Xidelang

Management Discussion and Analysis

(extracted from Annual Report 2016)

BUSINESS OVERVIEW

BUSINESS OVERVIEW

Our Group's humble beginning can be traced back to 1993 when HongPeng Footwear was founded in Jinjiang City, Fujian Province, China to carry out manufacturing of sports shoes. Our Group promptly recognised that it is important to create a proprietary brand to help differentiate ourselves from other industry players, and to move up the value chain. Accordingly, our Group's proprietary brand name – 'XiDeLang' was created.

To facilitate the management process, HongPeng Fujian was established in 1996 to focus on design, manufacturing and marketing of sports shoes as well as design and marketing of sports apparel, accessories and equipment under 'XiDeLang' brand; whilst HongPeng Footwear concentrates on manufacturing of sports shoes for external customers where the products are primarily for distribution in overseas markets.

Our Group's objectives, focus and business strategies for the two core business operations are discussed below.

Proprietary Brand ('XiDeLang') Operation

  • Objective:

    To become leading brand for trendy casual sportswear in China.

  • Targeted Customer:

    End-consumers, mass market in China.

  • Distribution Channel:

    Primarily through the authorised distributors who are responsible to coordinate and manage the retail outlets across various cities in China. Our Group enjoyed market presence in 23 cities within China during year 2016, consistent with prior year.

    In view of the rapid growth of e-commerce trend in recent years, our Group has also embarked on online-to-offline marketing strategy after communication and coordination with the authorised distributors. Products are listed on third party China-based online marketplaces to generate additional market awareness, with the ultimate aim to attract consumers to the physical retail outlets.

  • Focus and business strategies:
    1. Brand management

      The brand positioning for 'XiDeLang' is casual sportswear targeting the mass market of China and accommodating the demands from younger generation in the urban areas. We are committed to provide the consumers with 'value-for-money' sportswear, combining functionality with fashion.

      Our Group has remained cost-conscious in formulating the marketing strategies amid the challenging conditions encountered by China's sportswear industry in recent years, balancing the needs to maintain adequate level of brand awareness and cost control.

      Our Group has adopted a multi-medium marketing approach to reach out to end-consumers and strengthen the brand equity, which encompasses:

      • Television and radio advertising for wide coverage;
      • Brochures and other promotional campaigns coordinated by the authorised distributors, for local coverage; and
      • Product listings on third party China-based online marketplaces.
    2. Product innovation

      Over the years, consumers in China have become more discerning and grown more sophisticated in terms of demands and expectations, making their preference less predictable. Product innovation in terms of design appearance, functionality and specifications has become one of the essential components for sportswear companies to stay competitive and to sustain the consumers' brand loyalty.

      Continuous product innovation has always been one of the key emphasis of our Group. To accommodate the fast-changing fashion trend and consumers' preferences, we plan our product launching carefully to ensure that new models are introduced into the market periodically to sustain the consumers' interests in our brand. New models are usually introduced into the market in conjunction with the seasonal transition.

      To ensure that our products will appeal to the consumers, we gather inputs via various channels and from various parties:

      1. Our sales and marketing personnel engage the authorised distributors regularly to gather the endconsumers' feedbacks and insights to the consumers' preferences;
      2. Our purchasing team communicates with our raw material suppliers regularly to gather updates on new materials for footwear production; and
      3. Our in-house research and product development team will keep abreast with the changes in market trend and new technologies available in the market.

      Our in-house research and product development team will consolidate the insights and updates from the marketing team and purchasing team with their own findings in developing new models and in improving the existing well-received models.

    3. Supply-chain management and quality control

      Our Group has continued to build on the production capability and capacity throughout the years. Relocation to our Group's present headquarter and production centre (with a built-up area of over 110,000 square meters) in 2013 has enabled us to expand our production capacity and to centralise the sports shoes manufacturing operations at single location, thereby allowing us greater flexibility and efficiency in accommodating the changes in market demands.

      'XiDeLang' sports shoes are designed in-house by our research and product development team and manufactured internally. This enables us better integration and control for the entire production flow, as all key aspects (conceptual design, raw material procurement, costing, production process and production time) are considered and ascertained early at the design stage.

      Production of 'XiDeLang' sports apparel, accessories and equipment are outsourced to external manufacturers, with a combination of in-house designs and recommended designs by the external manufacturers.

      Our Group maintains a close relationship with the raw material suppliers and outsourced apparels, accessories and equipment manufacturers to ensure that the incoming supplies are of good quality with prompt delivery. All the supplies are sourced domestically, with majority of the suppliers located within the neighbouring areas. The close proximity allows us better communication with our suppliers, where any issues concerning the supplies can be resolved expediently.

      Quality control has always been the key priority of our Group, as we are committed to providing the endconsumers with products that are reliable and safe to use. Incoming supplies are inspected prior to acceptance to ensure that they meet the desired specifications. In-house production is carefully monitored with checks and controls incorporated into the various stages of production for prompt detection of any defects. Finished products have to undergo various testing and inspection for quality assurance prior to delivery.

    4. Distribution network management

      Our Group collaborates with the authorised distributors to create a wide retail network coverage across the dispersed provinces and cities in China. This model enables us to leverage on the knowledge and familiarity of the authorised distributors on the local markets for the effective monitoring and management of the retail outlets, without having to increase headcounts and incur additional administrative costs.

      Over the years, our Group has established a relatively mature distribution and retail network with presence over 23 provinces and cities within China. Our Group now places the emphasis on improving the retail efficiency of the existing outlets and have been coordinating with the authorised distributors and retailers for several reform initiatives:

      • Promoting brand unity, where standardised layout and promotional materials are adopted for the retail outlets.

      • Optimising the retail outlets coverage, where smaller size and less profitable stores were either closed or merged to form a flagship store, so that resources can be concentrated on areas with sustainable profitability and growth potential.

      • Optimising the in-store inventory level, where authorised distributors and retailers are encouraged to be more flexible in making replenishment orders in accordance to the market conditions and demands. Our Group's marketing team maintains close communication with the authorised distributors and retailers, with periodic visit to the retail outlets as part of the proactive control to prevent overstocking issues.

      • Modernising the layout of the retail outlets, to enhance the brand appeal to the younger generation and to improve the in-store experience of the consumers in line with our online-to-offline marketing strategy.

ODM Production Service

  • Objective:

    To become the reliable, trusted production partner for international brand names.

  • Targeted Customer:

    International brand names, where products are primarily for distribution in overseas markets.

  • Distribution Channel:

    Foreign trading / export companies and intermediaries based in China

  • Focus and business strategies:

    1. Production and design capability and capacity

      The relocation to our Group's present headquarter and production centre, which comes with wider production floor, has enabled us to install additional production lines to enhance our production and design capability as well as to expand our production capacity.

      The enhanced production and design capability and increased production capacity are part of the key components which our Group leverages on to secure new ODM production orders, and enhance customers' confidence for recurring orders.

    2. Quality control

      Our Group practices stringent checks and controls to uphold our quality commitment to the ODM customers. Raw materials to be used for the production are inspected to ensure adherence to the agreed specifications. Checks and controls are carried out at various stages of the production to ensure prompt detection of any defects and deviations from the agreed specifications. Finished products have to undergo various testing and inspection for quality assurance prior to delivery.

REVIEW OF OPERATING ACTIVITIES

REVIEW OF OPERATING ACTIVITIES

Proprietary Brand ('XiDeLang') Operation

During the financial year under review, revenue from own-branding sports shoes improved from RMB268.03 million in the preceding year to RMB331.01 million representing a growth of 23.50%. This was primarily attributable to the increase in volume sold.

The primary factor contributing to the higher volume sold for own-branding sports shoes is the growing demand in China. According to the statistics published by the National Bureau of Statistics of China (“NBS”), total retail sales of clothing and footwear in China recorded a year-on-year growth of 7.0% for year 2016. The growing consumption for sportswear in China is supported by the following:

  • Rising population with increasing urbanisation rate. China recorded a natural population growth rate of 5.86% in 2016, with a total population of over 1.38 billion as of the end of 2016 according to the statistics released by NBS;

  • Increasing purchasing power of the urban residents as a result of income growth. Per capita annual disposable income of China's urban residents grew to RMB33,616 in 2016, representing a year-on-year growth of 5.6% (after adjusting for price factors) according to statistics by NBS;

  • Improving health awareness and increasing participation in sports and exercise by China citizens; and

  • Active measures and policies implemented by the Government of China to boost private consumption.

Revenue from own-branding sports apparel, accessories and equipment, however, decreased from RMB135.94 million in the preceding year to RMB19.49 million during the financial year under review as a result of lower volume sold. This was primarily attributable to the calculated cutback by our Group in the supply of own-branding sports apparel, accessories and equipment.

During the financial year under review, in view of the sudden glut and intensifying competition within the apparels market in China which has resulted in margin pressure, our Group decided to implement a managed slowdown in the supply of own-branding sports apparel, accessories and equipment while stepping up the efforts to solidify the manufacturing and sales of own-branding casual sports shoes to capture the encouraging market demands.

Our Group will continue to monitor closely the conditions and developments of the apparels market in China, and where necessary, will make prompt adjustment to our business strategies in relation to the supply of own-branding sports apparel, accessories and equipment.

As an initiative to reduce reliance on outsourced production and to achieve greater integration for the supply of ownbranding sports apparel, accessories and equipment, our Group had previously entered into a heads of agreement on 29 July 2015 to acquire the entire business and undertakings of Jinjiang Yangsen Garments Co., Ltd including all of its assets and certain agreed liabilities. Relevant announcements had been made to Bursa Malaysia Securities Berhad (“Bursa Securities”). The aforementioned proposed acquisition had been mutually terminated during the financial year under review, on 29 February 2016, as both parties were unable to come to an agreement on the acquisition consideration and the proportion of acquisition consideration to be satisfied in cash and via issuance of shares.

Moving forward, our Group plans to explore further on e-commerce, particularly on strengthening the online-to-offline marketing efforts to complement the existing retail network through authorised distributors and retailers.

In addition to that, our Group will, from time to time, identify any potential merger and acquisition opportunities, jointventure opportunities and / or collaboration opportunities that may further strengthen the market competitiveness of our Group and improve our Group's operational efficiency and financial performance.

ODM Production Service

Revenue from ODM production of sports shoes for external customers improved from RMB140.85 million in the preceding year to RMB153.34 million during the financial year under review, representing a growth of 8.87%. This was primarily attributable to the increase in quantities sold.

Factors contributing to the increasing orders for ODM production of sports shoes attained by our Group include the following:

  • Improving market demands for sportswear in the overseas markets, particularly sports-inspired footwear; and

  • Our Group's enhanced production and design capability as well as increased production capacity, which have boosted the customers' confidence on us.

Moving forward, to further expand the ODM operations, our Group plans to:

  • Identify any collaboration or joint-venture opportunities with foreign trading / export companies with the aim to enlarge the customer base for ODM production and to be able to have direct business dealings with the international brand names;

  • Identify any strategic alliance, merger or acquisition opportunities with China-based ODM apparels producers with the aim to diversify and complement our Group's existing ODM sports shoes production, as well as for cross-selling.

FINANCIAL ANALYSIS

  1. Revenue

    During the financial year under review, our Group recorded total revenue of RMB503.83 million, lower by approximately RMB40.98 million or 7.52% as compared to total revenue of RMB544.81 million in the preceding year.

    The moderation was primarily due to the managed slowdown in the supply of own-branding sports apparel, accessories and equipment implemented by our Group in view of the sudden glut and intensifying competition within the apparels market of China, which had resulted in an unparalleled decrease in quantities sold for own-branding sports apparel, accessories and equipment during the financial year under review.

    The impact of reduced contribution from own-branding sports apparel, accessories and equipment for the financial year under review was, however, partially mitigated by additional contributions from own-branding sports shoes and ODM production of sports shoes as a result of increase in quantities sold in line with growing market demands.

  2. Other Income

    Other income comprised mainly interest income earned by our Group. Other income for the financial year under review stood at approximately RMB2.06 million, decreased by approximately RMB0.69 million or 25.09% as compared to RMB2.75 million in the preceding year as a result of non-recurrence of realised gain on foreign exchange of RMB0.60 million recorded in prior year.

  3. Administrative and Other Expenses

    During the financial year under review, administrative and other expenses incurred by our Group stood at RMB74.02 million, representing savings of RMB18.06 million or 19.61% as compared to administrative and other expenses of RMB92.08 million incurred in prior year.

    The key components of administrative and other expenses for the financial year under review comprised the following:

    • Employee benefits (including the directors' remuneration) amounted to RMB18.92 million (2015: RMB32.77 million), representing savings of RMB13.85 million or 42.26% as compared to preceding year. This was primarily due to non-recurrence of one-off expenses amounted to RMB13.10 million in relation to share options granted under share options scheme incurred in prior year; and

    • Brand promotion and advertisement costs amounted to RMB41.05 million (2015: RMB42.03 million), which had remained relatively consistent with prior year. The ratio of brand promotion and advertisement costs to the Group's total revenue stood at 8.15% (2015: 7.71%), which was largely consistent with the trend of other leading industry players.

  4. Effective tax rate

    The Group's effective tax rate stood at approximately 38.47% for the financial year under review, lower as compared to 45.04% in the preceding year. The effective tax rate was higher than the statutory tax rates applicable to our Group primarily due to the following factors:

    • Certain expenses were not allowed for deduction for the purpose of tax computation;

    • Deferred tax assets have not been recognised for temporary differences arising from the unused tax losses of a subsidiary; and

    • Withholding tax on undistributed profits of the Group's subsidiaries in China were accounted for as deferred tax liabilities.

  5. Profitability

    Despite the market challenges, our Group continued to be profitable during the financial year under review, upholding the uninterrupted profit track record since the Company's listing on the Main Market of Bursa Securities.

    Profitability

    The fluctuations in the profit levels were primarily attributable to the reasons explained in earlier sections. Profit margins achieved for the financial year under review were relatively consistent with prior year, save for a slight decrease in GP margin. This was primarily due to lower contribution from sales of own-branding sports apparel, accessories and equipment during the financial year, which historically fetched slightly higher margin as compared to sales of sports shoes.

  6. Financial Position

    Financial Position

    Remark
    (1) Formula: (Cash and cash equivalents + Loans and receivables) / Current liabilities
    (2) Formula: Total liabilities / Shareholders' equity

    Our Group maintains a healthy financial position as of 31 December 2016, with no significant variance as compared to prior year.

  7. Liquidity

    Liquidity

    Remark
    (1) Formula: Inventories / Cost of sales x 365 days
    (2) Formula: Trade receivables / Total revenue x 365 days
    (3) Formula: Trade payables / Cost of sales x 365 days

    The net working capital turnover days have been shortened from 100 days in 2015 to 90 days for the financial year under review, indicating an improvement in working capital management. This was primarily due to the following:

    1. Regular monitoring and follow-up on collections from receivables, which had resulted in the decrease of past due trade receivables' balances for the financial year under review as compared to preceding year; and

    2. Slight increase in trade payables' turnover period, in line with the longer credit terms granted to our Group by the trade payables which had been raised from 90 days in prior year to 120 days for the financial year under review.

    Liquidity

    During the financial year under review, our Group recorded net cash inflows of approximately RMB53.55 million as compared to net cash outflows of RMB8.65 million in prior year. This was primarily due to the abovementioned measures implemented by our Group to enhance working capital and cash flows management.

  8. Capital Requirements, Structure & Resources

    Our Group's capital commitment as of 31 December 2016 was as stated below:

    Capital Requirements, Structure & Resources

    Our Group had raised net proceeds (after deducting the relevant expenses) of RM83.70 million, which translated into RMB151.25 million, from the renounceable rights issue exercise completed on 27 January 2014. The net proceeds raised was earmarked to fund the stage-2 construction of our Group's design and production centre (“Stage-2 Construction”). For further details, kindly refer to the abridged prospectus dated 23 December 2013.

    Apart from that, our Group had obtained a 6-year term loan facility amounting to RMB130 million on 28 September 2013 from the Industrial and Commercial Bank of China (“ICBC”) to part finance the Stage-2 Construction. Subsequently on 10 September 2014, our Group had obtained additional credit facilities of up to RMB96.27 million.

    As of 31 December 2016, the Stage-2 Construction was still awaiting the necessary approvals and accordingly, the actual capital expenditure requirements cannot be ascertained at this juncture. Our Group will assess the capital expenditure required and reflect the relevant disclosures in the financial reports when Stage-2 Construction is ready to commence.

    The abovem entioned net proceeds raised, the term loan facility and the credit facilities remained unutilised as of 31 December 2016.

    Capital structure & resources

    Capital structure & resources

    As of 31 December 2016, our Group had sufficient cash reserves to fund the existing capital expenditure requirements, to settle the existing indebtedness and to carry out our day-to-day business operations.

    Although there is no immediate shortage in capital resources, our Group may, from time to time, assess the need for additional fund-raising to meet future capital expenditure requirements while ensuring that our Group's financial and liquidity position remains healthy.

TREND & RISK FACTORS

Known Trend

Intensifying market competition for the footwear and apparels market, although the demands for sports-inspired footwear and apparels are gradually increasing both in the context of China market and global market. This was the key factor / trend affecting our Group's performance for the recent years.

Our Group had taken the following initiatives to mitigate the impact arising from the intensifying market competition:

  1. Enhanced the sports shoes production capability and capacity of the Group, so that our Group is more flexible in accommodating to the changes in market demands;

  2. Optimised the existing distribution and retail network for ownbranding products to improve the efficiency at the retail stores, to promote brand unity and to provide better consumer experience;

  3. Embarked on online-to-offline marketing strategy to create an additional platform for promotion of our proprietary brand in addition to the television and radio advertising;

  4. Stepped up the efforts in securing additional ODM production orders, to diversify the revenue base of our Group; and

  5. Implemented a managed slowdown in the supply of own-branding sports apparel, accessories and equipment in response to the sudden glut in the apparels market of China, to steer clear of price competition given that the margin from apparels sales were eroding.

Principal Risk Factors

The principal risk factors faced by our Group's operations consist of the following:

  • Unfavourable macro and industry-related regulations and policies;

  • Impact of global economic uncertainties on China's economy;

  • Natural disaster causing disruption to operations;

  • Unsuccessful brand positioning and market competition;

  • Loss of authorised distributors; and

  • Non-recoverability of trade debts.

Kindly refer to Statement on Risk Management and Internal Control contained in this Annual Report for further details on the key risk management processes that have been put in place by our Group to mitigate the impact of the abovementioned principal risk factors.

PROSPECTS

Proprietary Brand ('XiDeLang') Operation

On 13 July 2016, the General Administration of Sport of China (中国国家体育总局) announced the 13th Five-Year Plan for the development of sports industry in China focusing on five core strategies:

  • Deepen the industry structural reform and enhance the industrial and technological revolution innovation;
  • Optimise the overall policy system and improve the efficiency and effectiveness of policy implementation;
  • Advocate private-public partnership and encourage private sector investment to enlarge the capital investment in China's sports industry, and enhance the capital utilisation efficiency;
  • Improve the welfare and education system for athletes, and strengthen the cultivation of reserved talents; and
  • Strengthen the monitoring of the industry development and promote public participation and active communication with the industry players.

The authorities are optimistic that the 13th Five-Year Plan and the National Fitness Campaign will contribute positively to the industry growth in the medium and long term and propel the nation to achieve the following development targets set for 2016 – 2020:

  • Enlarge the market size and employment size of China's sports industry to exceed RMB3 trillion and 6 million people;
  • Increase the industrial value-added contribution of the China's sports industry to 1.0% of the nation's GDP;
  • Increase the service-based value-added contribution to more than 30% of the overall industrial value-added contribution of the China's sports industry;
  • Expand the sports facilities and bases, per capita sports area to exceed 1.8m2; and
  • Increase the consumption value of sports to more than 2.5% of the disposable income per capita.

Demands for sportswear within the domestic China market are expected to be on increasing trend, backed by the following favourable factors:

  1. Active measures and policies by the Government of China to accelerate the development of the domestic sports industry, as abovementioned;

  2. Huge and rising population in China, particularly with the implementation of two-child policy; and

  3. Rising awareness on healthy lifestyle and increasing participation by the general public in sports and exercise within China.

On the domestic front, the outlook for the sportswear industry within China are expected to remain promising in the medium and long term. The outlook in the near term, however, is expected to be challenging in view of the intensifying market competition and fresh uncertainties stemmed from Brexit and potential changes of United States of America's fiscal policies and diplomatic stance under Trump's administration.

Our Group believes that the prospects remain promising for our own-branding operations, whilst being cautious that the industry may encounter increasing short term volatility for the near future.

ODM Production Service

Demands for sportswear in the global markets are estimated to be on gradual growth in the medium and long term, as the outlook for advanced economies has improved for 2017 – 2018 in view of the stronger economic activity during the second half of 2016 and a projected fiscal stimulus in the United States of America based on the estimates and projections of International Monetary Fund.

Our Group believes that there is good prospects for our ODM production operations, although we do acknowledge that the operating environment may remain challenging in the near term.

Overall

Barring any unforeseen circumstances, our Group is cautiously optimistic that the performance for the financial year ending 31 December 2017 will remain positive.

Dividend Policy

At present, our Group does not have a fixed dividend policy. The declaration of interim dividends and the recommendation of any final dividends are subject to the discretion of our Board of Directors and any final dividend proposed is subject to our shareholders' approval.

The Board will, from time to time, assess whether it is feasible to declare / recommend payment of dividends after taking into consideration our Group's operational performance, financial condition, capital expenditure plans, business expansion plans and working capital requirements; always bearing in mind the importance of long term value creation for our shareholders.

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report contains certain forward-looking statements with respect to the financial condition, results of operations and business of our Group.

Wordings such as “expects”, “estimates”, “anticipates”, “intends”, “plans”, “believes”, “potential”, and variations of these wordings and similar expressions are intended to identify forward-looking statements.

These forward-looking statements represent our Group's expectations or beliefs concerning future events and involve inherent risks and uncertainties. Forward-looking statements speak only as of the date they are made, and one should not assume that they have been revised or updated in the light of new information or future events. Accordingly, undue reliance should not be placed on them.

Readers should be cautioned that a number of factors could cause actual results to differ, in some instances materially, from those anticipated or implied in any forward-looking statement.

Trends and factors that are expected to affect our Group's results of operations are disclosed in the above sections.