welcome to Li Ning Company's 2012 annual results presentation. Today we have here with us Mr. Li, Executive Chairman, and Mr. Jin-Goon Kim, Executive Vice Chairman. First, Mr. Li will review the company's strategies in 2012 and share with us about the group's brand marketing. Mr. Kim will then take us through the financial highlights, business review, and operational progress, as well as outlook and future strategies. After that, we'll take questions from the floor. Now, may we invite Mr. Li to start the presentation. Mr. Li Dong, please. Good morning, ladies and gentlemen. For 2012, it is the year of change for Li Ning Company. Before we talk about the numbers, first of all, I'd like to together review with you the strategic decisions we have made, and also the thoughts behind those strategic decisions. As you can see that, on the short term, the sportswear industry in China is facing increasing fierce competition. The competition will continue, and also, if you talk about the apparel industry in the past, it has grown really fast. In the past, people actually were using wholesale model, but now, in this new economic situation, the industry is facing a series of challenges, including over-expanding, over channel expansion, and also over inventory, and also increased costs, and also the homogeneity of products. In the industry, people are facing a lot of problems with the management of companies. In the market, actually, we're seeing a lot of discounts. The discounts are becoming kind of poison for the industry. But we also need to be rational about the industry. Talking about the macroeconomic situation, we have predicted that, talking about the sportswear industry in China, even though the fast growth people saw in the past could not be sustainable, but still the growth will be 10%-15%, which is still a very good growth rate. On the long term, I think the sportswear industry in China will still see a lot of growth. I think it's driven by three factors. First, the fast urbanization rate in China. Each year, it's about 1%-2% of rural population is coming to the cities. Also, as increased of disposable income in China, and also as people become more participating in the sports, and also with people becoming more sophisticated, actually, their buying power is also increasing. Also, people are also trading up in the industry. So they're buying more premium products. Actually, they are buying more better products, and also faced with more choices of products. Actually, they are moving towards better products. This is a kind of trending consumption, so that these companies with better brands and better products will also benefit from the industry. Compared with the developed countries, talking about the sportswear industry in China, the penetration of this industry is still quite low. So I think we're facing a lot of good prospects for the industry, a lot of good growth opportunities in the industry. Talking about the impact on the Li Ning brand, talking about the wholesale business model and also the over-expansion in the channel. All those problems were reflected in the company since 2011. From those two charts, we can see that the Li Ning problem is that because of the over-inventory, the distributors and the retailers are giving a lot of discounts to the consumers. That actually, the profit margin is lowering and is becoming thinner and thinner, and also because of the decreasing of the profitability of the retail stores. Also, the payable turnover days are also increasing. A lot of low-performing stores are being closed. Amidst all these problems, the company has started, actually, a path of continuous and also effective reform. Now let's review 2012. Talking about 2012, I think this is a year of milestone for Li-Ning. In January 2012, the group started its cooperation with TPG, the leading PE firm, and also GIC, the Singapore government fund. We started our strategic partnership. With the participation of our strategic partners, Li-Ning started its new strategies so as to face more challenges in market, so as to increase our long-term profitability. In July, Li-Ning Group announced its overall reform plan. Including focusing on the Chinese market, focusing on the Li-Ning brand and also our core businesses, and also including enhancing our management and also enhancing the profitability of the channels and also to streamline the business. In the past, we used a wholesale business model. In 2012, actually, we switched towards this retail and also brands-oriented business model. With all those efforts, actually, we want to reinforce our leading status in the sportswear industry. Last year was the Olympic year in August. On the basis of what we have achieved, the Li-Ning Company continued to sponsor five Chinese national sports teams and also other world-class sponsored teams. In the Olympic Games, our partner teams and also athletes have won amazing achievements. Between August and October, the CBA also started its sessions and seasons, and also we started to sponsor CB and also we started our cooperation with Wade. By the end of 2012, the board approved a kind of comprehensive large-scale revival plan of channels so as to clear the inventories for the channels. As we started our clearance, we also started to actually consolidate the receivables of the distributors and also channels. We hope that through the revival plan, actually, we want to lay the foundation for our overall reform plan so as to provide a new platform for sustainable growth for future. Now we are at the critical stage. Actually, we are in the middle of transforming our business models. Here I want to stress that we have our three core strategies, focusing on the Chinese market, focusing on sports essence, and also focusing on our core brands. Still talking about all of our strategies and initiatives, all of them will be surrounding our three focuses. Here, the key is the transformation of our business models. Now, actually, we are having kind of a sports marketing and retail business model-oriented company. We hope that, yes, we can further enhance our profitability and also our capability of sports marketing. We know that this industry is changing constantly, and also the Chinese companies are still constantly changing. Basically, this industry is facing a kind of very serious downward cycle. We predicted that the fundamental transformation of the business model is inevitable for the industry. In the past, Li-Ning used a kind of traditional wholesale business model. But now, we are switching towards the retail and sports marketing-oriented business model. All these have triggered a kind of active discussions in the industry and a lot of debates are going on now. Still talking about our company and also the whole value chain of the industry. Everybody is facing a lot of challenges. Everybody wants to win breakthroughs, and everybody wants to survive these serious challenges. 20 years ago, Li-Ning Company was the first company that has set up our independent retail store chains. This has greatly fomented the growth of this industry of the previous round. But now, we are in another round of innovation transformation. We want to grasp the new rounds of opportunities and innovations. We believe that our innovations and also transformations will continue to lead the sustainable growth of this industry, of this market. Just now, as I mentioned, the Olympic Games last year. Now I want to talk about our initiatives related to our three focuses. Last year, we had the Olympic Games. We sponsored five Chinese national gold medal teams and other overseas athletes. Their performance has given a lot of driving forces for our growth. In terms of Olympic Games of London, for shooting and also diving and also badminton and other two teams, we have provided professional equipment and also sports wares. In terms of supporting, in addition to supporting the national teams, we have increased our exposure and also our sportswear professional image of Li-Ning. The five national gold medal teams have won 22 gold medals, taking up around 60% of all the gold medals won by Chinese national teams. We can say that their performance has really laid a very solid foundation for our continuous growth and also our social image. Here, I want to share with you about our strategic transformation and also shift. Talking about our sponsorship for CBA. This is a very important project for us. This is a kind of milestone for our business model transformation, and as a transformation that now we are a retail and sports marketing-oriented business. This is a very important project in our initiatives. Now, CBA has a lot of commercial values. As well as for all the fans, they are very loyal, the business model for that. For group, we decided we will access for the basketball tournament sponsorship as well as for the CBA platform. For just conclude the CBA, the first season session for the participation, the ratio for the audience that it's obviously higher than before, and also for the TV, the live and the coverage, and also achieved this, the awareness from all audience. From this platform were launched the new products with Wade, and for the new products, the selling also show the increase in the situation. In the first season for 2013, for the new products in the basketball category, they show the very good performance whenever for the sell-through and also for the total sales revenue. The growth rate year-on-year is on the first place in all the categories, and is only second to our running shoes category. That is our first category. For the sell-through rate for the new products, it also showed a very good momentum. For the footwear and the apparels, they are all higher than the average 1%-3%. Leveraging this platform, it helps our transformation plan through this model to launch the old products can meet our customers' demand and also gave a full play for our sports resources, make us younger and attract the younger customers and to find new customer groups. That strategy works quite well through this retail operation and also for the structure building and also for the sports marketing and to create new business growth points. For the basketball category, we also strengthened the cooperation with Wade. The strategic cooperation with Wade did start from four months ago, and it has also been attracted lots of the audience. He served for the Miami Heat fan. We had a very successful marketing. We designed the whole series of the Wade products. We also include the Miami basketball team visiting Beijing and increased our awareness for the Li Ning brand. For this cooperation, it also showcased the Li-Ning's professional performance. According our survey to the Chinese market, this cooperation is hugely increased the awareness for our young generation customers. Also increased the intention to buy Li-Ning products. We produced the Wade series and to get recognition from the young generation, the customers, whenever for the appearance and also for the professional performance. That is very in line with our strategy. We focus on the Chinese market. For the Wade sponsorship project is to showcase all the model transformation, where we will stick to these resources, optimize the resources to realize our core marketing strategy, and to increase our capability. Here, I want to give the floor to Jin-Goon Kim. To give us some of the financial results and company and the fiscal year of 2012 and our strategies in 2013. I am going to spend the first part walking you through the 2012 financial results, and then really spend time giving you an update on the overall transformation program and how we think about the outlook for the near-term future. These are truly challenging times, and what we are trying to achieve since we started the process middle of last year is to have a very clear, thoughtful, and bold plan that will address the problem at hand, and then have a very consistent execution, which we believe, including today's announcement, will demonstrate that we are on track and very much in line with the plan that we have announced middle of last year. Then to be extremely transparent, to give as much visibility to what is happening and what might be happening in the near and the long term. We want to tell the story as bad as we believe it is, or worse than what we think it is. We want to take an action that we believe is bigger than the problem at hand and be able to have a recovery that does not give a lot of surprise to our investors. That is our plan, and we today would like to keep that spirit. As we go through this journey, which in China is really the first time of this scale, we refer back to the experiences we have in other retail markets outside China. We came to a conclusion last year that we need a very large, upfront, one-time, decisive action to address the problem with a solution that was big enough to address it once and for all. That would entail, first, resizing the business, recognizing that the problem has been a chronic issue for the last years that has not paid attention enough to the retail of what was happening in the channels. To reverse that, you have got to short-term resize the business, perhaps below what the natural equilibrium of the size of the business is. The second thing is that we have to solve a problem at the system level, not at the company level. We have to first make sure the channels are healthy before you can have a healthy business and start building. It is because we believe the value of the brand is in the business it is going to build in the future, the product it is going to bring to the market, not the problem and the losses that it is going to cause. With that, I want to walk you through, before we go through the financials, the plan we had to approach this entire transformation, the first phase. In fixing the business, really the first thing that has to happen is you have to resize the business. You have to reduce the inventory to a level that is normal and sustainable. You have got to make sure it is fresh, that there is enough new products that are able to come in. You have to make sure that your stores and network is rationalized. The ones that you believe is not profitable will have to close and open in places where you believe profitable and productive stores can be found. Then the cost structure was built for a business that was bigger, mainly because of the chronic increase of the business based on what the team believed was the real size of the business, which in return, turns out to be not the case. If you resize the business to a healthy core, then you also have to resize the cost structure of the company. The near-term focus of this transformation in fixing the business is to make sure that cash flow is healthy and cash flow is the most important thing. We have to make sure channels are profitable. It's a very clear plan, proven plan, executed time and over again successfully by great retailers outside China. We're going to take that handbook and do it here. What it means to resize the business is that we have to reduce sell-in. Yes, it's going to have short-term channel impact, but we have to do this, and we are going to do it for as long as we need to make the business healthy. Second is we have to support the channels with current period income to help them address the problems that were built in and built up through the last few years of issues that they faced. They are not as resourceful, and we have to take the resources and the hits in order to make that happen. Third is you have to resize the network, and there will be costs associated both at the channels and at the company. The business needs to be resized. What that means is a lot of fat needs to go. We need to figure out a way to optimize. We have to flat out the organization. We have to focus on the core, but at the same time, build areas that is required to make the business much healthier, including in making a very bold step of investing in CBA and Wade that will define what Li-Ning's brand power is. What it all means for P&L is that we need to take a very large provisions for what we believe is a true risk in the company. In forms of excess inventory and AR. That's what we've done. We've taken a very large provisions, not necessarily actual loss yet, which will reflect the size of the risk we believe is there. Our goal, obviously, is to recover as much as possible through a successful transformation execution. As we have announced back in November, the board has endorsed and supported a revival program that will cost about CNY 1.4 billion to CNY 1.8 billion, of which last year we have already executed and have committed in various forms of trade agreements with the channels, about little less than half of that amount. What we are hoping to do is that we don't need to use all of that money or resources, and that we could spend the resources that is less than the total amount of risk that we've taken out in the business. That is the one-time bold action. That one-time bold action, I'll walk you through in more detail. It amounts to about CNY 1.5 billion of losses that is reflected in 2012. Now the numbers. Revenues is down 24%. First half to first half is down 10%. The second half, we took a very bold action to take additional, very big and significant reduction in revenues. This is what we have to do. That was 26% first half to second half. That will de-risk the channel inventory buildup, and that has resulted, as we will walk you through in the following pages, a much healthier overall structure, in terms of inventory and other key measures of recovery performance. The revenues are down, mainly because of reduced sell-in. Discount rates have been reduced to support the channels further, and then rebates and returns in order to support them through tough times. The gross profit is also down because of similar reasons. We have taken discount rates, returns, inventory valuation, and all these things have impacted, which we believe is a largely a one-time proactive action. Combined result of that, obviously, is a 37% decrease in the gross margin, gross profit dollars. Distribution cost has been down because of the sales decrease. What you see as a percent of sales is actually up. However, what you see that is that the actual amount has come down. Again, this includes the investments that we've made in all of the sports properties, including the marketing costs that we have spent in an Olympic year. Most of the cost decrease have come in the second half, although we've started this in first half. I won't go through all the details because I think in the announcements, the detailing of all of the costs are there. You'll see is that the cost structure has been reset to a more sustainable numbers that reflects the resizing of the business. Administrative expenses, same thing. What is in here is about 900 plus of the AR restructuring and provisions, I'm sorry, plus some losses and write-downs that add up to about 1.1. The administrative costs also have come down year on year. Net result of this is a loss of about $2 billion in the end. You can look at all of our numbers in the annual reports and announcements. What you'll find is that most of these losses, as we have communicated with the investor community in November, is originated from this one time actions that we've taken, large part of it for channel revival, others to get out of businesses or de-risk our exposure in places that we believe is not core to our strategy. I've already covered most of these issues. You can see that gross profit margin have come down, more so in the second half as we become more aggressive and proactive in terms of how we wanted to use this currency to support the channels in various forms. Okay, the ratios are down largely because, again, the revenue is down. As a percentage of revenues, you will see these things actually go up, even though the actual numbers and the structure of the cost have been reset. A lot of these details are actually in annual reports and other disclosures coming up. Next page. The key numbers is where do we land with some of these actions. The inventory, and you will see this in the announcement, is that after the de-risking of the balance sheet, we end up 2012 with CNY 920 million of inventory. As opposed to in 2011, CNY 1.13 billion. We have reduced to a level which we believe is sustainable and takes out the additional risks from the previous years of industry issues and business issues. AR, at the same time, also goes down quite significantly after we de-risked our business. From 2011, CNY 2.1 billion to 2012, CNY 1.5 billion. That is really year-end result of really the things that we've done in the one-time bold actions. These numbers you see here is less relevant as they represent more the average. What you'll see is that because of the decrease in revenues, you see these numbers go up. But again, the most important numbers is really what we end up at the end of the year on those figures that I just talked about. Next page, please. The summary of balance sheet, we end up with a pretty stable cash balance at the end of the year. What I also want to express to you here is that because our focus was to de-risk and make the channels healthy, as the industry goes through a cycle in which these channels have harder time getting additional financing. One of the things that we've done, which does not show up in these books, is that we also deleveraged, helped to deleverage the channels on various forms of loans and debts. That was very important for us as we try to look forward and try to minimize any kind of cash flow and operating issues that we might have from channels having overstressed themselves. A lot of the leveraging happened in Li Ning last year, and you see that the leverage actually has gone up quite a bit, both in form of bank borrowing as well as the convertible bonds. But the cash flow has stabilized quite a bit. If you look at the first half results as announced, you see that first half to second half, net negative cash flow from operations actually has come down significantly. Q1 to Q3 have been the most challenging cash flow quarters, and in Q4, we have seen a stabilization and really getting very close to a net operating cash flow breakeven. That was a pretty big achievement that we really focused on, because, again, going back to our transformation goals, cash flow is the king, and we wanted to make sure the business was stable from that perspective. These numbers will tell you, basically, if you go through the details there in the announcements, then you'll be able to kind of figure out that's kind of the trend we're on. We expect the trend to sustain as we continue to focus on cash flow and resizing the business. Especially if you look at the numbers, you will see that the biggest impact of sell-in reduction is that it actually reduces the back-end cash flow risks and AR risks for us. Naturally, what you see is a rebalancing. On top of that, of course, we have inventory clearance as well as buyback, which will accelerate the process. Next page. What you see is that due primarily to the rebalancing of the Li Ning brand business, which was primarily a Li Ning and a Lotto phenomenon. The other brands obviously are doing fine, but they are not our core business. What you see is a mix shift a bit of that. Then what we find also is that the footwear business, as we focus on the actual retail performance on how we adjust our business, we find that the footwear business is actually healthier. Therefore, you see a mix shift also in our revenues accordingly. Next page. Page 19 reflects natural rebalancing of the channel and our market share coverage. What you see is a really a proactive, and I will walk you through some of these numbers in the next section, is a natural rebalancing actually at two levels. One is because we rely on these channels, is actually the individual channels and their performance and their ability to either grow the business or support the business, reflects the movements that you see here in terms of year-on-year revenue numbers. The reason is because last year, our focus was really not about trying to understand what is our ultimate market size. We believe the market is quite healthy, macro, and the demand is there, and our market share is only a small portion of that. The really focus for us was thinking about where should we rebalance our business in terms of getting much healthier channels, and then grow from there. You see that there are few channels in certain places that represent large part of their business that had to be restructured. As a result of that, what you see here is not necessarily a decline in the market demand or market position, but a lot more around what is really happening with the strength of channels. Of course, their performance does depend on how they do in the market, but not entirely. This is a story that I think we need to sort of spend a little more time going forward to really play out. It does not truly reflect Li Ning's potential in each of the markets. Okay? Again, another thing I want to emphasize is that we, as Mr. Li Ning has emphasized, are going to focus on the domestic business. We are going to win in China, and we are going to win big before we go international. Therefore, what you will see is a continuous focus on that part of the business. Okay? I would like to walk you through some early updates from the transformation program. Next page, please. Last July, after spending several months, with the help of sector experts as well as our own experience, as well as my own experience of turning around and growing some of the retail and consumer companies, both in China and also in other parts of Asia, we came up with a blueprint, which we were quite confident will work. Looking back about 8 months from that time, we still believe this is the right blueprint, and we are very persistent and consistent in what we believe is the right thing to do. We have, since then, been able to make good progress, a number of operational initiatives, which I will walk you through today, and the thoughts behind how we are going to actually put it all together. However, I want to stress, as we will talk a little bit about our outlook for the future, that these things take time, that you will not see financial results happen within a period of few months. It is going to take time over few years, and you will first see the financial and operational performance improvement in the channel first. Clearly, because that is where the retail is. After that, you will see that trickling through to our business, because that is how we are going to stage our transformation and recovery. You will see that the chart on the left is our blueprint, and it is a very comprehensive focus, saying that it is not just about fixing the inventory problem. It is a much deeper problem. It is a transformation of the actual business model and a very full-scoped change in everything from product and how we develop product, all the way to how we sell products in the retail. Therefore, we have laid out those details, and since then, the company has been engaged quite intensively and very aligned with this plan across many initiatives. There are actually 6 large buckets that I am going to walk you through today. One is the management team building. This, of course, includes building of the talent pool in lower tiers of the organization, and also restructuring the organization, making it flatter, much more lean, and much more effective. Second is the distribution channel. This is really the short-term focus, because without the channels really going through this period with healthy business, we really do not have a way of rebuilding Li Ning long-term. So this has been our short-term focus. The third and fourth is that in the end, what is going to make Li Ning brand successful is really its brand, its product, and Mr. Li Ning, who obviously is more than just a founder, but really the spirit behind the whole sportswear industry. More and more, I am finding, as he steps into the business and helps out, how much impact he is having in terms of both defining the right product direction, getting the right kind of sportswear assets, and understanding what needs to be done in China, because he has lived it and created history for the last 20 years for the Li Ning brand. So that is really where the big return is going to come. Therefore, we are not going to wait. We started from day 1 to build this platform, and today, I want to share with you some early promising green shoots coming out of that. Cost structure is a given. We have to face the fact the business is about 20% smaller, and you have to grow from there, which means that costs have to come down by at least that amount, and we have done that. The retail business model really requires a totally new building of a capability set that the Chinese retail industry did not have to build in the past. Here, we have to pull a lot from outside China, and we have multiple experts and different firms that we have engaged to do this, including our own internal and advisory expertise. We believe that we're making some really interesting progress, which over time, in a very short time period, will pay off. Next page. We are almost done in a very short time period, really within 7 months or so, complete build-out of our, what we believe is a first-tier management team in the industry. The thought we had was, how do we find the best talent that is most suitable for doing this job, given the new business model and strategy that we have for the business? In thinking about supply chain, we didn't say, "Who is the best supply chain experience and expert in the shoe or apparels industry?" We said, "Who's got the best experience, industry, cross-industry-wide, and where can we find the talent in China?" As you know, Dell has pioneered the supply chain for the high-tech industry about 20 years ago, and they have a model that works really well, and we want to bring that in here. We have been able to hire the person that helped to build Dell China's supply chain, procurement, and other functions. Today, he is a core part of this new transformation and doing very well, leading that effort. The sales officer, we said, have to understand the market and business, and we took that person from Nike China, running the business, biggest region of Nike China. Again, leading that effort in transformation, with a different model, thinking beyond what Nike has been able to do within China. The chief product officer, we said, "Who is the best guy that will be able to create products for China in sportswear industry?" We said, "This guy has to come from a decentralized product creation organization. You cannot be U.S.-centric only. It has to have an experience of a local success." We said, "You know what? Adidas has done that very well." They have a great business in Japan and China, mainly because they have a local creation center that is different. We took the guy who ran those two centers, was very much part of that success. Today, he's doing some really wonderful things to help us build that capability, along with Mr. Li Ning, defining the true DNA of the Li Ning brand. Chief designer has many years of sportswear design industry, and she has come in and has done some really interesting things. Her full contribution, you'll see more in 2014. She has been working also quite closely with Edwin and both of us to start impacting the designs in 2013. Chief marketing officer, we said, "Who is a person that helped to build brand in one of the more mature consumer industries?" It had to be China-specific, and it had to be independent from a global brand building, because obviously, those functions often exist in the headquarters globally, not in China. We found a person who has just that experience of having built multiple new brands, in China and Greater China. They are all on board. They have been in their position for several months now, and we have very close discussions with our CFO and HR, final candidates that we believe will join the team in Q2, and we would have had completed our management team build-out. I will not go through the details, but this is the methodological and thoughtful process that we are going through to build the top team, not at just the top tier, but also in the lower tiers. We have dramatically restructured the organization to be able to target and facilitate the new business model that we are building. Next page, please. Next thing was distribution channel that everybody is very interested in. As you all know, the revival program is a very comprehensive program that started with a diagnosis of their core fundamental issues. Then had a period of pilot with some of the top guys. Once we became very confident, then we went to the board and said, "We need about CNY 1.4 billion to CNY 1.8 billion to fundamentally revive the channels." We laid out a very clear plan. The board has endorsed it, and we have been executing this. Before the year ended, we have spent about one-fourth, roughly, of that number, maybe one-fifth, actually. Then we have committed another about fourth to a third. We hope that we do not need to use it all, but we believe that that pool is there for us to continue to drive this. At the same time, what you see is that we have taken out the risk from an accounting perspective, what we believe is the true risk of inventory and AR that is beyond what is sustainable. That number adds up, including the actual money that we have spent, about CNY 1.5 billion, that you see reflected in the 2012 numbers. Hopefully, whatever we do to recover these channels will be below the risk that we had at the end of 2012. In that case, things will be better. If not, then we will have to spend more resources in order to recover. Therefore, it is very hard for us, at this point, to give you exactly where we are going to land. What we can say is that we did take what we believe is more than enough, and we believe that we are on track. But we still need another year or so in order to give you a much more clear update on how things are progressing. The target result is very simple. We want to make the channel clear of old problems. We want them to have healthy and new product mix. We want their retail performance to improve. It is not just about helping them with clearing the inventory. It is a lot more about making them much better retailers. In many cases, we are going to have to say that some are not suitable for being our partners. We have done that with a big number of the sub-distributors. I will walk you through some of the numbers where we had to close a lot of stores where we did not believe that there were permanent relationships that was going to grow. Then depending on, again, let the market clearing exactly where our optimized channel model is- Depending on what format works the best, we are going to push towards where we believe is the most profitable and productive format for our retail channels. Today, what we have is really four different kinds. One is our own stores. Second is the subbies that are directly managed by our own stores. The third is the distributors own stores. The fourth is the subbies that are managed by distributors. Therefore, where we're going to actually end up will depend on where we believe is the most effective and efficient model, and also the individual capability of each of the channels. I think we're going to let the retail capability and market clear to help us readjust our channel structure. Next page. We've closed a lot of stores. The good news here is that we have closed the right ones, mostly. I could say they're not 100%, but most of the stores we closed, you can see the right-hand side, that just about 20% of the stores that we closed is really the ones that are less productive and less profitable. This was very important for us, as we say, during the great times when the expansion happened without a lot of detail, knowledge, and analysis, when the market went the other way and became saturated and really challenged our network, we needed to resize. We needed to resize, shrink before we grow again. That's what we've done. You'll see that most of the stores that were closed were the sub distributors, which is the weakest part, and the least resourced part of the channels, and has the least retail capabilities. We believe that this was the right thing to do, and we believe that the store closing has more or less stabilized, and we do not expect, going forward, that there will be a major changes in the store count. Unless, again, we find that the network needs to be further rationalized. Next page, please. This is a really key number. Before I walk you through this number, I want to highlight that the number of months of inventory is based on sales. As your sales have been resized, the absolute number of inventory actually has gone down further than the actual month of inventory number. We peaked out in 2012 in Q2, and that was an unsustainable number, where basically you had inventory that was getting older and was being less productive, and that had to stop. We started in the second half to aggressively clear. It takes time because it's not your own inventory. You have to work with the channels and convince them they're taking losses and getting them out is the right thing to do. It was a very tough job, but we got it done. Most of the channels are working with us to clear them. It's harder, of course, for small mom-and-pops because they bought at a certain price. They paid a lot of money, and they don't want to let it go at much lower price. But we made much better progress among distributors, and we've spent probably more resources for subbies, sub distributors to get them clear out. But ultimately, if they are not the right retailers who would understand this concept, again, there is a weed-out process that will continue and have already run its course in the last year. What you see here is what we believe is a sustainable level, where we have now come down to very close to what we believe is normal. Again, with the reduction of sell-in, with the continuation of all the clearance and buyback, we believe that normal levels will come in a very near future. Second thing on the right is a very interesting pilot program that we started as part of the transformation pilots end of last year. We took one of the largest and most stressed distributor and said, "Let's work on together with their team, bring the best retail expert from outside Li-Ning, and then really work on one thing, which is merchandising," because that is the quickest lever. We haven't been able to work on all the other levers of retailing, but we said, "Let's get the right products in the right place, make sure there's minimum stock out. You got enough of the hero SKUs. You got enough of the fresh product." That's what we've done. Oh boy, the results were fantastic. We are now taking this to the next six, and then hopefully most of the channels over the next year or so. The difference represents the opportunity of how, in the past, the retail management was not done properly. We believe that this is a very early sign. It will take time for this to work through the system and reflect on our results. But we are quite pleased with what has happened in Shandong. I'm sorry, one of the distributors. On the left is before the pilot program. You will see that it was slightly better than the rest of the distributors in terms of its sales trajectory. After we started to clean up, especially in getting new products in there, getting the wrong merchandising out, and then ensuring that you've got enough of the right product when customers walk in, we had a very significant and a very short-term impact on the retail sales. The next page is then what is happening with all the short-term initiatives that we took. I would like to divide the sort of the main business or the core business product performance into really 2 to 3 stages. Please note that this is an industry and a business where it takes 15 months previously, we're going to change that, to bring products to market. Therefore, for you to impact the new products, it's already too late for this quarter. It takes at least 6 months of work beforehand to be able to do something. However, we didn't stop, and as we shared last year, we took every action that we think we needed to. For example, rationalizing SKUs in a product that was already sold in. Sometimes testing them or basically not shipping them out that we believe if the product is not going to perform, and then sell it through our own discount channels. We've also rationalized the products that we had a little more time before the manufacturing to say, "Look, these are redundant SKUs. We want to rationalize category-wise." Whatever we can do, then for something that's further down the road, we also started to change the design. This is after sell-in. Say, what really sells here is the trendy details, in certain apparels, and that's what we're going to do. We're going to change them. Yes, it's going to be slightly different than what they sort of sell in, but you know what? It's going to do better, and they're going to be all very happy about that. We did whatever we can do, and the results of all this is that we see that in Q4 and Q1, Q4 of last year, really the first quarter where we could impact this, and then Q1 of this year. You see the product doing quite well from two very important metrics, which is the discount level. It's the actual retail price. If you don't get this up, obviously channels can't make money. The whole business model doesn't work. What we found is that it's really not the product itself or the brand itself, but it's really how it was operated. Even with the old set of products, we were doing fine. The second thing is, of the products you put out in the pipeline, how much can you really sell? Which is a sellout rate. In both measures, we had a significant improvement from the three previous quarters of that year. The next one is a pioneering work we believe, is going to change the game of industry. Basically, it is about changing the whole wholesale model. The first is change how selling is done. Take what we believe is the right amount. What we have now is about 30%-50%. Then prescribe it based on the key things that determine the product demand. We found that things that really influence that would be things like your regions, whether you're in the south or north. Obviously, that's a very important impact. Then the tiers of city. We actually have prescribed order that a big part of our core network and distributors have to order and in certain amounts. That significantly reduces the random throwing the dart process that we had before. Second thing we did was on top of that, we're going to watch the sales performance and whatever we believe is doing well, especially in the core sizes, colors, and SKUs, we're going to figure out a way to replenish and put more of this back in there in order to minimize the stockout. That is really the quick replenishment and part of that is also taking stuff out. Third one, which is really a kind of revolutionary thing in China, especially for shoes industry and sports industry, is that we're going to take a process that used to take 15 months. We're going to say, we're going to identify an opportunity where we have not had a market presence through sell-in and basically create a product within few weeks, test it out, and launch them in a larger scale if we get confidence around how it's going to perform. Next page. Last announcement, we shared with you the early results of the pilot, which was a small scale, and we continue on that path. I want to give you one example of the 299. This is by now, pretty widely known success where the Q1 sell-through has already been better than first part of 2012. On top of that, actually, when we rolled it out to much bigger set of stores, what we found was that the sell-through performance was still very good. This quick replenishment really requires the skills to be able to understand the market demand, be able to create the right product, understand exactly what is needed, and then to be able to do this within a few weeks. This whole process took us within a matter of few months. What is good about it is that we're trying to create a platform in this with five pilots that are already done and being commercialized. This one here is commercialized, probably one of the first ones. Then we have now a monthly calendar that will continue to make this a permanent part of our business. We can't tell you how big it's going to be, but we're going to say that going forward, this business is going to be pretty significant part of our profit contribution as this will significantly de-risk the inventory and other problems that the previous model had. Okay, next page. 2012 was a very, very tough year. We were telling the employees to squeeze their belts. They couldn't go and do a lot of the things that they used to do. We dramatically reduced the plans for Olympic marketing participation. Most of the people that were planned to go were told, "You can't go to London." We had to improve processes to obviously, streamline every we can to make it effective and productive and cost-effective. At the same time, we said, "You know what? This is not about downsizing the business to success. That will never be the way that Li-Ning is going to win." Li-Ning is going to win if and only if it has great products and a great brand and great sports assets that really capture the imagination of the young people. We said, "No matter how tough last year was, we are going to make investments." The big investment that you guys know about is Wade and CBA. That was a pretty bold move, and that has turned out to be one of the biggest media and brand success, as a lot of you who are in the mainland have seen. Across the different kind of sports where we are focusing, again, focusing is the right word because we are now focused, and we are very differentiated in how we approach each one of these categories. The method we are driving the basketball is not the same we're going to drive running or other businesses. We're going to look at what the market needs, and we're going to come up with a different marketing model, if you will. We have started down the path. Next page. Cost initiatives. I think I'm running out of time here. Cost initiatives is also a very important part. We have to become responsible and effective. There are really three different areas where we can do this. Procurement. The team is really focused on doing everything they can, including overseas procurement for the first time this year. We're seeing a good part of our apparels already starting to be produced in lower-cost countries. The centralization of the procurement functions, so that experts who know how to balance between the quality and price negotiations own these metrics, as opposed to distributed throughout the organization, where designers have to also make a call on their cost, which doesn't typically work. Suppliers, restructuring and competition, which, in tough markets like this, is a process that is absolutely necessary. The second thing, a bucket of cost structures, is really the Li Ning Company itself, and we really tighten our belt, and we have optimized operating costs all across. As well as also to think about how do we make the products more cost-effective. We have employed some of these experts in what we call DTV, which is Design to Value, a very proven process developed actually in the industrial and the high-tech world. We're bringing that to sportswear for the first time and saying, "Let's do thorough focus groups and analysis to understand exactly what we pay for and what we don't, so that the consumers only get what they believe is valuable." We've done that and have had a pretty significant cost savings already in 2012. Consumers, our customers, we want to create a sustainable model. We have a very different sort of go-to-market approach and support structures that we're testing out and various forms, I think, we will be able to share with you more later this year. But we believe that the old model is not very effective and does not really incentivize the right things. Next page. This is a really key part of our total transformation. Once you have a great brand and very exciting products, you got to make sure they are in the stores, so that the customers, when they want it, actually can buy them. In one of the studies that we've done, what we find is that the conversion rate is very low, lower than, let's say 100 people walk in, there's so many people buy the product, and that conversion rate is way below what I think is a very healthy kind of best class retailer. What also it means is that there is quite a bit of people that actually like really Li Ning, go into their stores. It's just that for various reasons, they end up not buying the products. A big part of that is actually merchandising. Therefore, what we are going to do is build a retail platform that is going to give us what is close to a direct fast retailer. Not necessarily from a structure. We believe that asset-light distribution model is actually very good, and it is very effective in China, where they have probably much better cost structure and nimbleness that the large brands do not have. But that combination of the operational capability of a direct fast retailer and the actual format and the asset and the operations of cost structure of a current wholesale model, where we have a very rigid and a disciplined readout and a promotional process so that we increase the share of those who are doing well and are healthier, we believe is the right model. In order to achieve that, we have been working very hard with the supply chain team, to build this out. We believe that we will have pretty good progress happening over the next 12 months or so. On the left-hand side is the replenishment and product build model in the past, which took 15 months. Obviously, it is very difficult for you to gamble on a market demand 15 months beforehand. What we are going to do is build certain products that require platform investment in R&D, and that time will still shrink, but at a reasonable level, where we can have an exciting own creative and a unique set of technology and products. On top of that, we are going to take what has been proven to be a very successful fast retail model, where we can replenish as quick as we have done in few of these events, including sneakers and some of the apparel pilots, few weeks to produce a product, test it out, and then obviously get it to market. Now, obviously, it cannot be done from totally ground zero. You got to be very smart about leveraging the current product platforms and the product capabilities and have a dedicated team to be able to do this. So we believe that combination of these different kind of product lead time is going to give us the flexibility we need in order to flex up or down in our retail business. Next page, please. Another exciting sort of early sign, again, this is still very early, is that we took a set of stores that were self-owned and said, "Let us say, what would happen if this set of stores was totally fast retail, totally It had no other mandate to do anything it can to maximize its profitability. No sort of in-company issues, the old problems. Let us start fresh, set the clock today as if this was a totally fast retail source. And really work on the first model, which is merchandising model. And of course, with that comes with right kind of promotions. When we did that, what we found is that the pilot store, within a matter of just a few weeks, started to show significant increase in their sales performance. We have a plan now to roll this out, taking some parts of it and bring to the rest of the platform that can be implemented. This whole format of what we call the total retail, we are going to try to build it over the entire own stores, and then hopefully to those stores of distributors who are willing to participate in this area. What is really driving, as you can see, is we have got the right kind of new products. New product as a percentage of total sales is much bigger. But it is really that plus getting the right new products is what is driving the performance. Next page, please. This is not our core focus. There are a few businesses that is very related to what we are doing in the sportswear, especially, for example, DHS and Kason is very much part of our sportswear business and will continue to grow with us. But our focus is really the Li Ning brand. Except for Lotto, where we have made a very conscious decision saying, this is not our core business, and we want to be able to figure out a way to rationalize this. The other three businesses are actually doing fine and they are contributing to both our top line and, in some cases, also quite healthy to our bottom line. We will continue to not make that our focus until the right time. Okay. Now the final section, the future outlook. We have had a very challenging 2012. We believe the challenge from a financial and operations perspective will continue. 2013, we are doing everything we can to make it much better than 2012. We wanted to de-risk the business with the actions we have taken in 2012, both financially as well as operationally. But I do want to say that the industry is still very challenged. Short-term, it is very hard to make predictions when we are going to be through this. Second is that the operational transformation, while we have significant experience in the existing team that is driving this and the advisors and consultants that we have employed, it is really the first time in China, and is of a scale that is not seen, and also in an environment of overall industry that is not very favorable. So there is risk that we may not be as successful as we would like, or it would take longer. I want to make sure that as we talk about these great promising early shoots, that everybody understands also the risk associated with that and the time that it is going to take. The optimization of cash flow and channel inventory has had early results, and we feel much better about this because this was really our short-term focus. Unless big things that we have not foreseen happen, for example, much further deterioration of the channel performance or the macro or other things, we believe the stabilization should continue. But still, there are risks that we believe that we want to be very transparent with you as we communicate through this multi-year transformation. As part of this, we recognize that we need more money to improve the balance sheet of the company. As you can see from the results, our financial results, largely because of the actions that we have taken, and we believe is really what has happened in the last few years and how it's going to impact us. We have much more resources than the channels, so we are going to be the one that's going to come up with the resources to support this. There's a very broad support among the board, and we believe is also there among the shareholders. So we have a very clear fundraising plan in place, and ultimately, what is valuable in Li Ning Company and the brand is actually what we're going to build from here after we have put all these problems in the past. Long-term, we are very I won't say the right balanced words because I always tend to be too optimistic. It's a very positive macro view. In fact, even through these most difficult times, macro itself has not had much problems. I want to be very clear about this, is that as you can see from how our operational initiatives have had such quick results, is not because the market is really distressed and troubled. The market is still growing. We believe there are fundamental trends that Mr. Li has talked about that will make this industry quite interesting over the long term. It's the short-term imbalances and operational issues that we believe is really dragging it down, especially on the financial performance. So we believe that long-term is very bullish, and we believe we have a proven plan that has worked in the past, sometimes by the same people that are leading separate, that we have put in place, and we believe that's going to work. I want to highlight there's a lot of risk, and this is a massive undertaking in a very short time period that probably China hasn't seen too much in recent years. Our goal is very simple. Let Mr. Li Ning realize his personal dream of creating the best sportswear brand in China, as he has really made China's name quite glorious many years ago by having so many gold medals in Olympics. I believe that is also the mission that all of the management team and everyone involved in the transformation plan are focused on. We are pretty confident that