Zungui Haixi Corporation
TSX VENTURE : ZUN

Zungui Haixi Corporation

February 28, 2011 07:00 ET

Zungui Haixi Reports Q2 Fiscal 2011 Financial Results Strong Revenue Growth of 30%

TORONTO, ONTARIO--(Marketwire - Feb. 28, 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 six months ended December 31, 2010. All amounts in this release are in Canadian dollars unless otherwise indicated. 

"We are pleased to report strong revenue growth of 30% for the quarter based on increased retail outlets and consumer demand as well as our success in growing the Zungui brand in our key markets," indicated Mr. Yanda Cai, Chief Executive Officer. "We are on track for continuing the pace of our store network growth with the planned addition of 140 new retail outlets over the next two quarters and the expansion of our manufacturing capacity to meet current demand. We are pleased to report that we have received building permit approval for our new ten storey building and plan to commence construction in April, 2011."

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

  • Revenue increased 30% to $47.9 million in the second quarter and increased 23% to $98.3 million for the year-to-date;
  • In RMB, revenue increased 32% to RMB 314.7 million for the second quarter and increased 27% to RMB 643.2 million for the year-to-date;
  • Revenue before subsidies increased 33% to $50.0 million for the second quarter and increased 27% to $102.7 million for the year-to-date;
  • Gross margin improved to 26.3% for the quarter compared to 25.7% same quarter last year;
  • Opened 53 net new distributor owned retail outlets compared to 37 retail outlets same quarter last year;
  • Opened 56 net new corporate-owned retail outlets in the second quarter;
  • Corporate-owned retail outlets reported second quarter revenue of $1.6 million ($2.3 million year-to-date) compared to $0.1 million ($0.2 million year-to-date) for the same quarter last year reflecting a start up phase of development;
  • Selling expenses increased $3.7 million in the quarter compared to the same quarter last year primarily due to increased advertising expenditures of $2.7 million;
  • Net income decreased 10% to $5.0 million for the second quarter and decreased 9% to $12.1 million for the year-to-date reflecting increased subsidy provisions to distributors and increased selling expenses;
  • Diluted earnings per share of 8 cents compared to 11 cents for the same quarter last year based on a 21% increase in the weighted average number of shares outstanding in the period and a 3 cent impact for increased advertising expenses; and,
  • Diluted earnings per share of 19 cents for the six months ended December 31, 2010 compared to 26 cents for the same period last year on a 22% increase in the weighted average number of shares outstanding in the period.

On a trailing 12 month basis, the Company's revenue is $182.2 million, net income is $25.8 million and diluted earnings per share is 41 cents. 

Conference Call

Zungui will host a conference call to discuss the first quarter results at 9am (EST) February 28, 2011. The details are as follows:

Dial-in number: 1-877-440-9795 or 416-340-8527

Taped rebroadcast (until midnight on March 14, 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 six months ended December 31, 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 month and six months ended December 31, 2010 with comparative figures for the three and six months ended December 31, 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, and the unaudited consolidated financial statements for the three and six months ended December 31, 2010 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 February 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&A

Overview

Selected Financial Information

Factors Affecting the Results of Operations

Results of Operations

Summary of Quarterly Results

Liquidity and Capital Resources

Capital Structure

Off-Balance Sheet Arrangements

Use of Proceeds

Related Party Transactions

Financial Instruments and Other Instruments

Recent Accounting Changes

Outlook

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 December 31, 2010, Zungui distributes its products to consumers through 100 corporate-owned retail outlets and through 47 distributors, who in turn sell products via an extensive network of 1,935 retail outlets, 1,540 of which offer the Sportswear Product Line and 395 of which offer the Casual Product Line. All retail outlets exclusively sell products which carry the ZUNGUI brand.

Net new store openings

  Q1 Q2 Total
Corporate 13 56 69
Distributor 120 53 173

During the three and six months ended December 31, 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 network expansion. As well the Company increased its advertising expenditures to build brand recognition. For the three months ended December 31, 2010, revenue grew 30% to $47.9 million from $37.0 million compared to same period last year. In Renminbi ("RMB"), revenue grew 32% to RMB 314.7 million from RMB 238.9 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 and six months ended December 31, 2010.

Earnings Data For the three months ended
December 31
For the six months ended
December 31
  2010 2009 2010 2009
Revenue $ 47,877 $ 36,960 $ 98,302 $ 79,990
Cost of sales   35,304   27,455   73,035   58,744
Gross profit   12,573   9,505   25,267   21,246
Selling expenses   4,258   511   6,035   1,104
Research and development expenses   202   149   403   287
General and administrative expenses   1,265   840   2,320   1,404
Other expenses (income), net   (34)   (24)   82   (31)
Income tax expense   1,883   2,479   4,372   5,275
Net income $ 4,999 $ 5,550 $ 12,055 $ 13,207
                 
Earnings per share – basic and diluted $ 0.08 $ 0.11 $ 0.19 $ 0.26

 


Balance Sheet Data
As at December 31, 2010 As at June 30,
 2010
Cash $ 81,684 $ 85,876
Inventories 3,511 3,498
Property, plant and equipment 8,827 6,470
Total assets 129,498 131,705
Working capital 95,687 89,532
Retained earnings 66,648 56,161
Total shareholders' equity 104,514 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 December 31, 2010 and 2009 was 0.1521 and 0.1547 and for the six months ended December 31, 2010 and 2009 was 0.1528 and 0.1576. The movement of the Chinese currency relative to the Canadian dollar in the three and six months ended December 31, 2010 resulted in the statement of operations in Canadian dollars being 2% and 4% less than would have been reported if the Company had used the average exchange rate for the same period of 2009, respectively.

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 six months ended December 31, 2010 and 2009, immediately prior to their conversion to Canadian dollars.

In RMB For the three months ended
December 31
For the six months ended
December 31
  2010 2009 2010 2009
Revenue RMB 314,691 RMB 238,899 RMB 643,151 RMB 506,816
Cost of sales 232,052 177,459 477,828 372,272
Gross profit 82,639 61,440 165,323 134,544
Net income 32,858 35,878 78,820 83,553
         
Weighted average exchange rate for one RMB, expressed in Canadian dollars 0.1521 0.1547 0.1528 0.1576

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. 

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 Six Months Ended December 31, 2010 compared to December 31, 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. Total revenue increased 30% to $47.9 million for the three months ended December 31, 2010 compared to the second quarter of last year. In RMB, revenue increased 32% to RMB 314.7 million for the three months ended December 31, 2010 compared to RMB 238.9 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 2% when reported in Canadian dollars.

Total revenue increased 23% to $98.3 million for the six months ended December 31, 2010 compared to the same period last year. In RMB, revenue increased 27% to RMB 643.2 million compared to the first six months of last year. The strengthening of the Canadian dollar for the six months ended December 31, 2010 relative to the RMB reduced the percentage increase in revenue by 4% when reported in Canadian dollars.

Revenue by Product Line

  For the three months ended December 31 For the six months ended December 31
  2010 % of Total 2009 % of Total 2010 % of Total 2009 % of Total
Footwear $ 42,502 85.1 $ 31,767 84.3 $ 89,260 86.9 $ 69,156 85.3
Apparel and accessories   7,462 14.9   5,910 15.7   13,433 13.1   11,907 14.7
    49,964 100.0   37,677 100.0   102,693 100.0   81,064 100.0
Subsidy provision  
2,087
   
717
   
4,391
   
1,074
 
Total $ 47,877   $ 36,960   $ 98,302   $ 79,990  

Total revenue before subsidy provision increased 33% to $50.0 million for the three months ended December 31, 2010 compared to the second quarter of last year.

Footwear revenue increased 34% to $42.5 million for the three months ended December 31, 2010 compared to the same period last year, and was comprised of $37.1 million (Q2 2010 - $27.7 million) in revenue from athletic footwear and $5.4 million (Q2 2010 - $4.0 million) from casual footwear. Footwear units sold during the quarter increased to 3.0 million compared to 2.3 million for the same quarter last year. The growth in revenue was the result of increased number of retail outlets (2,035 retail outlets in total compared to 1,719 at December 31, 2009) and increased consumer demand. 

Total revenue before subsidies increased 27% to $102.7 million for the six months ended December 31, 2010 compared to the same period last year. Footwear units sold during the six months ended December 31, 2010 increased to 6.3 million compared to 5.1 million for the same period last year. 

In RMB, the Company's revenue per average number of retail outlets increased 14% to RMB 0.2 million during the three months ended December 31, 2010 compared to the same period last year. For each of the three months ended December 31, 2010 and 2009, 96.8% and 99.7% of the Company's revenue was derived from its wholesale distribution channel, respectively. The corporate stores contributed $1.6 million of revenue for the three months ended December 31, 2010 and $2.3 million for the six months ended December 31, 2010.

Cost of Sales

  For the three months ended December 31 For the six months ended December 31
  2010 % of Total 2009 % of Total 2010 % of Total 2009 % of Total
Footwear (internal production)                        
  Raw materials $ 13,389 37.9 $ 10,039 36.5 $ 24,714 33.8 $ 20,187 34.4
  Labour   1,880 5.3   1,088 4.0   3,278 4.5   2,211 3.8
  Manufacturing costs   1,004 2.9   496 1.8   1,818 2.5   1,015 1.7
Subtotal   16,273 46.1   11,623 42.3   29,810 40.9   23,413 39.9
Footwear (outsourced production)   13,660 38.7   11,426 41.6   33,577 46.0   26,552 45.2
Apparel and accessories (outsourced production)   5,371 15.2   4,406 16.1   9,648 13.2   8,779 14.9
Total $ 35,304 100.0 $ 27,455 100.0 $ 73,035 100.0 $ 58,744 100.0

During the three months ended December 31, 2010, cost of sales increased 29% to $35.3 million compared to last year. In RMB, cost of sales increased 31% to RMB 232.1 million for the three months ended December 31, 2010. The price of raw material inputs did not change materially this quarter. Outsourced production accounted for 47% of the footwear units sold compared to 55% for the same quarter last year. 

During the six months ended December 31, 2010, cost of sales increased 24% to $73.0 million compared to the first six months of fiscal 2010. In RMB, cost of sales increased 28% to RMB 477.8 million. Outsourced production accounted for 54% of the footwear units sold during the six months ended December 31, 2010 compared to 57% for the same period last year.

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 December 31 For the six months ended December 31
  2010 Gross
Margin
%
2009 Gross
Margin %
2010 Gross
Margin
%
2009 Gross
Margin
%
Footwear $ 10,794 26.5 $ 8,114 26.0 $ 22,049 25.8 $ 18,274 26.8
Apparel and accessories  
1,779

24.9
 
1,391

24.0
 
3,218

25.0
 
2,972

25.3
Total $ 12,573 26.3 $ 9,505 25.7 $ 25,267 25.7 $ 21,246 26.6

The gross margin improved for the three months ended December 31, 2010 compared to the same quarter last year on a positive impact of 1.1 percentage points from the corporate stores which have a higher gross margin. Excluding the corporate stores, the gross margin declined to 25.2% based on increased cost of goods sold and a subsidy provision of $2.1 million.

For the six months ended December 31, 2010, the gross margin declined compared to the prior year as a result of increased subsidy provision of $4.4 million made to distributors to support additional new store growth. 

Selling Expenses

  For the three months ended December 31 For the six months ended December 31
  2010 2009 Increase 2010 2009 Increase
Selling Expenses $ 4,258 $ 511 734% $ 6,035 $ 1,104 447%

The Company spent $3.2 million ($4.5 million for the year to date) on advertising during the three months ended December 31, 2010 compared to $0.4 million ($1.0 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 on five television stations this quarter. Selling expenses were increased by $0.9 million on the opening of new corporate owned retail outlets which are currently in the start up phase of operations. Selling expenses represented 8.9% and 1.4% of total revenue for the three months ended December 31, 2010 and 2009, respectively, and were 6.1% and 1.4% of total revenue for the six months ended December 31, 2010 and 2009, respectively. 

Research and Development Expenses

  For the three months ended December 31 For the six months ended December 31
  2010 2009 Increase 2010 2009 Increase
Research and Development Expenses $ 202 $ 149 35% $ 403 $ 287 41%

Research and development expenses increased during the three and six months ended December 31, 2010 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 December 31 For the six months ended December 31
  2010 2009 Increase 2010 2009 Increase
General and Administrative Expenses $ 1,265 $ 840 51% $ 2,320 $ 1,404 65%

Corporate expenses related to being a public company, including salaries, directors fees, audit fees and stock compensation expenses totalled $0.5 million and $0.9 million during the three and six months ended December 31, 2010. General and administrative expenses represented 2.6% and 2.3% of total revenue for the three months ended December 31, 2010 and 2009, respectively and 2.4% and 1.8% of total revenue for the six months ended December 31, 2010. 

Other Expenses (Income), net

  For the three months ended December 31 For the six months ended December 31
  2010 2009 Increase 2010 2009 Decrease
Other expense (income), net $ (34) $ (24) 42% $ 82 $ (31) 365%

Other expenses, net 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. 

Income Tax Expense

  For the three months ended December 31 For the six months ended December 31
  2010 2009 Decrease 2010 2009 Decrease
Income tax expense $ 1,883 $ 2,479 24% $ 4,372 $ 5,275 17%

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 31% 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 December 31, 2010 compared to 30% last year.

Net Income

  For the three months ended December 31 For the six months ended December 31
  2010 2009 Decrease 2010 2009 Decrease
Net income $ 4,999 $ 5,550 10% $ 12,055 $ 13,207 9%

Net income decreased 10% to $5.0 million for the three months ended December 31, 2010 compared to the same period last year. In RMB, net income decreased 8% to RMB 32.9 million for the three months ended December 31, 2010 compared to RMB 35.9 million in the second quarter of last year. Revenue growth of 30% generated an additional $3.1 million of gross profit which was more than offset by increases in selling expenses of $3.7 million, general and administrative expenses of $0.4 million, and research and development expenses of $0.1 million resulting in lower net income of $1.1 million, which was reduced by lower income taxes of $0.6 million resulted in a decrease in net income of 10% or $0.5 million. Net income decreased 9% to $12.1 million for the six months ended December 31, 2010 for the same combination of reasons.

Basic and Diluted Earnings Per Share

Basic and diluted earnings per share was 8 cents for the three months ended December 31, 2010 compared to 11 cents for the same quarter last year and was 19 cents for the six months ended December 31, 2010 compared to 26 cents for the first six months of fiscal 2010. There were 62,128,100 shares issued and outstanding as at December 31, 2010. The weighted average number shares outstanding during the three months ended December 31, 2010 and 2009 was 62,208,740 and 51,375,000, respectively and for the six months ended December 31, 2010 and 2009 was 62,234,256 and 50,687,500, 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 December 31, 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 32% from 1,544 retail outlets at January 1, 2009 to 2,035 retail outlets as at December 31, 2010. 

Quarter Ended Dec 31
2010
Sept 30
2010
June 30
2010
Mar 31
2010
Dec 31
2009
Sept 30
2009
June 30
2009
Mar 31
2009
Revenue $ 47,877 $ 50,425 $ 50,553 $ 33,342 $ 36,960 $ 43,030 $ 44,349 $ 31,104
Net income   4,999   7,056   8,575   5,194   5,550   7,657   7,597   5,144
Earnings per share – basic and diluted $ 0.08 $ 0.11 $ 0.14 $ 0.08 $ 0.11 $ 0.15 $ 0.15 $ 0.10

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 and support its' growth in retail outlets. As a result, the cash on hand has decreased from $85.9 million as at June 30, 2010 to $81.7 million as at December 31, 2010. The cash on hand is expected to decrease next quarter as the Company anticipates beginning construction of its new building. 

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 $2.7 million as at December 31, 2010 from $1.6 million as at June 30, 2010 but was lower than the level at December 31, 2009 of $9.9 million. The other components of inventory decreased 55% to $0.9 million. 

Accounts receivable decreased to $30.5 million as at December 31, 2010 compared to $34.1 million as at June 30, 2010 and $28.7 million as at December 31, 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 62 days for the three months ended December 31, 2010 compared to 60 days for the year ended June 30, 2010 and 58 days for the three months ended December 31, 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 used by operating activities for the three months ended December 31, 2010 was $4.9 million compared to $4.6 million for the same quarter last year. During the six months ended December 31, 2010 and 2009, net cash provided by operating activities was $2.6 million and $2.8 million, respectively. During the three months ended December 31, 2010, the increased accounts payable on subsidy payments expected to be made in future quarters increased the use of cash in the quarter. No dividends were paid out during the three or six months ended December 31, 2010 or 2009. Net cash provided/(used) during the three months ended December 31, 2010 and 2009 was ($9.8) million and $28.7 million, respectively. During the three months ended December 31, 2009, the Company's initial public offering raised cash of $34.0 million.

Working capital increased from $89.5 million (RMB 572.5 million) as at June 30, 2010 to $95.7 million (RMB 634.1 million) as at December 31, 2010 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 expects to complete the upgrade and/or replacement of its existing equipment by April, 2011. The Company has received building permits for its planned construction of a new ten storey building. The Company has been delayed on its construction as the City of Shishi has been constructing an eight lane highway in front of the planned building site. Once the highway construction has been completed, the Company will be in a position to begin construction which we anticipate will be in April, 2011. The Company expects to complete construction of the building and installation of two new production lines by the second quarter of fiscal 2012 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 December, 2010, the Company has 62,128,100 common shares issued and outstanding. As of February 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 December 31, 2010, the Company repurchased 131,400 shares at an average price of $2.79 for total proceeds of $0.4 million. All of the repurchased shares have been cancelled. Subsequent to December 31, 2010, the Company repurchased under its normal course issuer bid 47,700 shares at an average price of $2.67 for total proceeds of $0.1 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

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. 

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. 

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 Proceeds As disclosed
Disbursed as of
December 31 2010
Balance to be disbursed as of
December 31 2010
Retail and Distribution Network Expansion $ 16,000 $ 5,459 $ 4,860
Increase Production Capacity – Building and Equipment   7,000   1,553   5,447
Brand Recognition, Awareness and Image   9,000   5,088   3,912
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 distributors achieve the criteria for payment of the subsidies. The Company does not expect to utilize approximately $5.7 million of the expansion proceeds for the original 350 new retail outlets opened in calendar 2010. 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. 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 $1.4 million as at December 31, 2010 and June 30, 2010.

A loan was received from a director of Honorable for $0.4 million as at December 31, 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.

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 will be 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 is 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. 

Financial Instruments and Other Instruments

The Company held cash of $81.7 million on its balance sheet as at December 31, 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 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 two quarters and finalize the first-time adoption alternatives prior to June 30, 2010. The Company will review the impact on information technology, internal controls and contractual arrangements during the next two quarters. 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. Through to June 30, 2011, the Company expects to open an additional 40 corporate-owned retail outlets and 100 distributor retail outlets.

Zungui Haixi Corporation

Consolidated Balance Sheets

(Unaudited)

(Expressed in thousands of Canadian Dollars)

    December 31, 2010 June 30, 2010
Current assets      
  Cash   $ 81,684 $ 85,876
  Accounts receivable, net     30,497   34,128
  Prepaid expenses     2,826   343
  Inventories (Note 4)     3,511   3,498
  Other receivables (Note 13)     1,350   1,331
  Future income taxes     803   58
Total current assets     120,671   125,234
             
Property, plant and equipment (Note 5)     8,827   6,470
Total assets   $ 129,498 $ 131,705
             
Current liabilities          
  Accounts payable and accrued liabilities   $ 20,269 $ 30,288
  Taxes payable     4,282   4,974
  Due to related party (Note 13)     433   440
Total current liabilities     24,984   35,702
           
Shareholders' equity          
  Share capital (Note 7)     33,380   33,451
  Contributed surplus (Note 7)     3,512   3,282
  Surplus reserve funds (Note 9)     6,043   4,774
  Retained earnings     66,648   56,161
  Accumulated other comprehensive income (loss)     (5,069)   (1,665)
Total shareholders' equity     104,514   96,003
             
Total liabilities and shareholders' equity   $ 129,498 $ 131,705

Subsequent Event (Note 17)

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

Approved By the Board

(Signed) "Michael W. Manley"

Director

(Signed) "Patrick A. Ryan"

Director

Zungui Haixi Corporation

Consolidated Statements of Income and Comprehensive Income

(Unaudited)

(Expressed in thousands of Canadian Dollars, except per share data)

  Three Months Ended December 31, Six Months Ended
 December 31,
  2010 2009 2010 2009
                 
Revenue (Note 11) $ 47,877 $ 36,960 $ 98,302 $ 79,990
Cost of sales   35,304   27,455   73,035   58,744
Gross profit   12,573   9,505   25,267   21,246
Selling expenses   4,258   511   6,035   1,104
Research and development expenses   202   149   403   287
General and administrative expenses   1,265   840   2,320   1,404
Foreign exchange loss   23   -   32   -
Other expenses (income), net   (57)   (24)   50   (31)
    5,691   1,476   8,840   2,764
Income before income taxes   6,882   8,029   16,427   18,482
                 
Income tax expense (Note 12)   1,883   2,479   4,372   5,275
                 
Net income   4,999   5,550   12,055   13,207

Other comprehensive income (loss):
               
  Unrealized gain(loss) on foreign currency translation of self-sustaining operations   (1,984)   (1,055)   (3,404)   (3,950)
                 
Comprehensive income $ 3,015 $ 4,495 $ 8,651 $ 9,257
                 
Basic and diluted earnings per share (Note 7(b)) $ 0.08 $ 0.11 $ 0.19 $ 0.26
                 
Weighted average number of shares outstanding   62,208,740   51,375,000   62,234,256   50,687,500

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 December 31, Six Months Ended December 31,
  2010 2009 2010 2009
                 
Share Capital                
Balance, beginning of period $ 33,451 $ - $ 33,451 $ -
Issuance of share capital, net   -   33,040   -   33,040
Repurchased for cancellation   (71)   -   (71)   -
Stock based compensation expense   -   (1,816)   -   (1,816)
Balance, end of period $ 33,380 $ 31,224 $ 33,380 $ 31,224
                 
Contributed Surplus                
Balance, beginning of period $ 3,398 $ 1,174 $ 3,282 $ 1,174
Stock based compensation expense   114   1,829   230   1,829
Balance, end of period $ 3,512 $ 3,003 $ 3,512 $ 3,003
                 
Surplus Reserve Funds                
Balance, beginning of period $ 4,774 $ 1,938 $ 4,774 $ 1,938
Transfer from retained earnings   1,269   -   1,269   -
Balance, end of period $ 6,043 $ 1,938 $ 6,043 $ 1,938
                 
Retained Earnings                
Balance, beginning of period $ 63,217 $ 39,678 $ 56,161 $ 32,021
Net income   4,999   5,550   12,055   13,207
Repurchase of shares for cancellation   (299)   -   (299)   -
Transfer to surplus reserve funds   (1,269)   -   (1,269)   -
Balance, end of period $ 66,648 $ 45,228 $ 66,648 $ 45,228
                 
Accumulated Other Comprehensive Income (Loss)                
Balance, beginning of period $ (3,085) $ (2,853) $ (1,665) $ 42
Unrealized foreign currency translation gains (losses)  
(1,984)
 
(1,055)
 
(3,404)
 
(3,950)
Balance, end of period $ (5,069) $ (3,908) $ (5,069) $ (3,908)
                 
Total Shareholders' Equity $ 104,514 $ 77,485 $ 104,514 $ 77,485

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

Zungui Haixi Corporation

Consolidated Statements of Cash Flows

(Unaudited)

(Expressed in thousands of Canadian Dollars unless otherwise noted)

      Three Months Ended December 31, Six Months Ended December 31,
      2010 2009 2010 2009
                 
Cash flows from operating activities                
  Net income $ 4,999 $ 5,550 $ 12,055 $ 13,207
  Items not affecting cash:                
    Depreciation   467   109   778   223
    Future income taxes   (209)   -   (756)   (10)
    Provision for doubtful accounts   (46)   164   (32)   167
    Stock based compensation   114   13   230   13
    Loss on disposal of property, plant and equipment   20   -   202   -
  Changes in non-cash working capital                
    Accounts receivable   4,598   (5,400)   2,494   (9,071)
    Prepaid expenses   (1,421)   6   (2,525)   -
    Inventories   (246)   (3,780)   (137)   (8,029)
    Other receivables   (40)   (44)   (66)   (71)
    Accounts payable and accrued liabilities   (12,464)   (1,080)   (9,076)   6,252
    Taxes payable   (691)   (106)   (524)   144
Net cash provided (used) by operating activities   (4,919)   (4,568)   2,643   2,825
                     
Cash flows from investing activities                
  Property, plant and equipment   (2,152)   (16)   (2,922)   (16)
  Proceeds from sale of equipment   -   -   20   -
  Construction in progress   (685)   -   (695)   -
Net cash used in investing activities   (2,837)   (16)   (3,597)   (16)
                     
Cash flows from financing activities                
  Due to related party   (16)   -   (7)   -
  Increase in share capital   -   33,965   -   33,965
  Repurchase of shares for cancellation   (369)   -   (369)   -
Net cash provided (used) by financing activities   (385)   33,965   (376)   33,965
                 
Effect of exchange rate changes on cash   (1,669)   (685)   (2,862)   (2,508)
                 
Net increase (decrease) in cash   (9,810)   28,696   (4,192)   34,266
                 
Cash, beginning of period   91,494   29,327   85,876   23,757
Cash, end of period $ 81,684 $ 58,023 $ 81,684 $ 58,023
                 
Supplemental disclosure of cash information                
Interest paid in cash $ - $ 20 $ - $ 54
Income taxes paid in cash   2,832   2,611   5,716   5,189

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

Zungui Haixi Corporation

Notes to Consolidated Financial Statements

For the three and six month periods ended December 31, 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. 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 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.

(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.

4. INVENTORIES

Inventories consist of:

  December 31, June 30,
  2010 2010
Raw materials $ 384 $ 1,433
Work in progress   466   466
Finished goods   2,661   1,599
Total inventory $ 3,511 $ 3,498

Inventories expensed as cost of sales were $35,217 and $72,919 for the three and six months ended December 31, 2010, respectively and were $27,441 and $58,714 for the three and six months ended December 31, 2009, respectively.

5. PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consist of:

  December 31, 2010 June 30, 2010
  Cost Accumulated Depreciation Net Book Value Cost Accumulated Depreciation Net Book Value
Plant and building $ 5,331 $ 1,935 $ 3,396 $ 5,859 $ 2,036 $ 3,823
Machinery and production equipment   1,871   773   1,098   1,798   950   848
Automobiles and trucks   647   211   436   668   191   477
Leasehold improvements   3,832   683   3,149   1,422   156   1,266
Construction in progress   687   -   687   -   -   -
Office equipment   154   93   61   148   92   56
Total $ 12,522 $ 3,695 $ 8,827 $ 9,895 $ 3,425 $ 6,470

Depreciation expense was $467 and $778 for the three and six months ended December 31, 2010, respectively, and $109 and $223 for the three and six months ended December 31, 2009.

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 six months ended December 31, 2010 and $20 and $70 for the three and six months ended December 31, 2009, respectively.

7. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS

(a) Share Capital:

As at December 31, 2010 the authorized share capital of Zungui was unlimited common shares with no par value.

  Number of Shares
Issued
Number of
Stock
Options
Number of Compensation
Options
Weighted
Average
Exercise
Price
Amount
Balance as at August 11, 2009 1 - - $ - $ -
Share exchange transaction (Note 1) 50,000,000 - -   -   -
Initial public offering (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)) - - 805,000   3.25   (811)
Balance as at December 31, 2009 61,500,000 700,000 805,000 $ 3.25 $ 31,224
               
Balance as at:
June 30, 2010 and September 30, 2010
62,259,500 700,000 858,165 $ 3.25 $ 33,451
Normal course issuer bid (131,400) - -   -   (71)
Balance as at December 31, 2010 62,128,100 700,000 858,165 $ 3.25 $ 33,380

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 and six months ended December 31, 2010, the Company repurchased 131,400 shares at an average price of $2.79 for total proceeds of $370. Of the total cost, $71 is charged to share capital and $299 is charged to retained earnings. 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 December 31, 2010 are as follows:

  Exercise
Price
Date of
Grant
Expiry
Date
Remaining Contract-
ual
Life (Years)
Number Outstand-
ing
Number
Exercis-
able
Employee and Non-Employee Directors $3.25 December 21, 2009 December 21, 2014 4.0 950,000 316,666
Consultants $3.25 December 21, 2009 December 21, 2014 4.0 700,000 233,333
Underwriters $3.25 December 21, 2009 December 21, 2011 1.0 805,000 805,000
Underwriters $3.25 January 12, 2010 January 12, 2012 1.0 53,165 53,165
Employee and Non-Employee Directors $2.65 December 13, 2010 December 13, 2015 5.0 150,000 -

(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.

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:

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

Expected volatility is based on the historical volatility of companies in comparable industries. The risk-free interest rate is based on yields of Government of Canada T-bills with similar maturities. The expected option life was estimated based on vesting schedule 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 December 31, 2010, 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 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 December 31, 2010, 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 Six Months Ended Three and Six Months Ended
  December 31, 2010 December 31, 2009
Risk-free interest rate 2.558 2.46
Dividend yield 0.0% 0.0%
Expected volatility 57.8% 54.3%
Expected option life (in years) 4 4

Expected volatility is based on the historical volatility of companies in comparable industries. The risk-free interest rate is based on yields of Government of Canada T-bills with similar maturities. 

During the three and six months ended December 31, 2010, stock based compensation expense was $114 and $230, respectively, and during the three and six months ended December 31, 2009, stock based compensation was $13.

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 three months ended December 31, 2010, Mengshida transferred $1.3 million to its' surplus reserve funds. As of December 31, 2010 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 six month periods ended December 31, 2010 and 2009.

During the three month period ended December 31, 2010, purchases from three suppliers, each represented 16% ($5,446), 15% ($5,073) and 15% ($4,868) of total purchases. During the three month period ended December 31, 2009, purchases from three suppliers represented 18% ($5,208), 17% ($5,070) and 17% ($5,070) of total purchases. During the six month period ended December 31, 2010, purchases from three suppliers, each represented 18% ($12,212), 17% ($11,637) and 17% ($11,633) of total purchases. During the six month period ended December 31, 2009, purchases from three suppliers represented 18% ($11,569), 18% ($11,500) and 18% ($11,330) of total purchases. 

11. REVENUE

  Three Months Ended December 31, Six Months Ended December 31,
  2010 2009 2010 2009
Footwear $ 42,502 $ 31,767 $ 89,261 $ 69,157
Apparel and accessories   7,462   5,910   13,432   11,907
    49,964   37,677   102,693   81,064
Subsidy provision   2,087   717   4,391   1,074
Revenue $ 47,877 $ 36,960 $ 98,302 $ 79,990

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 $1,591 as at December 31, 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 December 31, 2010, the Company has income tax losses of $2,913 ($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 ($1,093). The Company has income tax losses of $175 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 $1.4 million from Directors.

(b) Due to related party consists of a loan from a Director of Honorable totalling $433 (Hong Kong $3,200,000 and RMB 100,000) as at December 31, 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 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) See Note 17.

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 ($674) 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:

December 31, 2010 Held for Trading Loans and Receivables Other Financial Liabilities Total Carrying Value
Financial assets                
Cash $ 81,684 $ - $ - $ 81,684
Accounts receivable   -   30,497   -   30,497
Other receivables   -   1,350   -   1,350
  $ 81,684 $ 31,847 $ - $ 113,531
                 
Financial liabilities                
Accounts payable and accrued liabilities $ - $ - $ 20,269 $ 20,269
Due to related party   -   -   433   433
  $ - $ - $ 20,702 $ 20,702
June 30, 2010 Held for Trading Loans and Receivables Other Financial Liabilities Total 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   -   -   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 or six months ended December 31, 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 December 31, 2010, the Company had $20,269 in accounts payable and accrued liabilities and due to related party $433. All financial liabilities have contractual maturities of less than one year as of December 31, 2010.

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

  December 31,
2010
June 30,
2010
Shareholders' equity excluding accumulated other comprehensive income (loss)  
$ 109,583
 
$ 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 December 31, 2010.

17. SUBSEQUENT EVENT

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. 

Contact Information

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