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Share Name | Share Symbol | Market | Type |
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Rumbu Holdings Ltd | TSXV:RMB | TSX Venture | Common Stock |
Price Change | % Change | Share Price | Bid Price | Offer Price | High Price | Low Price | Open Price | Shares Traded | Last Trade | |
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-0.025 | -16.67% | 0.125 | 0.125 | 0.15 | 0.13 | 0.125 | 0.13 | 25,000 | 21:00:11 |
Zungui Haixi Corporation (TSX VENTURE:ZUN), a China-based manufacturer of sportswear and casual footwear, today announced its financial results for the three and nine months ended March 31, 2010. All amounts in this release are in Canadian dollars unless otherwise indicated. "We are pleased to report our third quarter results showing consistent revenue growth," indicated Mr. Jixu Cai, Chief Executive Officer of Zungui. "During the quarter we laid the foundation for our growth strategy and opened 18 new corporate-owned stores in April, 2010 and held a successful sportswear sales fair with a 38% increase in orders. Our revenue and net income grew 28% and 21% in RMB, respectively, in the quarter." Highlights for the Third Quarter and Year-To-Date: -- Revenue increased 7% to $33.3 million for the quarter and 20% to $113.3 million for the year-to-date; -- In RMB, revenue increased 28% to RMB 218.7 million for the quarter and 30% to RMB 725.5 million for the nine months ended March 31, 2010; -- Gross margin of 26.7% for the third quarter and 26.6% for the nine months ended March 31, 2010 compared to 27.2% and 26.9% for the comparative periods of 2009, respectively; -- Net income increased 1% to $5.2 million for the quarter and 19% to $18.4 million for the nine months ended March 31, 2010; -- Net income increased 21% to RMB 34.1 million for the quarter and 29% to RMB 117.6 million for the nine months ended March 31, 2010; -- Diluted earnings per share of 8 cents compared to 10 cents for the same quarter last year based on a 24% increase in the weighted average number of shares outstanding in the period; and, -- Diluted earnings per share increased 7% to 33 cents for the nine months compared to 31 cents for the same period of 2009 on a 11% increase in the weighted average number of shares outstanding in the period. The results were impacted by the movement of the Chinese currency relative to the Canadian dollar. During the third quarter ended March 31, 2010 the average foreign exchange rate used to convert one Chinese Renminbi ("RMB") was 0.1524 expressed in Canadian dollars compared to 0.1821 for the same quarter of 2009. If the 2010 third quarter results were converted at the prior year's average exchange rate for the quarter, 2010 third quarter earnings per share would have been 10 cents. For the nine months ended March 31, 2010, the average foreign exchange rate used to convert one RMB was 0.1558 expressed in Canadian dollars compared to 0.1695 for the same period last year. If the 2010 nine month results were converted at the prior year's average exchange rate for 2009, 2010 nine month earnings per share would have been 36 cents, resulting in a 16% increase in earnings per share. Conference Call Zungui will host a conference call to discuss the third quarter results at 9am (EST) May 27, 2010. The details are as follows: Dial-in number: 1-888-789-9572 Participant passcode: 1730361 Taped rebroadcast (until midnight on June 10, 2010): 1-800-408-3053 Taped replay access passcode: 1146631. 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. 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 and nine months ended March 31, 2010 All amounts in 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 and nine months ended March 31, 2010 and 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 of Southern for the period ending June 30, 2009 and related notes contained in the final long form prospectus filed on December 11, 2009 on SEDAR at www.sedar.com. The consolidated financial statements were prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and are presented in thousands of Canadian dollars unless otherwise noted. Disclosure contained in this MD&A is current to May 26, 2010 the date of approval of the MD&A and financial statements by the Board of Directors. Certain statements in this MD&A contain forward-looking information that involve risk and uncertainties. Statements other than statements of historical fact contained in this MD&A may be forward-looking statements within the meaning of certain securities laws, including, without limitation, statements involving management's expectations, intentions and beliefs concerning the domestic PRC sportswear industry, the competitive landscape in this industry and the general economy, statements regarding the future financial position or results of the Company, business strategies, proposed acquisitions, growth opportunities, budgets, litigation, projected costs and plans and objectives of or involving the Company. Such statements should be considered forward-looking statements, Wherever possible, words such as "may", "would", "could", "will", "anticipate", "believe", "plan", "expect", "intend", "estimate", "aim", "endeavour", "project", "continue" and similar expressions have been used to identify forward-looking statements. These forward-looking statements reflect management's current beliefs and business judgement with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions, and you should not place undue reliance on these forward-looking statements. Although management believes its current beliefs and assumptions are reasonable, many factors could cause Zungui's actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements, including, without limitation, risks related to: failure to maintain or promote the ZUNGUI brand; dependency on distributors and retailers for product sales and brand promotion; difficulty in continuing to grow Zungui's distribution network; failure to effectively integrate additional corporate-owned and managed retail outlets; strong competition; the loss, or decrease in, sales to Zungui's major distributors; dependency on certain of its key executives, design, technical and other personnel; failure to successfully implement plans to expand production capacity and improve production efficiency; failure to execute growth strategy; reliance on subcontractors; fluctuations in the price, availability and quality of raw materials; exposure to credit risks of distributors; selling prices; failure to accurately track inventory levels or sales figures; failure to optimize and adjust product mix; failure to anticipate and respond in a timely manner to fashion trends and changes in consumer tastes in the PRC; liability for unpaid contributions to the social security insurance program; increases in labour costs and labour disputes; protection of trademarks and other proprietary rights; damage to administrative or production facilities, fire or other calamities; proof of title; exposure to environmental liability; exposure to product liability, property damage or personal injury claims; closure of retail outlets; failure to obtain additional financing; risks associated with state ownership; exposure to fluctuations in the economic conditions in the PRC; fluctuations in foreign exchange rates; changes in Zungui's tax treatment; limitations in the ability to repatriate profits or convert currency; limited shareholders' rights in China; risks relating to a developing legal system; intellectual property rights protection and enforcement; requirements for permits and business licenses; risks relating to the appropriation of land used in Zungui's operations; natural disasters; reliance on third-party sources and industry publications; volatile market price; return on an investment in common shares; risks relating to holding companies; limited recourse against certain securityholders; compliance with financial reporting and other requirements as a public company; language barriers between certain directors and officers of the Company; influence by the principal securityholder; future sales of common shares; conflicts of interest and dilution of common shares. See the "Risk Factors" section of the Company's other filings with Canadian securities regulatory authorities at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this MD&A. The forward-looking statements contained in this MD&A are expressly qualified in their entirety by this cautionary statement. These forward-looking statements are made as of and speak as of the date of this MD&A and the Company does not intend to, or assume any obligation to, update or revise these forward-looking statements to reflect new information, events, results or circumstances or otherwise after the date on which such statement is made as to reflect the occurrence of unanticipated events, except as required by law, including securities laws. Overview Zungui is principally engaged in the manufacture and sale of athletic footwear, apparel and accessories ("Sportswear Product Line") and casual leather footwear ("Casual Product Line"). Both product lines are marketed in the PRC under the well-recognized ZUNGUI brand. Zungui distributes its products to consumers throughout the PRC through three corporate-owned retail outlets and through 47 distributors, who in turn sell products via an extensive network of 1,731 retail outlets as of March 31, 2010, 1,410 of which offer the Sportswear Product Line and 321 of which offer the Casual Product Line. All retail outlets exclusively sell products which carry the ZUNGUI brand. During the three and nine months ended March 31, 2010, the expansion of the retail outlets continued and the Company focused on revenue growth and increased profitability. It provided services and training to distributors to help meet customer needs and increase their sales. For the three and nine months ended March 31, 2010, revenue grew 7% and 20% to $33.3 million and $113.3 million in Canadian dollars, respectively, compared to the same periods in the prior year. Revenue grew 28% and 30% in Renminbi ("RMB") to RMB 218.7 million and RMB 725.5 million, respectively, compared to the same periods last year with the difference attributable to the Chinese currency fluctuations relative to the Canadian dollar reporting currency in 2009 and 2010. Statement of Operations The following table sets forth selected financial information for the periods indicated. The selected financial information has been derived from the Company's unaudited interim consolidated financial statements for the three and nine month periods ended March 31, 2010. For the three months For the nine months ended Earnings Data ended March 31 March 31 ----------------------------------- ----------- -------------------------- 2010 2009 2010 2009 ------------ ----------- ------------ ------------ Revenue $ 33,342 $ 31,104 $ 113,332 $ 94,381 Cost of sales 24,442 22,656 83,186 69,007 ---------- ---------- ---------- ---------- Gross profit 8,900 8,448 30,146 25,374 Selling expenses 459 750 1,563 2,509 General and administrative expenses 1,243 757 2,934 1,712 Other expense (income), net 15 (16) (16) (33) Income taxes 1,989 1,813 7,264 5,736 ---------- ---------- ---------- ---------- Net income $ 5,194 $ 5,144 $ 18,401 $ 15,450 Earnings per share - basic and diluted $ 0.08 $ 0.10 $ 0.33 $ 0.31 Balance Sheet Data As at March 31, 2010 As at June 30, 2009 ------------------ --------------------------------------------- Cash $ 68,250 $ 23,757 Inventories 4,807 2,984 Property, plant and equipment 4,639 5,331 Total assets 103,124 56,079 Working capital 78,416 29,844 Retained earnings 50,422 32,021 Total shareholders' equity 83,055 35,175 Factors Affecting Results of Operations Foreign Currency All of the Company's revenues and expenses, other than the Canadian head office expenses, are generated in the People's Republic of China (PRC). Accordingly, the results of operations are impacted by the fluctuation of the Renminbi ("RMB") against the Canadian dollar when converted for financial reporting purposes. The weighted average exchange rate for one RMB, expressed in Canadian dollars, for the three months ended March 31, 2010 and 2009 was 0.1524 and 0.1821 and for the nine months ended March 31, 2010 and 2009 was 0.1558 and 0.1695. The movement of the Chinese currency relative to the Canadian dollar in the three and nine months ended March 31, 2010 resulted in the statement of operations in Canadian currency being 16% and 8% less than would have been reported if the Company had used the average exchange rate for the same periods 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 Canadian head office's functional currency is Canadian dollars. The Company uses Canadian dollars as its reporting currency. This information has been derived from the Company's records supporting the unaudited interim consolidated financial statements for the three months and nine months ended March 31, 2010 and 2009, immediately prior to their conversion to Canadian dollars. For the three months ended For the nine months ended In RMB March 31 March 31 ---------------- -------------- --------------- ------------ 2010 2009 2010 2009 ---------------- -------------- --------------- ------------ Revenue RMB 218,725 RMB 170,783 RMB 725,541 RMB 558,982 Cost of sales 160,339 124,397 532,612 408,838 ---------------- -------------- --------------- ------------ Gross profit 58,386 46,386 192,929 150,144 Net income 34,063 28,237 117,616 91,048 Weighted average exchange rate for one RMB, expressed in Canadian dollars 0.1524 0.1821 0.1558 0.1695 Revenues The Company's revenues consist of sales from footwear, apparel and accessories sold within the PRC. The Company provides sales rebates and advertising contributions to its distributors that are deducted from its gross revenue to derive its net revenue. Cost of Sales The Company's cost of sales consists of internal and external production costs. Internal production costs include raw materials, labour and manufacturing costs. Outsourced production costs refer to the cost of procuring finished footwear, apparel and accessories, which represents amounts paid to subcontracted manufacturers in the PRC. Seasonality The results of the Company are generally not subject to seasonality. Selling and general and administrative expenses The Company's selling and general and administrative expenses consist of advertising expenses, research and development expenses and salaries for administrative staff and management. Outlook The PRC domestic footwear market remains a high growth industry consistent with the growth of the PRC's economy. Zungui's focus is on the domestic market and the Company allocates its resources and efforts to meet the demands of China's growing local markets. Zungui is currently working to increase its presence in Tier 2 and 3 Cities, 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 and managed retail outlets and by assisting distributors in expanding their retail presence. Corporate-owned and managed retail outlets typically offer higher margins than sales through distributors as well as greater operating flexibility. By increasing the number of corporate-owned and managed retail outlets, Zungui believes it can focus its growth strategy in certain regions while complementing its current distribution network. The Company expects to add 100 corporate-owned and managed retail outlets, during the period April to December, 2010 and 250 retail outlets from distributors in calendar 2010. Results of Operations Three and Nine Months Ended March 31, 2010 compared to March 31, 2009 (Amounts in thousands of dollars, unless specified otherwise) Revenue The Company's revenues consist of sales from footwear, apparel and accessories sold domestically within the PRC. The Company derives its revenue from two distribution channels: wholesale and corporate-owned and managed retail outlets. The number of retail outlets increased 8% to 1,731 during the nine months ended March 31, 2010. During the three months ended March 31, 2010, 15 net new retail outlets were opened by distributors compared to 14 net new retail outlets during the same period last year. The Company currently has three corporate-owned and managed retail outlets with the balance being leased or owned by distributors or third-party retailers. No additional corporate-owned and managed retail outlets were opened during the nine months ended March 31, 2010. Revenue by Product Line For the three months For the nine months ended March 31 ended March 31 ---------------------------------------------------------------- % of % of % of % of 2010 Total 2009 Total 2010 Total 2009 Total --------- ------ -------- ------ -------- ------ -------- ------ Footwear $ 27,897 83.7 $ 25,889 83.2 $ 96,138 84.8 $ 78,819 83.5 Apparel and accessories 5,445 16.3 5,215 16.8 17,194 15.2 15,562 16.5 --------- ------ -------- ------ -------- ------ -------- ------ Total $ 33,342 100.0 $ 31,104 100.0 $113,332 100.0 $ 94,381 100.0 --------- ------ -------- ------ -------- ------ -------- ------ --------- ------ -------- ------ -------- ------ -------- ------ Total revenue increased 7% to $33.3 million for the three months ended March 31, 2010 compared to $31.1 million for the same period last year. In RMB, revenue increased 28% to RMB 218.7 million for the three month period ended March 31, 2010 compared to RMB 170.8 million for the same quarter last year. The strengthening of the Canadian dollar during the quarter relative to the RMB reduced the percentage increase in revenue by 21% when reported in Canadian dollars. Footwear revenue increased 8% to $27.9 million for the three months ended March 31, 2010 compared to the same period last year, and was comprised of $24.0 million in revenue from athletic footwear and $3.9 million from casual footwear. The growth in revenue was the result of increased number of retail outlets, demand for the Company's products and price increases implemented late in the quarter. Total revenue increased 20% to $113.3 million for the nine months ended March 31, 2010 compared to $94.4 million for the nine months ended March 31, 2009. For the nine months period ended March 31, 2010, revenue increased 30% to RMB 725.5 million compared to RMB 559.0 million for the same period last year. The strengthening of the Canadian dollar for the nine months ended March 31, 2010 relative to the RMB reduced the percentage increase in revenue by 10% when reported in Canadian dollars. In RMB, the Company's revenue per average number of retail outlets increased 15% to RMB 0.1 million during the three months ended March 31, 2010 compared to the same period last year and increased 17% to RMB 0.4 million for the nine months ended March 31, 2010 compared to the same period of 2009. Market demand for sportswear and casual products as well as increased consumer spending in the PRC has contributed to the growth rate in sales. For each of the three months ended March 31, 2010 and 2009, 99.7% of the Company's revenue was derived from its wholesale distribution channel. Cost of Sales For the three months ended March 31 -------------------------------------------- % of % of 2010 Total 2009 Total ------------ --------- ----------- --------- Footwear (internal production) Raw materials $ 9,780 40.0 $ 9,741 43.0 Labour 1,423 5.8 1,012 4.5 Manufacturing costs 628 2.6 507 2.2 ------------ --------- ----------- --------- Subtotal 11,831 48.4 11,261 49.7 Footwear (outsourced production) 8,588 35.1 7,490 33.1 Apparel and accessories (outsourced production) 4,023 16.5 3,905 17.2 ------------ --------- ----------- --------- Total $ 24,442 100.0 $ 22,656 100.0 ------------ --------- ----------- --------- ------------ --------- ----------- --------- For the nine months ended March 31 -------------------------------------------- % of % of 2010 Total 2009 Total ------------ --------- ----------- --------- Footwear (internal production) Raw materials $ 29,966 36.0 $ 29,920 43.4 Labour 3,634 4.4 3,246 4.7 Manufacturing costs 1,643 2.0 1,327 1.9 ------------ --------- ----------- --------- Subtotal 35,243 42.4 34,493 50.0 Footwear (outsourced production) 35,140 42.2 22,888 33.2 Apparel and accessories (outsourced production) 12,803 15.4 11,626 16.8 ------------ --------- ----------- --------- Total $ 83,186 100.0 $ 69,007 100.0 ------------ --------- ----------- --------- ------------ --------- ----------- --------- During the three months ended March 31, 2010, cost of sales increased 8% to $24.4 million from $22.7 million for the third quarter of 2009 relative to the 7% increase in revenue. In RMB, cost of sales increased 29% to RMB 160.3 million for the three months ended March 31, 2010 compared to RMB 124.4 million for the same quarter in 2009 relative to the 28% increase in revenue. During the nine months ended March 31, 2010, cost of sales increased by 21% to $83.2 million from $69.0 million for the same period last year which is comparable to the 20% increase in revenue for the same period. and In RMB, cost of sales increased 30% to RMB 532.6 million for the nine months ended March 31, 2010 compared to RMB 408.8 million for the same period last year consistent with the 30% increase in revenue for the period. During the quarter, the Company began remitting social insurance premiums on all employees which increased the cost of sales by approximately $0.4 million in the quarter and year-to-date. Raw materials accounted for 82.7% and 85.0% of the cost of sales on internally produced footwear for the three and nine months ended March 31, 2010, respectively compared to 86.5% and 86.7% for the three and nine months ended March 31, 2009. The average cost of raw materials did not materially change during the periods. Outsourced production accounted for approximately 35% and 55% of footwear requirements during the three and nine months ended March 31, 2010 compared to 51% and 56% for the same periods last year, respectively. During the quarter, the Company was able to reduce the outsourced production of the finished goods due to the build up of inventory as at December 31, 2009. The Company resumed a higher level of outsourced production in the latter part of the quarter. Gross Profit For the three months For the nine months ended March 31 ended March 31 ---------------------------------------------------------------- Gross Gross Gross Gross Margin Margin Margin Margin 2010 % 2009 % 2010 % 2009 % ---------------------------------------------------------------- Footwear $ 7,478 26.8 $ 7,138 27.6 $ 25,755 26.8 $ 21,438 27.2 Apparel and accessories 1,422 26.1 1,310 25.1 4,391 25.5 3,936 25.1 ------- ------- ------- ------- Total $ 8,900 26.7 $ 8,448 27.2 $ 30,146 26.6 $ 25,374 26.9 --------- --------- --------- --------- --------- --------- --------- --------- The gross margin declined in the quarter for the three and nine months ending March 31, 2010 compared to the same periods last year primarily a result of the inclusion of the social insurance premium payments in the cost of sales for production workers. The majority of the gross profit is derived from the sales of footwear which is consistent with the revenue breakdown. Selling Expenses For the three months ended For the nine months ended March 31 March 31 ----------------------------------------------------------- 2010 2009 Decrease 2010 2009 Decrease --------- -------- ---------- --------- -------- ---------- Selling Expenses $ 459 $ 750 (39%) $ 1,563 $ 2,509 (38%) Selling expenses decreased 39% to $0.5 million for the three months ended March 31, 2010 compared to the same period last year and were $1.6 million and $2.5 million for the nine months ended March 31, 2010 and 2009, respectively, as the Company spent less on advertising during both the three and nine months periods. Selling expenses represented 1.4% and 2.4% of total revenue for the three months ended March 31, 2010 and 2009, respectively, and 1.4% and 2.7% for the nine months ended March 31, 2010 and 2009. General and Administrative Expenses For the three months ended For the nine months ended March 31 March 31 ----------------------------------------------------------- 2010 2009 Increase 2010 2009 Increase --------- -------- --------- ---------- -------- ---------- General and Administrative Expenses $ 1,243 $ 757 64% $ 2,934 $ 1,712 71% Corporate expenses related to being a public company, including salaries, directors fees, audit fees and stock compensation expenses totalled $0.4 million and $0.7 million during the three and nine months ended March 31, 2010, respectively. Additional management bonuses were paid out in China during the quarter totalling $0.1 million. General and administrative expenses represented 3.7% and 2.4% of total revenue for the three months ended March 31, 2010 and 2009, respectively and 2.6% and 1.8% for the nine months ended March 31, 2010 and 2009, respectively. Other Expense (Income), net For the three months ended For the nine months ended March 31 March 31 ------------------------------------------------------------- 2010 2009 Decrease 2010 2009 Decrease --------- --------- --------- ---------- --------- ---------- Other expense (income), net $ 15 $ (16) 194% $ (16) $ (33) 52% Other expense (income), comprised primarily of interest income, is shown net of interest expense of $0.03 million and $0.04 million for the three months ended March 31, 2010 and 2009, respectively, and net of interest expense of $0.1 million for each of the nine months ended March 31, 2010 and 2009, respectively. Income Tax Expense For the three months ended For the nine months ended March 31 March 31 ----------------------------------------------------------- 2010 2009 Increase 2010 2009 Increase --------- -------- --------- ---------- -------- ---------- Income tax expense $ 1,989 $ 1,813 10% $ 7,264 $ 5,736 27% The statutory income tax rate in the PRC is 25%. However, due to non-deductible expenses, the effective tax rate is 28% and 26% for the three months ended March 31, 2010 and 2009 and 28% and 27% for the nine months ended March 31, 2010 and 2009. Net Income For the three months ended For the nine months ended March 31 March 31 ----------------------------------------------------------- 2010 2009 Increase 2010 2009 Increase --------- -------- ---------- --------- -------- ---------- Net income $ 5,194 $ 5,144 1% $ 18,401 $ 15,450 19% Net income increased marginally to $5.2 million for the three months ended March 31, 2010 compared to $5.1 million for the same period last year. In RMB, net income increased 21% to RMB 34.1 million for the three months ended March 31, 2010 compared to RMB 28.2 million in the third quarter of 2009. Net income increased during the quarter as a result of a $0.5 million increase in gross profit and a reduction of selling expenses of $0.3 million which were offset by an increase in general and administrative expenses of $0.5 million and additional income taxes of $0.2 million. Net income increased 19% to $18.4 million for the nine months ended March 31, 2010 compared to $15.5 million for the same period of 2009. For the nine months, net income in RMB increased 29% to RMB 117.6 million compared to RMB 91.0 million for the nine months ended March 31, 2009. Net income increased for the nine months as a result of an increase in gross profit of $4.8 million and lower selling expenses of $0.9 million offset by higher general and administrative expenses of $1.2 million and additional income taxes of $1.5 million. Basic and Diluted Earnings Per Share Basic and diluted earnings per share was 8 cents for the three months ended March 31, 2010 compared to 10 cents for the same quarter last year. Basic and diluted earnings per share was 33 cents for the nine months ended March 31, 2010 compared to 31 cents for the same period of 2009. There were 62,259,500 shares issued and outstanding as at March 31, 2010. The weighted average number shares outstanding during the three and nine months ended March 31, 2010 was 62,166,672 and 55,477,581, respectively. As a result of the application of continuity of interest accounting, all periods prior to the initial public offering completed on December 21, 2009 are deemed to have 50,000,000 shares issued and outstanding for the purpose of determining earnings per share. Reorganization and Share Capital On December 21, 2009, the Company completed a share exchange agreement with Southern whereby the 10,000 issued and outstanding common shares of Southern were exchanged for 50,000,000 common shares of the Company. On June 25, 2009, Southern, an investment holding company, acquired 100% ownership interest in Honorable 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 on July 25, 2008. Mengshida manufactures and sells athletic footwear and related apparel and accessories as well as leisure leather shoes in the People's Republic of China (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. The Company's fiscal year end is June 30, 2010. Accordingly these consolidated financial statements are for the three and nine month periods ended March 31, 2010 with comparative figures for the same periods in 2009. Initial Public Offering On December 21, 2009, the Company completed its initial public offering ("IPO") by issuing 11,500,000 common shares at a price of $3.25 per common share, resulting in net proceeds of $33,040 after deducting the underwriters' fees and other related expenses of the offering. The Company granted the underwriters an over-allotment option exercisable for a period of 30 days from closing of the IPO to purchase up to an additional 1,725,000 common shares at the issue price. In addition, the underwriters received compensation options entitling them to acquire up to 7% of the number of common shares issued under the IPO including any shares exercised under the over-allotment option. Each compensation option will be exercisable for common shares at $3.25 per share until December 21, 2011. On January 12, 2010, the underwriters exercised the over-allotment option to purchase 759,500 common shares at $3.25 and, as a result, received an additional 7% or 53,165 compensation options. Net proceeds of $2,278 were received after deducting the underwriters' fees and other related expenses of the offering. Each compensation option will be exercisable for common shares at $3.25 per share until January 12, 2012. Summary of Quarterly Results The quarterly data that is available is disclosed as follows: Mar 31 Dec 31 Sept 30 June 30 Mar 31 Dec 31 Sept 30 Quarter Ended 2010 2009 2009 2009 2009 2008 2008 --------- -------- -------- -------- -------- -------- -------- Revenue $ 33,342 $ 36,960 $ 43,030 $ 44,349 $ 31,104 $ 33,950 $ 29,327 Net income 5,194 5,550 7,657 7,597 5,144 5,293 5,013 Earnings per share - basic and diluted $ 0.08 $ 0.11 $ 0.15 $ 0.15 $ 0.10 $ 0.11 $ 0.10 Liquidity The purpose of liquidity management is to ensure there is sufficient cash to meet all of the Company's financial commitments and obligations as they fall due. The Company believes that it has the flexibility to obtain, from current cash holdings and ongoing operations, the funds needed to fulfill its cash requirements during the current financial year. The Company's main source of funds is from the sales of its products to distributors and cash on hand. The Company's use of funds is primarily for its operating expenses including the payment for its production of footwear and outsourced production to third party suppliers. The Company has a one year bank loan of $0.4 million that is due in July 16, 2010 and bears interest at the higher of 5.31% or the lending rate per Bank of China, reset every three months. Through the Company's growth and expansion as well as the initial public offering completed on December 21, 2009, it has increased its cash on hand from $23.8 million as at June 30, 2009 to $68.3 million as at March 31, 2010. The Company commences its manufacturing of most products at the time that it enters into a binding production contract with the distributor to limit its inventory levels. Finished goods inventory increased during the period to $4.1 million as at March 31, 2010 from $1.6 million as at June 30, 2009 but was lower than the $5.4 million as at March 31, 2009 all in spite of the 20% increase in the nine month revenue during the period. The higher level of finished goods inventory was a result of increased production during the quarter with subsequent shipping of the inventory in April, 2010. Accounts receivable decreased during the quarter to $23.7 million compared to $28.7 million as at December 31, 2009 as sales were higher during the second quarter of 2010 in preparation for higher retail sales during the Chinese New Year. The accounts receivable balance as at March 31, 2009 was $16.0 million. The increase in accounts receivable from the March 31, 2009 balance is reflective of the Company's 20% increase in revenue, currency fluctuations and the expanded payment terms offered to certain distributors to provide support to them to open more retail stores. 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, with the net proceeds from the initial public offering completed on December 21, 2009, to meet its business objectives and working capital and other cash requirements for at least twelve months. However, there can be no assurances that these funds will be sufficient and the Company may have to evaluate additional means of financing, including additional debt or equity financing. Net cash provided by operating activities for the three and nine months ended March 31, 2010 was $10.6 million and $13.7 million, respectively. During the three months ended March 31, 2010, the decrease in the accounts receivable and inventory balances generated a source of cash. 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 nine months. Net cash generated by financing activities was $1.5 million and $35.4 million for the three and nine months ended March 31, 2010. No dividends were paid out during fiscal 2010 or the nine months ended March 31, 2009. Net cash generated during the three and nine months ended March 31, 2010 and 2009 was $10.2 million, $5.5 million, $44.5 million and $16.4 million, respectively. Working capital increased from $29.8 million (RMB 281.1 million) as at June 30, 2009 to $78.4 million (RMB 511.5 million) as at March 31, 2010 as a result of the growth in revenue and profitability and the proceeds from the initial public offering. Risk Factors An additional risk factor was identified during the second quarter of 2010 being the Chinese government can issue income tax rules which have a retroactive application. On December 15, 2009, the State Administration of Taxation issued a taxation circular that has retroactive application to January 1, 2008. The Company's preliminary assessment is that this taxation circular has no financial impact to the Company. For further risk factors see "Risk Factors" as contained in the Company's final long form prospectus filed on December 11, 2009 on SEDAR at www.sedar.com. Capital Expenditures The Company's capital expenditures primarily relate to its investment in the equipment required in its production lines. The Company expects to use a portion of the net proceeds from the Offering to further invest in equipment as well as to construct a new building. The Company is reassessing its plans on the construction of the new building to expand its planned capacity from six to ten storeys. If successful, this will delay completion of the project to June, 2011. 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. As of March 31, 2010, there has been no variance in the Company's disclosure of its intended use of proceeds from the final prospectus dated December 11, 2009 and filed on SEDAR at www.sedar.com. Disbursed as of March 31 Update as of Intended Use of Proceeds As disclosed 2010 March 31 2010 ------------- ------------ -------------- Retail and Distribution Network Expansion $ 16,000 $ - $ 16,000 Increase Production Capacity 7,000 - 7,000 Brand Recognition, Awareness and Image 9,000 366 8,634 Working Capital 2,800 ----------- Net Proceeds $ 34,800 ------------- ------------- While the Company intends to use the net proceeds as stated above, circumstances may arise where, for sound business reasons and in order to account for currency fluctuations, a reallocation of monies may be necessary or advisable. Off-Balance Sheet Arrangements The Company has no off-balance sheet arrangements. Related Party Transactions Directors of Mengshida have jointly provided personal guarantees to indemnify Mengshida on certain potential tax exposures including related interest and penalties for periods prior to 2006. As a result, the Company has recorded an other receivables from the directors of $1.2 million as at March 31, 2010 and June 30, 2009. A loan was received from a director of Honorable for $0.4 million and $0.5 million as at March 31, 2010 and June 30, 2009, respectively. The loan is not secured, is interest free and payable on demand. Directors of Mengshida have jointly made personal guarantees to indemnify the Company for any premiums for social insurance in arrears in excess of RMB 4,465,000. One of the Directors has pledged 2,000,000 common shares of the Company owned by him for any potential liability that may become payable under this undertaking. A corporation owned 50% by one of Zungui's Directors received $400,000 in cash and 700,000 stock options of the Company in trust for various parties as consideration for services rendered in connection with the initial public offering. The stock options were granted at $3.25 and vest in equal amounts over three years. A company controlled by the same Director received 440,000 of the 700,000 stock options granted by the Company. The above transactions were conducted in the normal course of business and are measured at the exchange amount, which is the amount of consideration established and agreed to by the parties. Financial Instruments and Other Instruments The Company held cash of $68.3 million on its balance sheet as at March 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. 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 third quarter of 2010. The Company will invest in training and resources through the transition process to facilitate a timely conversion. Business Combinations, Consolidations and Non-Controlling Interests In January 2009, the CICA issued Handbook Section 1582, Business Combinations replacing Section 1581, Business Combinations. Section 1582 will apply to a transaction in which the acquirer obtains control of one or more businesses (as defined in the Section). Most assets acquired and liabilities assumed, including contingent liabilities that are considered to be probable, will be measured at fair value. A bargain purchase will result in the recognition of a gain. Acquisition costs will be expensed. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards. In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests replacing Section 1600, Consolidated Financial Statements. Section 1601 establishes standards for the preparation of consolidated financial statements and Section 1602 establishes standards for accounting for a non-controlling interest. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards. Financial Instruments In June 2009, the CICA revised section 3862 to include a hierarchy concept in measuring financial instruments, a requirement to provide disclosure concerning the fair value measurements of assets and liabilities for each hierarchy level and amendments to the liquidity disclosure requirements. The recommendations are effective for the Company's 2010 year end financial statements and MD&A. The Company is in the process of evaluating the impact of the revision to this standard. Zungui Haixi Corporation Consolidated Balance Sheets (Unaudited) (Expressed in thousands of Canadian Dollars) (Basis of Presentation - Note 1) March 31 2010 June 30 2009 Current assets Cash $ 68,250 $ 23,757 Accounts receivable, net 23,721 22,202 Prepaid expenses 453 510 Inventories (Note 4) 4,807 2,984 Other receivables (Note 7) 1,191 1,234 Future income taxes 63 61 ------------------------------ Total current assets 98,485 50,748 Property, plant and equipment (Note 5) 4,639 5,331 ------------------------------ Total assets $ 103,124 $ 56,079 ------------------------------ ------------------------------ Current liabilities Accounts payable and accrued liabilities $ 15,917 $ 15,624 Bank loan (Note 6) 446 511 Taxes payable 3,266 4,287 Due to related party (Note 7) 440 482 ------------------------------ Total current liabilities 20,069 20,904 Shareholders' equity Share capital (Note 8) 33,451 - Paid-in capital (Note 8) - - Contributed surplus (Note 8) 3,168 1,174 Surplus reserve funds 1,938 1,938 Retained earnings 50,422 32,021 Accumulated other comprehensive income (loss) (5,924) 42 ------------------------------ Total shareholders' equity 83,055 35,175 ------------------------------ Total liabilities and shareholders' equity $ 103,124 $ 56,079 ------------------------------ ------------------------------ Contingencies (Note 12) 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 Nine Months Ended March 31 March 31 2010 2009 2010 2009 ------------------------------------------------------ Revenue (Note 11) $ 33,342 $ 31,104 $ 113,332 $ 94,381 Cost of sales 24,442 22,656 83,186 69,007 ------------------------------------------------------ Gross profit 8,900 8,448 30,146 25,374 ------------------------------------------------------ Selling expenses 459 750 1,563 2,509 General and administrative expenses 1,243 757 2,934 1,712 Other expense (income), net 15 (16) (16) (33) ------------------------------------------------------ 1,717 1,491 4,481 4,188 ------------------------------------------------------ Income before income taxes 7,183 6,957 25,665 21,186 Income taxes 1,989 1,813 7,264 5,736 ------------------------------------------------------ Net income 5,194 5,144 18,401 15,450 ------------------------------------------------------ Other comprehensive income (loss): Unrealized gain (loss) on translation to Canadian reporting currency (2,016) 806 (5,966) 4,069 ------------------------------------------------------ Comprehensive income $ 3,178 $ 5,950 $ 12,435 $ 19,519 ------------------------------------------------------ ------------------------------------------------------ Basic and diluted earnings per share (Note 8) $ 0.08 $ 0.10 $ 0.33 $ 0.31 ------------------------------------------------------ Weighted average number shares outstanding during the period 62,166,672 50,000,000 55,477,581 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) Share Paid-in Contributed Retained Capital Capital Surplus Earnings Balance at June 30, 2008 $ - $ 1,174 $ - $ 8,974 Reorganization of capital (Note 8) - (1,174) 1,174 - Net income for the six months - - - 10,306 Exchange difference on translation to Canadian reporting currency - - - - --------------------------------------------------- Balance at December 31, 2008 - - 1,174 19,280 Net income for the three months - - - 5,144 Exchange difference on translation to Canadian reporting currency - - - - --------------------------------------------------- Balance at March 31, 2009 $ - $ - $ 1,174 $ 24,424 --------------------------------------------------- --------------------------------------------------- Balance at June 30, 2009 $ - $ - $ 1,174 $ 32,021 Issuance of share capital (Note 8) 33,040 - - - Stock based compensation expense (Notes 8 and 9) (1,816) - 1,829 - Net income for the six months - - - 13,207 Exchange difference on translation to Canadian reporting currency - - - - --------------------------------------------------- Balance at December 31, 2009 31,224 - 3,003 45,228 Issuance of share capital (Note 8) 2,278 - - - Stock based compensation expense (Notes 8 and 9) (51) - 165 - Net income for the three months - - - 5,194 Exchange difference on translation to Canadian reporting currency - - - - --------------------------------------------------- Balance at March 31, 2010 $ 33,451 $ - $ 3,168 $ 50,422 --------------------------------------------------- --------------------------------------------------- Accumulated Other Surplus Reserve Comprehensive Fund Income Total Balance at June 30, 2008 $ 1,938 $ (1,612) $ 10,474 Reorganization of capital (Note 8) - - - Net income for the six months - - 10,306 Exchange difference on translation to Canadian reporting currency - 3,263 3,263 -------------------------------------------------- Balance at December 31, 2008 1,938 1,651 24,043 Net income for the three months - - 5,144 Exchange difference on translation to Canadian reporting currency - 806 806 -------------------------------------------------- Balance at March 31, 2009 $ 1,938 $ 2,457 $ 29,993 -------------------------------------------------- -------------------------------------------------- Balance at June 30, 2009 $ 1,938 $ 42 $ 35,175 Issuance of share capital (Note 8) - - 33,040 Stock based compensation expense (Notes 8 and 9) - - 13 Net income for the six months - - 13,207 Exchange difference on translation to Canadian reporting currency - (3,950) (3,950) -------------------------------------------------- Balance at December 31, 2009 1,938 (3,908) 77,485 Issuance of share capital (Note 8) - - 2,278 Stock based compensation expense (Notes 8 and 9) - - 114 Net income for the three months - - 5,194 Exchange difference on translation to Canadian reporting currency - (2,016) (2,016) -------------------------------------------------- Balance at March 31, 2010 $ 1,938 $ (5,924) $ 83,055 ---------------------------------------------------- ---------------------------------------------------- The accompanying notes are an integral part of these consolidated financial statements Zungui Haixi Corporation Consolidated Statements of Cash Flows (Unaudited) (Expressed in thousands of Canadian Dollars unless otherwise noted) For the Three Months For the Nine Months Ended March 31 Ended March 31 2010 2009 2010 2009 ---------------------------------------------- Cash flows from operating activities Net income $ 5,194 $ 5,144 $ 18,401 $ 15,450 Items not affecting cash: Depreciation 114 129 337 365 Future income taxes - - (10) (8) Provision for doubtful accounts (45) 11 119 36 Stock based compensation 114 - 127 - Loss on disposal of property, plant and equipment (1) - (1) - Changes in non-cash working capital Accounts receivable 4,242 (812) (4,633) (1,624) Prepaid expenses (4) (117) (5) (348) Inventories 5,513 (2,503) (2,303) (2,647) Other receivables (46) (41) (117) (115) Accounts payable and accrued liabilities (3,919) 3,780 2,178 2,827 Taxes payable (529) (665) (398) (530) ---------------------------------------------- Net cash provided by operating activities 10,633 4,926 13,679 13,406 Cash flows from investing activities Property, plant and equipment (291) - (313) (9) ---------------------------------------------- Net cash used in investing activities (291) - (297) (9) Cash flows from financing activities Proceeds from bank loans - - - 443 Repayment of bank loans - - - (443) Due to related party - - - 438 Increase in share capital, net 1,466 - 35,431 - ---------------------------------------------- Net cash provided by financing activities 1,466 - 35,431 438 ---------------------------------------------- Effect of exchange rate changes on cash (1,581) 607 (4,320) 2,602 ---------------------------------------------- Net increase in cash 10,227 5,533 44,493 16,437 Cash, beginning of the period 58,023 15,928 23,757 5,024 ---------------------------------------------- Cash, end of the period $ 68,250 $ 21,461 $ 68,250 $ 21,461 ---------------------------------------------- ---------------------------------------------- Supplemental disclosure of cash information Interest paid in cash $ 5 $ 9 $ 18 $ 31 Income taxes paid in cash 2,541 2,334 7,730 6,229 The accompanying notes are an integral part of these consolidated financial statements Zungui Haixi Corporation Notes to Consolidated Financial Statements For the three and nine month periods ended March 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. The Company's fiscal year end is June 30, 2010. Accordingly these consolidated financial statements are for the three and nine month periods ended March 31, 2010 with comparative figures for the same periods in 2009. 2. INITIAL PUBLIC OFFERING On December 21, 2009, the Company completed its initial public offering ("IPO") by issuing 11,500,000 common shares at a price of $3.25 per common share, resulting in net proceeds of $33,040 after deducting the underwriters' fees and other related expenses of the offering. The Company granted the underwriters an over-allotment option exercisable for a period of 30 days from closing of the IPO to purchase up to an additional 1,725,000 common shares at the issue price. In addition, the underwriters received compensation options entitling them to acquire up to 7% of the number of common shares issued under the IPO including any shares exercised under the over-allotment option. Each compensation option will be exercisable for common shares at $3.25 per share until December 21, 2011. On January 12, 2010, the underwriters exercised the over-allotment option to purchase 759,500 common shares at $3.25 and, as a result, received an additional 7% or 53,165 compensation options. Net proceeds of $2,278 were received after deducting the underwriters' fees and other related expenses of the offering. Each compensation option will be exercisable for common shares at $3.25 per share until January 12, 2012. 3. SIGNIFICANT ACCOUNTING POLICIES These interim consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") for interim financial statements and are consistent with the accounting policies and methods of computation as were used in the preparation of the annual consolidated financial statements of Southern for the three years ended December 31, 2008 and the six months period ended on June 30, 2009. These interim consolidated financial statements do not contain all the information and disclosures required by GAAP applicable for annual consolidated financial statements and accordingly should be read in conjunction with Southern's audited consolidated financial statements which appear in Zungui's final long form prospectus dated December 11, 2009 and available on SEDAR at www.sedar.com. The results of the operations for the interim periods are not necessarily indicative of the full-year results. (a) Foreign currency translation The Company's primary economic activities are in China and the functional currency is Chinese Renminbi ("RMB") for its wholly owned subsidiary located in China. The Canadian head office's functional currency is Canadian dollars. The Company uses Canadian dollars as its reporting currency. The financial statements are translated into the reporting currency using the current rate method. Under this method, revenue and expenses of the Company are translated into 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. The weighted average exchange rate for one RMB expressed in Canadian dollars for the three months ended March 31, 2010 and 2009 is 0.1524 and 0.1821, respectively and is 0.1558 and 0.1695 for the nine months ended March 31, 2010 and 2009, respectively. (b) Adoption of new accounting policies Stock based compensation The Company has a stock based compensation plan which is described in Note 9. The Company estimates the fair value of options granted to employees, non-employee directors and consultants using the Black-Scholes option pricing model. The Company recognizes the fair value as a compensation expense over the period that the stock options vest, with a corresponding increase to contributed surplus. When these stock options are exercised, the amount of the proceeds together with the amount recorded in contributed surplus, is recorded in share capital. (c) Future accounting changes (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 third quarter of 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 is in the process of evaluating the impact of these standards. In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial Statements and 1602, Non-Controlling Interests replacing Section 1600, Consolidated Financial Statements. Section 1601 establishes standards for the preparation of consolidated financial statements and Section 1602 establishes standards for accounting for a non-controlling interest. These standards are applicable to interim and annual financial statements of the Company beginning on July 1, 2011. The Company is in the process of evaluating the impact of these standards. (c) Future accounting changes (iii) Financial Instruments In June 2009, the CICA revised section 3862 to include a hierarchy concept in measuring financial instruments, a requirement to provide disclosure concerning the fair value measurements of assets and liabilities for each hierarchy level and amendments to the liquidity disclosure requirements. The recommendations are effective for the Company's 2010 year end financial statements. The Company is in the process of evaluating the impact of the revision to this standard. 4. INVENTORIES Inventories consist of: ---------------------------------------------------------------------------- March 31, 2010 June 30, 2009 ---------------------------------------------------------------------------- Raw materials $ 498 $ 1,091 Work in progress 208 332 Finished goods 4,101 1,561 ---------------------------------------------------------------------------- Total inventory $ 4,807 $ 2,984 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Inventories expensed as cost of goods sold were $24,049 and $22,641 for the three months ended March 31, 2010 and 2009, respectively, and $82,763 and $68,959 for the nine months ended March 31, 2010 and 2009, respectively. No inventory writedowns occurred during these periods. 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consist of: ---------------------------------------------------------------------------- March 31, 2010 ---------------------------------------------------------------------------- Accumulated Cost Depreciation Net Book Value ---------------------------------------------------------------------------- Plant and building $ 5,574 $ 1,872 $ 3,702 Machinery and production equipment 1,462 1,005 457 Automobiles and trucks 366 166 200 Office equipment 367 87 280 ---------------------------------------------------------------------------- Total $ 7,769 $ 3,130 $ 4,639 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- June 30, 2009 ---------------------------------------------------------------------------- Accumulated Cost Depreciation Net Book Value ---------------------------------------------------------------------------- Plant and building $ 6,376 $ 1,920 $ 4,456 Machinery and production equipment 1,660 1,052 608 Automobiles and trucks 404 163 241 Office equipment 120 94 26 ---------------------------------------------------------------------------- Total $ 8,560 $ 3,229 $ 5,331 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Depreciation expense of $114 and $337 for the three and nine months ended March 31, 2010, respectively and $129 and $365 for the three and nine months ended March 31, 2009, respectively. Buildings with the net book value of $3,660 as of March 31, 2010 are provided as collateral for the bank loan (Note 6). 6. BANK LOAN On July 23, 2008, the Company signed a one year term loan agreement with Bank of Agriculture Shishi branch to borrow $443 (RMB 3,000,000) at a floating interest rate of the aggregate of the bank prime rate plus an additional 20% of the bank prime rate. The loan matured and was fully repaid on July 17, 2009. On July 17, 2009, the Company signed a one year term loan agreement with Bank of Agriculture Shishi branch to borrow $511 (RMB 3,000,000). The interest rate is the higher of 5.31% per annum or the lending rate per Bank of China, reset every 3 months. Interest is payable on a quarterly basis. Interest expense was $31 and $100 for the three and nine months ended March 31, 2010, respectively and was $40 and $117 for the three and nine months ended March 31, 2009, respectively. The bank loan is collateralized by the Company's buildings as referred to in Note 5. 7. 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. ---------------------------------------------------------------------------- March 31, 2010 June 30, 2009 ---------------------------------------------------------------------------- Other receivables $ 1,191 $ 1,234 ---------------------------------------------------------------------------- (b) Due to related party consists of a loan from a Director of Honorable totalling $440 (Hong Kong $3,200,000 and RMB 100,000) as at March 31, 2010 and $482 (Hong Kong $3,200,000 and RMB 100,000) as at June 30, 2009. 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 12. One of the Directors has pledged 2,000,000 common shares of the Company owned by him for any potential liability that may become payable under this undertaking. (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. 8. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS (a) Share Capital: As at March 31, 2010 the authorized share capital of Zungui was unlimited common shares with no par value. ---------------------------------------------------------------------------- Weighted Average Shares Stock Compensation Exercise Share Capital Issued Options Options Price Amount ---------------------------------------------------------------------------- Balance as at August 11, 2009 1 - - - $ - Share exchange transaction (Note 1) 50,000,000 - - - - Initial public offering (Notes 2 and 8(a)(i)) 11,500,000 - - - 33,040 Cancellation of share (1) - - - - Stock options (Note 8(b)): - - - - Granted - 1,660,000 - $ 3.25 (1,005) Underwriter options (Note 8(c)) - - 805,000 3.25 (811) ---------------------------------------------------------------------------- Balance as at December 31, 2009 61,500,000 1,660,000 805,000 - $ 31,224 Over-allotment option (Notes 2 and 8(a)(ii)) 759,500 - - 3.25 2,278 Underwriter options (Note 8(c)) - - 53,165 3.25 (51) Stock options: Forfeited - (10,000) - 3.25 - Balance as at March 31, 2010 62,259,500 1,650,000 858,165 - 33,451 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- (i) The expenses of the initial public offering, including underwriters' fees and other related expenses, were $4,335. (ii) On January 12, 2010, the underwriters exercised the over-allotment option and purchased 759,500 common shares at $3.25. The expenses of the over-allotment option, including underwriters' fees and other related expenses, were $190. (iii) As a result of the reorganization as described and the application of the continuity of interest accounting, all periods prior to the initial public offering completed on December 21, 2009 are deemed to have 50,000,000 shares issued and outstanding for the purposes of calculating earnings per share. (b) Stock Options: In conjunction with the initial public offering, on December 21, 2009 the Company granted 700,000 stock options at an exercise price of $3.25 to consultants (see Note 7(d)). The consultant's stock options vest equally over a three year period and as at March 31, 2010, none were vested nor exercisable. The stock options expire on December 21, 2014. The per share fair value of these grants was $1.44. Stock based compensation in the amount of $1,005 was deducted from share capital as part of the expenses of the offering. In addition, 960,000 stock options were granted to employees and non-employee Directors as further discussed in Note 9. (c) Underwriter Options: As described in Note 2, the Company granted the underwriters an over-allotment option to purchase up to an additional 1,725,000 common shares at $3.25 that expires within 30 days of the closing of the IPO. No stock based compensation was recorded for this option. The Company also granted the underwriters an option to purchase 805,000 common shares ("compensation options") at $3.25 for a period of 24 months. The per share fair value of these grants was $1.01. Stock based compensation in the amount of $811 was deducted from share capital as part of the expenses of the offering. On January 12, 2010, the underwriters earned an additional 53,165 common shares ("compensation options") at $3.25 for a period of 24 months in conjunction with the exercise of the over-allotment option. The per share fair value of these grants was $0.97. Stock based compensation in the amount of $51 was deducted from share capital as part of the expenses of the offering. The fair value of the option grants in (b) and (c) above were estimated at the date of the grant using a Black-Scholes option pricing model with the following weighted average assumptions: ---------------------------------------------------------------------------- Three Months Ended Nine Months Ended March 31, 2010 March 31, 2010 ---------------------------------------------------------------------------- Risk-free interest rate 1.27 1.27-2.46 Dividend yield 0.0% 0.0% Expected volatility 54.3% 54.3% Expected option life (in years) 2 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. (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. According to the registration document filed with the PRC government agency on April 30, 2008, the Company is required to increase its additional capital investment in Mengshida to $3,003 (RMB 20,000,000) within 2 years from the date of the filing. On December 28, 2009 $1,760 (RMB 11,223,825) in additional capital was injected to fulfill this requirement. 9. STOCK BASED COMPENSATION The Company has a stock option plan to 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 21, 2009, the Company granted 960,000 stock options at an exercise price of $3.25 to Company employees and directors with an expiry date of December 21, 2014. The stock options vest equally over a three year period and as at March 31, 2010, none were vested nor exercisable. The per share fair value of these grants was $1.44. During the three months ended March 31, 2010, no additional stock options were granted and 10,000 options were forfeited. 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: ---------------------------------------------------------------------------- Nine Months Ended March 31, 2010 ---------------------------------------------------------------------------- Risk-free interest rate 2.46 Dividend yield 0.0% Expected volatility 54.3% Expected option life (in years) 4 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Expected volatility is based on the historical volatility of companies in comparable industries. The risk-free interest rate is based on yields of Government of Canada T-bills with similar maturities. During the three and nine months ended March 31, 2010, stock based compensation expense was $114 and $127. 10. MAJOR CUSTOMERS AND SUPPLIERS The Company sells products to various customers. There were no customers that purchased more than 10% of the Company's products for the three or nine month periods ended March 31, 2010 and 2009. During the three month period ended March 31, 2010, purchases from three suppliers, each represented 10% ($1,745), 9% ($1,509) and 8% ($1,420) of total purchases. During the three month period ended March 31, 2009, purchases from three suppliers represented 16% ($4,719), 15% ($4,096) and 15% ($3,549) of the total purchases. During the nine month period ended March 31, 2010, purchases from three suppliers, each represented 16% ($13,075), 16% ($13,009) and 16% ($12,989) of total purchases. During the nine month period ended March 31, 2009, purchases from three suppliers represented 15% ($10,428), 12% ($8,388) and 10% ($6,513) of the total purchases. 11. REVENUE ---------------------------------------------------------------------------- Three Months Ended Nine Months Ended March 31, March 31, 2010 2009 2010 2009 ---------------------------------------------------------------------------- Revenue Footwear $ 27,897 $ 25,889 $ 96,138 $ 78,819 Apparel and accessories 5,445 5,215 17,194 15,562 ---------------------------------------------------------------------------- Revenue $ 33,342 $ 31,104 $ 113,332 $ 94,381 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- 12. CONTINGENCIES Pursuant to the relevant laws and regulations of the PRC, the Company makes contributions to the local Labour and Social Security Bureaus based on a rate determined by the local bureaus. The process of determining this rate involves uncertainties and judgments on the part of the Bureaus. Significant estimates and judgement are applied by management to determine the appropriate amount of social insurance to be paid. The Directors of Mengshida have jointly made personal guarantees to indemnify the Company for any premiums for social insurance in arrears and all related fines, penalties, interest and other payments in excess of RMB 4,465,000 ($664) that the Company may be required to make relating to periods prior to December 31, 2009 in the event of a dispute or settlement with the applicable government authorities. See Note 7(c). 13. FINANCIAL INSTRUMENTS Financial assets and financial liabilities are measured on an ongoing basis at fair value or amortized cost. Fair value estimates are made at a specific point in time, using available information about the financial instrument. These estimates are subjective in nature and involve uncertainties and the exercise of significant judgement. The fair value of financial assets and financial liabilities approximates their carrying value due to their short term maturity. The classification of the financial instruments as well as their carrying values is shown in the table below: ---------------------------------------------------------------------------- Other Total Held for Loans and Financial Carrying March 31, 2010 Trading Receivables Liabilities Value ---------------------------------------------------------------------------- Financial assets Cash $ 68,250 $ - $ - $ 68,250 Accounts receivable - 23,721 - 23,721 Other receivables - 1,191 - 1,191 ---------------------------------------------------------------------------- $ 68,250 $ 24,912 $ - $ 93,162 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Financial liabilities Accounts payable and accrued liabilities $ - $ - $ 15,917 $ 15,917 Bank loan - - 446 446 Due to related party - - 440 440 ---------------------------------------------------------------------------- $ - $ - $ 16,803 $ 16,803 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- June 30, 2009 Other Total Held for Loans and Financial Carrying Trading Receivables Liabilities Value ---------------------------------------------------------------------------- Financial assets Cash $ 23,757 $ - $ - $ 23,757 Accounts receivable - 22,202 - 22,202 Other receivables - 1,234 - 1,234 ---------------------------------------------------------------------------- $ 23,757 $ 23,436 $ - $ 47,193 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Financial liabilities Accounts payable and accrued liabilities $ - $ - $ 15,624 $ 15,624 Bank loan - - 511 511 Due to related party - - 482 482 ---------------------------------------------------------------------------- $ - $ - $ 16,617 $ 16,617 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- Financial risk management Financial risk is the risk to the Company's earnings that arises from fluctuations in market risk (including interest rate risk, foreign currency risk), credit risk and liquidity risk and the degree of volatility of these rates. The Company's business practices seek to minimize any potential adverse effects on the Company's financial performance. The Company's financial instruments that are included in the consolidated balance sheets are comprised of cash, accounts receivable, other receivables, accounts payable and accrued liabilities, bank loans and due to related party. As at the balance sheet date, there are no significant differences between the carrying value of these items and their estimated fair values because they are short-term in nature. Market risk Interest risk Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Company's exposure to interest rate fluctuations is primarily related to the bank loan from Bank of Agriculture Shishi branch under its existing term loan which bears interest at a floating rate that is reset every three months. The Company does not use any derivative financial instruments to reduce its exposure to interest rate risk. The potential effect of a 100 basis points increase or decrease in interest rates on the Company's bank loan would impact the Company's net income assuming all other variables remain constant would be $1 and $1 for the three months ended March 31, 2010 and 2009, respectively and $4 and $4 for the nine months ended March 31, 2010 and 2009, respectively. Foreign Currency risk Foreign currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign currency exchange rates. The Company has no financial instrument related to currency risk. The translation of foreign operations to the reporting currency is not taken into account. Credit risk Credit risk is the risk that a counterparty to a financial instrument will default on its obligations. The Company's maximum exposure to credit risk consists of the carrying value of its cash, accounts receivable and other receivables. The Company places its cash with a PRC regulated financial institution. Credit risk with respect to accounts receivable is mitigated through the sales to numerous different customers. No customer accounted for more than 10% of total sales. In addition, the Company evaluates the financial position of its customers and regularly reviews their credit limit. Allowances are established with regards to potential losses. The Company was not exposed to any particular credit risk concentration for the three or nine months ended March 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 a combination of the cash flows from operating activities and bank loans. The Company's goal is to maintain an optimal level of liquidity through the active management of the assets and liabilities as well as the cash flows. As at March 31, 2010, the Company had a $446 bank loan with a July 16, 2010 due date, $15,917 in accounts payable and accrued liabilities and due to related party $440. All financial liabilities, except for bank loan, have contractual maturities of less than one month as of March 31, 2010. 14. CAPITAL DISCLOSURE The Company's objectives when managing capital is to safeguard the entity's ability to continue as a going concern and continue to provide returns and benefits for its shareholders. The Company's capital is defined as interest-bearing bank loans and shareholders' equity as presented on the consolidated balance sheet excluding accumulated other comprehensive income (loss). The Company's capital is as follows: ---------------------------------------------------------------------------- March 31, 2010 June 30, 2009 ---------------------------------------------------------------------------- Bank loan $ 446 $ 511 Shareholders' equity excluding accumulated other comprehensive income (loss) 88,979 35,133 ---------------------------------------------------------------------------- $ 89,425 $ 35,644 ---------------------------------------------------------------------------- ---------------------------------------------------------------------------- The Company does not establish quantitative return on capital criteria for management or internally imposed restrictions, but rather promotes year-over-year sustainable profitable growth. The Company may adjust its capital mix in order to manage its capital structure. The Company is subject to externally imposed capital requirements for the paid in capital of Mengshida. There has been no change with respect to the overall capital risk management strategy during the three and nine month periods ended March 31, 2010. 15. SEGMENTED INFORMATION The Company's business is considered as operating in one segment based upon the Company's organizational structure, the way in which the operation is managed and evaluated, the availability of separate financial results and materiality considerations. All revenues are generated in China and substantially all of the Company's capital assets are located in China.
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