Mainland Headwear Sees H1 Profit and Turnover Fall

During the six months ended June 30, 2005, Mainland Headwear recorded a turnover of HK$233,746,000 ($30.0mm), representing a decrease of 12.4% when compared with the corresponding period last year. Profit attributable to shareholders was HK$35,967,000 ($4.6mm), a decline of 17.4% as compared with the first half of 2004. Basic earnings per share was 12.6 HK cents ($0.02). The Board of Directors recommends the payment of an interim dividend of 2 HK cents per share (2004: HK 3 cents per share).

Commenting on the Group's interim results, Mr. Ngan Hei Keung, Chairman of Mainland Headwear, said, “The decline in turnover was mainly attributable to the sluggish performance of Drew Pearson Marketing Inc., (“DPM”), following the restructuring of its trading business after loss of the MLB license, NHL strike for the past season and delay of orders from major retail customers in the US. In addition, Retail Business was still at its initial investment phase so the turnover contribution was relatively small. However, with stringent cost control measures coupled with an adjustment of procurement strategy reduced overall raw material costs, and outweighed the increase in staff costs, consequently leading to an increase in gross profit margin of Manufacturing Business. The continuous synergy effect of Manufacturing Business and Trading Businesses is also a factor to further enhance the Group's gross profit margin to 41%.”

The Manufacturing Business

Profit contribution from the Manufacturing Business increased from HK$48,496,000 ($6.2mm) to HK$49,571,000 ($6.4mm) in the first half of 2005. Turnover fell 8.6% to HK$172,382,000 ($22.1mm) as compared to the corresponding period last year, primarily attributed to lower sales to the Trading Business following loss of the MLB license. In addition, first half results for this year cannot be fairly compared with last year's first half performance as the business reported exceptionally good turnover in 2004 due to strong sales of headwear of certain popular licenses. Meanwhile, delay of orders from some major US retailers contributed to the lower sales performance for the period under review but sales has been shifted to the second half of the year.

During the period under review, the Group has engaged some new customers with high business potential, including new direct sourcing customers introduced through DPM. The Group recorded remarkable growth in orders from them. Sales of headwear for the 2008 Beijing Olympic Games were also encouraging although significant business growth is expected to only kick start in late 2006.

The Group started sourcing its raw materials directly from weaving manufacturers. The bulk purchase of grey fabrics significantly reduced the overall cost of materials, while increasing inventory levels, compared with the corresponding period last year. The successful adjustment of procurement strategy, together with implementation of stringent cost control measures, enabled the Group to mitigate the effects of higher labour costs and rising global raw material prices. As a result, the Group's Manufacturing Business was able to report a gross profit margin hike of over 35%.

The Trading Business

During the period under review, the Trading Business experienced a decrease in turnover of 25% to HK$99,704,000 ($12.8mm), resulting a loss of HK$4,394,000 ($0.6mm) as compared to a profit contribution of HK$356,000 ($0.05mm) last year. It was mainly attributed to the loss of MLB license in the US with effect from 2005, and the NHL strike for the past season.

Since 2004, the Trading Business has switched its marketing strategy to focusing more on brands, entertainment and character licenses and private label businesses, as well as being the marketing arm of the Manufacturing Business. Businesses from new licenses and private labels are expected to pick up in the second half of this year and into 2006.

With inclined competition and increase in the private label business which has a relatively lower margin, gross profit margin for the period under review was slightly below 25%. In July 2005, the Group consolidated the resources of its US offices for a more cost efficient operation and thus will improve the profitability of the business. In addition, the Group established a new marketing subsidiary in the United Kingdom in March 2005 to provide better customer services in Europe. This will help build closer ties with European customers and effectively ensure the Group keeps abreast of European fashion culture and headwear trends. The Group's direct management strategy has clearly been successful, with first profit contribution already seen from the new subsidiary.

Retail Business

Turnover of the Retail Business was HK$8,753,000 ($1.1mm), representing 3.7% of the Group's total turnover for the six months ended 30 June 2005. During the period under review, the Group recorded a loss of HK$4,710,000 ($0.6mm) for Retail Business as it is in its investment phase. The Group is most confident it will significantly contribute revenue in the future.

As at 30 June 2005, the Group had opened a total of 22 “LIDS” stores, of which 7 were in Hong Kong and 15 in the PRC. The LIDS operations incurred a loss during the period under review, with some of the outlets making shop level contributions. The gross profit margin of the LIDS operations has improved during the reviewed period since the Group introduced its private labels and acquired the distribution license for some characters of Disney in late 2004. The Group also started its wholesale business of its private label and own licenses products to other retailers in the PRC in June 2005.

In response to the high shop rental cost in Hong Kong, the Group will control the growth of LIDS outlets to a total of 10 stores by the end of 2005. For the PRC market, the Group will take advantage of lower operation costs and will continue to open new stores in China to maximize on benefits of the burgeoning Chinese economy. It is anticipated that a total of 28 LIDS stores will be opened by end of 2005 in the PRC. The Group also plans to start its franchise business in the PRC in early 2006 and strives to achieve break-even results by the middle of 2006.

In March 2005, the Group acquired a 51% interest in a joint venture, to operate an exclusive retail license which includes the design, manufacture and sale of “SANRIO” products in PRC. As at 30 June 2005, a total of 7 stores had been opened. During the period under review, the “SANRIO” operations incurred a small loss which is expected to continue into the second half of the year, as the Group is still in the initial phase of investing in the infrastructure and product development. The Group is optimistic that it will see positive contribution from this segment by late 2006, with the goal of opening a total of 28 stores by the end of 2005.

Prospects

The first half of 2005 was a challenging period for the headwear industry, but the Group is confident about the outlook for the second half of the year and 2006.

As orders from private label business and new customers are growing steadily, orders received during the third quarter has increased by 30% over the corresponding period last year. Also, the Group has increased its efforts to catch the growing demand for knitted headwear. The knitted headwear business in 2005 is estimated to increase by 40% as compared to the previous year. It is anticipated that the need for knitted headwear will continue to grow rapidly. In addition, one of the largest retailers in the US is planning to set up a headwear display mechanisms throughout its stores in early 2006 and DPM is one of the approved suppliers. For the first season, it is estimated that DPM will supply for about 30% of the headwear on the display while another major customer of the Group should gain another 30% of the shelf space of the new displays.

In August 2005, DPM was informed that it has been granted exclusive rights to produce and distribute headwear for the NYC (“New York City”) brand along with rights to produce and distribute T-shirts and other basic apparel items bearing the NYC marks. The license will contain an initial term of 4 years and an option period of 3 years commencing January 2006. The brand includes the popular NYPD and FDNY marks along with other well known logos of NYC. The Group is dedicated to further expanding its license portfolio and expects demand for New York City products to make substantial turnover contribution in 2006.

In addition, the Group strives to further extend its market coverage. In Japan, since the Group has achieved encouraging results during the first half of 2005, and with the expansion of its client base, it is anticipated that the Group will receive more orders from existing and new clients during the second half of 2005, which include new orders from an international automobile manufacturer. With the Group's marketing subsidiary in the U.K., and leveraging on the extensive network established by the newly appointed sole European distributor, the Group projected that the market coverage in Europe would extend to Northern, Central and Southern Europe in the second half of the year and 2006.

Mr. Peter Ho, CEO of Mainland Headwear is optimistic about the future growth of Retail Business and said, “The Group will continue to extend its presence in the PRC market through LIDS and SANRIO stores while actively seeking opportunities to add new licenses to the operation. By leveraging on the Group's established retail platform, the Retail Business is well positioned to be a key growth driver in the future.”

Mr. Ngan concluded, “With strategies of business diversification and market diversification, Mainland Headwear is well prepared to capture the arising business opportunities and will continue to create fruitful returns for shareholders.”