Zungui Haixi Corporation
TSX VENTURE : ZUN

Zungui Haixi Corporation

November 24, 2010 07:00 ET

Zungui Haixi Reports Q1 Fiscal 2011 Financial Results

TORONTO, ONTARIO--(Marketwire - Nov. 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 months ended September 30, 2010. All amounts in this release are in Canadian dollars unless otherwise indicated.

"In our first year of being a public company, we have added almost 350 new retail outlets, increased revenue and maintained profitability," indicated Mr. Yanda Cai, Chief Executive Officer. "With more than 2,000 retail outlets, store expansions continue to build our brand prominence and remain key to our growth."

Highlights for the First Quarter:



- Revenue increased 17% to $50.4 million and in RMB, revenue increased 23%
to RMB 328.5 million;
- Gross margin declined to 25.2% in the first quarter of fiscal 2011
compared to 27.3% in the same quarter last year as a result of subsidy
payments to distributors for new store openings which lowered the gross
margin by 3.1%;
- Opened a quarterly record of 120 net new distributor owned retail outlets
compared to 72 retail outlets for the same quarter last year;
- Corporate-owned retail outlets reported revenue of $0.7 million compared
to $0.1 million for the same quarter last year reflecting a start up phase
of development;
- Selling expenses increased 200% to $1.8 million as part of the launch of
the brand recognition strategy with increased advertising;
- Net income decreased 8% to $7.1 million reflecting payments expensed to
distributors on new store openings and increased selling expenses; and,
- Diluted earnings per share of 11 cents compared to 15 cents for the same
quarter last year based on a 25% increase in the weighted average number
of shares outstanding in the period and a 3 cent impact for subsidy
payments.


During the quarter, the Company expensed a portion of the subsidy payment that will be made to distributors once the new stores reach the required operating criteria. This item reduced our revenue growth by 5% but will benefit the Company over the longer term with increased revenue. Subsequent to September 30, 2010, the Company and its distributors have opened an additional 112 retail outlets increasing the number of retail outlets to 2,038.

On a trailing 12 month basis, the Company's revenue is $171.3 million, net income is $26.4 million and diluted earnings per share is 44 cents.

The results were impacted by the movement of the Chinese currency relative to the Canadian dollar. During the first quarter ended September 30, 2010 the average foreign exchange rate used to convert one Chinese Renminbi ("RMB") was 0.1535 expressed in Canadian dollars compared to 0.1606 for the same quarter last year. If the 2011 first quarter results were converted at the prior year's average exchange rate for the quarter, 2011 first quarter earnings per share would have been 12 cents.

Conference Call

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



Dial-in number: 1-866-225-0198 or 416-340-8061
Taped rebroadcast (until midnight on December 8, 2010): 1-800-408-3053
Taped replay access passcode: 1754237.


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 62,259,500 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
Operations
For the three months ended September 30, 2010
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 months ended September 30, 2010 with comparative figures for the three months ended September 30, 2009. 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, the second and third quarter 2010 MD&As and the final long form prospectus filed on December 11, 2009. 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 November 23, 2010 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&A Page

Overview 3
Selected Financial Information 3
Factors Affecting the Results of Operations 4
Results of Operations 5
Summary of Quarterly Results 9
Liquidity and Capital Resources 9
Capital Structure 10
Off-Balance Sheet Arrangements 11
Use of Proceeds 12
Related Party Transactions 12
Financial Instruments and Other Instruments 13
Recent Accounting Changes 13
Outlook 14


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 September 30, 2010, Zungui distributes its products to consumers through 44 corporate-owned retail outlets and through 47 distributors, who in turn sell products via an extensive network of 1,882 retail outlets, 1,515 of which offer the Sportswear Product Line and 367 of which offer the Casual Product Line. All retail outlets exclusively sell products which carry the ZUNGUI brand.

During the three months ended September 30, 2010, 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 increase their sales. For the three months ended September 30, 2010, revenue grew 17% to $50.4 million from $43.0 million compared to same period last year. In Renminbi ("RMB"), revenue grew 23% to RMB 328.5 million from RMB 267.9 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 2009 and 2010.

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 months ended September 30, 2010.



Earnings Data
For the three months ended September 30,
------------------------------------------
2010 2009
-------------------- ---------------------
Revenue $ 50,425 $ 43,030
Cost of sales 37,731 31,288
-------------------- ---------------------
Gross profit 12,694 11,742
Selling expenses 1,777 593
Research and development expenses 201 136
General and administrative
expenses 1,055 566
Other expenses (income), net 116 (7)
Income tax expense 2,489 2,797
-------------------- ---------------------
Net income $ 7,056 $ 7,657

Earnings per share - basic and
diluted $ 0.11 $ 0.15


As at September 30, As at June 30,
Balance Sheet Data 2010 2010
-----------------------------------------
Cash $ 91,494 $ 85,876
Inventories 3,332 3,498
Property, plant and equipment 6,624 6,470
Total assets 140,545 131,705
Working capital 95,123 89,532
Retained earnings 63,217 56,161
Total shareholders' equity 101,755 96,003


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 September 30, 2010 and 2009 was 0.1535 and 0.1606. The movement of the Chinese currency relative to the Canadian dollar in the three months ended September 30, 2010 resulted in the statement of operations in Canadian dollars being 6% less than would have been reported if the Company had used the average exchange rate for the same period of 2009.

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 months ended September 30, 2010 and 2009, immediately prior to their conversion to Canadian dollars.



In RMB For The Three Months Ended
September 30,
-------------------------------
2010 2009
--------------- ---------------
Revenue RMB 328,462 RMB 267,918
Cost of sales 245,777 194,814
--------------- ---------------
Gross profit 82,685 73,104
Net income 45,962 47,675

Weighted average exchange rate for one RMB,
expressed in Canadian dollars 0.1535 0.1606


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 accrues subsidies payable 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. Gross margin on sales of outsourced production is normally approximately 1% less than internally produced footwear.

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 Months Ended September 30, 2010 compared to
September 30, 2009
(Amounts in thousands of dollars, unless specified otherwise)


Revenue

The Company derives its revenue from two distribution channels: distributors and corporate-owned retail outlets. The number of distributor owned retail outlets (operated by distributors and/or third-party retailers) increased by 120 net new retail outlets to 1,882 during the three months ended September 30, 2010 (1,679 retail outlets at September 30, 2009). The Company currently has 44 corporate-owned retail outlets (3 at September 30, 2009). The Company opened 15 new corporate-owned retail outlets during the three months ended September 30, 2010 with 2 corporate-owned retail outlets demolished as part of the new building construction.

Revenue by Product Line



For The Three Months Ended September 30,
--------------------------------------------------

2010 % of Total 2009 % of Total
------------ ----------- ------------- -----------
Footwear $ 44,709 88.7 $ 37,085 86.2
Apparel and accessories 5,716 11.3 5,945 13.8
------------ ----------- ------------- -----------
Total $ 50,425 100.0 $ 43,030 100.0
------------ ----------- ------------- -----------
------------ ----------- ------------- -----------


Total revenue increased 17% to $50.4 million for the three months ended September 30, 2010 compared to the first quarter of last year. In RMB, revenue increased 23% to RMB 328.5 million for the three months ended September 30, 2010 compared to RMB 267.9 million for the same period last year. The strengthening of the Canadian dollar during the year relative to the RMB reduced the percentage increase in revenue by 6% when reported in Canadian dollars. Revenue was reduced by $2.2 million for accruals for subsidies that will be paid in the future to distributors for new stores opened in calendar 2010. The number of new stores opened during the quarter was the highest in the Company's history.

Footwear revenue increased 21% to $44.7 million for the three months ended September 30, 2010 compared to the same period last year, and was comprised of $38.7 million (Q1 2010 - $32.3 million) in revenue from athletic footwear and $6.0 million (Q1 2010 - $4.8 million) from casual footwear. The growth in revenue was the result of increased number of retail outlets (1,926 retail outlets in total compared to 1,682 at September 30, 2009), increased consumer demand for the Company's products and price increases implemented late in March, 2010.

In RMB, the Company's revenue per average number of retail outlets increased 9% to RMB 0.2 million during the three months ended September 30, 2010 compared to the same period last year. For each of the three months ended September 30, 2010 and 2009, 98.6% and 99.7% of the Company's revenue was derived from its wholesale distribution channel, respectively.

Cost of Sales



For The Three Months Ended September 30,
--------------------------------------------------

2010 % of Total 2009 % of Total
------------ ----------- ------------- -----------
Footwear (internal
production)
Raw materials $ 11,325 30.0 $ 10,148 32.4
Labour 1,398 3.7 1,123 3.6
Manufacturing costs 814 2.2 519 1.7
------------ ----------- ------------- -----------

Subtotal 13,537 35.9 11,790 37.7
Footwear (outsourced
production) 19,917 52.8 15,126 48.3
Apparel and accessories
(outsourced production) 4,277 11.3 4,372 14.0
------------ ----------- ------------- -----------

Total $ 37,731 100.0 $ 31,288 100.0
------------ ----------- ------------- -----------
------------ ----------- ------------- -----------


During the three months ended September 30, 2010, cost of sales increased 21% to $37.7 million compared to last year. In RMB, cost of sales increased 26% to RMB 245.8 million for the three months ended September 30, 2010. Raw material pricing increased 8% this quarter, however, higher selling prices compared to last year have offset this increased cost. Units sold during the quarter increased to 3.3 million compared to 2.8 million for the same quarter last year. Outsourced production accounted for 61% of the units sold compared to 58% for the same quarter last year. There has been a shift in the mix of shoes selected for outsourced production increasing the cost of manufacturing this quarter.

With the completion of some upgrades to existing production lines, the Company had increased its internal production capacity to 3.4 million pairs of shoes by the end of the quarter. The Company expects to have additional increased production capacity by April 2011 when the existing five production lines will be fully upgraded and/or replaced with new equipment.

Gross Profit



For The Three Months Ended September 30,
--------------------------------------------------
Gross Gross
2010 Margin % 2009 Margin %
------------ ----------- ------------- -----------
Footwear $ 11,255 25.2 $ 10,169 27.4
Apparel and accessories 1,439 25.2 1,573 26.4
------------ -------------
Total $ 12,694 25.2 $ 11,742 27.3
------------ -------------
------------ -------------


The gross margin declined for the three months ended September 30, 2010 due to a reduction in net revenue of $2.2 million from subsidies recorded that will be paid to distributors on new stores. Corporate-owned retail outlets increased the gross margin by 0.5% on $0.7 million of corporate store revenue.

Selling Expenses



For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Increase
---------------- ----------------- ---------------
Selling Expenses $ 1,777 $ 593 200%


The Company spent $1.3 million on advertising during the three months ended September 30, 2010 compared to $0.5 million last year. The Company has been repositioning the brand and recently launched a new advertising campaign in the second quarter of fiscal 2011. Selling expenses were increased by $0.3 million on the opening of new corporate-owned retail outlets which are currently in the start up phase of operations. Selling expenses represented 3.4% and 1.4% of total revenue for the three months ended September 30, 2010 and 2009, respectively.

Research and Development Expenses



For The Three Months Ended September 30,
-----------------------------------------
2010 2009 Increase
------------- -------------- ------------
Research and Development Expenses $ 201 $ 136 46%


Research and development expenses increased during the three months ended September 30, 2010 as the Company invested additional funds on expanding its research and development centre and the number of new products it developed.

General and Administrative Expenses



For The Three Months Ended September 30,
------------------------------------------
2010 2009 Increase
-------------- -------------- ------------
General and Administrative
Expenses $ 1,055 $ 566 87%


Corporate expenses related to being a public company, including salaries, directors fees, audit fees and stock compensation expenses totalled $0.4 million during the three months ended September 30, 2010. General and administrative expenses represented 2.0% and 1.3% of total revenue for the three months ended September 30, 2010 and 2009, respectively.

Other Expenses (Income), net



For The Three Months Ended September 30,
------------------------------------------
2010 2009 Increase
------------- --------------- ------------
Other expenses (income), net $ 116 $ (7) n/a


Other expenses, net includes a loss of $0.2 million on the disposition of several buildings that were demolished during the quarter as part of preparation of the new building construction.

Income Tax Expense



For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Decrease
---------------- ----------------- ---------------
Income tax expense $ 2,489 $ 2,797 11%


The statutory income tax rate in the PRC is 25% and in Canada is 33%. During the quarter, the Company implemented procedures to reduce the level of non-deductible expenses in the PRC which lowered the effective tax rate to approximately 25% in the PRC. Tax losses in Canada for which no accounting benefit has been recognized further increased the effective tax rate to 26% for the three months ended September 30, 2010 compared to 27% last year.

Net Income



For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Decrease
---------------- ----------------- ---------------
Net income $ 7,056 $ 7,657 8%


Net income decreased 8% to $7.1 million for the three months ended September 30, 2010 compared to the same period last year. In RMB, net income decreased 4% to RMB 46.0 million for the three months ended September 30, 2010 compared to RMB 47.7 million in the first quarter of last year. Revenue growth of 17% generated an additional $1.0 million of gross profit. Increases in selling expenses of $1.2 million, general and administrative expenses of $0.5 million and research and development expenses of $0.1 million lowered net income by $1.8 million which was offset by lower income taxes of $0.3 million, resulting in a decrease in net income of 8% or $0.6 million.

Basic and Diluted Earnings Per Share

Basic and diluted earnings per share was 11 cents for the three months ended September 30, 2010 compared to 15 cents for the same period last year. There were 62,259,500 shares issued and outstanding as at September 30, 2010. The weighted average number shares outstanding during the three months ended September 30, 2010 and 2009 was 62,259,500 and 50,000,000, 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 September 30, 2010. 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 27% from 1,514 retail outlets at October 1, 2008 to 1,926 retail outlets as at September 30, 2010. Net income has also correspondingly increased.



Quarter Ended Sept 30 2010 June 30 2010 Mar 31 2010 Dec 31 2009
------------ ------------ ------------ ------------
Revenue $ 50,425 $ 50,553 $ 33,342 $ 36,960
Net income 7,056 8,575 5,194 5,550
Earnings per share -
basic and diluted $ 0.11 $ 0.14 $ 0.08 $ 0.11

Quarter Ended Sept 30 2009 June 30 2009 Mar 31 2009 Dec 31 2008
------------ ------------ ------------ ------------
Revenue $ 43,030 $ 44,349 $ 31,104 $ 33,950
Net income 7,657 7,597 5,144 5,293
Earnings per share -
basic and diluted $ 0.15 $ 0.15 $ 0.10 $ 0.11


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.

Through the Company's growth and expansion, with cash from operations of $7.6 million, it has increased its cash on hand from $85.9 million as at June 30, 2010 to $91.5 million as at September 30, 2010.

The Company commences its manufacturing or outsourcing 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 to $2.4 million as at September 30, 2010 from $1.6 million as at June 30, 2010 but was lower than the level at September 30, 2009 of $5.6 million. The other components of inventory decreased 52% to $0.9 million.

Accounts receivable increased to $35.7 million as at September 30, 2010 compared to $34.1 million as at June 30, 2010 and $24.0 million as at September 30, 2009 as sales continued to increase and extended payment terms continued to be offered to certain distributors to provide support to them to open more retail stores. The days sales outstanding is 63 days for the three months ended September 30, 2010 compared to 60 days for the year ended June 30, 2010 and 49 days for the three months ended September 30, 2009. The Company has not experienced any increase in bad debts or increased provision for allowance for doubtful accounts.

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 provided by operating activities for the three months ended September 30, 2010 was $7.6 million compared to $7.7 million for the same quarter last year. The growth in the business has been the main driver of the increased cash generated from operating activities and the decreased working capital requirement for the period. No dividends were paid out during the three months ended September 30, 2010 or 2009. Net cash generated during the three months ended September 30, 2010 and 2009 was $5.6 million.

Working capital increased from $89.5 million (RMB 572.5 million) as at June 30, 2010 to $95.1 million (RMB 618.1 million) as at September 30, 2010 as a result of the growth in revenue and profitability.

Capital Expenditures

The Company's capital expenditures primarily relate to its investment in the equipment to upgrade its production lines and leasehold improvements for the corporate-owned retail outlets. The Company expects to complete the upgrade and/or replacement of its existing equipment by April, 2011. The Company has submitted plans for the construction of a new building of ten storeys and is awaiting approval from government officials. The Company expects to complete construction of the building and installation of two new production lines by June, 2011.

Capital Structure

Shares Outstanding

As of September 30, 2010 and current date, November 23, 2010, the Company has 62,259,500 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 will commence on October 4, 2010 and terminate on October 3, 2011, or on such earlier date as the Bid is completed or otherwise terminated by Zungui.

As of November 23, 2010, the Company repurchased 70,800 shares at an average price of $2.88 for total proceeds of $0.2 million. All of the repurchased shares will be 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

There are 700,000 stock options outstanding granted to consultants and 950,000 stock options outstanding 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.

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.



Balance to be
disbursed as of
Disbursed as of September 30
Intended Use of Proceeds As disclosed September 30 2010 2010
----------------- ----------------- ----------------
Retail and Distribution
Network Expansion $ 16,000 $ 1,971 $ 8,348
Increase Production
Capacity - Building and
Equipment 7,000 846 6,154
Brand Recognition,
Awareness and Image 9,000 2,612 6,388
Working Capital 2,800
-----------------
Net Proceeds $ 34,800
-----------------
-----------------


The disbursement of the network expansion proceeds is expected to continue to increase during the next two quarters of fiscal 2011 as more stores are opened and distributors achieve the criteria for payment of the subsidy payments. The Company does not expect to pay out all of the expansion use of proceeds for the original 350 new retail outlets as outlined in the final prospectus dated December 11, 2009 and filed on SEDAR at www.sedar.com. This will not affect the Company's ability to achieve its business objectives and milestones. The Company will use the remaining funds to construct a larger building and implement growth plans in fiscal 2011 and beyond in the same manner as outlined above. The Company recently launched a new strategy in the second quarter of fiscal 2011 on brand recognition, awareness and image. 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 September 30, 2010 and June 30, 2010.

A loan was received from a director of Honorable for $0.4 million as at September 30, 2010 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.

Financial Instruments and Other Instruments

The Company held cash of $91.5 million on its balance sheet as at September 30, 2010. 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 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 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. 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 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 does not anticipate any significant impact upon the adoption 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 does not anticipate any significant impact upon the adoption of these standards.

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. During the period October 1 - November 23, 2010, the Company has opened an additional 55 corporate-owned retail outlets and distributors have opened an additional 57 retail outlets. The number of new stores opened during calendar year 2010 now totals 341 compared to the target for the full calendar year 2010 of 350 new retail outlets.



Zungui Haixi Corporation
Consolidated Balance Sheets
(Unaudited)
(Expressed in thousands of Canadian Dollars)

September 30, 2010 June 30, 2010
Current assets
Cash $ 91,494 $ 85,876
Accounts receivable, net 35,708 34,128
Prepaid expenses 1,444 343
Inventories (Note 3) 3,332 3,498
Other receivables (Note 12) 1,335 1,331
Future income taxes 608 58
--------------------------------------
Total current assets 133,921 125,234

Property, plant and equipment (Note 4) 6,624 6,470
--------------------------------------
Total assets $ 140,545 $ 131,705
--------------------------------------
--------------------------------------

Current liabilities
Accounts payable and accrued
liabilities $ 33,275 $ 30,288
Taxes payable 5,066 4,974
Due to related party (Note 12) 449 440
--------------------------------------
Total current liabilities 38,790 35,702

Shareholders' equity
Share capital (Note 6) 33,451 33,451
Contributed surplus (Note 6) 3,398 3,282
Surplus reserve funds (Note 8) 4,774 4,774
Retained earnings 63,217 56,161
Accumulated other comprehensive
income (loss) (3,085) (1,665)
--------------------------------------
Total shareholders' equity 101,755 96,003

--------------------------------------
Total liabilities and shareholders'
equity $ 140,545 $ 131,705
--------------------------------------
--------------------------------------

Subsequent Event (Note 16)

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 September 30,
2010 2009
--------------------------------------


Revenue (Note 10) $ 50,425 $ 43,030
Cost of sales 37,731 31,288
--------------------------------------
Gross profit 12,694 11,742
--------------------------------------
--------------------------------------
Selling expenses 1,777 593
Research and development expenses 201 136
General and administrative expenses 1,055 566
Foreign exchange loss 9 -
Other expenses (income), net 107 (7)
--------------------------------------
3,149 1,288
Income before income taxes 9,545 10,454

Income tax expense (Note 11) 2,489 2,797
--------------------------------------

Net income 7,056 7,657
--------------------------------------
--------------------------------------

Other comprehensive income (loss):
Unrealized gain(loss) on foreign
currency translation of self-
sustaining operations (1,420) (2,895)
--------------------------------------
--------------------------------------

Comprehensive income $ 5,636 $ 4,762
--------------------------------------
--------------------------------------

Basic and diluted earnings per share
(Note 6(b)) $ 0.11 $ 0.15
--------------------------------------

Weighted average number of shares
outstanding 62,259,500 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)

Three Months Ended September 30,
2010 2009
--------------------------------------

Share Capital
Balance, beginning and end of period $ 33,451 $ -

Contributed Surplus
Balance, beginning of period $ 3,282 $ 1,174
Stock based compensation expense 116 -
--------------------------------------
Balance, end of period $ 3,398 $ 1,174

Surplus Reserve Fund
Balance, beginning and end of period $ 4,774 $ 1,938

Retained Earnings
Balance, beginning of period $ 56,161 $ 32,021
Net income 7,056 7,657
--------------------------------------
Balance, end of period $ 63,217 $ 39,678

Accumulated Other Comprehensive Income
(Loss)
Balance, beginning of period $ (1,665) $ 42
Unrealized foreign currency
translation gains (losses) (1,420) (2,895)
--------------------------------------
Balance, end of period $ (3,085) $ (2,853)

Total Shareholders' Equity $ 101,755 $ 39,937
--------------------------------------
--------------------------------------

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 September 30,
2010 2009
--------------------------------------

Cash flows from operating activities
Net income $ 7,056 $ 7,657
Items not affecting cash:
Depreciation 311 113
Future income taxes (549) (10)
Provision for doubtful accounts 15 40
Stock based compensation 116 -
Loss on disposal of property,
plant and equipment 183 -
Changes in non-cash working capital
Accounts receivable (2,135) (3,626)
Prepaid expenses (1,103) (6)
Inventories 110 (4,515)
Other receivables (25) (29)
Accounts payable and accrued
liabilities 3,458 7,834
Taxes payable 171 250
--------------------------------------
Net cash provided by operating
activities 7,608 7,708

Cash flows from investing activities
Property, plant and equipment (763) -
Proceeds from sale of equipment 20 -
Construction in process (7) -
--------------------------------------
Net cash used in investing activities (750) -

Cash flows from financing activities
Due to related party 8 -
--------------------------------------
Net cash provided by financing
activities 8 -

Effect of exchange rate changes on
cash (1,248) (2,138)
--------------------------------------

Net increase in cash 5,618 5,570

Cash, beginning of period 85,876 23,757
--------------------------------------
Cash, end of period $ 91,494 $ 29,327
--------------------------------------
--------------------------------------

Supplemental disclosure of cash
information
Interest paid in cash $ - $ 7
Income taxes paid in cash 2,884 2,617

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 September 30, 2010 and 2009
(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. 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 7. 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 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 14. 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 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. The Company will invest in training and resources through the transition process to facilitate a timely conversion.

(ii) 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 does not anticipate any significant impact upon the adoption of these new 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 does not anticipate any significant impact upon the adoption of these new standards.

3. INVENTORIES

Inventories consist of:



----------------------------------------------------------------------------
September 30, 2010 June 30, 2010
----------------------------------------------------------------------------
Raw materials $ 487 $ 1,433
Work in progress 418 466
Finished goods 2,427 1,599
----------------------------------------------------------------------------
Total inventory $ 3,332 $ 3,498
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Inventories expensed as cost of sales were $37,702 and $31,272 for the three months ended September 30, 2010 and 2009, respectively.

4. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of:



----------------------------------------------------------------------------
September 30, 2010
----------------------------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
----------------------------------------------------------------------------
Plant and building $ 5,501 $ 1,948 $ 3,553
Machinery and production equipment 1,860 748 1,112
Automobiles and trucks 660 202 458
Leasehold improvements 1,789 342 1,447
Office equipment 147 93 54
----------------------------------------------------------------------------
Total $ 9,957 $ 3,333 $ 6,624
----------------------------------------------------------------------------
----------------------------------------------------------------------------

----------------------------------------------------------------------------
June 30, 2010
----------------------------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
----------------------------------------------------------------------------
Plant and building $ 5,859 $ 2,036 $ 3,823
Machinery and production equipment 1,798 950 848
Automobiles and trucks 668 191 477
Leasehold improvements 1,422 156 1,266
Office equipment 148 92 56
----------------------------------------------------------------------------
Total $ 9,895 $ 3,425 $ 6,470
----------------------------------------------------------------------------
----------------------------------------------------------------------------


Depreciation expense was $311 and $113 for the three months ended September 30, 2010 and 2009, respectively.

5. 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 and $49 for the three months ended September 30, 2010 and 2009, respectively.

6. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS

(a) Share Capital:

As at September 30, 2010 the authorized share capital of Zungui was unlimited common shares with no par value.



----------------------------------------------------------------------------
Weighted
Number of Number of Number of Average
Shares Stock Compensation Exercise
Share Capital Issued Options Options Price Amount
----------------------------------------------------------------------------
Balance as at:
June 30, 2010 and
September 30,
2010 62,259,500 700,000 858,165 $ 3.25 $ 33,451
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(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 September 30, 2010 are as follows:



----------------------------------------------------------------------------
Exercise Price Date of Grant Expiry Date
----------------------------------------------------------------------------
Employee and Non-Employee $ 3.25 December 21, December 21,
Directors 2009 2014
----------------------------------------------------------------------------
Consultants $ 3.25 December 21, December 21,
2009 2014
----------------------------------------------------------------------------
Underwriters $ 3.25 December 21, December 21,
2009 2011
----------------------------------------------------------------------------
Underwriters $ 3.25 January 12, January 12,
2010 2012
----------------------------------------------------------------------------
----------------------------------------------------------------------------

----------------------------------------------------------------------------
Remaining
Contractual Life Number Number
(Years) Outstanding Exercisable
----------------------------------------------------------------------------
Employee and Non-Employee 4.3 950,000 -
Directors
----------------------------------------------------------------------------
Consultants 4.3 700,000 -
----------------------------------------------------------------------------
Underwriters 1.3 805,000 805,000
----------------------------------------------------------------------------
Underwriters 1.3 53,165 53,165
----------------------------------------------------------------------------
----------------------------------------------------------------------------


(d) 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 September 30, 2010, Mengshida's registered capital was $29.7 million (RMB 193.0 million). By January 29, 2012, the Company is required to inject additional capital of $4.2 million (RMB 27.0 million) to fulfil this requirement.

7. 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. During the three months ended September 30, 2010, no additional stock options were granted nor were any forfeited.

During the three months ended September 30, 2010, stock based compensation expense was $116.

8. 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.

As of September 30, 2010 and June 30, 2010, Mengshida's surplus reserve fund aggregated $4,774 which represents 15% of Mengshida's registered capital.

9. 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 month periods ended September 30, 2010 and 2009.

During the three month period ended September 30, 2010, purchases from three suppliers, each represented 19% ($6,766), 19% ($6,765) and 18% ($6,565) of total purchases. During the three month period ended September 30, 2009, purchases from three suppliers represented 19% ($6,498), 18% ($6,292) and 18% ($6,260) of total purchases.

10. REVENUE



----------------------------------------------------------------------------
Three Months Ended September 30,
2010 2009
----------------------------------------------------------------------------
Revenue
Footwear $ 44,709 $ 37,085
Apparel and accessories 5,716 5,945
----------------------------------------------------------------------------
Revenue $ 50,425 $ 43,030
----------------------------------------------------------------------------
----------------------------------------------------------------------------


11. 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 $1,547 as at September 30, 2010 ($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 September 30, 2010, the Company has income tax losses of $2,332 ($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 ($512). The Company has income tax losses of $391 in Hong Kong which do not expire.

12. 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 from Directors.

(b) Due to related party consists of a loan from a Director of Honorable totalling $449 (Hong Kong $3,200,000 and RMB 100,000) as at September 30, 2010 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 13. 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.

13. 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 ($687) 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 12(c).

14. 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:



----------------------------------------------------------------------------
September 30, 2010 Other Total
Held for Loans and Financial Carrying
Trading Receivables Liabilities Value
----------------------------------------------------------------------------
Financial assets
Cash $ 91,494 $ - $ - $ 91,494
Accounts receivable - 35,708 - 35,708
Other receivables - 1,335 - 1,335
----------------------------------------------------------------------------
$ 91,494 $ 37,043 $ - $ 128,537
----------------------------------------------------------------------------

----------------------------------------------------------------------------
Financial liabilities
Accounts payable and
accrued liabilities $ - $ - $ 33,275 $ 33,275
Due to related party - - 449 449
----------------------------------------------------------------------------
$ - $ - $ 33,724 $ 33,724
----------------------------------------------------------------------------
----------------------------------------------------------------------------


----------------------------------------------------------------------------
June 30, 2010 Other Total
Held for Loans and Financial Carrying
Trading Receivables Liabilities 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 - - 440 440
----------------------------------------------------------------------------
$ - $ - $ 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 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 months ended September 30, 2010 and 2009, 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 September 30, 2010, the Company had $33,275 in accounts payable and accrued liabilities and due to related party $449. All financial liabilities have contractual maturities of less than one month as of September 30, 2010.

15. 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 income (loss). The Company's capital is as follows:



----------------------------------------------------------------------------
September 30, 2010 June 30, 2010
----------------------------------------------------------------------------
Shareholders' equity excluding
accumulated other comprehensive income
(loss) $ 104,840 $ 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 months ended September 30, 2010.

16. SUBSEQUENT EVENT

(a) 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.

As of November 23, 2010, the Company repurchased 70,800 shares at an average price of $2.88 for total proceeds of $206. All of the repurchased shares will be cancelled.

Contact Information

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