Management Discussion and Analysis
(extracted from Annual Report 2017)
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
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Objective:
To become leading brand for trendy casual sportswear in China.
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Targeted Customer:
End-consumers, mass market in China.
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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 2017, 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 which are positioned as the “experience store”.
- Focus and business strategies:
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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 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.
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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:
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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.
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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.
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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:
- Our sales and marketing personnel engage the authorised distributors regularly to gather the endconsumers’ feedbacks and insights to the consumers’ preferences;
- Our purchasing team communicates with our raw material suppliers regularly to gather updates on new materials for footwear production; and
- 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.
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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.
Our Group maintains a close relationship with the raw material suppliers 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.
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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:
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.
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
Proprietary Brand ('XiDeLang') Operation
Backed by higher volume sold, revenue from own-branding sports shoes improved from RMB331.01 million in the preceding year to RMB346.91 million during the financial year under review, representing a growth of 4.80%.
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 7.8% for year 2017.
The growing consumption for sportswear in China is supported by the following:
Active measures and policies implemented by the Government of China to boost private consumption and accelerate the development of local sports industry;
Improving health awareness and increasing participation in sports and exercise by China citizens; and
Rising population with 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 RMB36,396 in 2017, representing a year-on-year growth of 6.5% (after adjusting for price factors) according to statistics by NBS.
Due to the sudden glut and intensifying competition within the apparels market in China which has resulted in margin pressure, our Group has decided to halt the supply of own-branding sports apparel, accessories and equipment temporarily since last year. Accordingly, no revenue was recorded from sales of sports apparel, accessories and equipment during the financial year under review.
At this juncture, our Group will focus on 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.
Going forward, our Group plans to deepen the online-to-offline marketing efforts, leveraging on the third party e-commerce platforms to enhance market awareness on our brand and products. The existing retail outlets managed by the authorised distributors and retailers will be transformed into “experience stores”, where consumers will get access to an extensive range of our products and have personalised experience and physical touch of our products, which are crucial in boosting their confidence in our products and desire to purchase.
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
Our Group recorded an encouraging revenue growth for our ODM Production Service segment during the financial year under review, where sales improved from RMB153.34 million in the preceding year to RMB195.51 million for the financial year under review, representing a growth of 27.50%. This was primarily attributable to the increase in quantities sold, in line with the gradual recovery of market demands for sportswear in the overseas market, particularly sports-inspired footwear.
Backed by our Group’s enhanced production and design capability as well as increased production capacity, our Group has the flexibility to step up our efforts in securing additional orders for ODM production of sports shoes.
In view of the gradual recovery of market demands for sportswear in overseas market, our Group intends to further expand our ODM operations. Our Group will, from time to time:
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; and
Identify any strategic alliance, merger or acquisition opportunities with China-based ODM producers with the aim to diversify and complement our Group’s existing ODM sports shoes production, as well as for cross-selling.
TRENDS & RISK FACTORS
Known Trend
The key factor/trend affecting our Group’s performance for the recent years, as well as the financial year under review, is intensifying market competition for the footwear and apparels market. Despite the gradual recovery of demand for sportsinspired footwear and apparels both in the context of China market and overseas market, consumers are generally more selective in spending and their expectations are growing more sophisticated where industry players will have to be more proactive in order to stay competitive.
Our Group had taken the following initiatives to mitigate the impact arising from the intensifying market competition:
Adopted multi-channel marketing strategy, leveraging on third-party e-commerce platforms to promote brand awareness in addition to conventional television and radio advertisement;
Optimised the existing distribution and retail network for own-branding products to improve efficiency at the retail stores, to promote brand unity and to provide better consumer experience. In particular, in line with our online-to-offline marketing strategy, the physical stores are transformed to serve as the “experience stores” providing consumers access to an extensive collection of our products and personalised, physical experience of our products to boost their desire to buy;
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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;
Stepped up the efforts in securing additional ODM production orders, to diversify the revenue base of our Group; and
Halted in the supply of own-branding sports apparel, accessories and equipment temporarily 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 and to mitigate risk of overstocking.
Principal Risk Factors
The principal risk factors faced by our Group’s operations remained largely consistent with prior years, comprising the following:
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.
FINANCIAL ANALYSIS
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Revenue
Backed by the gradual recovery of demands for sportswear, our Group recorded encouraging growth in revenue during the financial year under review, where total revenue improved by approximately 7.66% from RMB503.83 million in the preceding year to RMB542.42 million for the financial year under review.
In line with the growing market demands, our Group recorded increase in quantities sold for both the own-branding sports shoes and ODM production orders, the primary factor contributing to the revenue growth during the financial year under review.
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Other Income
Other income comprised mainly interest income earned by our Group. Other income for the financial year under review stood at approximately RMB2.29 million, increased by approximately RMB0.23 million or 11.06%, primarily due to higher interest income earned in line with the enhanced cash and bank balances held by our Group.
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Administrative and Other Expenses
During the financial year under review, administrative and other expenses incurred by our Group stood at RMB69.65 million, marginally lower by 5.90% as compared to 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 RMB18.98 million (2016: RMB18.92 million), largely consistent with prior year; and
Brand promotion and advertisement costs amounted to RMB35.24 million (2016: RMB41.05 million), lower by approximately RMB5.81 million or 14.15% as compared to the preceding year, in line with our multi-channel marketing strategy where the conventional television and radio advertising was balanced and complemented by digital marketing through listing of our products on third-party e-commerce platforms. The ratio of brand promotion and advertisement costs to the Group’s total revenue stood at 6.50% (2016: 8.15%), relatively consistent with the trend of other leading industry players.
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Effective tax rate
The Group’s effective tax rate stood at approximately 33.25% for the financial year under review, lower as compared to 38.47% 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.
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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.
Backed by the revenue growth during the financial year under review, our Group’s GP improved from RMB83.93 million in prior year to RMB92.90 million for the financial year under review, representing a growth of 10.69%.
Our Group’s PBT and NP were more than doubled during the financial year under review, as compared to the preceding year, primarily attributable to the revenue and GP growth, as well as decrease in brand promotion and advertisement costs as explained above.
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Financial Position
Remark
(1) Formula: (Cash and cash equivalents + Receivables) / Current liabilities
(2) Formula: Total liabilities / Shareholders' equity
Backed by the improved performance, our Group’s financial position as of 31 December 2017 remained relatively strong and healthy, with no significant unusual fluctuation as compared to prior year.
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Liquidity
Remark
(1) Formula: Inventories / Cost of sales x 365 days
(2) Formula: Trade receivables / Total revenue x 365 days
(3) Formula: payables / Cost of sales x 365 days
The net working capital turnover days have been shortened from 90 days in 2016 to 59 days for the financial year under review, indicating an improvement in working capital management. This was primarily attributable to regular monitoring and follow-up on collections from receivables, where no past due trade receivables’ balances were recorded as at 31 December 2017.
In line with our improved collection, we continued to make prompt payments to our suppliers resulting in a slight decrease in trade payables’ turnover period from 88 days in prior year to 67 days for the financial year under review.
During the financial year under review, our Group recorded net cash inflows of approximately RMB57.03 million, higher as compared to the preceding year. This was primarily attributable to the improved performance of our Group, coupled with enhanced working capital and cash flows management.
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Capital Requirements, Structure & Resources
Our Group’s capital commitment as of 31 December 2017 was as stated below: (
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 2017, 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 above mentioned net proceeds raised, the term loan facility and the credit facilities remained unutilised as of 31 December 2017.
Capital structure & resources
As of 31 December 2017, 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.
PROSPECTS
Proprietary Brand ('XiDeLang') Operation
Looking ahead, demands for sportswear within the China market are generally expected to be on gradual growth momentum, backed by the following favourable factors:
Supportive government policies and initiatives which, amongst others, including Several Opinions on Accelerating the Development of Sports Industry to Promote Sports Consumption announced by the State Council of the People’s Republic of China, the 13th Five-Year Plan announced by the General Administration of Sports of China and the National Fitness Campaign.
These policies and initiatives are expected to contribute positively to the sports industry growth in the medium and
long term and propel the nation to achieve the following development targets set for 2016 - 2020:
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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.
Huge and rising population in China particularly with the implementation of two-child policy, complemented by an rising disposable per capita income; and
Increasing popularity of sports and rising participation levels, in line with the growing awareness on healthy lifestyle. More consumers have started to undertake regular exercise, including retirees, working adults and students, giving rise to more frequent purchases of sportswear.
Although the outlook of the sports industry within China is expected to remain challenging in view of the intensifying market competition and the uncertainties in the global economy particularly those associated with Brexit and changes in United States of America’s fiscal policies and diplomatic stance under Trump’s administration. Notwithstanding that, the outlook for the sportswear industry within China for the medium and long term is expected to remain promising. This is echoed by the recent research report entitled “Consumer Market Development Report 2018” published by China Council for the Promotion of International Trade (“CCPIT”) Academy, where the total retail sales of consumer products in China is forecasted to exceed RMB40 trillion in 2018 representing an annual nominal growth rate of approximately 10%.
Our Group believes that the prospects remain promising for our own-branding operations, but remains cautious on the increasing short term volatility for the near future.
ODM Production Service
Demands for sportswear in the global markets are generally expected to be trending upwards in the medium and long term backed by the increasing participation in sports activity for health and fitness and increasing purchasing power.
Our Group believes that the increasing demands for sportswear in the global markets will have a positive impact on the demand for ODM production, which fares well for our ODM production operations.
Overall
Barring any unforeseen circumstances, our Group is cautiously optimistic that the performance for the financial year ending 31 December 2018 will remain positive.
Dividend Policy
The Board has established a dividend policy to distribute up to 20% of the Company’s profit after tax as dividend payment to our shareholders. The dividend payment will be made after taking into consideration, inter alia, cash availability, return on equity and the projected level of capital expenditures; always bearing in mind the importance of long term value creation for our shareholders.
The declaration of interim dividends and the recommendation of any final dividends are subject to the discretion of the Board, whilst any final dividend proposed is subject to our shareholders’ approval.
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.