Earnings Call: H1 2013

Aug 12, 2013

Good morning, ladies and gentlemen. Welcome to Li Ning Company's 2013 interim results presentation. Before the management presents the interim results, we would like to share with you a short video to review the Li Ning Company's history and development. All right. Hope you all enjoyed the show. We will now have Mr. Li Ning, the Executive Chairman of the company, to start the presentation. Good morning. Thank you. I am really pleased to see you all and share with you Li Ning Company's 2013 interim results. On my left is Mr. Jin-Goon Kim, the Executive Vice Chairman of the company. I am also pleased to introduce Mr. Terence Tsang, the Chief Financial Officer of the company. Mr. Tsang has more than 20 years of experience in the apparel industry. He has been with us since April this year. I would like to take this opportunity to welcome Mr. Tsang again. In the presentation today, I will highlight some products and marketing initiatives of the company in the first half as we are in the process of transforming into a retail-oriented business model with a focus on sports. I will talk about the company's strategy under the current industry environment. We will talk about the products and also our strategic directions. Mr. Kim will share with you an update on phase one of the transformation plan, our achievements of the transformation plan in the first half, as well as the focus of the transformation plan in the second half. Following that, Terence will walk you through the financial highlights. Lastly, we will take questions from you. As you can see that there is an influx of local and homogeneous products in the market, there is very fierce competition in the market. We are facing these local and homogeneous products. In the past, I have mentioned this with you. Actually, this is the phenomenon in the market, that is, the homogeneity in the market. Actually now we are making a lot of major adjustments, and we are investing a lot of resources. Now we are trying to differentiate ourselves from others, focusing on retail-oriented business. We continue our brand promotion in the three sports categories with the highest potential in China market, namely basketball, running, and badminton. In the past half a year, actually, that is more than half a year. Actually, we started that long ago. Taking basketball as an example, we cooperated with Dwyane Wade, who has helped his team win the NBA championship for three times. This has been a tremendous success. As the chief brand officer of the Way of Wade series, Wade proactively participated in product design, created the Li Ning basketball shoes collections, adding his own elements. The Wade 2013 China Tour created much buzz among the domestic consumers, driving the sales of Li Ning brand products. At the same time, Li Ning has been sponsoring CBA, for example, through launching the CBA athletes apparel, arranging a series of interactive activities during the CBA playoff season to bolster the interaction with fans. This is the unique sports resource in Li Ning Company's history. As I've mentioned that our strategy is, yes, sports-oriented marketing and retail-oriented business. Actually, we have invested into the interaction with fans, and also we have created a CBA culture, and we have boosted product sales. As digital marketing has become an increasingly important communication platform among young consumers, we have launched a series of digital marketing initiatives in the first half of this year in order to enhance our online visibility and enhance customer interactions. This helps us to penetrate into the young consumer market. Now this, yes, penetration is very much helpful. Yes, the fans, a number of Li Ning's official Weibo has exceeded 400,000. We enhanced our brand loyalty among our customers through digital media, enhancing the support to Li Ning Company's marketing campaign, as well as brand professionalism. Now we have enhanced people's awareness and recognition for our brand. I think this digital marketing is very helpful. In terms of product differentiation, we have also made a lot of investments. In addition to building up our brand differentiation, we also seek to enhance the uniqueness of our products through continued enhancement in product design, research, and development. We seek to raise the product function and quality, launch the product series which can satisfy the need of ordinary customers and professional athletes. I'd like to introduce a few products which were launched in the first half of this year. They are the representatives of Li Ning's new products and show the best-in-class performance in terms of shoes. On the top left-hand corner is Li Ning Bo and the Li Ning Arc shoes, showcasing our anti-shock technologies. The shoes provide a powerful anti-shock support to enhance the sports performance. These shoes are well-received among the consumers. Li Ning Bo series has been demonstrating the highest sell-out rate across all of our running shoes since 2011. By the end of last year and in this year, yes, we have introduced, launched the new versions, and they're well-received. Li Ning Arc has also been demonstrating excellent performance with a sell-out rate being twice above average. The Li Ning Arc series displayed here today shows the unique technology. This is a Li Ning Arc third-generation. In addition, the Ultralight basketball shoes series, also one of our highest-performing products and have the highest sell-out rate among the basketball shoes. All those products actually are the results of our new positioning. As I've mentioned that actually our strategic adjustment is sports marketing and retail-oriented business. We have mentioned basketball, running, and badminton. Yes, now we are demonstrating high-performing products in the three categories. Yes, we have greatly enhanced our products recognition among our consumers. In terms of apparel fabric, the Li Ning AT technology platform has become a leading technology platform recognized as industry benchmark. We seek to further optimize AT technology platform. Build on our exclusive technology attributes, we expanded the applications of functional fabric in the special products. Actually, just now mentioning that the homogeneity in the market in terms of fabric material, yes, usually, actually, we focus on the needs of our life or the needs of the leisure. We know that in China, there are a lot of factories. Usually, the factories tend to switch those technologies into products, and then they just put a brand onto the products. But in the markets, we are seeing the same products, because now we have picked the strategy of sports marketing oriented. In terms of fabric selection, I think, yes, the fabric is very much impactful on the participation of the consumers in the sports. I think, yes, this is really different from the past. On the bottom right-hand corner is another functional material, coffee charcoal fabric. The material is made of coffee check, showing heat insulation and antibacterial capabilities, and is an environmentally friendly product. You can see, actually, this is the technology and materials now we are using. You can see all these are our new products. Yes, these are all the products we launched. Other than the professional functionalities that are welcomed by the athletes, the style and design also recognized by our customers. You can see the Ultralight products. Yes. This is the highlight of our sales. Yes, the Ultralight Generation 10 is very well recognized in the market, and the sellout rate is very high. You can see we have the Wade product series on the right, and also we have the badminton products and the N90. N90 series badminton products. As I mentioned, actually, yes, we have added a special function. Yes, actually, we have established our own proprietary technology for the badminton rackets. The rackets have helped our professional athletes to enhance their performance, and a lot of badminton fans also love the product, because sports means experience. If, actually, the technology is integrated with the sports, then the sports fans will want to experience the products. Our proprietary technology badminton rackets are very well recognized by the badminton players in China. Last night, Guangzhou badminton world tournament has just concluded. Even though China's national team has just won two gold medals, but still, it's a sensation for the badminton fans. Also during the seven days of the tournament, I just came back yesterday, on the spot, actually, we established our sales highlight. We let the fans experience the products, and our sales was more than 1 million. Actually, the final is only three days, and there are a lot of participants. Actually, more than 1 million is all the products related to the national team. Yes, the rackets and also the apparel. Also the apparel is also kind of this AT DRY ULTRA technology. You can see that our product has catered for the needs of the professional athletes. Also we have considered the needs of the amateurs. We are very well recognized by the market. Now we are focusing on the differentiation. Talking about our strategic selection, I think it's totally different from what you can see in the market. Because many people are worried about the homogeneity, now we want to jump out of that loop. I will not go into details about other products. This is the Li Ning. This is an advertising for Li Ning. Lingbo 简阵，放任由你。李宁弧三代。Li-Ning。 This is to help you relax and watch. That is our commercial. Also, it is now online. We have shot the commercial and we have broadcasted it online. I believe this commercial has drawn wide attention from our young consumers, especially Internet users. I think that Li Ning brand was respected a lot in the past. However, we thought the brand in the past was too serious. We hope that we can bring the vigor of sport into our product marketing and sales process. This is our commercial. It reflects our direction and our intention here. I'd like to briefly review our case and the market environment. I believe that at present, China is in a critical period of transformation. We have established our direction of sports marketing and retail orientation. Throughout the year, we are going to continue with our transformation. So far, we have made major progress and achievements, especially in the sector of sports marketing and retail orientation. We are very encouraged by those achievements. Most importantly, everybody is thinking about how to improve our profitability. I think that the market itself is good. We still have market potential. The problem is that we have serious homogeneity in the market. The threshold of the market is very low. Everybody is trying to grab a share in the market. I think that so long as we are able to establish the correct positioning of Li Ning brand, we will be able to grab our due market share. Therefore, against such market circumstances, I believe our strategy of differentiation will be very critical for us to clear the obstacles going forward. Our company has more than 20 years of history. In the new environment, we hope that we can continue to carry on Li Ning's unique sporting heritage, performance DNA, and the essence of Chinese athletics, and to build a brand champion in China's sportswear industry. In order to realize that vision, Li Ning Company is the only company with a combination of unique sports performance brand DNA and world-class management expertise to undertake a comprehensive transformation of the company, including building an innovative retail and merchandising business model. I believe that so far, we have made initial achievements of this transformation. Of course, in order to see the financial results, we still need to wait. Now, I am going to invite Mr. Kim to give us introduction of the progress of our transformation. Today's meeting is going to be a bit long because we have a lot more to cover, and we wanted to give you a lot more update on what was happening in a transformation that, as you all know, is very different than what we have seen in China. It is an exciting journey. We are doing a lot of things for the first time. In the middle of that process, it was very difficult for us to share with you a lot of details. We were only able to talk to you about what we are doing and what kind of progress we are making. We are pleased to announce today that we are able to share a lot more detail in the next section, and also what we think is going to be the ultimate outcome from this. We want to thank you for your patience. I will do this. Please don't touch, okay? All right. The transformation plan, as of July of last year, is really a statement saying, "This is the direction we are going." It is not about simply reducing inventory, increasing sales. It is about fundamental changes that have to take place in a market that is going through a very big evolution, as everybody knows. We knew last year that a simple surgery would not work. We set out with a plan that was very aggressive, will take time, but is going to be very fundamental in the way it is going to create what we believe is an exciting and a new brand company based on the brand DNA that was built around Mr. Li Ning, who himself, who was a legend in the sportswear industry and in the world of sports. And we believe that with that spirit, we are going to undertake a very big journey and a long journey that is going to change every aspect of the business as needed. We talked about, on the left-hand side, what we were going to focus on in July of last year. As you can see, we have stayed the course. We have not wavered from the direction we have set out, which was a result of about a half a year of diagnosis with some of the world-class experts and our own management team looking at the problem and then saying that this is really the way forward. What turns out after about six months is that we have made some significant progress across both fixing the business as well as building a very exciting long-term platform. But also, at the same time, some of the concepts which were going to be first time done in China, although these are proven business models and methodologies outside China. What we are finding is that in China, these methodologies and business models actually work. Of course, it requires a lot of customization and a lot of thinking around how to make this work in China as well. So we are pleased to walk you through some of the key highlights. I will not go through all the details because it is just too much for us to cover in the time we have. Let us go back to before 2012. This was a problem not just of Li Ning, but as a sector, the whole sportswear industry was seeing a deteriorating fundamentals. Even the fact that the numbers in core financials were actually not getting better, the industry continued to grow. And Li Ning, although it was not the fastest in terms of its growth in stores, was also growing despite the eroding fundamentals. This was partly because, as we talked about before, the changes in the industry dynamics, the growth was slowing. There were also a lot of people coming in without a retail knowledge. So it was very difficult, including Li Ning, to know that channels were actually getting worse and that those problems were going to come and bite you in exactly the case of Li Ning, starting from middle of 2011 and much more so in the first half of 2012. So then what needed to be done was really fix the business. And when we talk about fixing the business, it is not just about reducing inventory or increasing the sell-through or minimizing discount that was taking place. What we have seen in the evolution of the Chinese retail as well as sportswear in the last 10, 15 years, very unusual from historical point of view. But because of that unusual background, it has also created a lot of problems that would call for a major surgery. So what we set out to do is at first, we have to undo what was done that made the industry and Li Ning very unhealthy. First, we have to resize the business. What it meant was we had to reverse the expansion in the areas that was not healthy and was not sustainable. And the mix of business had to be a lot more core to where the strategic and competitive advantages were the strongest. The industry had expanded too much into non-sportswear, and it also did not have enough of what differentiated itself from many of the other brands. It was fine in the days when casual wear wasn't in China. It was not the case when they start to come in big numbers. We have to resize the business in every way. Second is that before we fix Li-Ning, we had to fix the channels. It was very important for people to understand and recognize the deep issues that were in the channels. Again, same kind of overexpansion that took place, which made some of these mom-and-pop businesses overnight into several hundred million dollar businesses, which was really not how our industry grows healthily. So came with that, a lot of issues. We had to take on the revival of the channels, including restructuring some of the bad ones, but really fundamentally making them much better channels with stronger retail capabilities as well as stronger fundamentals in their financials. Finally, all of this will result in much healthier cash flow and capital structure for Li-Ning. We have seen from 2011 to 2012, deteriorating cash flow and capital structure, which had to be reversed. The way you do it is to do something that is very difficult for public companies to do, which is to take on a fundamental surgery, which we have done. We believe those results are showing today. The revival program we have announced back in the second half of last year was a very thorough program. It is not just about reducing inventory. It is a lot more about converting them into the large-scale channel partners they needed to be in terms of how they run their retail platforms and how they think about the productivity and profitability of every part of their network, and how to think about the mix of the business they're putting out. A lot of these skill sets were not existent in China retail market overall, and in particular, in a lot of these local retail partners. We were able to sign up almost all of the distributors in a very tough course where it also called on them to make sacrifices and make big changes in their business, which has, in about seven or eight months of intense effort, created a big improvement in cash flow and inventory, as well as their profitability, which we'll talk about in the coming pages. Finally, we had to take out the ones that couldn't make it, and we believe that this kind of weeding out will have to continue as part of the regular business. Here's the first key metrics that everybody is interested in understanding. We want to give you a lot more data today because we have a stabilized results and a trend that we believe is sustainable. First is that we were able to take down the inventory by more than 30% overall in terms of value, which has resulted in about going from a nine month to less than seven month. We are not going too fast at this point. We believe that we're going to be at a very natural balance towards the end of the year. The intense inventory clearance efforts are pretty much, in our opinion, behind us. Now it is all about building the business. You will see in the lower part of the chart where we had to take a very bold action of reducing the sell-in, which started from Q3. The only way to massively reverse the course is to create less pressure on the channels. You can see that the blue part, which is the share of the new products in their inventory, went down as a natural consequence of that. But then as the inventory levels became much more normal, we started to increase that part, and you will see that new product part of that inventory is going to continue to go up and start to drive sales normally. The second thing that we have done is we resized the distribution channel, and we have taken out about 27% from peak to trough, and it has started to slow down in terms of what we had to take out, because I think, as you know, most of the really bad part of our channel has been taken out before end of last year. What you see is that the weakest parts of the channels from productivity as well as their growth, has been taken out primarily through what we call the sub-distributors that are very small, one or two shop, mom and pops. That is where majority of the actions were taken. The ones that are taken out in each of the category, which is the green line, compared to its overall average in terms of their productivity, is significantly lower. We have taken out mostly from the weakest part of the channels, and we have taken out the weakest part of that category of channels. What you will also see is a SSSG of our growing part of business, the strongest part of the business, which before we started the transformation, did not necessarily have higher growth rate and profitability. But through our retail transformation where we control the fate, we were able to drive that business very hard. It is already a 31% of our business, and you can imagine part of cash flow generation as well as their profit contribution would be bigger from this part. This is the highest growing part of our network. It is already at 9% of SSG, which is, I believe, above the industry and clearly far above what we are able to do in the indirect channels. Indirect channels will take time for it to recover, and some of them won't make it. Some of them will do very well. It will all depend on how fast we can revive them through the aggressive initiatives that we have rolling out right now. The next page is about cost. While we are investing in the growth and in exciting products and brands in a very aggressive manner. We are also very disciplined in that we are restructuring the cost. Basically, everybody that were worried about how we are going to afford CBA will be pleased to know that there were almost no incremental spending for both CBA and Weight, as well as all of the investments we have made since second half of the year, including all of the new talents and a lot of investments in the product team, design team, as well as retail platform building. All of this came literally from the cost actions that we have taken since the first half of last year. Overall, cost is flat. Cost structure and cash flow, as a result, has started to dramatically improve as we have taken very strong actions. You will see that AR turnover days has meaningfully come down and will continue to go down. EBITDA has also normalized, and this includes, as you would imagine, a very big part of the revival program cost, which is in the tune of several hundred million CNY. A million renminbi, sorry. If you were to then say, "What is my run rate without those costs?" You can see that the business, even today, is actually doing fine. Operating cash flow has reached from a very challenging situation beginning of the year to the second half of the year to finally, on a pro forma basis, positive. This also allowed us to take more investments to accelerate the revival program, as well as to rationalize our payables with our key suppliers, which also has helped them through tough times as well. In the end, we ended up with some negative, but it is really from some of the actions we've taken. As you can see, the first part of the fixing the business from all of the key metrics that we have set out in a very short span of six months, we have made very meaningful progress. We believe that the trends are going to be sustainable and will continue to be on positive trend because we have taken the problems at the core as opposed to trying to fix superficially the symptoms that have created the problems for us the last few years. That's fixing the business. That's not what's going to get us all excited. What is going to get all excited is actually the part that Chairman Li has shared in the beginning, which is why we started with that, because we are already behind. Already we have moved past the worst days, and we want to talk about how we're going to create really exciting products and how we're going to become the first brand in China. It's all about building. While we were very busy fixing the business, we started down this path, and we have completed hiring of the entire management team, which as you can see from their bios- And the companies and the experience they have is really probably one of the best in the industry. In order to take on a very big task of transforming the company into retail-oriented business, we have taken from each of the relevant sectors, the best qualified talents for each of the functions. For example, for supply chain, we have taken the person and the team that has built Dell China's supply chain, which is probably one of the best, not just in China, but also globally. We have also taken the CFO as well as CHRO from companies that are known either for relevance to what we need to do here or for their functional capabilities. We are very pleased that the team is working very well together, has been very stable over the last 6 months of the transformation. This is an example of how much more methodologically we are building a dominant sportswear asset. Basketball is the dominant asset. Even though we had a very difficult, cash as well as cost situation last year, we knew that this had to be done when the industry was weak. We have pretty much taken all of the dominant assets in basketball in China. We have taken everything from CBA to the top NBA star, to all of the other leagues. No one else has it, only Li Ning does. This is the most important sportswear category in China. In sportswear, sports asset is what matters. We are going to continue to take an aggressive stance to building our brand through very careful investments in the sportswear marketing and brand building, even as we are keeping our cost in a very competitive level, so it would not overall impact our P&L over time. The next one is a very exciting story. This is really first time for any Chinese company, and I would say first time for sportswear industry, and probably for shoes company, probably first time in the world. We have taken a very aggressive approach in creating a very retail-oriented business model. We have, for the first time in industry, introduced a prescribed order called A+ as soon as we started this transformation. It started to impact from Q1 of this year, only 6 months after the transformation was launched. As well as a, what we call the quick replenishment, which is how most of the fast retail is done, plus what we call the quick strike, which is the third part. The quick strike is a notion that we are going to create very unique set of products with our own capability set, as opposed to copying what is out there as a trend. All three of those together went from a 0% of our business, where it was a wholesale business, totally dependent on the order of the wholesalers and their retail sub distributors, to a place where about 40% of this business has been now dictated and guided by Li Ning, in some cases through fast retail. As you can see, this is what has been driving the revenue recovery as well as profit recovery. Sell-through rates of this category is higher than any time we have seen in the recent history. Combined in Q2 of this company, we have reached a sell-through at about 40%, as we will talk about soon, which was not achieved in the last several years as a company. Part of this was focusing on the best products, betting on them, and then really enhancing by focusing our resources to make those the strongest products. This is why we are able to talk about today some of these leading, main styles that have done very well in the last few quarters. The per SKU productivity per store, as well as number of SKUs, have improved. This will generate into much healthier business and a statement about what Li Ning stands as a brand and the products that it produces. So there was a page in there I must have skipped through, which has also the performance of the new products. Let me just see. Just quickly. I'm not sure. Oh, here we go. So you can see that the performance of the new products, as I just discussed. On the right-hand side is the sell-through rate. That's 40% in Q2. In Q1, of course, there's a seasonality to this, but it's significantly higher than the last two years. You can see that there's a market change there, which we hope and believe will continue. This is what has changed overall health of the business, because when you sell in the beginning of the business, you actually don't have to take a lot of a discount. So higher part of your total product set is actually sold at a much higher price. As a result, the new product discount rate has also improved. Finally, we're building a platform that we believe is unique in China. That is a platform that combines the best experts that we have brought together in the company to build a supply chain, as well as IT and fast response product management, as well as a world-class design team, as well as all the other pieces that are needed to produce a much better result. This will take time. It is talking about changing 6,000 stores and 25,000 people. But as we can see in the results where we have focused our efforts on our direct stores and a set of partners who are participating in this RBM initiatives, what we have found is that results are quite dramatic and significant. We believe that this goodness over time will spread to rest of the network. So with that, I'd like to now turn over to Terrence. Thank you, Mr. Kim. I'm going to walk you through with some financial highlights. For the first six months ended June 30, 2013, our revenues declined 24.6% to $2.9 billion compared to the same period in 2012. The decrease was resulted from 28.4% drop in Li Ning brand. This is partly due to the challenging market and industry environment, as well as our initiatives in phase one of our transformation, which includes, among others, reduction in selling and store network rationalization. Our ending store count declined by 18% as we closed down non-performing stores. Consequently, our gross profit declined 24% to $1.3 billion. Our distribution costs increased $65 million or 5.7%, primarily due to our increased strategic investment in marketing, including the sponsorship of CBA and Wade, as Mr. Kim mentioned before. These increases are largely offset by our cost reduction initiatives. Administrative expenses decreased $309 million or 66%. This decline was mainly attributable to provision for asset impairment in Lotto license last year, as well as a CNY 107 million reduction in bad debt provision to reflect the improvements in our collection of our receivables during the period. While our net loss for the period was CNY 184 million, our EBITDA registered a positive of CNY 58 million, reflecting some of the progress we made in our revival initiatives. I just want to mention the dollars I'm referring to renminbi. From a profit margin standpoint, gross profit margin for the period increased 40 basis points to 43.6% due to improved margins in our current season products, which are also performing well at the retail level, as Mr. Kim demonstrated in the earlier charts. The negative margin impact due to accelerated clearance on our prior season inventory was mostly offset by the CNY 125 million decline in obsolete inventory provision. A&P expenses stand at 20.3% of revenue versus 12.9% last year, and the increase was resulted from increase in spending, as mentioned earlier, with a lower revenue base. Staff cost increase as a percent of revenue over last year was due to lower revenue base, as our staff cost actually declined 14% in dollar spending over the period due to our cost reduction initiative. Looking at key operation indicators. Inventory turnover days went up slightly to 96 days as a result of the inventory repurchase from our distributor initiative progress along. During the period, as our operating cash flow and our channel partners financial health improves, both our receivables and payable days turnover have returned to more normal level. Thus, our cash conversion cycle remained quite stable at 93 days as compared to last year. Capital expenditures decreased 27% to CNY 91.3 million as a result of our continued cost reduction efforts. In terms of the balance sheet, our capital structure and balance sheet has improved significantly during the period as a result of our revival initiatives, which include capital raising and improving operating cash flow. Those due negative at CNY 243 million. Our operating cash flow improved substantially compared to the negative CNY 602 million registered in the same period last year. Particularly when you consider a decline of CNY 328 million in our over 30 days trade payables balance during the last six months. Our cash and cash equivalents increased 30% to CNY 1.6 billion, and our bank borrowings declined 45% to CNY 793 million, allowing us to return to net cash position of CNY 180 million versus negative of CNY 870 million as of end of 2012. With our current liabilities decreased 31%, our liquidity improves with our current ratio standing at 1.88 versus 1.2 in the same period as of last year. As you can see, also our total liabilities to total assets also improved to 50% versus 70% as of end of 2012. As you can see, this balance sheet clearly reflects the progress we made with the first phase of our transformation strategy. Regarding other brands, Double Happiness, which accounted for 13% of our total business, grew 23.4% over the same period last year. Other brands, which mainly include Kason and Lotto, account for only 2.4% of our total revenues. For AIGLE, as a result of adopting IFRS Number 11, we restated the 2012 figures to reflect the equity method of accounting for this brand, and there was no effect on the consolidating income to the group. With that, I return to Stefan. Thank you.