Zungui Haixi Corporation
TSX VENTURE : ZUN

Zungui Haixi Corporation

February 24, 2010 07:00 ET

Zungui Haixi Reports Second Quarter Results

TORONTO, ONTARIO--(Marketwire - Feb. 24, 2010) - Zungui Haixi Corporation (TSX VENTURE:ZUN), a China-based manufacturer of sportswear and casual footwear, today announced its financial results for the three and six months ended December 31, 2009. All amounts in this release are in Canadian dollars unless otherwise indicated. 

"We are pleased to report our second quarter results, the first time we are reporting as a public company," indicated Mr. Jixu Cai, Chief Executive Officer of Zungui. "The results for the quarter indicate strong revenue and net income growth in Chinese Renminbi ("RMB") of 22% and 20%, respectively. In Canadian dollars revenue increased 9% and net income increased 5% for the quarter. The gross margin was reduced by 0.7% and 0.1% for the second quarter and six months year to date, respectively, due to an increase in the outsourced production of our athletic footwear. The expansion of the Company's production capacity will lower the need for outsourced production as our current facility is operating at full capacity. We expect to have our additional capacity functioning by March, 2011 after the construction of the facility and the installation and testing of the new production lines is completed." 

"On December 21, 2009, we successfully completed our initial public offering and raised gross proceeds of almost $40 million including the exercise of the over-allotment on January 12, 2010. We are working to deploy these funds and execute our growth strategy as we outlined for our shareholders in the prospectus. We expect to meet expectations in opening 350 new retails stores in calendar 2010 with the strong support of our distributors."

Highlights for the Second Quarter and Year-To-Date:

  • Revenue increased 9% to $37.0 million for the quarter and 26% to $80.0 million for the year-to-date;
  • In RMB, revenue increased 22% to RMB 238.9 million for the quarter and 31% to RMB 506.8 million for the six months ended December 31, 2009;
  • Gross margin of 25.7% for the second quarter and 26.6% for the six months ended December 31, 2009 compared to 26.4% and 26.7% for the comparative periods of 2008, respectively;
  • Net income increased 5% to $5.6 million for the quarter and 28% to $13.2 million for the six months ended December 31, 2009;
  • Net income increased 20% to RMB 35.9 million for the quarter and 33% to RMB 83.6 million for the six months ended December 31, 2009;
  • Diluted earnings per share of 11 cents compared to 11 cents for the same quarter last year based on a 3% increase in the weighted average number of shares outstanding in the period; and,
  • Diluted earnings per share increased 24% to 26 cents for the six months compared to 21 cents for the same period of 2008.

The results were impacted by the movement of the Chinese currency relative to the Canadian dollar. During the second quarter ended December 31, 2009 the average foreign exchange rate used to convert one RMB was 0.1547 expressed in Canadian dollars compared to 0.1576 for the same quarter of 2008. If the second quarter results were converted at the prior year's average exchange rate for the quarter, earnings per share for the three months ended December 31, 2009 would have been 13 cents, resulting in an 18% increase in earnings per share. For the six months ended December 31, 2009, the average foreign exchange rate used to convert one RMB was 0.1772 expressed in Canadian dollars compared to 0.1638 for the same period last year. If the six month results were converted at the prior year's average exchange rate, the earnings per share for the six months ended December 31, 2009 would have been 27 cents, resulting in a 29% increase in earnings per share. 

Conference Call
Zungui will host a conference call to discuss the second quarter results at 9am (EST) February 24, 2010. The details are as follows:

Dial-in number: 1-800-952-4972
Taped rebroadcast (until midnight on March 10, 2010): 1-800-408-3053
Taped replay access passcode: 5523501. 

About Zungui
Zungui Haixi Corporation, through its wholly owned subsidiaries, is engaged in the manufacture and sale of athletic footwear, apparel and accessories, and also casual footwear, in the People's Republic of China. Both product lines are marketed under the ZUNGUI brand. Zungui distributes its products to consumers throughout China through an extensive network of retail outlets which exclusively carry ZUNGUI branded products. There are currently 62,259,500 common shares issued and outstanding.

Caution Regarding Forward-Looking Statements
This press release contains statements that may constitute forward-looking statements, which may include financial and other projections, as well as statements regarding future plans, objectives or economic performance. Forward-looking information involves significant risks, assumptions, uncertainties and other factors that may cause actual future results or anticipated events to differ materially from those expressed or implied and accordingly, investors should not place undue reliance on any such forward-looking statements. Factors that could cause results to vary include, but are not limited to, those expressed in Zungui's filings with Canadian securities regulatory authorities. All information presented herein should be read in conjunction with such filings and the cautionary note made in Management's Discussion and Analysis of Financial Condition and Results of Operation contained within this press release.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following management's discussion and analysis of financial condition and results of operation (the "MD&A") of Zungui Haixi Corporation ("Zungui" or "Company") is prepared for the three and six months ended December 31, 2009 and 2008. Zungui became the parent company of Southern Trends International Holding Company Limited ("Southern Trends"), through a share exchange agreement completed in conjunction with the completion of the Company's initial public offering on December 21, 2009. All figures presented for periods prior to December 21, 2009 refer to Southern Trends financial statements. The MD&A should be read in conjunction with the audited consolidated financial statements of Southern Trends for the period ending June 30, 2009 and related notes contained in the final long form prospectus filed on December 11, 2009 on SEDAR at www.sedar.com. The consolidated financial statements were prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are presented in thousands of Canadian dollars unless otherwise noted. 

Disclosure contained in this MD&A is current to February 23, 2010 the date of approval of the MD&A and financial statements by the Board of Directors.

Certain statements in this MD&A contain forward-looking information that involve risk and uncertainties. Statements other than statements of historical fact contained in this MD&A may be forward-looking statements within the meaning of certain securities laws, including, without limitation, statements involving management's expectations, intentions and beliefs concerning the domestic PRC sportswear industry, the competitive landscape in this industry and the general economy, statements regarding the future financial position or results of the Company, business strategies, proposed acquisitions, growth opportunities, budgets, litigation, projected costs and plans and objectives of or involving the Company. Such statements should be considered forward-looking statements, Wherever possible, words such as "may", "would", "could", "will", "anticipate", "believe", "plan", "expect", "intend", "estimate", "aim", "endeavour", "project", "continue" and similar expressions have been used to identify forward-looking statements.

These forward-looking statements reflect management's current beliefs and business judgement with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions, and you should not place undue reliance on these forward-looking statements. Although management believes its current beliefs and assumptions are reasonable, many factors could cause Zungui's actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, without limitation, risks related to: failure to maintain or promote the ZUNGUI brand; dependency on distributors and retailers for product sales and brand promotion; difficulty in continuing to grow Zungui's distribution network; failure to effectively integrate additional corporate-owned and managed retail outlets; strong competition; the loss, or decrease in, sales to Zungui's major distributors; dependency on certain of its key executives, design, technical and other personnel; failure to successfully implement plans to expand production capacity and improve production efficiency; failure to execute growth strategy; reliance on subcontractors; fluctuations in the price, availability and quality of raw materials; exposure to credit risks of distributors; selling prices; failure to accurately track inventory levels or sales figures; failure to optimize and adjust product mix; failure to anticipate and respond in a timely manner to fashion trends and changes in consumer tastes in the PRC; liability for unpaid contributions to the social security insurance program; increases in labour costs and labour disputes; protection of trademarks and other proprietary rights; damage to administrative or production facilities, fire or other calamities; proof of title; exposure to environmental liability; exposure to product liability, property damage or personal injury claims; closure of retail outlets; failure to obtain additional financing; risks associated with state ownership; exposure to fluctuations in the economic conditions in the PRC; fluctuations in foreign exchange rates; changes in Zungui's tax treatment; limitations in the ability to repatriate profits or convert currency; limited shareholders' rights in China; risks relating to a developing legal system; intellectual property rights protection and enforcement; requirements for permits and business licenses; risks relating to the appropriation of land used in Zungui's operations; natural disasters; reliance on third-party sources and industry publications; volatile market price; return on an investment in common shares; risks relating to holding companies; limited recourse against certain securityholders; compliance with financial reporting and other requirements as a public company; language barriers between certain directors and officers of the Company; influence by the principal securityholder; future sales of common shares; conflicts of interest and dilution of common shares. See the "Risk Factors" section of the Company's other filings with Canadian securities regulatory authorities at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this MD&A. The forward-looking statements contained in this MD&A are expressly qualified in their entirety by this cautionary statement. These forward-looking statements are made as of and speak as of the date of this MD&A and the Company does not intend to, or assume any obligation to, update or revise these forward-looking statements to reflect new information, events, results or circumstances or otherwise after the date on which such statement is made as to reflect the occurrence of unanticipated events, except as required by law, including securities laws.

Overview
Zungui is principally engaged in the manufacture and sale of athletic footwear, apparel and accessories ("Sportswear Product Line") and casual leather footwear ("Casual Product Line"). Both product lines are marketed in the PRC under the well-recognized ZUNGUI brand. Zungui distributes its products to consumers throughout the PRC through three corporate-owned retail outlets and through 47 distributors, who in turn sell products via an extensive network of 1,716 retail outlets as of December 31, 2009, 1,407 of which offer the Sportswear Product Line and 309 of which offer the Casual Product Line. All retail outlets exclusively sell products which carry the ZUNGUI brand.

During the three and six months ended December 31, 2009, the expansion of the retail outlets continued and the Company focused on revenue growth and increased profitability. It provided services and training to distributors to help meet customer needs and increase their sales. For the three and six months ended December 31, 2009, revenue grew 9% and 26% to $37.0 and $80.0 million in Canadian dollars, respectively, compared to the same periods in the prior year. Revenue grew 22% and 31% in Renminbi ("RMB") to RMB 238.9 million and RMB 506.8 million, respectively, compared to the same periods last year with the difference attributable to the Chinese currency fluctuations relative to the Canadian dollar reporting currency in 2009.

Statement of Operations
The following table sets forth selected financial information for the periods indicated. The selected financial information has been derived from the Company's unaudited interim consolidated financial statements for the three and six month periods ended December 31, 2009.

Earnings Data For the three months ended December 31   For the six months ended December 31  
  2009   2008   2009   2008  
Revenue $              36,960   $           33,950   $           79,990   $           63,277  
Cost of sales   27,455     24,983     58,744     46,351  
Gross profit   9,505     8,967     21,246     16,926  
Selling expenses   511     1,106     1,104     1,759  
General and administrative expenses   989     580     1,691     955  
Other income (net)   (24)     (9)     (31)     (17)  
Income taxes   2,479     2,087     5,275     3,923  
Net income $             5,550   $             5,293   $           13,207   $           10,306  
                         
Earnings per share – basic and diluted $                 0.11   $               0.11   $               0.26   $ 0.21  
Balance Sheet Data   As at December 31, 2009   As at June 30, 2009  
Cash   58,023   23,757  
Inventories   10,497   2,984  
Property, plant and equipment   4,601   5,331  
Total assets   103,487   56,079  
Working capital   72,884   29,844  
Retained earnings   45,228   32,021  
Total shareholders' equity   77,485   35,175  

Factors Affecting Results of Operations

Foreign Currency

All of the Company's revenues and expenses, other than the Canadian head office expenses, are generated in the People's Republic of China (PRC). Accordingly, the results of operations are impacted by the fluctuation of the Renminbi ("RMB") against the Canadian dollar. The weighted average exchange rate for one RMB, expressed in Canadian dollars, for the three and six months ended December 31, 2009 and 2008 was 0.1547, 0.1576, 0.1772 and 0.1638. The strengthening of the Chinese currency relative to the Canadian dollar in the six months ended December 31, 2009 resulted in the statement of operations in Canadian currency being 8% less than would have reported if the Company had used the average exchange rate for the same period of 2008.

Financial Highlights in RMB
The following table sets forth selected financial information for the Company for the periods indicated in RMB which is the Company's functional currency for its wholly owned subsidiary in China. The Canadian head office's functional currency is Canadian dollars. The Company uses Canadian dollars as its reporting currency. This information has been derived from the Company's records supporting the unaudited interim consolidated financial statements for the three months and six months ended December 31, 2009, immediately prior to their conversion to Canadian dollars.

    For the three months ended December 31   For the six months ended December 31  
    2009   2008   2009   2008  
Revenue   $       238,899   $         195,521   $         506,816   $         388,199  
Cost of sales     177,459     144,055     372,273     284,441  
Gross profit     61,440     51,466     134,544     103,758  
Net income   $           35,878   $           29,866   $           83,553   $           62,810  
                           
Weighted average exchange rate for one RMB, expressed in Canadian dollars     0.1547     0.1576     0.1772     0.1638  

Revenues

The Company's revenues consist of sales from footwear, apparel and accessories sold within the PRC. The Company provides sales rebates and advertising contributions to its distributors that are deducted from its gross revenue to derive its net revenue.

Cost of Sales

The Company's cost of sales consists of internal and external production costs. Internal production costs include raw materials, labour and manufacturing costs. Outsourced production costs refer to the cost of procuring finished footwear, apparel and accessories, which represents amounts paid to subcontracted manufacturers in the PRC.

Seasonality

The results of the Company are generally not subject to seasonality.

Selling and general and administrative expenses

The Company's selling and general and administrative expenses consist of advertising expenses, research and development expenses and salaries for administrative staff and management.

Outlook

The PRC domestic footwear market remains a high growth industry consistent with the growth of the PRC's economy. Zungui's focus is on the domestic market and the Company allocates its resources and efforts to meet the demands of China's growing local markets. Zungui is currently working to increase its presence in Tier 2 and 3 Cities throughout the PRC, where both population and disposable income are growing. This increased presence will be achieved by opening additional corporate-owned and managed retail outlets and by assisting distributors in expanding their retail presence. 

Corporate-owned and managed retail outlets typically offer higher margins than sales through distributors as well as greater operating flexibility. By increasing the number of corporate-owned and managed retail outlets, Zungui believes it can focus its growth strategy in certain regions while complementing its current distribution network. During the calendar year 2010, the Company expects to add 100 corporate-owned and managed retail outlets, predominantly during the period April to December, 2010. 

Results of Operations Three and Six Months Ended December 31, 2009 compared to December 31, 2008

 (Amounts in thousands of dollars, unless specified otherwise)

Revenue

The Company's revenues consist of sales from footwear, apparel and accessories sold domestically within the PRC. The Company derives its revenue from two distribution channels: wholesale and corporate-owned and managed retail outlets. The number of retail outlets increased 7% to 1,716 during the six months ended December 31, 2009. During the three months ended December 31, 2009, 37 net new retail outlets were opened. The Company currently has three corporate-owned and managed retail outlets with the balance being leased or owned by distributors or third-party retailers. No additional corporate-owned and managed retail outlets were opened during the six months ended December 31, 2009.

Revenue by Product Line

    For the three months ended December 31   For the six months ended December 31  
    2009   % of Total   2008   % of Total   2009   % of Total   2008   % of Total  
Footwear   $   31,163   84.3   $   28,491   84.0   $   68,241   85.3   $   52,930   83.7  
Apparel and accessories     5,797   15.7     5,459   16.0     11,749   14.7     10,347   16.3  
Total   $                36,960   100.0   $                33,950   100.0   $                79,990   100.0   $                63,277   100.0  

For the three and six months ended December 31, 2009, footwear accounted for 84.3% and 85.3% of revenue, respectively, compared to 84.0% and 83.7% for the three and six months ended December 31, 2008. Total revenue increased 9% to $37.0 million for the three months ended December 31, 2009 compared to $33.9 million for the same period last year. Total revenue increased 26% to $80.0 million for the six months ended December 31, 2009 compared to $63.3 million for the six months ended December 31, 2008. In RMB, revenue increased 22% to RMB 238.9 million for the three month period ended December 31, 2009 compared to RMB 195.5 million for the same quarter last year. For the six months period ended December 31, 2009, revenue increased 31% to RMB 506.8 million compared to RMB 388.2 million for the same period last year. The fluctuation in the Chinese currency during the second quarter accounted for the relative decreased percentage increase in revenue when reported in Canadian dollars. Footwear revenue increased 9% to $31.2 million for the three months ended December 31, 2009 compared to the same period last year, and was comprised of $26.5 million in revenue from athletic footwear and $4.7 million from casual footwear.

In RMB, the Company's revenue per average number of retail outlets increased 11% to RMB 0.1 million during the three months ended December 31, 2009 compared to the same period last year and increased 18% to RMB 0.3 million for the six months ended December 31, 2009 compared to the same period of 2008. Market demand for sportswear and casual products as well as increased consumer spending in the PRC has contributed to the growth rate in sales. For each of the three months ended December 31, 2009 and 2008, 99.7% of the Company's revenue was derived from its wholesale distribution channel.

Cost of Sales

  For the three months ended December 31   For the six months ended December 31  
  2009   % of Total   2008   % of Total   2009   % of Total   2008   % of Total  
Footwear (internal production)                                
  Raw materials $ 10,039   36.5   $ 10,952   43.8   $ 20,187   34.4   $ 20,179   43.5  
  Labour   1,088   4.0     1,205   4.8     2,211   3.8     2,234   4.8  
  Manufacturing costs   496   1.8     363   1.4     1,015   1.7     820   1.8  
Subtotal   11,623   42.3     12,520   50.1     23,413   39.9     23,233   50.1  
Footwear (outsourced production)   11,426   41.6     8,383   33.6     26,552   45.2     15,397   33.2  
Apparel and accessories (outsourced production)   4,406   16.1     4,080   16.3     8,779   15.9     7,721   16.7  
Total $ 27,455   100.0   $ 24,983   100.0   $ 58,744   100.0   $ 46,351   100.0  

During the three months ended December 31, 2009, cost of sales increased 10% to $27.5 million from $25.0 million for the second quarter of 2008 relative to the 9% increase in revenue. Similarly, during the six months ended December 31, 2009, cost of sales increased by 27% to $58.7 million from $46.4 million for the same period last year compared to a 26% increase in revenue for the same period. In RMB, cost of sales increased 23% to RMB 177.5 million for the three months ended December 31, 2009 compared to RMB 144.1 million for the same quarter in 2008 and increased 31% to RMB 372.3 million for the six months ended December 31, 2008 compared to RMB 284.4 million for the same period last year. Raw materials accounted for 36.5% and 43.8% of the total costs of sales during the three months ended December 31, 2009 and 2008, respectively and 34.4% and 43.5% for the six months ended December 31, 2009 and 2008, respectively. Raw materials accounted for 86.4% and 86.2% of the cost of sales on internally produced footwear for the three and six months ended December 31, 2009, respectively compared to 87.5% and 86.9% for the three and six months ended December 31, 2008. The average cost of raw materials did not materially change during the periods.

Outsourced production accounted for approximately 56% and 59% of footwear requirements during the three and six months ended December 31, 2009 compared to 32% and 40% for the same periods last year, respectively. The cost of sales on outsourced production of footwear represented 41.6% and 45.2% of the total cost of sales for the three and six months ended December 31, 2009 compared to 33.6% and 33.2% during the three and six months ended December 31, 2008. As the Company expanded its sale of footwear and apparel it has relied upon external suppliers to produce an increased percentage of its footwear and 100% of its apparel and accessories.

Gross Profit

    For the three months ended December 31   For the six months ended December 31  
    2009   % of Total   2008   % of Total   2009   % of Total   2008   % of Total  
Footwear   $   8,114   85.4   $     7,617   84.9   $   18,274   86.0   $   14,327   84.6  
Apparel and accessories     1,391   14.6     1,350   15.1     2,972   14.0     2,599   15.4  
Total   $                9,505   100.0   $                8,967   100.0   $                21,246   100.0   $                16,926   100.0  

The gross margin on footwear was 26.0% and 26.6% for the three month period ended December 31, 2009 and 2008, respectively and was 26.8% and 27.0% for the six month periods ended December 31, 2009 and 2008, respectively. The gross margin declined for the three and six months ending December 31, 2009 compared to the same periods last year as an increased percentage of footwear was outsourced, which has a higher cost of sales. The gross margin on apparel and accessories was 24.0% and 24.8% for the three month period ended December 31, 2009 and 2008, respectively and was 25.3% and 25.1% for the six months ended December 31, 2009 and 2008, respectively. The majority of the gross margin is derived from the sales of footwear which is consistent with the revenue breakdown.

Selling Expenses

        For the three months ended December 31       For the six months ended December 31      
        2009       2008       Decrease       2009       2008       Decrease      
Selling Expenses       $        511       $   1,016       (50%)       $   1,104       $      1,759       (37%)      

Selling expenses decreased 50% to $0.5 million for the three months ended December 31, 2009 compared to the same period last year and were $1.1 million and $1.8 million for the six months ended December 31, 2009 and 2008, respectively, as the Company spent less on advertising during this period. Selling expenses represented 1.4% and 3.0% of total revenue for the three months ended December 31, 2009 and 2008, respectively, and 1.4% and 2.8% for the six months ended December 31, 2009 and 2008.

General and Administrative Expenses

    For the three months ended December 31   For the six months ended December 31  
    2009   2008   Increase   2009   2008   Increase  
General and Administrative Expenses   $        989   $   580   71%   $   1,691   $         955   77%  

 Corporate expenses related to being a public company, including insurance, salaries, directors fees and audit fees totalled $0.3 million during the three and six months ended December 31, 2009. Increased research and development costs, salaries of administrative staff and management and employee incentives during the first quarter of 2010 increased the six month expense by $0.1 million. General and administrative expenses represented 2.7% and 1.7% of total revenue for the three months ended December 31, 2009 and 2008, respectively and 2.1% and 1.5% for the six months ended December 31, 2009. 

Other Income, net

    For the three months ended December 31   For the six months ended December 31  
    2009   2008   Increase   2009   2008   Increase  
Other income, net   $          24   $   9   167%   $        31   $           17   82%  

Other income, comprised primarily of interest income, is shown net of interest expense of $0.02 million and $0.04 million for the three months ended December 31, 2009 and 2008, respectively, and net of interest expense of $0.07 million and $0.08 million for each of the six months ended December 31, 2009 and 2008, respectively.

Income Tax Expense

    For the three months ended December 31   For the six months ended December 31  
    2009   2008   Increase   2009   2008   Increase  
Income tax expense   $     2,479   $   2,087   19%   $   5,275   $      3,923   34%  

The statutory income tax rate in the PRC is 25%. However, due to non-deductible expenses, the effective tax rate is 31% and 28% for the three months ended December 31, 2009 and 2008 and 29% and 28% for the six months ended December 31, 2009.

Net Income

    For the three months ended December 31   For the six months ended December 31  
    2009   2008   Increase   2009   2008   Increase  
Net income   $     5,550   $    5,293   5%   $ 13,207   $    10,306   28%  

Net income increased 5% to $5.6 million for the three months ended December 31, 2009 compared to $5.3 million for the same period last year. Net income increased 28% to $13.2 million for the six months ended December 31, 2009 compared to $10.3 million for the same period of 2008. In RMB, net income increased 20% to RMB 35.9 million for the three months ended December 31, 2009 compared to RMB 29.9 million in the second quarter of 2008. For the six months, net income in RMB increased 33% to RMB 83.6 million compared to RMB 62.8 million for the six months ended December 31, 2008. Net income for the three months ended December 31, 2009 was reduced as a result of a 0.7% decrease in gross profit, public company head office costs ($0.3 million), higher tax rate impact ($0.2 million) and increased subsidies ($0.4 million) to distributors to encourage expansion of the retail network.

Basic and Diluted Earnings Per Share

Basic and diluted earnings per share was 11 cents for the three months ended December 31, 2009 compared to 11 cents for the same quarter last year. Basic and diluted earnings per share was 26 cents for the six months ended December 31, 2009 compared to 21 cents for the same period of 2008. There were 61,500,000 shares issued and outstanding as at December 31, 2009. The weighted average number shares outstanding during the three and six months ended December 31, 2009 was 51,375,000 and 50,951,128, respectively. As a result of the application of continuity of interest accounting, all periods prior to the initial public offering completed on December 21, 2009 are deemed to have 50,000,000 shares issued and outstanding for the purpose of determining earnings per share.

Reorganization and Share Capital
On December 21, 2009, the Company completed a share exchange agreement with Southern whereby the 10,000 issued and outstanding common shares of Southern were exchanged for 50,000,000 common shares of the Company. On June 25, 2009, Southern, an investment holding company, acquired 100% ownership interest in Honorable which is an investment holding company based in Hong Kong. Honorable acquired 100% interest in Mengshida on July 25, 2008. 

These reorganization transactions were accounted for on a continuity of interest basis of accounting whereby the various assets and liabilities are accounted for at the carrying value in the combining companies' records. Current and comparative consolidated financial results are presented as if the companies have always been combined. The number of common shares outstanding has been restated for the purpose of determining earnings per share to reflect the reorganization.

The Company's fiscal year end is June 30, 2010. Accordingly these consolidated financial statements are for the three and six month periods ended December 31, 2009 with comparative figures for the same periods in 2008.

Initial Public Offering
On December 21, 2009, the Company completed its initial public offering ("IPO") by issuing 11,500,000 common shares at a price of $3.25 per common share, resulting in net proceeds of $33,040 after deducting the underwriters' fees and other related expenses of the offering.

The Company granted the underwriters an over-allotment option exercisable for a period of 30 days from closing of the IPO to purchase up to an additional 1,725,000 common shares at the issue price.

In addition, the underwriters received compensation options entitling them to acquire up to 7% of the number of common shares issued under the IPO including any shares exercised under the over-allotment option. Each compensation option will be exercisable for common shares at $3.25 per share until December 21, 2011.

Summary of Quarterly Results

The quarterly data that is available is disclosed as follows:

Quarter Ended   Dec 31 2009   Sept 30 2009   Dec 31 2008   Sept 30 2008  
Revenue   $              36,960   $           43,030   $           33,950   $           29,327  
Net income     5,550     7,657     5,293     5,013  
Earnings per share – basic and diluted   $                 0.11   $               0.15   $               0.11   $ 0.10  

Liquidity
The purpose of liquidity management is to ensure there is sufficient cash to meet all of the Company's financial commitments and obligations as they fall due. The Company believes that it has the flexibility to obtain, from current cash holdings and ongoing operations, the funds needed to fulfill its cash requirements during the current financial year. The Company's main source of funds is from the sales of its products to distributors and cash on hand. The Company's use of funds is primarily for its operating expenses including the payment for its production of footwear and outsourced production to third party suppliers.

The Company has a one year bank loan of $0.5 million that is due in July 16, 2010 and bears interest at the higher of 5.31% or the lending rate per Bank of China, reset every three months.

Through the Company's growth and expansion as well as the initial public offering completed on December 21, 2009, it has increased its cash on hand from $23.8 million as at June 30, 2009 to $58.0 million as at December 31, 2009. The Company's agreements with distributors provide for sales rebates that are offset against amounts owed by the distributor to limit the use of the Company's cashflow. The Company also commences its manufacturing of most products at the time that it enters into a binding production contract with the distributor to limit its inventory levels. Finished goods inventory increased during the period to $9.9 million as at December 31, 2009 from $1.6 million as at June 30, 2009. The higher level of finished goods inventory was a result of increased production during the quarter with subsequent shipping of the inventory in January, 2010. Accounts receivable also increased during the quarter as a result of the Company expanding the terms with certain distributors to provide support to them to open more retail store. As a result of the production of future months sales requirements in the second quarter of 2009, inventory as a percentage of cost of sales increased from 6% as at June 30, 2009 to 18% as at December 31, 2009.

At present, there are no known demands, commitments, events or uncertainties that would adversely affect the trends and expected fluctuations in the Company's liquidity. The Company believes it has the funds required, with the net proceeds from the initial public offering completed on December 21, 2009, to meet its business objectives and working capital and other cash requirements for at least twelve months. However, there can be no assurances that these funds will be sufficient and the Company may have to evaluate additional means of financing, including additional debt or equity financing.

Net cash provided/(used) by from operating activities for the three and six months ended December 31, 2009 and 2008 was ($4.6) million and $2.8 million, respectively. During the three months ended December 31, 2009, the increase in the accounts receivable and inventory balances generated a use of cash during the quarter. The growth in the business has been the main driver of the increased cash generated from operating activities and the decrease working capital requirement for the six months. Net cash generated by financing activities was $34.0 for the three and six months ended December 31, 2009. No dividends were paid out in 2009 or the six months ended December 31, 2008. Net cash generated during the three and six months ended December 31, 2009 and 2008 was $28.7 million, $34.3 million, $8.1 million and $10.9 million, respectively.

Working capital increased from $29.8 million as at June 30, 2009 to $72.9 million as at December 31, 2009 as a result of the growth in revenue and profitability.

Risk Factors
An additional risk factor was identified during the quarter being the Chinese government can issue income tax rules which have a retroactive application. On December 15, 2009, the State Administration of Taxation issued a taxation circular that has retroactive application to January 1, 2008. The Company's preliminary assessment is that this taxation circular has no financial impact to the Company.

For further risk factors see "Risk Factors" as contained in the Company's final long form prospectus filed on December 11, 2009 on SEDAR at www.sedar.com.

Capital Expenditures
The Company's capital expenditures primarily relate to its investment in the equipment required in its production lines. The Company expects to use a portion of the net proceeds from the Offering to further invest in equipment as well as to construct a new six story building during calendar year 2010.

Use of Proceeds
The Company completed its initial public offering on December 21, 2009 and received net cash proceeds of $34,759 after deducting the underwriter fees but prior to the issue costs of $1,720. As of December 31, 2009, there has been no variance in the Company's disclosure of its intended use of proceeds from the final prospectus dated December 11, 2009 and filed on SEDAR at www.sedar.com.

Intended Use of Proceeds   As disclosed   Update as ofDecember 31 2009  
Retail and Distribution Network Expansion   $              16,000   $              16,000  
Increase Production Capacity     7,000     7,000  
Brand Recognition, Awareness and Image     9,000     9,000  
Working Capital     2,800        
Net Proceeds   $              34,800        

While the Company intends to use the net proceeds as stated above, circumstances may arise where, for sound business reasons and in order to account for currency fluctuations, a reallocation of monies may be necessary or advisable.

Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.

Related Party Transactions
Directors of Mengshida have jointly provided personal guarantees to indemnify Mengshida on certain potential tax exposures including related interest and penalties for periods prior to 2006. As a result, the Company has recorded an other receivables from the directors of $1.2 million as at December 31, 2009 and June 30, 2009.

A loan was received from a director of Honorable for $0.5 million as at June 30, 2009 and December 31, 2008. The loan is not secured, is interest free and payable on demand.

Directors of Mengshida have jointly made personal guarantees to indemnify the Company for any premiums for social insurance in arrears in excess of RMB 4,465,000. One of the Directors has pledged 2,000,000 common shares of the Company owned by him for any potential liability that may become payable under this undertaking.

A corporation owned 50% by one of Zungui's Directors received $400,000 in cash and 700,000 stock options of the Company in trust for various parties as consideration for services rendered in connection with the initial public offering. The stock options were granted at $3.25 and vest in equal amounts over three years. A company controlled by the same Director received 440,000 of the 700,000 stock options granted by the Company. The above transactions were conducted in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to by the parties. 

Financial Instruments and Other Instruments
The Company held cash of $58.0 million on its balance sheet as at December 31, 2009. The Company does not have any cash equivalents or invested assets. The Company does not currently utilize any other instruments such as derivative financial instruments to reduce its exposure to interest rate risk. The Company's location in the Fujian Province is in close proximity to a large number of suppliers of raw materials required in the manufacturing of the Company's products creating procurement efficiency and, as a result, the Company does not need to enter into any forward future contracts to purchase raw materials. All of the Company's financial assets and financial liabilities are short term in nature and are measured on an ongoing basis at fair value or amortized cost.

Adoption of New Accounting Policies
The Company has a stock based compensation plan which is described in Note 9. The Company estimates the fair value of options granted to employees, non-employees directors and consultants using the Black-Scholes option pricing model. The Company recognizes the fair value as a compensation expense over the period that the stock options vest, with a corresponding increase to contributed surplus. When these stock options are exercised, the amount of the proceeds together with the amount recorded in contributed surplus, is recorded in share capital. 

Future Accounting Changes

Transition to IFRS
Canada's Accounting Standards Board ratified a strategic plan that will result in Canadian GAAP, as used by public companies, being evolved and converged with International Financial Reporting Standards ("IFRS") over a transitional period to be complete by 2011. The Company will be required to report using IFRS effective for interim and annual financial statements relating to the fiscal year ended June 30, 2012.

The Company expects the transition to IFRS to have an impact on financial reporting, business processes and information systems. The Company will begin a preliminary assessment during the third quarter of 2010. The Company will invest in training and resources through the transition process to facilitate a timely conversion.

Business Combinations, Consolidations and Non-Controlling Interests
In January 2009, the CICA issued Handbook Section 1582, Business Combinations replacing Section 1581, Business Combinations. Section 1582 will apply to a transaction in which the acquirer obtains control of one or more businesses (as defined in the Section). Most assets acquired and liabilities assumed, including contingent liabilities that are considered to be improbable, will be measured at fair value. A bargain purchase will result in the recognition of a gain. Acquisition costs will be expensed. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards. 

In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests replacing Section 1600, Consolidated Financial Statements. Section 1601 establishes standards for the preparation of consolidated financial statements and Section 1602 establishes standards for accounting for a non-controlling interest. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards.

Financial Instruments
In June 2009, the CICA revised section 3862 to include a hierarchy concept in measuring financial instruments, a requirement to provide disclosure concerning the fair value measurements of assets and liabilities for each hierarchy level and amendments to the liquidity disclosure requirements. The recommendations are effective for the Company's 2010 year end financial statements and MD&A. The Company is in the process of evaluating the impact of the revision to this standard.

 Zungui Haixi Corporation  
 Consolidated Balance Sheets  
 (Unaudited)  
 [Expressed in thousands of Canadian Dollars]  
 [Basis of Presentation – Note 1]  
   
         December 31 2009    June 30 2009  
Current assets              
    Cash       $        58,023   $            23,757  
    Accounts receivable, net         28,659     22,202  
    Prepaid expenses         461     510  
    Inventories (Note 4)         10,497     2,984  
    Other receivables (Note 7)         1,181     1,234  
    Future income taxes         65     61  
Total current assets         98,886     50,748  
                       
Property, plant and equipment (Note 5)         4,601     5,331  
Total assets       $      103,487   $             56,079  
                       
Current liabilities                  
    Accounts payable and accrued liabilities       $        21,143   $             15,624  
    Bank loan (Note 6)         460     511  
    Taxes payable         3,896     4,287  
    Due to related party (Note 7)         503     482  
Total current liabilities         26,002     20,904  
                   
Shareholders' equity                  
    Share capital (Notes 8 and 16)         31,224     -  
    Paid-in capital (Note 8)         -     -  
    Contributed surplus (Note 8)         3,003     1,174  
    Surplus reserve funds         1,938     1,938  
    Retained earnings         45,228     32,021  
    Accumulated other comprehensive income (loss)         (3,908)     42  
Total shareholders' equity         77,485     35,175  
                       
Total liabilities and shareholders' equity       $       103,487   $             56,079  

 Contingencies (Note 12) and Subsequent Event (Note 16)

The accompanying notes are an integral part of these consolidated financial statements

Approved By the Board

(Signed) "Michael W. Manley"

Director

(Signed) "Patrick A. Ryan"

Director

Zungui Haixi Corporation 
Consolidated Statements of Income and Comprehensive Income 
(Unaudited)  
[Expressed in thousands of Canadian Dollars, except per share data]
 
    Three Months Ended December 31   Six Months Ended December 31  
    2009   2008   2009   2008  
                   
Revenue (Note 11)   $    36,960   $    33,950   $    79,990   $ 63,277  
Cost of sales     27,455     24,983     58,744     46,351  
Gross profit     9,505     8,967     21,246     16,926  
Selling expenses     511     1,016     1,104     1,759  
General and administrative expenses     989     580     1,691     955  
Other income, net     (24)     (9)     (31)     (17)  
      1,476     1,587     2,764     2,697  
Income before income taxes     8,029     7,380     18,482     14,229  
                           
Income taxes     2,479     2,087     5,275     3,923  
                           
Net income     5,550     5,293     13,207     10,306  
Other comprehensive    income (loss):                          
  Unrealized gain(loss) on translation to Canadian reporting currency     (1,055)     2,624     (3,950)     3,263  
                           
Comprehensive income   $      4,495   $      7,917   $      9,257   $      13,569  
                           
Basic and diluted earnings per share (Note 8)   $               0.11   $          0.11   $        0.26   $          0.21  
                           
Weighted average number shares outstanding during the period     51,375,000     50,000,000     50,951,128     50,000,000  

The accompanying notes are an integral part of these consolidated financial statements

Zungui Haixi Corporation 
Consolidated Statements of Shareholders' Equity 
 (Unaudited)
 [Expressed in thousands of Canadian Dollars]
 
                        Accumulated      
                    Surplus   Other      
    Share   Paid-in   Contributed   Retained   Reserve   Comprehensive      
    Capital   Capital   Surplus   Earnings   Fund   Income   Total  
                               
Balance at June 30, 2008   $            -   $ 1,174   $               -   $     8,974   $ 1,938   $     (1,612)   $    10,474  
Reorganization of capital (Note 8)     -     (1,174)     1,174     -     -     -     -  
Net income for the three months     -     -     -     5,013     -     -     5,013  
Exchange difference on  translation to Canadian reporting currency     -     -     -     -     -     639     639  
Balance at September 30, 2008     -     -     1,174     13,987     1,938     (973)     16,126  
Net income for the three months     -     -     -     5,293     -     -     5,293  
Exchange difference on translation to Canadian reporting currency     -     -     -     -     -     2,624     2,624  
Balance at December 31, 2008   $           -   $         -   $ 1,174   $   19,280   $ 1,938   $      1,651   $    24,043  
                                             
Balance at June 30, 2009   $              -   $           -   $ 1,174   $   32,021   $ 1,938   $           42   $    35,175  
Net income for the three months     -     -     -     7,657     -     -     7,657  
Exchange difference on translation to Canadian reporting currency     -     -     -     -     -     (2,895)     (2,895)  
Balance at September 30, 2009     -     -     1,174     39,678     1,938     (2,853)     39,937  
Issuance of share capital (Note 8)     33,040     -     -     -     -     -     33,040  
Stock based compensation expense (Notes 8 and 9)     (1,816)     -     1,829     -     -     -     13  
Net income for the three months     -     -     -     5,550     -     -     5,550  
Exchange difference on translation to Canadian reporting currency     -     -     -     -     -     (1,055)     (1,055)  
                                             
Balance at December 31, 2009   $      31,224   $         -   $ 3,003   $   45,228   $ 1,938   $     (3,908)   $                    77,485  

The accompanying notes are an integral part of these consolidated financial statements

        Zungui Haixi Corporation 
         Consolidated Statements of Cash Flows
         (Unaudited)
        [Expressed in thousands of Canadian Dollars unless otherwise noted] 
         
            For the Three Months Ended   For the Six Months Ended  
            December 31   December 31  
            2009   2008   2009   2008  
                   
Cash flows from operating activities                  
    Net income   $       5,550   $     5,293   $     13,207   $                  10,306  
    Items not affecting cash:                          
        Depreciation     109     126     223     236  
        Future income taxes     -     (5)     (10)     (7)  
        Provision for doubtful accounts     164     2     167     25  
        Stock based compensation     13     -     13     -  
    Changes in non-cash working capital                          
        Accounts receivable     (5,400)     (543)     (9,071)     (835)  
        Prepaid expenses     6     135     -     (230)  
        Inventories     (3,780)     1,727     (8,029)     (305)  
        Other receivables     (44)     (43)     (71)     (74)  
        Accounts payable and accrued liabilities     (1,080)     (497)     6,252     (651)  
        Taxes payable     (106)     67     144     75  
Net cash provided by (used in) operating activities     (4,568)     6,262     2,825     8,540  
                                   
Cash flows from investing activities                          
    Property, plant and equipment     (16)     (1)     (16)     (9)  
    Proceed from sale of equipment     -     -     -     -  
Net cash used in investing activities     (16)     (1)     (16)     (9)  
                                   
Cash flows from financing activities                          
    Proceeds from bank loans     -     -     -     443  
    Repayment of bank loans     -     -     -     (443)  
    Due to related party     -     -     -     438  
    Increase in share capital     33,965     -     33,965        
Net cash provided by financing activities     33,965     -     33,965     438  
                           
Effect of exchange rate changes on cash     (685)     1,807     (2,508)     1,935  
                           
Net increase in cash     28,696     8,068     34,266     10,904  
                           
Cash, beginning of the period     29,327     7,860     23,757     5,024  
Cash, end of the period   $     58,023   $   15,928   $     58,023   $                  15,928  
                           
Supplemental disclosure of cash information                          
Interest paid in cash   $             20   $           32   $             54   $                  72  
Income taxes paid in cash     2,611     2,064     5,189     3,920  

The accompanying notes are an integral part of these consolidated financial statements

Zungui Haixi Corporation
Notes to Consolidated Financial Statements
For the three and six month periods ended December 31, 2009 and 2008
(Unaudited)
(Expressed in thousands of Canadian Dollars except per share and share amounts)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Zungui Haixi Corportaion ["Zungui" or "Company"] was incorporated under the Ontario Business Corporation Act on August 11, 2009. Zungui is a holding company listed on TSX Venture Exchange. Through its subsidiaries, Zungui manufactures and sells sports footwear and related apparel and accessories as well as leisure leather shoes in the People's Republic of China ( the "PRC" or "China"). Zungui's wholly owned subsidiaries include Southern Trends International Holding Company Ltd. ["Southern"], Honorable Int'l Investment Co., Limited ["Honorable"] and Mengshida Shoes Co., Ltd. Shishi City ["Mengshida"].

On December 21, 2009, the Company completed a share exchange agreement with Southern whereby the 10,000 issued and outstanding common shares of Southern were exchanged for 50,000,000 common shares of the Company. On June 25, 2009, Southern, an investment holding company, acquired 100% ownership interest in Honorable which is an investment holding company based in Hong Kong. Honorable acquired 100% interest in Mengshida on July 25, 2008. 

These reorganization transactions were accounted for on a continuity of interest basis of accounting whereby the various assets and liabilities are accounted for at the carrying value in the combining companies' records. Current and comparative consolidated financial results are presented as if the companies have always been combined. The number of common shares outstanding has been restated for the purpose of determining earnings per share to reflect the reorganization.

The Company's fiscal year end is June 30, 2010. Accordingly these consolidated financial statements are for the three and six month periods ended December 31, 2009 with comparative figures for the same periods in 2008.

2. INITIAL PUBLIC OFFERING

On December 21, 2009, the Company completed its initial public offering ("IPO") by issuing 11,500,000 common shares at a price of $3.25 per common share, resulting in net proceeds of $33,040 after deducting the underwriters' fees and other related expenses of the offering.

The Company granted the underwriters an over-allotment option exercisable for a period of 30 days from closing of the IPO to purchase up to an additional 1,725,000 common shares at the issue price.

In addition, the underwriters received compensation options entitling them to acquire up to 7% of the number of common shares issued under the IPO including any shares exercised under the over-allotment option. Each compensation option will be exercisable for common shares at $3.25 per share until December 21, 2011.

3. SIGNIFICANT ACCOUNTING POLICIES

These interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") for interim financial statements and are consistent with the accounting policies and methods of computation as were used in the preparation of the annual consolidated financial statements of Southern for the three years ended December 31, 2008 and the six months period ended on June 30, 2009. These interim consolidated financial statements do not contain all the information and disclosures required by GAAP applicable for annual consolidated financial statements and accordingly should be read in conjunction with Southern's audited consolidated financial statements which appear in Zungui's final long form prospectus dated December 11, 2009 and available on SEDAR at www.sedar.com. The results of the operations for the interim periods are not necessarily indicative of the full-year results.

(a) Foreign currency translation

The Company's primary economic activities are in China and the functional currency is Chinese Renminbi ("RMB") for its wholly owned subsidiary located in China. The Canadian head office's functional currency is Canadian dollars. The Company uses Canadian dollars as its reporting currency. The financial statements are translated into the reporting currency using the current rate method. Under this method, revenue and expenses of the Company are translated into reporting currency using weighted average exchange rates for the period and assets and liabilities are translated using the exchange rate at the end of the period. Capital transactions are translated using historical rates. All resulting exchange differences are reported as accumulated other comprehensive income (loss), which is presented as a separate component of shareholders' equity. 

The weighted average exchange rate for one RMB expressed in Canadian dollars for the three months ended December 31, 2009 and 2008 is 0.1547 and 0.1576, respectively and is 0.1772 and 0.1638 for the six months ended December 31, 2009 and 2008, respectively.

(b) Adoption of new accounting policies

Stock based compensation

The Company has a stock based compensation plan which is described in Note 9. The Company estimates the fair value of options granted to employees, non-employee directors and consultants using the Black-Scholes option pricing model. The Company recognizes the fair value as a compensation expense over the period that the stock options vest, with a corresponding increase to contributed surplus. When these stock options are exercised, the amount of the proceeds together with the amount recorded in contributed surplus, is recorded in share capital. 

(c) Future accounting changes

  1. Transition to IFRS

Canada's Accounting Standards Board ratified a strategic plan that will result in Canadian GAAP, as used by public companies, being evolved and converged with International Financial Reporting Standards ("IFRS") over a transitional period to be complete by 2011. The Company will be required to report using IFRS for interim and annual financial statements relating to the fiscal year ended June 30, 2012.

The Company expects the transition to IFRS to have an impact on financial reporting, business processes and information systems. The Company will begin a preliminary assessment during the third quarter of 2010. The Company will invest in training and resources through the transition process to facilitate a timely conversion.

  1. Business Combinations, Consolidations and Non-Controlling Interests

In January 2009, the CICA issued Handbook Section 1582, Business Combinations replacing Section 1581, Business Combinations. Section 1582 will apply to a transaction in which the acquirer obtains control of one or more businesses (as defined in the Section). Most assets acquired and liabilities assumed, including contingent liabilities that are considered to be probable, will be measured at fair value. A bargain purchase will result in the recognition of a gain. Acquisition costs will be expensed. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards. 

In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests replacing Section 1600, Consolidated Financial Statements. Section 1601 establishes standards for the preparation of consolidated financial statements and Section 1602 establishes standards for accounting for a non-controlling interest. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards.

(iii) Financial Instruments

In June 2009, the CICA revised section 3862 to include a hierarchy concept in measuring financial instruments, a requirement to provide disclosure concerning the fair value measurements of assets and liabilities for each hierarchy level and amendments to the liquidity disclosure requirements. The recommendations are effective for the Company's 2010 year end financial statements. The Company is in the process of evaluating the impact of the revision to this standard.

4. INVENTORIES

Inventories consist of:

    December 31,   June 30,  
    2009   2009  
Raw materials   $                  348   $           1,091  
Work in progress     297     332  
Finished goods     9,852     1,561  
Total inventory   $            10,497   $           2,984  

Inventories expensed as cost of goods sold were $27,441 and $24,961 for the three months ended December 31, 2009 and 2008, respectively, and $58,714 and $46,315 for the six months ended December 31, 2009 and 2008, respectively. No inventory writedowns occurred during these periods.

5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of:

    December 31, 2009   June 30, 2009  
    Cost   Accumulated Depreciation   Net Book Value   Cost   Accumulated Depreciation   Net Book Value  
Plant and building   $ 5,743   $       1,862   $ 3,881   $ 6,376   $        1,920   $ 4,456  
Machinery and production equipment     1,495     1,014     481     1,660     1,052     608  
Automobiles and trucks     377     162     215     404     163     241  
Office equipment     110     86     24     120     94     26  
Total   $ 7,725   $       3,124   $ 4,601   $ 8,560   $        3,229   $ 5,331  
               

Depreciation expense of $109 and $223 for the three and six months ended December 31, 2009, respectively and $125 and $235 for the three and six months ended December 31, 2008, respectively. Buildings with the net book value of $3,881 as of December 31, 2009 are provided as collateral for the bank loan (Note 6).

6. BANK LOAN

On July 23, 2008, the Company signed a one year term loan agreement with Bank of Agriculture Shishi branch to borrow $443 (RMB 3,000,000) at a floating interest rate of the aggregate of the bank prime rate plus an additional 20% of the bank prime rate. The loan matured and was fully repaid on July 17, 2009.

On July 17, 2009, the Company signed a one year term loan agreement with Bank of Agriculture Shishi branch to borrow $511 (RMB 3,000,000). The interest rate is the higher of 5.31% per annum or the lending rate per Bank of China, reset every 3 months. Interest is payable on a quarterly basis.

Interest expense was $20 and $70 for the three and six months ended December 31, 2009, respectively and was $43 and $77 for the three and six months ended December 31, 2008, respectively.

The bank loan is collateralized by the Company's buildings as referred to in Note 5.

7. RELATED PARTY TRANSACTIONS

  1. Directors of Mengshida have jointly made personal guarantees to indemnify Mengshida on certain potential tax exposures including the related interest and penalties arising in periods prior to 2006. Accordingly, the Company has recorded an other receivables from Directors.
      December 31, 2009     June 30, 2009  
Other receivables   $              1,181   $            1,234  
  1. Due to related party consists of a loan from a Director of Honorable totalling $503 (Hong Kong $3,210,000 and RMB 100,000) as at December 31, 2009 and $482 (Hong Kong $3,200,000 and RMB 100,000) as at June 30, 2009. These loans are unsecured, are interest free and are payable on demand.
  1. The Directors of Mengshida have jointly made personal guarantees to indemnify Mengshida for any premiums for social insurance in arrears in excess of RMB 4,465,000 as discussed in Note 12. One of the Directors has pledged 2,000,000 common shares of the Company owned by him for any potential liability that may become payable under this undertaking.
  2. A corporation 50% owned by one of Zungui's Directors received $400,000 in cash and 700,000 stock options of the Company in trust for various parties as consideration for services rendered in connection with the initial public offering. The stock options were granted at $3.25 and vest in equal amounts over three years. A company controlled by the same Director received 440,000 of the 700,000 stock options granted by the Company. The above transactions were conducted in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to by the parties. 

8. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS

  1. Share Capital:

As at December 31, 2009 the authorized share capital of Zungui was unlimited common shares with no par value. 

Share Capital   Shares Issued   Stock Options   Compensation Options   Weighted Average Exercise Price   Amount  
Balance as at August 11, 2009   1   -   -   -   $              -  
Share exchange transaction (Note 1)   50,000,000   -   -   -   -  
Initial public offering (Notes 2 and 8(i))   11,500,000   -   -   -   31,224  
Cancellation of share   (1)   -   -   -   -  
Stock options (Note 8(b)):   -   -   -       -  
    Granted   -   1,660,000   -   $         3.25   -  
Underwriter options (Note 8(c))   -   -   805,000   3.25   -  
  Balance as at December 31, 2009   61,500,000   1,660,000   805,000   $         3.25   $   31,124  
  1. The expenses of the initial public offering, including underwriters' fees and other related expenses, were $4,335. 
  1. As a result of the reorganization as described and the application of the continuity of interest accounting, all periods prior to the initial public offering completed on December 21, 2009 are deemed to have 50,000,000 shares issued and outstanding for the purposes of calculating earnings per share. 
  1. Stock Options:

In conjunction with the initial public offering, on December 21, 2009 the Company granted 700,000 stock options at an exercise price of $3.25 to consultants. The consultant's stock options vest equally over a three year period and as at December 31, 2009, none were vested nor exercisable. The stock options expire on December 21, 2014. The per share fair value of these grants was $1.44. Stock based compensation in the amount of $1,005 was deducted from share capital as part of the expenses of the offering.

In addition, 960,000 stock options were granted to employees and non-employee Directors as further discussed in Note 9. 

8. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS (Continued)

  1. Underwriter Options:

As described in Note 2, the Company granted the underwriters an over-allotment option to purchase up to an additional 1,725,000 common shares at $3.25 that expires within 30 days of the closing of the IPO. No stock based compensation was recorded for this option. The Company also granted the underwriters an option to purchase 805,000 common shares ("compensation options") at $3.25 for a period of 24 months. The per share fair value of these grants was $1.01. Stock based compensation in the amount of $811 was deducted from share capital as part of the expenses of the offering.

The fair value of the option grants in (b) and (c) above were estimated at the date of the grant using a Black-Scholes option pricing model with the following weighted average assumptions:

    December 31,  
    2009  
  Risk-free interest rate   1.59 – 2.46  
  Dividend yield   0.0%  
  Expected volatility   54.3%  
  Expected option life (in years)   2 - 4  

Expected volatility is based on the historical volatility of companies in comparable industries. The risk-free interest rate is based on yields of Government of Canada T-bills with similar maturities. The expected option life was estimated based on vesting schedule of the stock options and the expiry dates for both the stock and compensation options. 

  1. Paid in Capital:

As part of the reorganization referred to in Note 1, the paid in capital of Mengshida ($1,174) became the contributed surplus of the Company.

According to the registration document filed with the PRC government agency on April 30, 2008, the Company is required to increase its additional capital investment in Mengshida to $3,003 (RMB 20,000,000) within 2 years from the date of the filing. On December 28, 2009 $1,760 (RMB 11,223,825) in additional capital was injected to fulfill this requirement.

9. STOCK BASED COMPENSATION

The Company has a stock option plan to incentive directors, officers, consultants and employees. In accordance with the stock option plan, the term of any stock option grant cannot exceed five years and no more than 10% of Company's common shares are reserved for stock option grants. On December 21, 2009, the Company granted 960,000 stock options at an exercise price of $3.25 to Company employees and directors with an expiry date of December 21, 2014. The stock options vest equally over a three year period and as at December 31, 2009, none were vested nor exercisable. The per share fair value of these grants was $1.44. The fair value of the options grants was estimated at the date of the grant using a Black-Scholes option pricing model with the following weighted average assumptions:

    December 31,  
    2009  
Risk-free interest rate   2.46  
Dividend yield   0.0%  
Expected volatility   54.3%  
Expected option life (in years)   4  

Expected volatility is based on the historical volatility of companies in comparable industries. The risk-free interest rate is based on yields of Government of Canada T-bills with similar maturities. During the three months ended December 31, 2009, stock based compensation expense was $13.

10. MAJOR CUSTOMERS AND SUPPLIERS

The Company sells products to various customers. There were no customers that purchased more than 10% of the Company's products for the three or six month periods ended December 31, 2009 and 2008.

During the three month period ended December 31, 2009, purchases from three suppliers, each represented 18% ($5,208), 17% ($5,070), and 17% ($5,070) of total purchases. During the three month period ended December 31, 2008, purchases from two suppliers represented 14% ($2,767) and 11% ($2,054) of the total purchases. During the six month period ended December 31, 2009, purchases from three suppliers, each represented 18% ($11,569), 18% ($11,500), and 18% ($11,330) of total purchases. During the six month period ended December 31, 2008, purchases from two suppliers represented 15% ($5,709) and 11% ($4,292) of the total purchases.

11. REVENUE

    Three Months Ended December 31,   Six Months Ended December 31,  
    2009   2008   2009   2008  
Revenue                  
  Footwear   $ 31,163   $ 28,491   $    68,241   $ 52,930  
  Apparel and accessories     5,797     5,459     11,749     10,347  
Revenue   $ 36,960   $ 33,950   $    79,990   $ 63,277  

12. CONTINGENCIES

Pursuant to the relevant laws and regulations of the PRC, the Company makes contributions to the local Labour and Social Security Bureaus based on a rate determined by the local bureaus. The process of determining this rate involves uncertainties and judgments on the part of the Bureaus. Significant estimates and judgement are applied by management to determine the appropriate amount of social insurance to be paid. The Directors of Mengshida have jointly made personal guarantees to indemnify the Company for any premiums for social insurance in arrears and all related fines, penalties, interest and other payments in excess of RMB 4,465,000 ($684) that the Company may be required to make relating to periods prior to December 31, 2009 in the event of a dispute or settlement with the applicable government authorities. See Note 7(c).

13. FINANCIAL INSTRUMENTS

Financial assets and financial liabilities are measured on an ongoing basis at fair value or amortized cost. Fair value estimates are made at a specific point in time, using available information about the financial instrument. These estimates are subjective in nature and involve uncertainties and the exercise of significant judgement. The fair value of financial assets and financial liabilities approximates their carrying value due to their short term maturity. The classification of the financial instruments as well as their carrying values is shown in the table below:

December 31, 2009   Held for trading   Loans and Receivables   Other financial liabilities   Total Carrying Value  
Financial assets                  
Cash   $ 58,023   $              -   $              -   $           58,023  
Accounts receivable     -     28,659           28,659  
Other receivables     -     1,181           1,181  
    $ 58,023   $   29,840   $              -   $           87,863  
                           
Financial liabilities                          
Accounts payable and accrued liabilities   $            -   $            -   $    21,143   $          21,143  
Bank loan     -     -     460     460  
Due to related party     -     -     503     503  
    $            -   $            -   $    22,106   $          22,106  
June 30, 2009  
    Held for   Loans and   Other financial   Carrying value  
    trading   Receivables   Liabilities   Total  
Financial assets                  
  Cash   $ 23,757   $            -   $            -   $   23,757  
Accounts receivable     -     22,202     -     22,202  
Other receivables     -     1,234     -     1,234  
    $ 23,757   $ 23,436   $            -   $   47,193  
                           
Financial liabilities                          
Accounts payable and accrued liabilities   $            -   $            -   $ 15,624   $   15,624  
Bank loan     -     -     511     511  
Due to related party     -     -     482     482  
    $            -   $            -   $ 16,617   $   16,617  

Financial risk management

Financial risk is the risk to the Company's earnings that arises from fluctuations in market risk (including interest rate risk, foreign currency risk), credit risk and liquidity risk and the degree of volatility of these rates. The Company's business practices seek to minimize any potential adverse effects on the Company's financial performance.

The Company's financial instruments that are included in the consolidated balance sheets are comprised of cash, accounts receivable, other receivables, accounts payable and accrued liabilities, bank loans and due to related party. As at the balance sheet date, there are no significant differences between the carrying value of these items and their estimated fair values because they are short-term in nature.

Market risk

Interest risk

Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company's exposure to interest rate fluctuations is primarily related to the bank loan from Bank of Agriculture Shishi branch under its existing term loan which bears interest at a floating rate that is reset every three months. The Company does not use any derivative financial instruments to reduce its exposure to interest rate risk.

The potential effect of a 100 basis points increase or decrease in interest rates on the Company's net income assuming all other variables remain constant would be $5 and $1 for the three months ended December 31, 2009 and 2008, respectively and $8 and $3 for the six months ended December 31, 2009 and 2008, respectively.

Foreign Currency risk

Foreign currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign currency exchange rates. The Company has no financial instrument related to currency risk. The translation of foreign operations to the reporting currency is not taken into account.

Credit risk

Credit risk is the risk that a counterparty to a financial instrument will default on its obligations. The Company's maximum exposure to credit risk consists of the carrying value of its cash, accounts receivable and other receivables. The Company places its cash with a PRC regulated financial institution.

Credit risk with respect to accounts receivable is mitigated through the sales to numerous different customers. No customer accounted for more than 10% of total sales. In addition, the Company evaluates the financial position of its customers and regularly reviews their credit limit. Allowances are established with regards to potential losses. The Company was not exposed to any particular credit risk concentration for the three or six months ended December 31, 2009 and 2008, respectively. 

Liquidity risk

Liquidity risk is the risk that the Company is not able to meet its financial obligations as they become due. The Company finances its operations through a combination of the cash flows from operating activities and bank loans. The Company's goal is to maintain an optimal level of liquidity through the active management of the assets and liabilities as well as the cash flows. As at December 31, 2009, the Company had a $460 bank loan with a July 16, 2010 due date, $21,143 in accounts payable and accrued liabilities and due to related party $503. All financial liabilities have contractual maturities of less than one month as of December 31, 2009.

14. CAPITAL DISCLOSURE

The Company's objectives when managing capital is to safeguard the entity's ability to continue as a going concern and continue to provide returns and benefits for its shareholder. The Company's capital is defined as interest-bearing bank loans and shareholders' equity as presented on the consolidated balance sheet excluding accumulated other comprehensive income (loss). The Company's capital is as follows:

    December 31,   June 30,  
    2009   2009  
Bank loan   $         460   $         511  
Shareholders' equity excluding accumulated other comprehensive income (loss)     81,394     35,133  
    $   81,854   $   35,644  

The Company does not establish quantitative return on capital criteria for management or internally imposed restrictions, but rather promotes year-over-year sustainable profitable growth. The Company may adjust its capital mix in order to manage its capital structure.

The Company is subject to externally imposed capital requirements for the paid in capital of Mengshida. There has been no change with respect to the overall capital risk management strategy as at December 31, 2009.

15. SEGMENTED INFORMATION

The Company's business is considered as operating in one segment based upon the Company's organizational structure, the way in which the operation is managed and evaluated, the availability of separate financial results and materiality considerations. All revenues are generated in China and substantially all of the Company's capital assets are located in China.

16. SUBSEQUENT EVENT

On January 12, 2010, the Company issued 759,500 common shares in conjunction with the exercise of the over-allotment option by the underwriters, with net proceeds of $2,223 received. An additional 53,165 compensation options, as described in Note 2, were issued to the underwriters in conjunction with the completion of the over-allotment. 

Contact Information

  • Zungui Haixi Corporation
    Ms. Shelly Gobin
    Chief Financial Officer
    416.862.0887