Zungui Haixi Corporation
TSX VENTURE : ZUN

Zungui Haixi Corporation

May 26, 2011 07:00 ET

Zungui Haixi Reports Higher Earnings Per Share for Q3 2011 on Strong Revenue Growth of 34%

TORONTO, ONTARIO--(Marketwire - May 26, 2011) - Zungui Haixi Corporation (TSX VENTURE:ZUN), a China-based manufacturer of sportswear and casual footwear, today announced its financial results for the three and nine months ended March 31, 2011. All amounts are in Canadian dollars unless otherwise indicated.

"We are very pleased to report a continuation of our strong growth for the quarter which is a product of the continued success the ZUNGUI brand is realizing in new and existing markets," said Mr. Yanda Cai, Chief Executive Officer. "In addition to continued strong revenue growth of 34%, we grew our earnings per share and improved our gross margin while continuing to make substantial investments in our future, including expending significant resources in marketing our brand, developing our corporate store network and incentivizing our distributors. We have begun construction on our new ten storey building and are working diligently to complete the upgrades on our five existing productions lines that will supplement our production capacity."

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

  • Diluted earnings per share ("EPS") of 9 cents for the quarter compared to 8 cents for the same quarter last year;
  • Excluding the increased advertising expenses of $1.4 million and subsidy provisions of $1.4 million, EPS would have been 12 cents or a 44% increase over the same quarter last year;
  • Revenue increased 34% to $44.6 million for the quarter and 26% to $142.9 million for the year-to-date;
  • In RMB, revenue increased 36% to RMB 297.8 million for the quarter and 30% to RMB 941.0 million for the year-to-date;
  • Revenue before subsidies increased 38% to $46.2 million for the quarter and 30% to $148.8 million for the year-to-date;
  • Gross margin improved to 27.2% for the quarter compared to 26.7% for the same quarter last year;
  • Added 30 net new distributor owned retail outlets compared to 15 in the same quarter last year;
  • Opened 3 net new corporate-owned retail outlets in the quarter;
  • Corporate-owned retail outlets reported third quarter revenue of $2.9 million ($5.2 million year-to-date) compared to $0.1 million ($0.3 million year-to-date) for the same quarter last year reflecting a start up phase of development;
  • Selling expenses increased $3.2 million in the quarter compared to the same quarter last year primarily due to increased advertising expenditures of $1.4 million and operating expenses of the corporate stores of $1.4 million;
  • Net income increased 4% to $5.4 million for the quarter and decreased 5% to $17.4 million for the year-to-date on increased subsidy provisions to distributors and selling expenses; and,
  • Diluted EPS of 28 cents for the year-to-date compared to 34 cents for the same period last year on a 14% increase in the weighted average number of shares outstanding in the period and increased advertising expenses and subsidy provisions of $9.7 million which impacted the EPS by 12 cents.

On a trailing 12 month basis, the Company's revenue was $193.5 million, net income was $26.0 million and diluted EPS was 42 cents.

Conference Call

Zungui will host a conference call to discuss the first quarter results at 9am (EDT) May 26, 2011. The details are as follows:

Dial-in number: 1-877-440-9795 or 416-340-8527
Taped rebroadcast (until midnight on June 9, 2011): 1-800-408-3053
Taped replay access passcode: 2366382

About Zungui Haixi

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 Haixi distributes its products to consumers throughout China through an extensive network of retail outlets which exclusively carry ZUNGUI branded products. There are 62,080,400 common shares issued and outstanding. The corporate website is www.zunguihaixi.com.

Caution Regarding Forward-Looking Statements

Certain statements in this press release contain forward-looking information that involve risk and uncertainties. Statements other than statements of historical fact contained in this press release 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, those listed in 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 press release. The forward-looking statements contained in this press release 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 press release 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.

Zungui Haixi Corporation

Management's Discussion and Analysis of Financial Condition and Results of Operation

For the three and nine months ended March 31, 2011

All amounts in thousands of Canadian dollars unless otherwise stated

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 month and nine months ended March 31, 2011 with comparative figures for the three and nine months ended March 31, 2010. Zungui became the parent company of Southern Trends International Holding Company Limited ("Southern"), 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 financial statements. The MD&A should be read in conjunction with the audited consolidated financial statements for the year ended June 30, 2010, and the notes contained therein, and the unaudited consolidated financial statements for the three and nine months ended March 31, 2011 and the notes contained therein. The unaudited interim 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. Additional information relating to the Company can be found at www.sedar.com.

Disclosure contained in this MD&A is current to May 25, 2011 the date of approval of the MD&A and financial statements by the Board of Directors.

Caution Regarding Forward-Looking Statements

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 People's Republic of China (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; dependency on certain of its key executives, design, technical and other personnel; failure to effectively integrate additional corporate-owned and managed retail outlets; strong competition; the loss, or decrease in, sales to Zungui's major distributors; 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 maintain and cultivate key relationships; 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 relating to holding companies; risks associated with dividends; conflict of interests of directors and officers; limited recourse against principal securityholder and existing shareholders; disclosure controls and procedures and internal controls over financial reporting; language barriers between certain directors and officers of the Company; influence by the majority shareholder; future sales of common shares; 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. 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.

Contents of MD&APage
Overview3
Selected Financial Information3
Factors Affecting the Results of Operations4
Results of Operations5
Summary of Quarterly Results9
Liquidity and Capital Resources9
Capital Structure10
Off-Balance Sheet Arrangements11
Use of Proceeds12
Related Party Transactions12
Financial Instruments and Other Instruments13
Recent Accounting Changes13
Outlook14

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") in the PRC. Both product lines are marketed under the well-recognized ZUNGUI brand. As of March 31, 2011, Zungui distributes its products to consumers through 103 corporate-owned retail outlets, 83 of which offer the Sportswear Product Line and 20 of which offer the Casual Product Line, and through 47 distributors, who in turn sell products via an extensive network of 1,965 retail outlets, 1,555 of which offer the Sportswear Product Line and 410 of which offer the Casual Product Line. All retail outlets exclusively sell products which carry the ZUNGUI brand.

Net new store openings

Q1Q2Q3Total
Corporate1356372
Distributor1205330203

During the three and nine months ended March 31, 2011, the Company focused on revenue growth and increased profitability through the expansion of its retail network. It provided services and training and accrued subsidies to distributors to help meet customer needs and network expansion. As well the Company increased its advertising expenditures by $4.9 million for the nine months ended March 31, 2011 to build brand recognition. For the three months ended March 31, 2011, revenue grew 34% to $44.6 million from $33.3 million compared to same period last year. In Renminbi ("RMB"), revenue grew 36% to RMB 297.8 million from RMB 218.7 million last year. The lower growth rate in Canadian dollars is attributable to the fluctuations in the Chinese currency relative to the Canadian dollar reporting currency in 2010 and 2011.

Selected Financial Information

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 nine months ended March 31, 2011.

Earnings DataFor the three months ended
March 31
For the nine months ended
March 31
2011201020112010
Revenue$44,628$33,342$142,930$113,332
Cost of sales32,48424,442105,51983,186
Gross profit12,1448,90037,41130,146
Selling expenses3,2074599,2421,563
Research and development expenses195152598439
General and administrative expenses1,3591,0913,6792,495
Other expenses (income), net(73)159(19)
Income tax expense2,0721,9896,4447,264
Net income$5,384$5,194$17,439$18,401
Earnings per share – basic and diluted$0.09$0.08$0.28$0.34

Balance Sheet Data
As at March 31, 2011As at June 30, 2010
Cash$65,258$85,876
Inventories12,5823,498
Property, plant and equipment9,1936,470
Total assets124,649131,705
Working capital99,05089,532
Retained earnings71,92956,161
Total shareholders' equity108,24396,003

Factors Affecting Results of Operations

Foreign Currency

All of the Company's revenues and expenses, other than the corporate expenses, are generated in the PRC. Accordingly, the results of operations are impacted by the fluctuation of the RMB against the Canadian dollar when converted for financial reporting purposes. The weighted average exchange rate for one RMB, expressed in Canadian dollars, for the three months ended March 31, 2011 and 2010 was 0.1498 and 0.1524 and for the nine months ended March 31, 2011 and 2010 was 0.1485 and 0.1488. The movement of the Chinese currency relative to the Canadian dollar in the three and nine months ended March 31, 2011 resulted in the statement of operations in Canadian dollars being 2% less for the three months ended March 31, 2011 than if the Company had used the average exchange rate for the three month ended March 31, 2010 and 3% greater for the nine month period ended March 31, 2011 if the Company had used the average exchange rate for the nine month period ended March 31, 2010.

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 Company's 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 and nine months ended March 31, 2011 and 2010, immediately prior to their conversion to Canadian dollars.

In RMBFor the three months ended
March 31
For the nine months ended
March 31
2011201020112010
RevenueRMB 297,829RMB 218,725RMB 940,980RMB 725,541
Cost of sales216,777160,339694,605532,612
Gross profit81,05258,386246,375192,929
Net income35,93234,063114,752117,616
Weighted average exchange rate for one RMB, expressed in Canadian dollars0.14980.15240.14850.1488

Revenues

The Company's revenues consist of sales from footwear, apparel and accessories sold within the PRC. The Company provides sales rebates, advertising contributions and subsidies 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 although the Company is modestly affected by the Chinese New Year typically held in the third quarter of the fiscal year.

Results of Operations Three and Nine Months Ended March 31, 2011 compared to March 31, 2010

(Amounts in thousands of dollars, unless specified otherwise)

Revenue

The Company derives its revenue from two distribution channels: distributors and corporate-owned retail outlets. Total revenue increased 34% to $44.6 million for the three months ended March 31, 2011 compared to the third quarter of last year. In RMB, revenue increased 36% to RMB 297.8 million for the three months ended March 31, 2011 compared to RMB 218.7 million for the same period last year. The strengthening of the Canadian dollar during the quarter relative to the RMB reduced the percentage increase in revenue reported in Canadian dollars.

Total revenue increased 26% to $142.9 million for the nine months ended March 31, 2011 compared to the same period last year. In RMB, revenue increased 30% to RMB 941.0 million compared to the first nine months of last year. The strengthening of the Canadian dollar for the nine months ended March 31, 2011 relative to the RMB reduced the percentage increase in revenue reported in Canadian dollars.

Revenue by Product Line

For the three months ended March 31For the nine months ended March 31
2011% of Total2010% of Total2011% of Total2010% of Total
Footwear$37,30380.8$27,98283.7$126,55785.0$97,14284.8
Apparel and accessories
8,851

19.2

5,468

16.3

22,290

15.0

17,372

15.2
46,154100.033,450100.0148,847100.0114,514100.0
Subsidy provision
1,526

108

5,917

1,182
Total$44,628$33,342$142,930$113,332

Total revenue before subsidy provision increased 38% to $46.2 million for the three months ended March 31, 2011 compared to the third quarter of last year.

Footwear revenue increased 33% to $37.3 million for the three months ended March 31, 2011 compared to the same period last year, and was comprised of $31.4 million (Q3 2010 - $24.0 million) in revenue from athletic footwear and $5.9 million (Q3 2010 - $4.0 million) from casual footwear. Footwear units sold during the quarter increased to 2.6 million compared to 2.1 million for the same quarter last year. Apparel and accessories revenue increased 62% to $8.9 million for the three months ended March 31, 2011 compared to the same period of last year. The growth in revenue was the result of increased number of retail outlets (2,068 retail outlets in total compared to 1,734 at March 31, 2010), increased consumer demand and selling price increases implemented at the end of March 31, 2010.

Total revenue before subsidies increased 30% to $148.8 million for the nine months ended March 31, 2011 compared to the same period last year. Footwear units sold during the nine months ended March 31, 2011 increased to 9.0 million compared to 7.2 million for the same period last year.

In RMB, the Company's revenue per average number of retail outlets increased 18% to RMB 0.2 million during the three months ended March 31, 2011 compared to the same period last year. For each of the three months ended March 31, 2011 and 2010, 93.7% and 99.7% of the Company's revenue was derived from its wholesale distribution channel, respectively. The corporate stores contributed $2.9 million of revenue for the three months ended March 31, 2011 and $5.2 million for the nine months ended March 31, 2011.

Cost of Sales

For the three months ended March 31For the nine months ended March 31
2011% of Total2010% of Total2011% of Total2010% of Total
Footwear (internal production)
Raw materials$7,40322.8$9,78040.0$32,11730.5$29,96636.0
Labour1,0833.31,4235.84,3614.13,6344.4
Manufacturing costs5941.86282.62,4122.31,6432.0
Subtotal9,08027.911,83148.438,89036.935,24342.4
Footwear (outsourced production)17,08452.68,58835.150,66148.035,14042.2
Apparel and accessories (outsourced production)6,32019.54,02316.515,96815.112,80315.4
Total$32,484100.0$24,442100.0$105,519100.0$83,186100.0

During the three months ended March 31, 2011, cost of sales increased 33% to $32.5 million compared to last year. In RMB, cost of sales increased 35% to RMB 216.8 million for the three months ended March 31, 2011. Employee labour rates increased 10% in February, 2011 for production workers, however, labour costs represent 12% of internal production costs and are not expected to have a significant impact on the Company's gross margin. Outsourced production accounted for 65% of the footwear units sold compared to 42% for the same quarter last year.

During the nine months ended March 31, 2011, cost of sales increased 27% to $105.5 million compared to the first nine months of fiscal 2010. In RMB, cost of sales increased 30% to RMB 694.6 million. Outsourced production accounted for 57% of the footwear units sold during the nine months ended March 31, 2011compared to 53% for the same period last year.

The Company expects to have additional increased production capacity in June 2011 when the installation and testing of the existing five production lines will be completed.

Gross Profit

For the three months ended March 31For the nine months ended March 31
2011Gross
Margin
%
2010Gross
Margin %
2011Gross
Margin
%
2010Gross
Margin
%
Footwear$9,90527.5$7,47826.8$31,95426.3$25,75526.8
Apparel and accessories
2,239

26.2

1,422

26.1

5,457

25.5

4,391

25.5
Total$12,14427.2$8,90026.7$37,41126.2$30,14626.6

The gross margin improved for the three months ended March 31, 2011 compared to the same quarter last year on a positive impact of 2.4 percentage points from the corporate stores which have a higher gross margin. Excluding the corporate stores, the gross margin declined to 24.8% (26.8% for the same quarter last year) based on increased cost of goods sold and a subsidy provision of $1.5 million for the three months ended March 31, 2011.

Excluding the corporate stores, the gross margin declined to 24.9% (26.8% for the same period last year) based on increased cost of goods sold and a subsidy provision of $5.9 million for the nine months ended March 31, 2011.

Selling Expenses

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Increase
Selling expenses$ 3,207$ 459600%$ 9,242$ 1,563492%

The Company spent $1.8 million ($6.3 million for the year to date) on advertising during the three months ended March 31, 2011 compared to $0.4 million ($1.4 million for the year to date) for the same quarter last year as the Company continued with its advertising campaign to increase brand recognition predominantly through television commercials and outdoor billboard advertising. Selling expenses were increased by $1.4 million on the operating expenses of the corporate owned retail outlets which are currently still in the start up phase of operations. Selling expenses represented 7.2% and 1.4% of total revenue for the three months ended March 31 2011 and 2010, respectively, and were 6.5% and 1.4% of total revenue for the nine months ended March 31 2011 and 2010, respectively.

Research and Development Expenses

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Increase
Research and development expenses$ 195$ 15229%$ 598$ 43936%

Research and development expenses increased during the three and nine months ended March 31, 2011 as the Company invested additional funds on expanding its research and development centre and the number of new products being developed.

General and Administrative Expenses

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Increase
General and administrative expenses$ 1,359$ 1,09124%$ 3,679$ 2,49547%

Corporate expenses related to being a public company, including salaries, directors fees, audit fees and stock compensation expenses totalled $0.5 million and $1.4 million during the three and nine months ended March 31, 2011 compared to $0.4 million and $0.7 million for the same periods of the prior year. General and administrative expenses represented 3.0% and 3.3% of total revenue for the three months ended March 31, 2011 and 2010, respectively and 2.6% and 2.2% of total revenue for the nine months ended March 31, 2011.

Other Expenses (Income), net

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Decrease
Other expense (income), net$ (73)$ 15587%$ 9$ (19)147%

Other expenses, net include interest income of $0.06 million for the three months ended March 31, 2011. For the nine months ended March 31, 2011, the net expense includes a loss of $0.2 million on the disposition of several buildings that were demolished during the first quarter as part of preparation of the new building construction.

IncomeTax Expense

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Decrease
Income tax expense$ 2,072$ 1,9894%$ 6,444$ 7,26411%

The statutory income tax rate in the PRC is 25% and in Canada is 33%. During the first quarter, the Company implemented procedures to reduce the level of non-deductible expenses in the PRC which lowered the effective tax rate in the quarter to 26% compared to 28% for the same quarter last year. Tax losses in Canada for which no accounting benefit has been recognized further increased the effective tax rate tax to 27% for the three months ended March 31, 2011 compared to 28% last year.

Net Income

For the three months ended March 31For the nine months ended March 31
20112010Increase20112010Decrease
Net income$ 5,384$ 5,1944%$ 17,439$ 18,4015%

Net income increased 4% to $5.4 million for the three months ended March 31, 2011 compared to the same period last year. In RMB, net income increased 6% to RMB 35.9 million for the three months ended March 31, 2011 compared to RMB 34.1 million in the third quarter of last year. Revenue growth before subsidy provisions increased 38% over the third quarter of 2010 and subsidy provisions increased $1.4 million over the same period last year. A combination of increased sales to distributors and revenues from corporate owned stores generated an additional $3.2 million of gross profit which was offset by increases in selling expenses of $2.7 million (primarily operating costs of corporate stores and advertising expenses) and general and administrative expenses of $0.3 million resulting in higher net income by $0.2 million or 4%.

Net income decreased 5% to $17.4 million for the nine months ended March 31, 2011 compared to the nine months ended March 31, 2010. Revenue growth before subsidy provision increased 30% over the nine months ended March 31, 2010 and subsidy provisions increased $4.7 million over the same period last year. A combination of increased sales to distributors and revenues from corporate owned stores generated an additional $7.3 million of gross profit which was offset by increases in selling expenses of $7.7 million (primarily operating costs of corporate stores and advertising expenses), increased general and administrative expenses of $1.2 million (primarily corporate head office expenses) and lower income taxes of $0.8 million resulting in a lower net income by $1.0 million or 5%.

Basic and Diluted Earnings Per Share

Basic and diluted earnings per share was 9 cents for the three months ended March 31, 2011 compared to 8 cents for the same quarter last year and was 28 cents for the nine months ended March 31, 2011 compared to 34 cents for the first nine months of fiscal 2010. There were 62,080,400 shares issued and outstanding as at March 31, 2011. The weighted average number shares outstanding during the three months ended March 31, 2011 and 2010 was 62,114,261 and 62,166,672, respectively and for the nine months ended March 31, 2011 and 2010 was 62,157,742 and 54,508,112 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.

Summary of Quarterly Results

The following table is a summary of the selected quarterly financial information for each of the eight quarters ended March 31, 2011. The results over the last eight quarters are impacted by the fluctuation of the RMB against the Canadian dollar. Revenue has increased over the past eight quarters as a result of the expansion of the number of distributor and corporate owned retail outlets by 33% from 1,557 retail outlets at April 1, 2009 to 2,068 retail outlets as at March 31, 2011.

Quarter EndedMar 31
2011
Dec 31
2010
Sept 30
2010
June 30
2010
Mar 31
2010
Dec 31
2009
Sept 30
2009
June 30
2009
Revenue$44,628$47,877$50,425$50,553$33,342$36,960$43,030$44,349
Net income5,3844,9997,0568,5755,1945,5507,6577,597
Earnings per share – basic and diluted$0.09$0.08$0.11$0.14$0.08$0.11$0.15$0.15

Liquidity and Capital Resources

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 been expanding and utilizing cash to increase its brand recognition, support its' growth in retail outlets and shorten the payment cycle. As a result, the cash on hand has decreased from $85.9 million as at June 30, 2010 to $65.3 million as at March 31, 2011. The cash on hand is expected to decrease next quarter as the Company anticipates beginning construction of its new building which will be financed from existing cash on hand and operating cash flow.

The Company commences its manufacturing or outsourcing of most products at the time that it enters into a binding sales contract with the distributor. Finished goods inventory increased to $12.6 million as at March 31, 2011 compared to $4.1 million as at March 31, 2010. Finished goods inventory was higher as at March 31, 2011 as a result of the timing of outsourced manufacturing orders. The other components of inventory decreased 50% to $0.9 million.

Accounts receivable decreased to $33.3 million as at March 31, 2011 compared to $34.1 million as at June 30, 2010 and $23.7 million as at March 31, 2010. The days sales outstanding is 63 days for the three months ended March 31, 2011 compared to 60 days for the year ended June 30, 2010 and 71 days for the three months ended March 31, 2010. The Company has not experienced any increase in bad debts or increased provision for allowance for doubtful accounts.

Accounts payable decreased to $12.1 million as at March 31, 2011 compared to $30.3 million as at June 30, 2010 and $15.9 million as at March 31, 2010. The Company has been shortening the payment terms to its supplier.

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 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 used by operating activities for the three and nine months ended March 31, 2011 was $14.1 million and $11.6 million, respectively compared to net cash provided of $10.6 million and $13.7 million for the comparable periods of fiscal 2010. During the three months ended March 31, 2011, the increased inventory of finished goods, the disbursement of subsidy payments and the reduction of accounts payable increased the use of cash in the quarter. No dividends were paid out during the three or nine months ended March 31, 2011 and 2010. Net cash provided/(used) during the three months ended March 31, 2011 and 2010 was ($16.4) million and $10.2 million, respectively. During the nine months ended March 31, 2011 and 2010, net cash provided/(used) was ($20.6) million and $44.5 million. The Company's initial public offering raised cash of $34.0 million during the nine months ended March 31, 2010 which the Company has been disbursing in fiscal 2011.

Working capital increased from $89.5 million (RMB 572.5 million) as at June 30, 2010 to $99.0 million (RMB 667.0 million) as at March 31, 2011 as a result of the growth in revenue and profitability.

Capital Expenditures

The Company's capital expenditures primarily relate to its investment in equipment to upgrade its production lines and leasehold improvements for the corporate-owned retail outlets. The Company will complete the installation and testing of its upgraded five existing production lines in June, 2011. The Company has recently commenced construction of a new ten storey building. The Company expects to complete construction of the building and installation of two new production lines by the end of the fourth quarter of fiscal 2012, barring any construction delays, at a cost of approximately $7 million. Additional research and development and quality control equipment will also be installed at a cost of approximately $3 million.

Capital Structure

Shares Outstanding

As of March 31, 2011, the Company has 62,080,400 common shares issued and outstanding. As of May 25, 2011, the date of this MD&A, the Company has 62,080,400 common shares issued and outstanding.

Normal Course Issuer Bid

On September 17, 2010 the Company announced approval from the TSX Venture Exchange to proceed with a normal course issuer bid. The Company can purchase for cancellation, at market prices, up to 3,112,975 of its issued and outstanding common shares, representing 5% of the 62,259,500 common shares outstanding as at September 29, 2010. The Bid commenced on October 4, 2010 and will terminate on October 3, 2011, or on such earlier date as the Bid is completed or otherwise terminated by Zungui.

During the three months ended March 31, 2011, the Company repurchased 47,700 shares at an average price of $2.67 for total proceeds of $0.1 million. During the nine months ended March 31, 2011, the Company repurchased 179,100 shares at an average price of $2.78 for total proceeds of $0.5 million. All of the repurchased shares have been cancelled.

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 Int'l Investment Co., Limited ("Honorable") which is an investment holding company based in Hong Kong. Honorable acquired 100% interest in Mengshida Shoes Co., Ltd Shishi City ("Mengshida") on July 25, 2008. Mengshida manufactures and sells athletic footwear and related apparel and accessories as well as leisure leather shoes in the PRC.

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.

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 of $4,355.

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. No stock based compensation was recorded for this option. On January 12, 2010, the underwriters exercised the over-allotment option and purchased 759,500 common shares at $3.25. Net proceeds of $2,278 were received after deducting the underwriters' fees and related expenses of $190.

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. On December 21, 2009, the underwriters received an option to purchase 805,000 common shares ("compensation options") at $3.25 for a period of 24 months. On January 12, 2010, the underwriters received a further 53,165 compensation options in conjunction with the exercise of the over-allotment that will be exercisable for common shares at $3.25 per share until January 12, 2012.

Stock Options

On December 13, 2010, the Company granted 150,000 stock options to employee and non-employee directors at an exercise price of $2.65 and an expiry date of December 13, 2015. As of March 31, 2011, none of these stock options have vested nor are exercisable.

In addition, there are 700,000 stock options outstanding granted to consultants and 950,000 stock options outstanding previously granted to employees and non-employee directors. The stock options have the same terms and conditions and were granted on December 21, 2009 at an exercise price of $3.25 and an expiry date of December 21, 2014. As of March 31, 2011, one-third of these stock options are vested but not have been exercised.

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements.

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 $1,719. On January 12, 2010, the Company received a further $2,278 of net cash proceeds from the exercise of the over-allotment option.

Intended Use of ProceedsAs disclosed
Disbursed as
of March 31
2011
Balance to be
disbursed as
of March 31
2011
Retail and Distribution Network Expansion$16,000$8,775$1,545
Increase Production Capacity – Building and Equipment7,0001,8415,159
Brand Recognition, Awareness and Image9,0008,273727
Working Capital2,800
Net Proceeds$34,800

The disbursement of the network expansion proceeds is expected to continue to increase during the next quarter of fiscal 2011 as distributors achieve the criteria for payment of the subsidies. The Company does not expect to utilize approximately $5.7 million of the network expansion proceeds for the original 350 new retail outlets opened in calendar 2010. The Company expects to spend $10 million on a new building and equipment which is $3 million more than forecasted in the initial public offering. The savings achieved on the network expansion more than offset the increase in cost for the new building and equipment and, accordingly, this will not affect the Company's ability to achieve its business objectives and milestones. 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.

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 $1.3 million as at March 31, 2011 and June 30, 2010.

A loan was received from a director of Honorable for $0.4 million as at March 31, 2011 and June 30, 2010. 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 relating to periods prior to December 31, 2009. 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.

On January 5, 2011, the Company entered into a consulting contract with a China based firm to provide management training, over a two year period, to the 50 most senior executives at Mengshida. The consideration for these services is an option on 800,000 common shares of the Company at an exercise price of $2.60 per share. The options have been granted and will be settled upon exercise through the transfer of shares of the Company from the holdings of the Chairman and controlling shareholder. The options have an expiry date of January 5, 2013. The Company has the right to terminate this agreement by July 1, 2011 and require the consultant to return the option on 800,000 common shares of the Company if it is not satisfied with the services provided. The Company recorded a stock based compensation expense for the services rendered for the three months ended March 31, 2011 of $56 with a credit to contributed surplus.

Financial Instruments and Other Instruments

The Company held cash of $65.3 million on its balance sheet as at March 31, 2011. 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. 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.

The Canadian Institute of Chartered Accountants ("CICA") has amended Handbook Section 3862 to require enhanced disclosure on the fair value of certain financial instruments. The Company adopted these recommendations effective June 30, 2010 and the required disclosures are included in the note 16 to the unaudited interim consolidated financial statements. The Company does not have any financial instruments measured at fair value that require disclosure of the hierarchy levels. These amendments did not impact the company's results of operations or financial position.

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 will issue its financial statement in the first quarter of 2012 in accordance with IFRS including comparative data for 2011.

The Company expects the transition to IFRS to have an impact on financial reporting, business processes and information systems. The Company began a preliminary assessment during the year ended June 30, 2010. During the second quarter of 2011, the Company engaged an external advisor to assist with the initial assessment phase of the process and develop a conversion plan for the detailed assessment, design and implementation phase of the project. The Company has completed its initial analysis of key areas for which changes to accounting policies may be required and is currently in the detailed analysis phase of the project reviewing all relevant IFRS requirements and identification of areas requiring accounting policies changes or those with accounting policy alternatives. The Company will continue to assess the first-time adoption requirements and alternatives (IFRS 1) throughout the next quarter and finalize the first-time adoption alternatives prior to June 30, 2011. The Company expects the more significant areas of impact to be in relation to the IFRS1 policy choices to reset foreign currency translation differences to zero on transition and in relation to stock based compensation. The Company will review the impact on information technology, internal controls and contractual arrangements during the next quarter. The Company will invest in training and resources through the transition process to facilitate a timely conversion.

The Company will cease to prepare its consolidated financial statements in accordance with Canadian GAAP and will apply IFRS as its basis of accounting. Consequently, future accounting changes to Canadian GAAP that are effective for periods beginning on or after July 1, 2011 are not discussed in these interim financial statements.

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, with populations ranging up to 5 million people, throughout the PRC, where both population and disposable income are growing. This increased presence will be achieved by opening additional corporate-owned retail outlets and by assisting distributors in expanding their retail presence.

Corporate-owned retail outlets typically offer higher margins than sales through distributors as well as greater operating flexibility. By increasing the number of corporate-owned retail outlets, Zungui believes it can focus its growth strategy in certain regions while complementing its current distribution network. Through to June 30, 2011, the Company expects to open an additional 30 corporate-owned retail outlets and 70 distributor retail outlets.

Zungui Haixi Corporation
Consolidated Balance Sheets
(Unaudited)

(Expressed in thousands of Canadian Dollars)
March 31,
2011
June 30,
2010
Current assets
Cash$65,258$85,876
Accounts receivable, net33,32834,128
Prepaid expenses2,497343
Inventories (Note 4)12,5823,498
Other receivables (Note 13)1,2961,331
Future income taxes49558
Total current assets115,456125,234
Property, plant and equipment (Note 5)9,1936,470
Total assets$124,649$131,705
Current liabilities
Accounts payable and accrued liabilities$12,146$30,288
Taxes payable3,8364,974
Due to related party (Note 13)424440
Total current liabilities16,40635,702
Shareholders' equity
Share capital (Note 7)33,35533,451
Contributed surplus (Note 7)3,6953,282
Surplus reserve funds (Note 9)6,0434,774
Retained earnings71,92956,161
Accumulated other comprehensive income (loss)(6,779)(1,665)
Total shareholders' equity108,24396,003
Total liabilities and shareholders' equity$124,649$131,705

Subsequent Event (Note 17)

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

Approved By the Board

Michael W. Manley, Director

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
March 31,
Nine Months Ended
March 31,
2011201020112010
Revenue (Note 11)$44,628$33,342$142,930$113,332
Cost of sales32,48424,442105,51983,186
Gross profit12,1448,90037,41130,146
Selling expenses3,2074599,2421,563
Research and development expenses195152598439
General and administrative expenses1,3591,0913,6792,495
Foreign exchange loss (gain)(10)-22-
Other expenses (income), net(63)15(13)(19)
4,6881,71713,5284,481
Income before income taxes7,4567,18323,88325,665
Income tax expense (Note 12)2,0721,9896,4447,264
Net income5,3845,19417,43918,401

Other comprehensive loss:
Unrealized loss on foreign currency translation of self-sustaining operations(1,710)(2,016)(5,114)(5,966)
Comprehensive income$3,674$3,178$12,325$12,435
Basic and diluted earnings per share (Note 7(b))$0.09$0.08$0.28$0.34
Weighted average number of shares outstanding62,114,26162,166,67262,157,74254,508,112

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)
Three Months Ended
March 31,
Nine Months Ended
March 31,
2011201020112010
Share Capital
Balance, beginning of period$33,380$31,224$33,451$-
Issuance of share capital, net-2,278-35,318
Repurchased for cancellation(25)-(96)-
Stock based compensation expense-(51)-(1,867)
Balance, end of period$33,355$33,451$33,355$33,451
Contributed Surplus
Balance, beginning of period$3,512$3,003$3,282$1,174
Stock based compensation expense1831654131,994
Balance, end of period$3,695$3,168$3,695$3,169
Surplus Reserve Funds
Balance, beginning of period$6,043$1,938$4,774$1,938
Transfer from retained earnings--1,269-
Balance, end of period$6,043$1,938$6,043$1,938
Retained Earnings
Balance, beginning of period$66,648$45,228$56,161$32,021
Net income5,3845,19417,43918,401
Repurchase of shares for cancellation(103)-(402)-
Transfer to surplus reserve funds--(1,269)-
Balance, end of period$71,929$50,422$71,929$50,422
Accumulated Other Comprehensive Income (Loss)
Balance, beginning of period$(5,069)$(3,908)$(1,665)$42
Unrealized foreign currency translation losses
(1,710
)
(2,016
)
(5,114
)
(5,966
)
Balance, end of period$(6,779)$(5,924)$(6,779)$(5,924)
Total Shareholders' Equity$108,243$83,055$108,243$83,055

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)
Three Months Ended
March 31,
Nine Months Ended
March 31,
2011201020112010
Cash flows from operating activities
Net income$5,384$5,194$17,439$18,401
Items not affecting cash:
Depreciation6191141,401337
Future income taxes292-(449)(10)
Provision for doubtful accounts34(45)3119
Stock based compensation183114413127
Gain (loss) on disposal of property, plant and equipment-(1)201(1)
Changes in non-cash working capital
Accounts receivable(3,380)4,242(948)(4,633)
Prepaid expenses288(4)(2,218)(5)
Inventories(9,210)5,513(9,468)(2,303)
Other receivables34(46)(32)(117)
Accounts payable and accrued liabilities(7,873)(3,919)(16,995)2,178
Taxes payable(381)(529)(906)(398)
Net cash provided (used) by operating activities(14,010)10,633(11,559)13,679
Cash flows from investing activities
Property, plant and equipment(1,118)(291)(4,036)(297)
Proceeds from sale of equipment--20-
Construction in progress(12)-(703)-
Net cash used in investing activities(1,130)(291)(4,719)(297)
Cash flows from financing activities
Due to related party(10)-(17)-
Increase in share capital-1,466-35,431
Repurchase of shares for cancellation(128)-(498)-
Net cash provided (used) by financing activities(138)1,466(515)35,431
Effect of exchange rate changes on cash(1,148)(1,581)(3,825)(4,320)
Net increase (decrease) in cash(16,426)10,227(20,618)44,493
Cash, beginning of period81,68458,02385,87623,757
Cash, end of period$65,258$68,250$65,258$68,250
Supplemental disclosure of cash information
Interest paid in cash$-$5$-$18
Income taxes paid in cash2,1272,5417,8447,730

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

Zungui Haixi Corporation
Notes to Consolidated Financial Statements
For the three month periods ended March 31, 2011 and 2010
(Unaudited)
(Expressed in thousands of Canadian Dollars except per share and share amounts)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Zungui Haixi Corporation ["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.

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 of $4,335.

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. No stock based compensation was recorded for this option. On January 12, 2010, the underwriters exercised the over-allotment option and purchased 759,500 common shares at $3.25, resulting in net proceeds of $2,278 after deducting the underwriters' fees and other related expenses of $190.

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. Refer to Note 7(d).

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 audited consolidated financial statements for the year ended June 30, 2010. The 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 the audited consolidated financial statements for the year ended June 30, 2010. 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, Mengshida, located in China. The Company's head office, Honorable and Southern's functional currency is Canadian dollars. The Company uses Canadian dollars as its reporting currency. Mengshida is considered to be a self-sustaining foreign operation and its' financial statements are translated into the reporting currency using the current rate method. Under this method, revenue and expenses are translated into the reporting currency using the 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.

(b) Changes in accounting policies

(i) Stock-based compensation plan

The Company has a stock based compensation plan which is described in Note 8. The Company measures and recognizes compensation expense using the fair value method. Under this method, the Company estimates the fair value of options granted to employees, non-employee directors and consultants at the grant date 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 on a straight line basis, 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.

(ii) Financial Instruments

The Canadian Institute of Chartered Accountants ("CICA") has amended Handbook Section 3862 to require enhanced disclosure on the fair value of certain financial instruments. The Company adopted these recommendations effective June 30, 2010 and the required disclosures are included in Note 15. The Company does not have any financial instruments measured at fair value that require disclosure of the hierarchy levels. These amendments did not impact the Company's results of operations or financial position.

(c) Future accounting changes

(i) 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 will issue its financial statement in the first quarter of 2012 in accordance with IFRS including comparative data for 2011.

The Company expects the transition to IFRS to have an impact on financial reporting, business processes and information systems. The Company began a preliminary assessment during the year ended June 30, 2010. During the second quarter of 2011, the Company engaged an external advisor to assist with the initial assessment phase of the process and develop a conversion plan for the detailed assessment, design and implementation phase of the project. The Company will invest in training and resources through the transition process to facilitate a timely conversion.

The Company will cease to prepare its consolidated financial statements in accordance with Canadian GAAP and will apply IFRS as its basis of accounting. Consequently, future accounting changes to Canadian GAAP that are effective for periods beginning on or after July 1, 2011 are not discussed in these interim financial statements.

4. INVENTORIES

Inventories consist of:

March 31,June 30,
20112010
Raw materials$451$1,433
Work in progress497466
Finished goods11,6341,599
Total inventory$12,582$3,498

Inventories expensed as cost of sales were $32,405 and $105,324 for the three and nine months ended March 31, 2011, respectively and were $24,412 and $83,126 for the three and nine months ended March 31, 2010, respectively.

5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of:

March 31, 2011June 30, 2010
CostAccumulated DepreciationNet Book ValueCostAccumulated DepreciationNet Book Value
Plant and building$5,246$1,963$3,283$5,859$2,036$3,823
Machinery and production equipment2,0987981,3001,798950848
Automobiles and trucks639222417668191477
Leasehold improvements4,5571,1713,3861,4221561,266
Construction in progress688-688
Office equipment215961191489256
Total$13,443$4,250$9,193$9,895$3,425$6,470

Depreciation expense was $619 and $1,401 for the three and nine months ended March 31, 2011, respectively, and $114 and $337 for the three and nine months ended March 31, 2010, respectively.

6. BANK LOAN

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. The loan was fully repaid on June 25, 2010.

Interest expense was $nil for the three and nine months ended March 31, 2011, respectively, and $31 and $100 for the three and nine months ended March 31, 2010, respectively.

7. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS

(a) Share Capital:

As at March 31, 2011 the authorized share capital of Zungui was unlimited common shares with no par value.

Number of
Shares
Issued
Number of
Stock
Options
Number of
Compen-
sation
Options
Weighted
Average
Exercise
Price
Amount
Balance as at August 11, 20091--$-$-
Share exchange transaction (Note 1)50,000,000----
Initial public offering (Note 2)11,500,000---33,040
Cancellation of share(1)----
Stock options (Note 7(d)):
Granted-700,000-3.25(1,005)
Underwriter options (Note 7(d))--805,0003.25(811)
Balance as at December 31, 200961,500,000700,000805,000-$31,224
Over-allotment option (Note 2)759,500--$3.25$2,278
Underwriter options (Note 7(d))--53,1653.25(51)
Balance as at March 31, 2010 and June 30, 201062,259,500700,000858,165-$33,451
Normal course issuer bid(131,400)---(71)
Balance as at December 31, 201062,128,100700,000858,165$3.25$33,380
Normal course issuer bid(47,700)---(25)
Balance as at March 31, 201162,080,400700,000858,165-$33,355

On September 17, 2010, the Company announced its intention to proceed with a normal course issuer bid as approved by the TSX Venture Exchange. The Company can purchase for cancellation, at market prices, up to 3,112,975 of its issued and outstanding common shares during the period October 4, 2010 to October 3, 2011. During the three months ended March 31, 2011, the Company repurchased 47,700 shares at an average price of $2.67 for total proceeds of $128. During the nine months ended March 31, 2011, the Company repurchased 179,100 shares at an average price of $2.78 for total proceeds of $498. Of the total cost, $25 and $96 is charged to share capital for the three and nine months, respectively, and $103 and $402 is charged to retained earnings for the three and nine months, respectively. All of the repurchased shares were cancelled.

(b) Earnings Per Share:

As a result of the reorganization as described in Note 1 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.

(c) Stock Options Outstanding:

A summary of the stock options outstanding as at March 31, 2011 are as follows:

Exercise
Price
Date of
Grant
Expiry
Date
Remaining
Contractual
Life
(Years)
Number
Outstanding
Number
Exercisable
Employee and Non-Employee Directors$3.25December 21, 2009December 21, 20143.7950,000316,666
Consultants$3.25December 21, 2009December 21, 20143.7700,000233,333
Underwriters$3.25December 21, 2009December 21, 20110.7805,000805,000
Underwriters$3.25January 12, 2010January 12, 20120.753,16553,165
Employee and Non-Employee Directors$2.65December 13, 2010December 13, 20154.7150,000-

(d) Consultant and Underwriters 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 (see Note 13(d)). The consultant's stock options vest equally over a three year period. 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.

On December 21, 2009, 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.

On January 12, 2010, the underwriters earned an additional 53,165 common shares ("compensation options") at $3.25 for a period of 24 months in conjunction with the exercise of the over-allotment option. The per share fair value of these grants was $0.97. Stock based compensation in the amount of $51 was deducted from share capital as part the expenses of the offering.

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

Three Months EndedNine Months Ended
March 31, 2010March 31, 2010
Risk-free interest rate1.271.27-2.46
Expected dividend yield0.0%0.0%
Expected volatility54.3%54.3%
Expected option life (in years)22 - 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 and the expiry date for the compensation options.

(e) Paid in Capital:

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

On January 29, 2010, the Company applied to change the registered capital of Mengshida to $33.9 million (RMB 220.0 million). As of March 31, 2011, Mengshida's registered and paid in capital was $33.8 million (RMB 220.3 million).

8. STOCK BASED COMPENSATION

The Company introduced a stock option plan on December 21, 2009 to incent 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 January 5, 2011, the Company entered into a consulting contract with a China based firm to provide management training, over a two year period, to the 50 most senior executives at Mengshida. The consideration for these services is an option on 800,000 common shares of the Company at an exercise price of $2.60 per share. The options have been granted and will be settled upon exercise through the transfer of shares of the Company from the holdings of the Chairman and controlling shareholder (Refer to Note 13(e)). The options have an expiry date of January 5, 2013. The Company has the right to terminate this agreement by July 1, 2011 and require the consultant to return the option on the 800,000 common shares of the Company if it is not satisfied with the services provided. The Company recorded a stock based compensation expense for the services rendered for the three months ended March 31, 2011 of $56 with a credit to contributed surplus.

On December 13, 2010, the Company granted 150,000 stock options at an exercise price of $2.65 to Company employee and non-employee directors with an expiry date of December 13, 2015. The stock options vest equally over a three year period and as at March 31, 2011, none were vested nor exercisable. The per share fair value of these grants was $1.23.

On December 21, 2009, the Company granted 950,000 stock options at an exercise price of $3.25 to Company employees and non-employee directors with an expiry date of December 21, 2014. The stock options vest equally over a three year period and as at December 31, 2010, 316,666 were vested and 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:

Three and Nine Months EndedThree and Nine Months Ended
March 31, 2011March 31, 2010
Risk-free interest rate1.768 - 2.5582.46
Dividend yield0.0%0.0%
Expected volatility56.6% - 57.8%54.3%
Expected option life (in years)1 - 44

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 and nine months ended March 31, 2011, stock based compensation expense was $183 and $413, respectively, and during the three and nine months ended March 31, 2010, stock based compensation was $114 and $127, respectively.

9. SURPLUS RESERVE FUNDS

In accordance with applicable regulations for foreign funded enterprises in the PRC, Mengshida, the Company's operating subsidiary, is required to retain a certain amount from net income as reserve funds. The amount retained shall not be less than 10% of net income as determined under PRC GAAP annually for statutory reserves. When the balance of the statutory reserves reaches 50% of the registered capital of Mengshida, no further appropriations are required.

During the nine months ended March 31, 2011, Mengshida transferred $1.3 million to its' surplus reserve funds. As of March 31, 2011 Mengshida's surplus reserve funds aggregated $6,043 (June 30, 2010 - $4,774) which represents 17% (15% as of June 30, 2010) of Mengshida's registered capital.

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 and nine month periods ended March 31, 2011 and 2010.

During the three month period ended March 31, 2011, purchases from three suppliers, each represented 15% ($5,981), 13% ($4,968) and 13% ($4,955) of total purchases. During the three month period ended March 31, 2010, purchases from three suppliers represented 10% ($1,745), 9% ($1,509) and 8% ($1,420) of total purchases. During the nine month period ended March 31, 2011, purchases from three suppliers, each represented 17% ($18,193), 15% ($16,601) and 15% ($16,592) of total purchases. During the nine month period ended March 31, 2010, purchases from three suppliers represented 16% ($13,075), 16% ($13,009) and 16% ($12,989) of total purchases.

11. REVENUE

Three Months Ended
March 31,
Nine Months Ended
March 31,
2011201020112010
Footwear$37,303$27,982$126,557$97,142
Apparel and accessories8,8515,46822,29017,372
46,15433,450148,847114,514
Subsidy provision1,5261085,9171,182
Revenue$44,628$33,342$142,930$113,332

12. INCOME TAXES

The Company is subject to income taxes in Canada while its operating subsidiary, Mengshida is subject to the Corporate Income Tax Law of the PRC enacted on January 1, 2008 which resulted in a unified tax rate of 25% for all enterprises. The Company is not subject to any taxation in the British Virgin Islands and the Company is subject to 16.5% income tax rate in Hong Kong.

The Company established a valuation allowance of $1,651 as at March 31, 2011 ($1,515 as at June 30, 2010) due to the uncertainty of future realization of future income tax assets that originated from tax losses recognized in Canada and Hong Kong. As at March 31, 2011, the Company has income tax losses of $3,502 ($1,820 as at June 30, 2010) for which no accounting benefit has been recognized and which can be applied against future years' taxable income in Canada. These losses expire in the year 2020 ($1,820) and 2021 ($1,682). The Company has income tax losses of $42 in Hong Kong which do not expire.

13. RELATED PARTY TRANSACTIONS

(a) 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 of $1,296 from Directors.

(b) Due to related party consists of a loan from a Director of Honorable totalling $424 (Hong Kong $3,200,000 and RMB 100,000) as at March 31, 2011 and $440 (Hong Kong $3,200,000 and RMB 100,000) as at June 30, 2010. This loan is unsecured, is interest free and is payable on demand.

(c) 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 14. 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.

(d) 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.

(e) The Chairman and controlling shareholder granted an option on 800,000 common shares of the Company to a China based consulting company at an exercise price of $2.60 per share that will be settled upon exercise through the transfer of shares of the Company from the Chairman and controlling shareholder's holding. Refer to Note 8.

14. CONTINGENCY

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 ($663) 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 13(c).

15. 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:

March 31, 2011Held for TradingLoans and ReceivablesOther Financial LiabilitiesTotal Carrying Value
Financial assets
Cash$65,258$-$-$65,258
Accounts receivable-33,328-33,328
Other receivables-1,296-1,296
$65,258$34,624$-$99,882
Financial liabilities
Accounts payable and accrued liabilities$-$-$12,146$12,146
Due to related party--424424
$-$-$12,570$12,570
June 30, 2010Held for TradingLoans and ReceivablesOther Financial LiabilitiesTotal Carrying Value
Financial assets
Cash$85,876$-$-$85,876
Accounts receivable-34,128-34,128
Other receivables-1,331-1,331
$85,876$35,459$-$121,335
Financial liabilities
Accounts payable and accrued liabilities$-$-$30,288$30,288
Due to related party--440440
$-$-$30,728$30,728

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 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 of future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company repaid its bank loan on June 25, 2010 and no longer has exposure to interest rate fluctuations. The Company does not use any derivative financial instruments to reduce its exposure to interest rate risk.

Foreign Currency risk

Foreign currency risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in foreign currency exchange rates. The Company has some financial assets and liabilities in foreign currencies that expose the Company to foreign exchange risks. The Company has not hedged its exposure to currency fluctuations. 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 the majority of 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 nine months ended March 31, 2011 and 2010, 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 cash flows from operating activities. 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 March 31, 2011, the Company had $12,146 in accounts payable and accrued liabilities and due to related party $424. All financial liabilities have contractual maturities of less than one year as of March 31, 2011.

16. 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 shareholders. The Company's capital is defined as shareholders' equity as presented on the consolidated balance sheet excluding accumulated other comprehensive loss. The Company's capital is as follows:

March 31, 2011June 30, 2010
Shareholders' equity excluding accumulated other comprehensive loss
$ 115,022

$ 97,668

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. There has been no change with respect to the overall capital risk management strategy during the three or nine months ended March 31, 2011.

17. SUBSEQUENT EVENT

On April 15, 2011 the Company entered into a contract to construct a ten storey building and an addition to the dormitory building for a cost of $4 million.

Neither TSX Venture Exchange nor its Regulation Services Provider (as that term is defined in the policies of the TSX Venture Exchange) accepts responsibility for the adequacy or accuracy of this release.

Contact Information

  • Zungui Haixi Corporation
    Ms. Shelly Gobin
    Chief Financial Officer
    647-726-0192
    www.zunguihaixi.com