The Hong Kong-based company, which is the largest producer of athletic and other footwear in the world, said it decided to review its contributions to employee benefits funds at all its factories in China following the strike of 45,000 workers at its Gaobu factory in April 2014. That strike resulted in $27 million in lost sales and created major supply chain headaches for the company’s customers, who include the biggest names in athletic and outdoor footwear.

 

After reviewing the tenure and wages at all its factories, Yue Yuen increased payments to its employee benefits plans by $90 million during the six months ended June 30 in what the company says is its best estimate of the amount it will ultimately owe. Together with a non-cash $25.2 million mark down of the fair market value of some financial derivatives, the additional payments nearly wiped out six months of company profits. Yue Yuen attributed the mark down to the volatility and depreciation of the RMB in the first half of 2014.

 

Yue Yuen reported total revenues rose 6.8 percent to approximately $3.95 billion for the six months ended June 30, compared with the first half of 2013. That included Manufacturing Business revenues of $2.99 billion, up 5.1 percent; and Retail Business revenues of $963.2 million, down 12.4 percent.  

 

The Manufacturing Business’s sales of athletic shoes and casual/outdoor shoes were up by 1.1 percent and 14.2 percent respectively during the quarter, due largely to higher average selling prices, which climbed 4.8 percent to $16.93. Total shoe manufacturing volume was almost unchanged at 158.0 million pairs, compared with 158.7 million in the first half of 2013. Athletic shoes accounted for 71.8 percent of Manufacturing sales during the six months, while casual/outdoor shoes accounted for the remainder.

 

Revenues from Yue Yuen’s Retail Business increased by 12.4 percent to $963.2 million compared to $856.9 million recorded in the first half of the previous year. The sales reflect results at Pou Sheng International, a publicly traded affiliate that retails and wholesales international athletic and outdoor footwear and sportswear brands in the Greater China Region.

 

In its own earnings statement, Pou Sheng attributed the gains primarily to a shift in focus to growing profits through better inventory and staffing management rather than opening new stores. The company said it also did a better job managing mark downs to reduce inventory.

 

As of June 30, the company had 3,868 directly operated counters/stores in the Greater China region and 2,405 sub-distributors in the PRC.  In addition to being a key national account for both Nike and Adidas, Pou Sheng  had exclusive distribution rights to the O’Neill brand in China, Hong Kong and Macau as well as licensing rights to the Hush Puppies brand in Taiwan during the reporting period.

 

In the Manufacturing Business, direct labor costs and production overhead costs were flat, while total material costs increased 8.3 percent. 

 

During the period, the company’s gross profit increased by 13.7 percent to $885.5 million, or 22.4 percent of net sales, up 130 basis points from a year earlier. Gross profit for the Manufacturing Business increased primarily due to flat direct labor and production overhead costs  and despite an 8.4 percent increase in material costs. In the Retail Business (Pou Sheng), gross profit increased 15.4 percent to $287.9 million, or 29.8 percent of net sales thanks to a greater share of retail versus wholesale revenues as well as less severe discounting activities compared to the same period last year.  Recurring operating profit was up 14.5 percent to $218.1 million compared to the same period last year.

 

Selling, distribution and administrative expenses increased 8.0 percent, compared to the first six months last year, including a 5.6 percent increase at the Manufacturing Business and a 9.8 percent decrease at the Retail Business compared with the same period last year.  The company spent $86.5 million on product development, up 2.1 percent.  Other expenses increased by 95.2 percent to $198.8 million compared to the first six months of 2013 due to the higher employee benefit contributions and the mark down of financial assets.

 

Operating profits from continuing operations reached $218.1 million, up 14.5 percent, but after subtracting the one-time increase in employee benefit contributions and the non-cash mark down of financial assets, the company reported consolidated net income attributable to shareholders o $101.4 million, or $6.15 per share, down 47.84 percent from the six months a year earlier.

 

The company ended the period with cash and cash equivalents o $897.8 million, down 0.8 percent from a year earlier.
Going forward, Yue Yuen said it will continue investing in supply chain integration, allocating more capacity across other parts of Asia and manufacturing excellence programs to counter significant inflationary pressure in China.  The company spent $38.4 million during building new factories and ancillary facilities mainly in Vietnam  and Indonesia during the first half of the year. During that period, it produced 29 percent of its footwear in the PRC, 39% in Vietnam, 31% in Indonesia and 1% in other countries during the six months ended June 30.

While rising labor and manufacturing costs signal near term challenges in the Manufacturing business and for the footwear industry in general, Yue Yuen sees conditions improving in the Retail business as discounting activity stabilizes and retail inventories decline.

 

“It appears that consumers will have more confidence in the coming 18 to 24 months” Pou Sheng reported in its financial statement. “The sportswear industry has experienced some consolidation so that issues in earlier years such as excess capacity and excess inventory have peaked in their significance. It is expected that the margins and profitability of the remaining market participants should stabilize over time and begin to improve in 2016.”

 

In this envrionment, Pou Sheng will seek to increase its distribution of international outdoor apparel and footwear brands, open multi-brand stores and build an e-commerce platform in the coming year.

 

“Major athletic and outdoor performance brands are also devoting more attention to developing the opportunities in China,” Pou Sheng stated in its interim report. “A few of them are deploying demand creation strategies that are similar to those used in the USA and Europe. The Group is of the view that product differentiation and segmentation will ensure that consumers recognize that “performance” athletic or outdoor products have features that are superior to those of fast retailing “fashion” products.”