Zungui Haixi Corporation (TSX VENTURE:ZUN), a China-based manufacturer of
sportswear and casual footwear, today announced its financial results for the
three months ended September 30, 2010. All amounts in this release are in
Canadian dollars unless otherwise indicated.
"In our first year of being a public company, we have added almost 350 new
retail outlets, increased revenue and maintained profitability," indicated Mr.
Yanda Cai, Chief Executive Officer. "With more than 2,000 retail outlets, store
expansions continue to build our brand prominence and remain key to our growth."
Highlights for the First Quarter:
- Revenue increased 17% to $50.4 million and in RMB, revenue increased 23%
to RMB 328.5 million;
- Gross margin declined to 25.2% in the first quarter of fiscal 2011
compared to 27.3% in the same quarter last year as a result of subsidy
payments to distributors for new store openings which lowered the gross
margin by 3.1%;
- Opened a quarterly record of 120 net new distributor owned retail outlets
compared to 72 retail outlets for the same quarter last year;
- Corporate-owned retail outlets reported revenue of $0.7 million compared
to $0.1 million for the same quarter last year reflecting a start up phase
of development;
- Selling expenses increased 200% to $1.8 million as part of the launch of
the brand recognition strategy with increased advertising;
- Net income decreased 8% to $7.1 million reflecting payments expensed to
distributors on new store openings and increased selling expenses; and,
- Diluted earnings per share of 11 cents compared to 15 cents for the same
quarter last year based on a 25% increase in the weighted average number
of shares outstanding in the period and a 3 cent impact for subsidy
payments.
During the quarter, the Company expensed a portion of the subsidy payment that
will be made to distributors once the new stores reach the required operating
criteria. This item reduced our revenue growth by 5% but will benefit the
Company over the longer term with increased revenue. Subsequent to September 30,
2010, the Company and its distributors have opened an additional 112 retail
outlets increasing the number of retail outlets to 2,038.
On a trailing 12 month basis, the Company's revenue is $171.3 million, net
income is $26.4 million and diluted earnings per share is 44 cents.
The results were impacted by the movement of the Chinese currency relative to
the Canadian dollar. During the first quarter ended September 30, 2010 the
average foreign exchange rate used to convert one Chinese Renminbi ("RMB") was
0.1535 expressed in Canadian dollars compared to 0.1606 for the same quarter
last year. If the 2011 first quarter results were converted at the prior year's
average exchange rate for the quarter, 2011 first quarter earnings per share
would have been 12 cents.
Conference Call
Zungui will host a conference call to discuss the first quarter results at 9am
(EST) November 24, 2010. The details are as follows:
Dial-in number: 1-866-225-0198 or 416-340-8061
Taped rebroadcast (until midnight on December 8, 2010): 1-800-408-3053
Taped replay access passcode: 1754237.
About Zungui Haixi
Zungui Haixi Corporation, through its wholly owned subsidiaries, is engaged in
the manufacture and sale of athletic footwear, apparel and accessories, and also
casual footwear, in the People's Republic of China. Both product lines are
marketed under the ZUNGUI brand. Zungui Haixi distributes its products to
consumers throughout China through an extensive network of retail outlets which
exclusively carry ZUNGUI branded products. There are 62,259,500 common shares
issued and outstanding. The corporate website is www.zunguihaixi.com.
Caution Regarding Forward-Looking Statements
Certain statements in this press release contain forward-looking information
that involve risk and uncertainties. Statements other than statements of
historical fact contained in this press release may be forward-looking
statements within the meaning of certain securities laws, including, without
limitation, statements involving management's expectations, intentions and
beliefs concerning the domestic PRC sportswear industry, the competitive
landscape in this industry and the general economy, statements regarding the
future financial position or results of the Company, business strategies,
proposed acquisitions, growth opportunities, budgets, litigation, projected
costs and plans and objectives of or involving the Company. Such statements
should be considered forward-looking statements, Wherever possible, words such
as "may", "would", "could", "will", "anticipate", "believe", "plan", "expect",
"intend", "estimate", "aim", "endeavour", "project", "continue" and similar
expressions have been used to identify forward-looking statements.
These forward-looking statements reflect management's current beliefs and
business judgement with respect to future events and are based on information
currently available to management. Forward-looking statements involve
significant known and unknown risks, uncertainties and assumptions, and you
should not place undue reliance on these forward-looking statements. Although
management believes its current beliefs and assumptions are reasonable, many
factors could cause Zungui's actual results, performance or achievements to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements, including,
without limitation, those listed in the "Risk Factors" section of the Company's
other filings with Canadian securities regulatory authorities at www.sedar.com.
Should one or more of these risks or uncertainties materialize, or should
assumptions underlying the forward-looking statements prove incorrect, actual
results, performance or achievements could vary materially from those expressed
or implied by the forward-looking statements contained in this press release.
The forward-looking statements contained in this press release are expressly
qualified in their entirety by this cautionary statement. These forward-looking
statements are made as of and speak as of the date of this press release and the
Company does not intend to, or assume any obligation to, update or revise these
forward-looking statements to reflect new information, events, results or
circumstances or otherwise after the date on which such statement is made as to
reflect the occurrence of unanticipated events, except as required by law,
including securities laws.
Zungui Haixi Corporation
Management's Discussion and Analysis of Financial Condition and Results of
Operations
For the three months ended September 30, 2010
All amounts in thousands of Canadian dollars unless otherwise stated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following management's discussion and analysis of financial condition and
results of operation (the "MD&A") of Zungui Haixi Corporation ("Zungui" or
"Company") is prepared for the three months ended September 30, 2010 with
comparative figures for the three months ended September 30, 2009. Zungui became
the parent company of Southern Trends International Holding Company Limited
("Southern"), through a share exchange agreement completed in conjunction with
the completion of the Company's initial public offering on December 21, 2009.
All figures presented for periods prior to December 21, 2009 refer to Southern
financial statements. The MD&A should be read in conjunction with the audited
consolidated financial statements for the year ended June 30, 2010, and the
notes contained therein, the second and third quarter 2010 MD&As and the final
long form prospectus filed on December 11, 2009. The unaudited interim
consolidated financial statements were prepared in accordance with Canadian
generally accepted accounting principles ("GAAP") and are presented in thousands
of Canadian dollars unless otherwise noted. Additional information relating to
the Company can be found at www.sedar.com.
Disclosure contained in this MD&A is current to November 23, 2010 the date of
approval of the MD&A and financial statements by the Board of Directors.
Caution Regarding Forward-Looking Statements
Certain statements in this MD&A contain forward-looking information that involve
risk and uncertainties. Statements other than statements of historical fact
contained in this MD&A may be forward-looking statements within the meaning of
certain securities laws, including, without limitation, statements involving
management's expectations, intentions and beliefs concerning the domestic
People's Republic of China (PRC) sportswear industry, the competitive landscape
in this industry and the general economy, statements regarding the future
financial position or results of the Company, business strategies, proposed
acquisitions, growth opportunities, budgets, litigation, projected costs and
plans and objectives of or involving the Company. Such statements should be
considered forward-looking statements, Wherever possible, words such as "may",
"would", "could", "will", "anticipate", "believe", "plan", "expect", "intend",
"estimate", "aim", "endeavour", "project", "continue" and similar expressions
have been used to identify forward-looking statements.
These forward-looking statements reflect management's current beliefs and
business judgement with respect to future events and are based on information
currently available to management. Forward-looking statements involve
significant known and unknown risks, uncertainties and assumptions, and you
should not place undue reliance on these forward-looking statements. Although
management believes its current beliefs and assumptions are reasonable, many
factors could cause Zungui's actual results, performance or achievements to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements, including,
without limitation, risks related to: failure to maintain or promote the ZUNGUI
brand; dependency on distributors and retailers for product sales and brand
promotion; difficulty in continuing to grow Zungui's distribution network;
dependency on certain of its key executives, design, technical and other
personnel; failure to effectively integrate additional corporate-owned and
managed retail outlets; strong competition; the loss, or decrease in, sales to
Zungui's major distributors; failure to successfully implement plans to expand
production capacity and improve production efficiency; failure to execute growth
strategy; reliance on subcontractors; fluctuations in the price, availability
and quality of raw materials; exposure to credit risks of distributors; selling
prices; failure to accurately track inventory levels or sales figures; failure
to maintain and cultivate key relationships; failure to optimize and adjust
product mix; failure to anticipate and respond in a timely manner to fashion
trends and changes in consumer tastes in the PRC; liability for unpaid
contributions to the social security insurance program; increases in labour
costs and labour disputes; protection of trademarks and other proprietary
rights; damage to administrative or production facilities, fire or other
calamities; proof of title; exposure to environmental liability; exposure to
product liability, property damage or personal injury claims; closure of retail
outlets; failure to obtain additional financing; risks relating to holding
companies; risks associated with dividends; conflict of interests of directors
and officers; limited recourse against principal securityholder and existing
shareholders; disclosure controls and procedures and internal controls over
financial reporting;
language barriers between certain directors and officers of the Company;
influence by the majority shareholder; future sales of common shares; risks
associated with state ownership; exposure to fluctuations in the economic
conditions in the PRC; fluctuations in foreign exchange rates; changes in
Zungui's tax treatment; limitations in the ability to repatriate profits or
convert currency; limited shareholders' rights in China; risks relating to a
developing legal system; intellectual property rights protection and
enforcement; requirements for permits and business licenses; risks relating to
the appropriation of land used in Zungui's operations; natural disasters;
reliance on third-party sources and industry publications; volatile market
price; return on an investment in common shares. Should one or more of these
risks or uncertainties materialize, or should assumptions underlying the
forward-looking statements prove incorrect, actual results, performance or
achievements could vary materially from those expressed or implied by the
forward-looking statements contained in this MD&A. The forward-looking
statements contained in this MD&A are expressly qualified in their entirety by
this cautionary statement. These forward-looking statements are made as of and
speak as of the date of this MD&A and the Company does not intend to, or assume
any obligation to, update or revise these forward-looking statements to reflect
new information, events, results or circumstances or otherwise after the date on
which such statement is made as to reflect the occurrence of unanticipated
events, except as required by law, including securities laws.
Contents of MD&A Page
Overview 3
Selected Financial Information 3
Factors Affecting the Results of Operations 4
Results of Operations 5
Summary of Quarterly Results 9
Liquidity and Capital Resources 9
Capital Structure 10
Off-Balance Sheet Arrangements 11
Use of Proceeds 12
Related Party Transactions 12
Financial Instruments and Other Instruments 13
Recent Accounting Changes 13
Outlook 14
Overview
Zungui is principally engaged in the manufacture and sale of athletic footwear,
apparel and accessories ("Sportswear Product Line") and casual leather footwear
("Casual Product Line") in the PRC. Both product lines are marketed under the
well-recognized ZUNGUI brand. As of September 30, 2010, Zungui distributes its
products to consumers through 44 corporate-owned retail outlets and through 47
distributors, who in turn sell products via an extensive network of 1,882 retail
outlets, 1,515 of which offer the Sportswear Product Line and 367 of which offer
the Casual Product Line. All retail outlets exclusively sell products which
carry the ZUNGUI brand.
During the three months ended September 30, 2010, the Company focused on revenue
growth and increased profitability through the expansion of its retail network.
It provided services and training and accrued subsidies to distributors to help
meet customer needs and increase their sales. For the three months ended
September 30, 2010, revenue grew 17% to $50.4 million from $43.0 million
compared to same period last year. In Renminbi ("RMB"), revenue grew 23% to RMB
328.5 million from RMB 267.9 million last year. The lower growth rate in
Canadian dollars is attributable to the fluctuations in the Chinese currency
relative to the Canadian dollar reporting currency in 2009 and 2010.
Selected Financial Information
The following table sets forth selected financial information for the periods
indicated. The selected financial information has been derived from the
Company's unaudited interim consolidated financial statements for the three
months ended September 30, 2010.
Earnings Data
For the three months ended September 30,
------------------------------------------
2010 2009
-------------------- ---------------------
Revenue $ 50,425 $ 43,030
Cost of sales 37,731 31,288
-------------------- ---------------------
Gross profit 12,694 11,742
Selling expenses 1,777 593
Research and development expenses 201 136
General and administrative
expenses 1,055 566
Other expenses (income), net 116 (7)
Income tax expense 2,489 2,797
-------------------- ---------------------
Net income $ 7,056 $ 7,657
Earnings per share - basic and
diluted $ 0.11 $ 0.15
As at September 30, As at June 30,
Balance Sheet Data 2010 2010
-----------------------------------------
Cash $ 91,494 $ 85,876
Inventories 3,332 3,498
Property, plant and equipment 6,624 6,470
Total assets 140,545 131,705
Working capital 95,123 89,532
Retained earnings 63,217 56,161
Total shareholders' equity 101,755 96,003
Factors Affecting Results of Operations
Foreign Currency
All of the Company's revenues and expenses, other than the corporate expenses,
are generated in the PRC. Accordingly, the results of operations are impacted by
the fluctuation of the RMB against the Canadian dollar when converted for
financial reporting purposes. The weighted average exchange rate for one RMB,
expressed in Canadian dollars, for the three months ended September 30, 2010 and
2009 was 0.1535 and 0.1606. The movement of the Chinese currency relative to the
Canadian dollar in the three months ended September 30, 2010 resulted in the
statement of operations in Canadian dollars being 6% less than would have been
reported if the Company had used the average exchange rate for the same period
of 2009.
Financial Highlights in RMB
The following table sets forth selected financial information for the Company
for the periods indicated in RMB which is the Company's functional currency for
its wholly owned subsidiary in China. The Company's head office's functional
currency is Canadian dollars. The Company uses Canadian dollars as its reporting
currency. This information has been derived from the Company's records
supporting the unaudited interim consolidated financial statements for the three
months ended September 30, 2010 and 2009, immediately prior to their conversion
to Canadian dollars.
In RMB For The Three Months Ended
September 30,
-------------------------------
2010 2009
--------------- ---------------
Revenue RMB 328,462 RMB 267,918
Cost of sales 245,777 194,814
--------------- ---------------
Gross profit 82,685 73,104
Net income 45,962 47,675
Weighted average exchange rate for one RMB,
expressed in Canadian dollars 0.1535 0.1606
Revenues
The Company's revenues consist of sales from footwear, apparel and accessories
sold within the PRC. The Company provides sales rebates, advertising
contributions and accrues subsidies payable to its distributors that are
deducted from its gross revenue to derive its net revenue.
Cost of Sales
The Company's cost of sales consists of internal and external production costs.
Internal production costs include raw materials, labour and manufacturing costs.
Outsourced production costs refer to the cost of procuring finished footwear,
apparel and accessories, which represents amounts paid to subcontracted
manufacturers in the PRC. Gross margin on sales of outsourced production is
normally approximately 1% less than internally produced footwear.
Seasonality
The results of the Company are generally not subject to seasonality although the
Company is modestly affected by the Chinese New Year typically held in the third
quarter of the fiscal year.
Results of Operations Three Months Ended September 30, 2010 compared to
September 30, 2009
(Amounts in thousands of dollars, unless specified otherwise)
Revenue
The Company derives its revenue from two distribution channels: distributors and
corporate-owned retail outlets. The number of distributor owned retail outlets
(operated by distributors and/or third-party retailers) increased by 120 net new
retail outlets to 1,882 during the three months ended September 30, 2010 (1,679
retail outlets at September 30, 2009). The Company currently has 44
corporate-owned retail outlets (3 at September 30, 2009). The Company opened 15
new corporate-owned retail outlets during the three months ended September 30,
2010 with 2 corporate-owned retail outlets demolished as part of the new
building construction.
Revenue by Product Line
For The Three Months Ended September 30,
--------------------------------------------------
2010 % of Total 2009 % of Total
------------ ----------- ------------- -----------
Footwear $ 44,709 88.7 $ 37,085 86.2
Apparel and accessories 5,716 11.3 5,945 13.8
------------ ----------- ------------- -----------
Total $ 50,425 100.0 $ 43,030 100.0
------------ ----------- ------------- -----------
------------ ----------- ------------- -----------
Total revenue increased 17% to $50.4 million for the three months ended
September 30, 2010 compared to the first quarter of last year. In RMB, revenue
increased 23% to RMB 328.5 million for the three months ended September 30, 2010
compared to RMB 267.9 million for the same period last year. The strengthening
of the Canadian dollar during the year relative to the RMB reduced the
percentage increase in revenue by 6% when reported in Canadian dollars. Revenue
was reduced by $2.2 million for accruals for subsidies that will be paid in the
future to distributors for new stores opened in calendar 2010. The number of new
stores opened during the quarter was the highest in the Company's history.
Footwear revenue increased 21% to $44.7 million for the three months ended
September 30, 2010 compared to the same period last year, and was comprised of
$38.7 million (Q1 2010 - $32.3 million) in revenue from athletic footwear and
$6.0 million (Q1 2010 - $4.8 million) from casual footwear. The growth in
revenue was the result of increased number of retail outlets (1,926 retail
outlets in total compared to 1,682 at September 30, 2009), increased consumer
demand for the Company's products and price increases implemented late in March,
2010.
In RMB, the Company's revenue per average number of retail outlets increased 9%
to RMB 0.2 million during the three months ended September 30, 2010 compared to
the same period last year. For each of the three months ended September 30, 2010
and 2009, 98.6% and 99.7% of the Company's revenue was derived from its
wholesale distribution channel, respectively.
Cost of Sales
For The Three Months Ended September 30,
--------------------------------------------------
2010 % of Total 2009 % of Total
------------ ----------- ------------- -----------
Footwear (internal
production)
Raw materials $ 11,325 30.0 $ 10,148 32.4
Labour 1,398 3.7 1,123 3.6
Manufacturing costs 814 2.2 519 1.7
------------ ----------- ------------- -----------
Subtotal 13,537 35.9 11,790 37.7
Footwear (outsourced
production) 19,917 52.8 15,126 48.3
Apparel and accessories
(outsourced production) 4,277 11.3 4,372 14.0
------------ ----------- ------------- -----------
Total $ 37,731 100.0 $ 31,288 100.0
------------ ----------- ------------- -----------
------------ ----------- ------------- -----------
During the three months ended September 30, 2010, cost of sales increased 21% to
$37.7 million compared to last year. In RMB, cost of sales increased 26% to RMB
245.8 million for the three months ended September 30, 2010. Raw material
pricing increased 8% this quarter, however, higher selling prices compared to
last year have offset this increased cost. Units sold during the quarter
increased to 3.3 million compared to 2.8 million for the same quarter last year.
Outsourced production accounted for 61% of the units sold compared to 58% for
the same quarter last year. There has been a shift in the mix of shoes selected
for outsourced production increasing the cost of manufacturing this quarter.
With the completion of some upgrades to existing production lines, the Company
had increased its internal production capacity to 3.4 million pairs of shoes by
the end of the quarter. The Company expects to have additional increased
production capacity by April 2011 when the existing five production lines will
be fully upgraded and/or replaced with new equipment.
Gross Profit
For The Three Months Ended September 30,
--------------------------------------------------
Gross Gross
2010 Margin % 2009 Margin %
------------ ----------- ------------- -----------
Footwear $ 11,255 25.2 $ 10,169 27.4
Apparel and accessories 1,439 25.2 1,573 26.4
------------ -------------
Total $ 12,694 25.2 $ 11,742 27.3
------------ -------------
------------ -------------
The gross margin declined for the three months ended September 30, 2010 due to a
reduction in net revenue of $2.2 million from subsidies recorded that will be
paid to distributors on new stores. Corporate-owned retail outlets increased the
gross margin by 0.5% on $0.7 million of corporate store revenue.
Selling Expenses
For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Increase
---------------- ----------------- ---------------
Selling Expenses $ 1,777 $ 593 200%
The Company spent $1.3 million on advertising during the three months ended
September 30, 2010 compared to $0.5 million last year. The Company has been
repositioning the brand and recently launched a new advertising campaign in the
second quarter of fiscal 2011. Selling expenses were increased by $0.3 million
on the opening of new corporate-owned retail outlets which are currently in the
start up phase of operations. Selling expenses represented 3.4% and 1.4% of
total revenue for the three months ended September 30, 2010 and 2009,
respectively.
Research and Development Expenses
For The Three Months Ended September 30,
-----------------------------------------
2010 2009 Increase
------------- -------------- ------------
Research and Development Expenses $ 201 $ 136 46%
Research and development expenses increased during the three months ended
September 30, 2010 as the Company invested additional funds on expanding its
research and development centre and the number of new products it developed.
General and Administrative Expenses
For The Three Months Ended September 30,
------------------------------------------
2010 2009 Increase
-------------- -------------- ------------
General and Administrative
Expenses $ 1,055 $ 566 87%
Corporate expenses related to being a public company, including salaries,
directors fees, audit fees and stock compensation expenses totalled $0.4 million
during the three months ended September 30, 2010. General and administrative
expenses represented 2.0% and 1.3% of total revenue for the three months ended
September 30, 2010 and 2009, respectively.
Other Expenses (Income), net
For The Three Months Ended September 30,
------------------------------------------
2010 2009 Increase
------------- --------------- ------------
Other expenses (income), net $ 116 $ (7) n/a
Other expenses, net includes a loss of $0.2 million on the disposition of
several buildings that were demolished during the quarter as part of preparation
of the new building construction.
Income Tax Expense
For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Decrease
---------------- ----------------- ---------------
Income tax expense $ 2,489 $ 2,797 11%
The statutory income tax rate in the PRC is 25% and in Canada is 33%. During the
quarter, the Company implemented procedures to reduce the level of
non-deductible expenses in the PRC which lowered the effective tax rate to
approximately 25% in the PRC. Tax losses in Canada for which no accounting
benefit has been recognized further increased the effective tax rate to 26% for
the three months ended September 30, 2010 compared to 27% last year.
Net Income
For The Three Months Ended September 30,
--------------------------------------------------
2010 2009 Decrease
---------------- ----------------- ---------------
Net income $ 7,056 $ 7,657 8%
Net income decreased 8% to $7.1 million for the three months ended September 30,
2010 compared to the same period last year. In RMB, net income decreased 4% to
RMB 46.0 million for the three months ended September 30, 2010 compared to RMB
47.7 million in the first quarter of last year. Revenue growth of 17% generated
an additional $1.0 million of gross profit. Increases in selling expenses of
$1.2 million, general and administrative expenses of $0.5 million and research
and development expenses of $0.1 million lowered net income by $1.8 million
which was offset by lower income taxes of $0.3 million, resulting in a decrease
in net income of 8% or $0.6 million.
Basic and Diluted Earnings Per Share
Basic and diluted earnings per share was 11 cents for the three months ended
September 30, 2010 compared to 15 cents for the same period last year. There
were 62,259,500 shares issued and outstanding as at September 30, 2010. The
weighted average number shares outstanding during the three months ended
September 30, 2010 and 2009 was 62,259,500 and 50,000,000, respectively. As a
result of the application of continuity of interest accounting, all periods
prior to the initial public offering completed on December 21, 2009 are deemed
to have 50,000,000 shares issued and outstanding for the purpose of determining
earnings per share.
Summary of Quarterly Results
The following table is a summary of the selected quarterly financial information
for each of the eight quarters ended September 30, 2010. The results over the
last eight quarters are impacted by the fluctuation of the RMB against the
Canadian dollar. Revenue has increased over the past eight quarters as a result
of the expansion of the number of distributor and corporate owned retail outlets
by 27% from 1,514 retail outlets at October 1, 2008 to 1,926 retail outlets as
at September 30, 2010. Net income has also correspondingly increased.
Quarter Ended Sept 30 2010 June 30 2010 Mar 31 2010 Dec 31 2009
------------ ------------ ------------ ------------
Revenue $ 50,425 $ 50,553 $ 33,342 $ 36,960
Net income 7,056 8,575 5,194 5,550
Earnings per share -
basic and diluted $ 0.11 $ 0.14 $ 0.08 $ 0.11
Quarter Ended Sept 30 2009 June 30 2009 Mar 31 2009 Dec 31 2008
------------ ------------ ------------ ------------
Revenue $ 43,030 $ 44,349 $ 31,104 $ 33,950
Net income 7,657 7,597 5,144 5,293
Earnings per share -
basic and diluted $ 0.15 $ 0.15 $ 0.10 $ 0.11
Liquidity and Capital Resources
Liquidity
The purpose of liquidity management is to ensure there is sufficient cash to
meet all of the Company's financial commitments and obligations as they fall
due. The Company believes that it has the flexibility to obtain, from current
cash holdings and ongoing operations, the funds needed to fulfill its cash
requirements during the current financial year. The Company's main source of
funds is from the sales of its products to distributors and cash on hand. The
Company's use of funds is primarily for its operating expenses including the
payment for its production of footwear and outsourced production to third party
suppliers.
Through the Company's growth and expansion, with cash from operations of $7.6
million, it has increased its cash on hand from $85.9 million as at June 30,
2010 to $91.5 million as at September 30, 2010.
The Company commences its manufacturing or outsourcing of most products at the
time that it enters into a binding production contract with the distributor to
limit its inventory levels. Finished goods inventory increased to $2.4 million
as at September 30, 2010 from $1.6 million as at June 30, 2010 but was lower
than the level at September 30, 2009 of $5.6 million. The other components of
inventory decreased 52% to $0.9 million.
Accounts receivable increased to $35.7 million as at September 30, 2010 compared
to $34.1 million as at June 30, 2010 and $24.0 million as at September 30, 2009
as sales continued to increase and extended payment terms continued to be
offered to certain distributors to provide support to them to open more retail
stores. The days sales outstanding is 63 days for the three months ended
September 30, 2010 compared to 60 days for the year ended June 30, 2010 and 49
days for the three months ended September 30, 2009. The Company has not
experienced any increase in bad debts or increased provision for allowance for
doubtful accounts.
At present, there are no known demands, commitments, events or uncertainties
that would adversely affect the trends and expected fluctuations in the
Company's liquidity. The Company believes it has the funds required to meet its
business objectives and working capital and other cash requirements for at least
twelve months. However, there can be no assurances that these funds will be
sufficient and the Company may have to evaluate additional means of financing,
including additional debt or equity financing.
Net cash provided by operating activities for the three months ended September
30, 2010 was $7.6 million compared to $7.7 million for the same quarter last
year. The growth in the business has been the main driver of the increased cash
generated from operating activities and the decreased working capital
requirement for the period. No dividends were paid out during the three months
ended September 30, 2010 or 2009. Net cash generated during the three months
ended September 30, 2010 and 2009 was $5.6 million.
Working capital increased from $89.5 million (RMB 572.5 million) as at June 30,
2010 to $95.1 million (RMB 618.1 million) as at September 30, 2010 as a result
of the growth in revenue and profitability.
Capital Expenditures
The Company's capital expenditures primarily relate to its investment in the
equipment to upgrade its production lines and leasehold improvements for the
corporate-owned retail outlets. The Company expects to complete the upgrade
and/or replacement of its existing equipment by April, 2011. The Company has
submitted plans for the construction of a new building of ten storeys and is
awaiting approval from government officials. The Company expects to complete
construction of the building and installation of two new production lines by
June, 2011.
Capital Structure
Shares Outstanding
As of September 30, 2010 and current date, November 23, 2010, the Company has
62,259,500 common shares issued and outstanding.
Normal Course Issuer Bid
On September 17, 2010 the Company announced approval from the TSX Venture
Exchange to proceed with a normal course issuer bid. The Company can purchase
for cancellation, at market prices, up to 3,112,975 of its issued and
outstanding common shares, representing 5% of the 62,259,500 common shares
outstanding as at September 29, 2010. The Bid will commence on October 4, 2010
and terminate on October 3, 2011, or on such earlier date as the Bid is
completed or otherwise terminated by Zungui.
As of November 23, 2010, the Company repurchased 70,800 shares at an average
price of $2.88 for total proceeds of $0.2 million. All of the repurchased shares
will be cancelled.
Reorganization and Share Capital
On December 21, 2009, the Company completed a share exchange agreement with
Southern whereby the 10,000 issued and outstanding common shares of Southern
were exchanged for 50,000,000 common shares of the Company. On June 25, 2009,
Southern, an investment holding company, acquired 100% ownership interest in
Honorable Int'l Investment Co., Limited ("Honorable") which is an investment
holding company based in Hong Kong. Honorable acquired 100% interest in
Mengshida Shoes Co., Ltd Shishi City ("Mengshida") on July 25, 2008. Mengshida
manufactures and sells athletic footwear and related apparel and accessories as
well as leisure leather shoes in the PRC.
These reorganization transactions were accounted for on a continuity of interest
basis of accounting whereby the various assets and liabilities are accounted for
at the carrying value in the combining companies' records. Current and
comparative consolidated financial results are presented as if the companies
have always been combined. The number of common shares outstanding has been
restated for the purpose of determining earnings per share to reflect the
reorganization.
Initial Public Offering
On December 21, 2009, the Company completed its initial public offering ("IPO")
by issuing 11,500,000 common shares at a price of $3.25 per common share,
resulting in net proceeds of $33,040 after deducting the underwriters' fees and
other related expenses of the offering of $4,355.
The Company granted the underwriters an over-allotment option exercisable for a
period of 30 days from closing of the IPO to purchase up to an additional
1,725,000 common shares at the issue price. No stock based compensation was
recorded for this option. On January 12, 2010, the underwriters exercised the
over-allotment option and purchased 759,500 common shares at $3.25. Net proceeds
of $2,278 were received after deducting the underwriters' fees and related
expenses of $190.
In addition, the underwriters received compensation options entitling them to
acquire up to 7% of the number of common shares issued under the IPO including
any shares exercised under the over-allotment option. On December 21, 2009, the
underwriters received an option to purchase 805,000 common shares ("compensation
options") at $3.25 for a period of 24 months. On January 12, 2010, the
underwriters received a further 53,165 compensation options in conjunction with
the exercise of the over-allotment that will be exercisable for common shares at
$3.25 per share until January 12, 2012.
Stock Options
There are 700,000 stock options outstanding granted to consultants and 950,000
stock options outstanding granted to employees and non-employee directors. The
stock options have the same terms and conditions and were granted on December
21, 2009 at an exercise price of $3.25 and an expiry date of December 21, 2014.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Use of Proceeds
The Company completed its initial public offering on December 21, 2009 and
received net cash proceeds of $34,759 after deducting the underwriter fees but
prior to the issue costs of $1,719. On January 12, 2010, the Company received a
further $2,278 of net cash proceeds from the exercise of the over-allotment
option.
Balance to be
disbursed as of
Disbursed as of September 30
Intended Use of Proceeds As disclosed September 30 2010 2010
----------------- ----------------- ----------------
Retail and Distribution
Network Expansion $ 16,000 $ 1,971 $ 8,348
Increase Production
Capacity - Building and
Equipment 7,000 846 6,154
Brand Recognition,
Awareness and Image 9,000 2,612 6,388
Working Capital 2,800
-----------------
Net Proceeds $ 34,800
-----------------
-----------------
The disbursement of the network expansion proceeds is expected to continue to
increase during the next two quarters of fiscal 2011 as more stores are opened
and distributors achieve the criteria for payment of the subsidy payments. The
Company does not expect to pay out all of the expansion use of proceeds for the
original 350 new retail outlets as outlined in the final prospectus dated
December 11, 2009 and filed on SEDAR at www.sedar.com. This will not affect the
Company's ability to achieve its business objectives and milestones. The Company
will use the remaining funds to construct a larger building and implement growth
plans in fiscal 2011 and beyond in the same manner as outlined above. The
Company recently launched a new strategy in the second quarter of fiscal 2011 on
brand recognition, awareness and image. While the Company intends to use the net
proceeds as stated above, circumstances may arise where, for sound business
reasons and in order to account for currency fluctuations, a reallocation of
monies may be necessary or advisable.
Related Party Transactions
Directors of Mengshida have jointly provided personal guarantees to indemnify
Mengshida on certain potential tax exposures including related interest and
penalties for periods prior to 2006. As a result, the Company has recorded an
other receivables from the directors of $1.3 million as at September 30, 2010
and June 30, 2010.
A loan was received from a director of Honorable for $0.4 million as at
September 30, 2010 and June 30, 2010. The loan is not secured, is interest free
and payable on demand.
Directors of Mengshida have jointly made personal guarantees to indemnify the
Company for any premiums for social insurance in arrears in excess of RMB
4,465,000 relating to periods prior to December 31, 2009. One of the Directors
has pledged 2,000,000 common shares of the Company owned by him for any
potential liability that may become payable under this undertaking.
A corporation owned 50% by one of Zungui's Directors received $400,000 in cash
and 700,000 stock options of the Company in trust for various parties as
consideration for services rendered in connection with the initial public
offering. The stock options were granted at $3.25 and vest in equal amounts over
three years. A company controlled by the same Director received 440,000 of the
700,000 stock options granted by the Company. The above transactions were
conducted in the normal course of business and are measured at the exchange
amount, which is the amount of consideration established and agreed to by the
parties.
Financial Instruments and Other Instruments
The Company held cash of $91.5 million on its balance sheet as at September 30,
2010. The Company does not have any cash equivalents or invested assets. The
Company does not currently utilize any other instruments such as derivative
financial instruments to reduce its exposure to interest rate risk. The
Company's location in the Fujian Province is in close proximity to a large
number of suppliers of raw materials required in the manufacturing of the
Company's products creating procurement efficiency and, as a result, the Company
does not need to enter into any forward future contracts to purchase raw
materials. All of the Company's financial assets and financial liabilities are
short term in nature and are measured on an ongoing basis at fair value or
amortized cost.
Adoption of New Accounting Policies
The Company has a stock based compensation plan. The Company estimates the fair
value of options granted to employees, non-employees directors and consultants
using the Black-Scholes option pricing model. The Company recognizes the fair
value as a compensation expense over the period that the stock options vest,
with a corresponding increase to contributed surplus. When these stock options
are exercised, the amount of the proceeds together with the amount recorded in
contributed surplus, is recorded in share capital.
The CICA has amended Handbook Section 3862 to require enhanced disclosure on the
fair value of certain financial instruments. The Company adopted these
recommendations effective June 30, 2010 and the required disclosures are
included in the note 16 to the unaudited interim consolidated financial
statements. The Company does not have any financial instruments measured at fair
value that require disclosure of the hierarchy levels. These amendments did not
impact the company's results of operations or financial position.
Future Accounting Changes
Transition to IFRS
Canada's Accounting Standards Board ratified a strategic plan that will result
in Canadian GAAP, as used by public companies, being evolved and converged with
International Financial Reporting Standards ("IFRS") over a transitional period
to be complete by 2011. The Company will be required to report using IFRS
effective for interim and annual financial statements relating to the fiscal
year ended June 30, 2012.
The Company expects the transition to IFRS to have an impact on financial
reporting, business processes and information systems. The Company began a
preliminary assessment during the year ended June 30, 2010. The Company will
invest in training and resources through the transition process to facilitate a
timely conversion.
Business Combinations, Consolidations and Non-Controlling Interests
In January 2009, the CICA issued Handbook Section 1582, Business Combinations
replacing Section 1581, Business Combinations. Section 1582 will apply to a
transaction in which the acquirer obtains control of one or more businesses (as
defined in the Section). Most assets acquired and liabilities assumed, including
contingent liabilities that are considered to be probable, will be measured at
fair value. A bargain purchase will result in the recognition of a gain.
Acquisition costs will be expensed. These standards are applicable to interim
and annual financial statements of the Company beginning on July 1, 2011. The
Company does not anticipate any significant impact upon the adoption of these
standards.
In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial
Statements and 1602, Non-Controlling Interests replacing Section 1600,
Consolidated Financial Statements. Section 1601 establishes standards for the
preparation of consolidated financial statements and Section 1602 establishes
standards for accounting for a non-controlling interest. These standards are
applicable to interim and annual financial statements of the Company beginning
on July 1, 2011. The Company does not anticipate any significant impact upon the
adoption of these standards.
Outlook
The PRC domestic footwear market remains a high growth industry consistent with
the growth of the PRC's economy. Zungui's focus is on the domestic market and
the Company allocates its resources and efforts to meet the demands of China's
growing local markets. Zungui is currently working to increase its presence in
Tier 2 and 3 Cities, with populations ranging up to 5 million people, throughout
the PRC, where both population and disposable income are growing. This increased
presence will be achieved by opening additional corporate-owned retail outlets
and by assisting distributors in expanding their retail presence.
Corporate-owned retail outlets typically offer higher margins than sales through
distributors as well as greater operating flexibility. By increasing the number
of corporate-owned retail outlets, Zungui believes it can focus its growth
strategy in certain regions while complementing its current distribution
network. During the period October 1 - November 23, 2010, the Company has opened
an additional 55 corporate-owned retail outlets and distributors have opened an
additional 57 retail outlets. The number of new stores opened during calendar
year 2010 now totals 341 compared to the target for the full calendar year 2010
of 350 new retail outlets.
Zungui Haixi Corporation
Consolidated Balance Sheets
(Unaudited)
(Expressed in thousands of Canadian Dollars)
September 30, 2010 June 30, 2010
Current assets
Cash $ 91,494 $ 85,876
Accounts receivable, net 35,708 34,128
Prepaid expenses 1,444 343
Inventories (Note 3) 3,332 3,498
Other receivables (Note 12) 1,335 1,331
Future income taxes 608 58
--------------------------------------
Total current assets 133,921 125,234
Property, plant and equipment (Note 4) 6,624 6,470
--------------------------------------
Total assets $ 140,545 $ 131,705
--------------------------------------
--------------------------------------
Current liabilities
Accounts payable and accrued
liabilities $ 33,275 $ 30,288
Taxes payable 5,066 4,974
Due to related party (Note 12) 449 440
--------------------------------------
Total current liabilities 38,790 35,702
Shareholders' equity
Share capital (Note 6) 33,451 33,451
Contributed surplus (Note 6) 3,398 3,282
Surplus reserve funds (Note 8) 4,774 4,774
Retained earnings 63,217 56,161
Accumulated other comprehensive
income (loss) (3,085) (1,665)
--------------------------------------
Total shareholders' equity 101,755 96,003
--------------------------------------
Total liabilities and shareholders'
equity $ 140,545 $ 131,705
--------------------------------------
--------------------------------------
Subsequent Event (Note 16)
The accompanying notes are an integral part of these consolidated financial
statements
Approved By the Board
Michael W. Manley, Director
Patrick A. Ryan, Director
Zungui Haixi Corporation
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
(Expressed in thousands of Canadian Dollars, except per share data)
Three Months Ended September 30,
2010 2009
--------------------------------------
Revenue (Note 10) $ 50,425 $ 43,030
Cost of sales 37,731 31,288
--------------------------------------
Gross profit 12,694 11,742
--------------------------------------
--------------------------------------
Selling expenses 1,777 593
Research and development expenses 201 136
General and administrative expenses 1,055 566
Foreign exchange loss 9 -
Other expenses (income), net 107 (7)
--------------------------------------
3,149 1,288
Income before income taxes 9,545 10,454
Income tax expense (Note 11) 2,489 2,797
--------------------------------------
Net income 7,056 7,657
--------------------------------------
--------------------------------------
Other comprehensive income (loss):
Unrealized gain(loss) on foreign
currency translation of self-
sustaining operations (1,420) (2,895)
--------------------------------------
--------------------------------------
Comprehensive income $ 5,636 $ 4,762
--------------------------------------
--------------------------------------
Basic and diluted earnings per share
(Note 6(b)) $ 0.11 $ 0.15
--------------------------------------
Weighted average number of shares
outstanding 62,259,500 50,000,000
--------------------------------------
--------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
Zungui Haixi Corporation
Consolidated Statements of Shareholders' Equity
(Unaudited)
(Expressed in thousands of Canadian Dollars)
Three Months Ended September 30,
2010 2009
--------------------------------------
Share Capital
Balance, beginning and end of period $ 33,451 $ -
Contributed Surplus
Balance, beginning of period $ 3,282 $ 1,174
Stock based compensation expense 116 -
--------------------------------------
Balance, end of period $ 3,398 $ 1,174
Surplus Reserve Fund
Balance, beginning and end of period $ 4,774 $ 1,938
Retained Earnings
Balance, beginning of period $ 56,161 $ 32,021
Net income 7,056 7,657
--------------------------------------
Balance, end of period $ 63,217 $ 39,678
Accumulated Other Comprehensive Income
(Loss)
Balance, beginning of period $ (1,665) $ 42
Unrealized foreign currency
translation gains (losses) (1,420) (2,895)
--------------------------------------
Balance, end of period $ (3,085) $ (2,853)
Total Shareholders' Equity $ 101,755 $ 39,937
--------------------------------------
--------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements
Zungui Haixi Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(Expressed in thousands of Canadian Dollars unless otherwise noted)
Three Months Ended September 30,
2010 2009
--------------------------------------
Cash flows from operating activities
Net income $ 7,056 $ 7,657
Items not affecting cash:
Depreciation 311 113
Future income taxes (549) (10)
Provision for doubtful accounts 15 40
Stock based compensation 116 -
Loss on disposal of property,
plant and equipment 183 -
Changes in non-cash working capital
Accounts receivable (2,135) (3,626)
Prepaid expenses (1,103) (6)
Inventories 110 (4,515)
Other receivables (25) (29)
Accounts payable and accrued
liabilities 3,458 7,834
Taxes payable 171 250
--------------------------------------
Net cash provided by operating
activities 7,608 7,708
Cash flows from investing activities
Property, plant and equipment (763) -
Proceeds from sale of equipment 20 -
Construction in process (7) -
--------------------------------------
Net cash used in investing activities (750) -
Cash flows from financing activities
Due to related party 8 -
--------------------------------------
Net cash provided by financing
activities 8 -
Effect of exchange rate changes on
cash (1,248) (2,138)
--------------------------------------
Net increase in cash 5,618 5,570
Cash, beginning of period 85,876 23,757
--------------------------------------
Cash, end of period $ 91,494 $ 29,327
--------------------------------------
--------------------------------------
Supplemental disclosure of cash
information
Interest paid in cash $ - $ 7
Income taxes paid in cash 2,884 2,617
The accompanying notes are an integral part of these consolidated financial
statements
Zungui Haixi Corporation
Notes to Consolidated Financial Statements
For the three month periods ended September 30, 2010 and 2009
(Unaudited)
(Expressed in thousands of Canadian Dollars except per share and share
amounts)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Zungui Haixi Corporation ("Zungui" or "Company") was incorporated under the
Ontario Business Corporation Act on August 11, 2009. Zungui is a holding company
listed on TSX Venture Exchange. Through its subsidiaries, Zungui manufactures
and sells sports footwear and related apparel and accessories as well as leisure
leather shoes in the People's Republic of China ( the "PRC" or "China").
Zungui's wholly owned subsidiaries include Southern Trends International Holding
Company Ltd. ("Southern"), Honorable Int'l Investment Co., Limited ("Honorable")
and Mengshida Shoes Co., Ltd. Shishi City ("Mengshida").
On December 21, 2009, the Company completed a share exchange agreement with
Southern whereby the 10,000 issued and outstanding common shares of Southern
were exchanged for 50,000,000 common shares of the Company. On June 25, 2009,
Southern, an investment holding company, acquired 100% ownership interest in
Honorable which is an investment holding company based in Hong Kong. Honorable
acquired 100% interest in Mengshida on July 25, 2008.
These reorganization transactions were accounted for on a continuity of interest
basis of accounting whereby the various assets and liabilities are accounted for
at the carrying value in the combining companies' records. Current and
comparative consolidated financial results are presented as if the companies
have always been combined. The number of common shares outstanding has been
restated for the purpose of determining earnings per share to reflect the
reorganization.
2. SIGNIFICANT ACCOUNTING POLICIES
These interim consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles ("GAAP") for interim
financial statements and are consistent with the accounting policies and methods
of computation as were used in the preparation of the audited consolidated
financial statements for the year ended June 30, 2010. The interim consolidated
financial statements do not contain all the information and disclosures required
by GAAP applicable for annual consolidated financial statements and accordingly
should be read in conjunction with the audited consolidated financial statements
for the year ended June 30, 2010. The results of the operations for the interim
periods are not necessarily indicative of the full-year results.
(a) Foreign currency translation
The Company's primary economic activities are in China and the functional
currency is Chinese Renminbi ("RMB") for its wholly owned subsidiary, Mengshida,
located in China. The Company's head office, Honorable and Southern's functional
currency is Canadian dollars. The Company uses Canadian dollars as its reporting
currency. Mengshida is considered to be a self-sustaining foreign operation and
its' financial statements are translated into the reporting currency using the
current rate method. Under this method, revenue and expenses are translated into
the reporting currency using the weighted average exchange rates for the period
and assets and liabilities are translated using the exchange rate at the end of
the period. Capital transactions are translated using historical rates. All
resulting exchange differences are reported as accumulated other comprehensive
income (loss), which is presented as a separate component of shareholders'
equity.
(b) Changes in accounting policies
(i) Stock-based compensation plan
The Company has a stock based compensation plan which is described in Note 7.
The Company measures and recognizes compensation expense using the fair value
method. Under this method, the Company estimates the fair value of options
granted to employees, non-employee directors and consultants at the grant date
using the Black-Scholes option pricing model. The Company recognizes the fair
value as a compensation expense over the period that the stock options vest on a
straight line basis, with a corresponding increase to contributed surplus. When
these stock options are exercised, the amount of the proceeds together with the
amount recorded in contributed surplus, is recorded in share capital.
(ii) Financial Instruments
The CICA has amended Handbook Section 3862 to require enhanced disclosure on the
fair value of certain financial instruments. The Company adopted these
recommendations effective June 30, 2010 and the required disclosures are
included in Note 14. The Company does not have any financial instruments
measured at fair value that require disclosure of the hierarchy levels. These
amendments did not impact the Company's results of operations or financial
position.
(c) Future accounting changes
(i) Transition to IFRS
Canada's Accounting Standards Board ratified a strategic plan that will result
in Canadian GAAP, as used by public companies, being evolved and converged with
International Financial Reporting Standards ("IFRS") over a transitional period
to be complete by 2011. The Company will be required to report using IFRS for
interim and annual financial statements relating to the fiscal year ended June
30, 2012.
The Company expects the transition to IFRS to have an impact on financial
reporting, business processes and information systems. The Company began a
preliminary assessment during the year ended June 30, 2010. The Company will
invest in training and resources through the transition process to facilitate a
timely conversion.
(ii) Business Combinations, Consolidations and Non-Controlling Interests
In January 2009, the CICA issued Handbook Section 1582, Business Combinations
replacing Section 1581, Business Combinations. Section 1582 will apply to a
transaction in which the acquirer obtains control of one or more businesses (as
defined in the Section). Most assets acquired and liabilities assumed, including
contingent liabilities that are considered to be probable, will be measured at
fair value. A bargain purchase will result in the recognition of a gain.
Acquisition costs will be expensed. These standards are applicable to interim
and annual financial statements of the Company beginning on July 1, 2011. The
Company does not anticipate any significant impact upon the adoption of these
new standards.
In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial
Statements and 1602, Non-Controlling Interests replacing Section 1600,
Consolidated Financial Statements. Section 1601 establishes standards for the
preparation of consolidated financial statements and Section 1602 establishes
standards for accounting for a non-controlling interest. These standards are
applicable to interim and annual financial statements of the Company beginning
on July 1, 2011. The Company does not anticipate any significant impact upon the
adoption of these new standards.
3. INVENTORIES
Inventories consist of:
----------------------------------------------------------------------------
September 30, 2010 June 30, 2010
----------------------------------------------------------------------------
Raw materials $ 487 $ 1,433
Work in progress 418 466
Finished goods 2,427 1,599
----------------------------------------------------------------------------
Total inventory $ 3,332 $ 3,498
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Inventories expensed as cost of sales were $37,702 and $31,272 for the three
months ended September 30, 2010 and 2009, respectively.
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
----------------------------------------------------------------------------
September 30, 2010
----------------------------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
----------------------------------------------------------------------------
Plant and building $ 5,501 $ 1,948 $ 3,553
Machinery and production equipment 1,860 748 1,112
Automobiles and trucks 660 202 458
Leasehold improvements 1,789 342 1,447
Office equipment 147 93 54
----------------------------------------------------------------------------
Total $ 9,957 $ 3,333 $ 6,624
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
June 30, 2010
----------------------------------------------------------------------------
Accumulated Net Book
Cost Depreciation Value
----------------------------------------------------------------------------
Plant and building $ 5,859 $ 2,036 $ 3,823
Machinery and production equipment 1,798 950 848
Automobiles and trucks 668 191 477
Leasehold improvements 1,422 156 1,266
Office equipment 148 92 56
----------------------------------------------------------------------------
Total $ 9,895 $ 3,425 $ 6,470
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Depreciation expense was $311 and $113 for the three months ended September 30,
2010 and 2009, respectively.
5. BANK LOAN
On July 17, 2009, the Company signed a one year term loan agreement with Bank of
Agriculture Shishi branch to borrow $511 (RMB 3,000,000). The interest rate is
the higher of 5.31% per annum or the lending rate per Bank of China, reset every
3 months. Interest is payable on a quarterly basis. The loan was fully repaid on
June 25, 2010.
Interest expense was $nil and $49 for the three months ended September 30, 2010
and 2009, respectively.
6. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS
(a) Share Capital:
As at September 30, 2010 the authorized share capital of Zungui was unlimited
common shares with no par value.
----------------------------------------------------------------------------
Weighted
Number of Number of Number of Average
Shares Stock Compensation Exercise
Share Capital Issued Options Options Price Amount
----------------------------------------------------------------------------
Balance as at:
June 30, 2010 and
September 30,
2010 62,259,500 700,000 858,165 $ 3.25 $ 33,451
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(b) Earnings Per Share:
As a result of the reorganization as described in Note 1 and the application of
the continuity of interest accounting, all periods prior to the initial public
offering completed on December 21, 2009 are deemed to have 50,000,000 shares
issued and outstanding for the purposes of calculating earnings per share.
(c) Stock Options Outstanding:
A summary of the stock options outstanding as at September 30, 2010 are as follows:
----------------------------------------------------------------------------
Exercise Price Date of Grant Expiry Date
----------------------------------------------------------------------------
Employee and Non-Employee $ 3.25 December 21, December 21,
Directors 2009 2014
----------------------------------------------------------------------------
Consultants $ 3.25 December 21, December 21,
2009 2014
----------------------------------------------------------------------------
Underwriters $ 3.25 December 21, December 21,
2009 2011
----------------------------------------------------------------------------
Underwriters $ 3.25 January 12, January 12,
2010 2012
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Remaining
Contractual Life Number Number
(Years) Outstanding Exercisable
----------------------------------------------------------------------------
Employee and Non-Employee 4.3 950,000 -
Directors
----------------------------------------------------------------------------
Consultants 4.3 700,000 -
----------------------------------------------------------------------------
Underwriters 1.3 805,000 805,000
----------------------------------------------------------------------------
Underwriters 1.3 53,165 53,165
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(d) Paid in Capital:
As part of the reorganization referred to in Note 1, the paid in capital of
Mengshida of $1,174 became the contributed surplus of the Company.
On January 29, 2010, the Company applied to change the registered capital of
Mengshida to $33.9 million (RMB 220.0 million). As of September 30, 2010,
Mengshida's registered capital was $29.7 million (RMB 193.0 million). By January
29, 2012, the Company is required to inject additional capital of $4.2 million
(RMB 27.0 million) to fulfil this requirement.
7. STOCK BASED COMPENSATION
The Company introduced a stock option plan on December 21, 2009 to incent
directors, officers, consultants and employees. In accordance with the stock
option plan, the term of any stock option grant cannot exceed five years and no
more than 10% of Company's common shares are reserved for stock option grants.
During the three months ended September 30, 2010, no additional stock options
were granted nor were any forfeited.
During the three months ended September 30, 2010, stock based compensation
expense was $116.
8. SURPLUS RESERVE FUNDS
In accordance with applicable regulations for foreign funded enterprises in the
PRC, Mengshida, the Company's operating subsidiary, is required to retain a
certain amount from net income as reserve funds. The amount retained shall not
be less than 10% of net income as determined under PRC GAAP annually for
statutory reserves. When the balance of the statutory reserves reaches 50% of
the registered capital of Mengshida, no further appropriations are required.
As of September 30, 2010 and June 30, 2010, Mengshida's surplus reserve fund
aggregated $4,774 which represents 15% of Mengshida's registered capital.
9. MAJOR CUSTOMERS AND SUPPLIERS
The Company sells products to various customers. There were no customers that
purchased more than 10% of the Company's products for the three month periods
ended September 30, 2010 and 2009.
During the three month period ended September 30, 2010, purchases from three
suppliers, each represented 19% ($6,766), 19% ($6,765) and 18% ($6,565) of total
purchases. During the three month period ended September 30, 2009, purchases
from three suppliers represented 19% ($6,498), 18% ($6,292) and 18% ($6,260) of
total purchases.
10. REVENUE
----------------------------------------------------------------------------
Three Months Ended September 30,
2010 2009
----------------------------------------------------------------------------
Revenue
Footwear $ 44,709 $ 37,085
Apparel and accessories 5,716 5,945
----------------------------------------------------------------------------
Revenue $ 50,425 $ 43,030
----------------------------------------------------------------------------
----------------------------------------------------------------------------
11. INCOME TAXES
The Company is subject to income taxes in Canada while its operating subsidiary,
Mengshida is subject to the Corporate Income Tax Law of the PRC enacted on
January 1, 2008 which resulted in a unified tax rate of 25% for all enterprises.
The Company is not subject to any taxation in the British Virgin Islands and the
Company is subject to 16.5% income tax rate in Hong Kong.
The Company established a valuation allowance of $1,547 as at September 30, 2010
($1,515 as at June 30, 2010) due to the uncertainty of future realization of
future income tax assets that originated from tax losses recognized in Canada
and Hong Kong. As at September 30, 2010, the Company has income tax losses of
$2,332 ($1,820 as at June 30, 2010) for which no accounting benefit has been
recognized and which can be applied against future years' taxable income in
Canada. These losses expire in the year 2020 ($1,820) and 2021 ($512). The
Company has income tax losses of $391 in Hong Kong which do not expire.
12. RELATED PARTY TRANSACTIONS
(a) Directors of Mengshida have jointly made personal guarantees to indemnify
Mengshida on certain potential tax exposures including the related interest and
penalties arising in periods prior to 2006. Accordingly, the Company has
recorded an other receivables from Directors.
(b) Due to related party consists of a loan from a Director of Honorable
totalling $449 (Hong Kong $3,200,000 and RMB 100,000) as at September 30, 2010
and $440 (Hong Kong $3,200,000 and RMB 100,000) as at June 30, 2010. This loan
is unsecured, is interest free and is payable on demand.
(c) The Directors of Mengshida have jointly made personal guarantees to
indemnify Mengshida for any premiums for social insurance in arrears in excess
of RMB 4,465,000 as discussed in Note 13. One of the Directors has pledged
2,000,000 common shares of the Company owned by him for any potential liability
that may become payable under this undertaking.
(d) A corporation 50% owned by one of Zungui's Directors received $400,000 in
cash and 700,000 stock options of the Company in trust for various parties as
consideration for services rendered in connection with the initial public
offering. The stock options were granted at $3.25 and vest in equal amounts over
three years. A company controlled by the same Director received 440,000 of the
700,000 stock options granted by the Company. The above transactions were
conducted in the normal course of business and are measured at the exchange
amount, which is the amount of consideration established and agreed to by the
parties.
13. CONTINGENCY
Pursuant to the relevant laws and regulations of the PRC, the Company makes
contributions to the local Labour and Social Security Bureaus based on a rate
determined by the local bureaus. The process of determining this rate involves
uncertainties and judgments on the part of the Bureaus. Significant estimates
and judgement are applied by management to determine the appropriate amount of
social insurance to be paid. The Directors of Mengshida have jointly made
personal guarantees to indemnify the Company for any premiums for social
insurance in arrears and all related fines, penalties, interest and other
payments in excess of RMB 4,465,000 ($687) that the Company may be required to
make relating to periods prior to December 31, 2009 in the event of a dispute or
settlement with the applicable government authorities. See Note 12(c).
14. FINANCIAL INSTRUMENTS
Financial assets and financial liabilities are measured on an ongoing basis at
fair value or amortized cost. Fair value estimates are made at a specific point
in time, using available information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and the exercise of
significant judgement. The fair value of financial assets and financial
liabilities approximates their carrying value due to their short term maturity.
The classification of the financial instruments as well as their carrying values
is shown in the table below:
----------------------------------------------------------------------------
September 30, 2010 Other Total
Held for Loans and Financial Carrying
Trading Receivables Liabilities Value
----------------------------------------------------------------------------
Financial assets
Cash $ 91,494 $ - $ - $ 91,494
Accounts receivable - 35,708 - 35,708
Other receivables - 1,335 - 1,335
----------------------------------------------------------------------------
$ 91,494 $ 37,043 $ - $ 128,537
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Financial liabilities
Accounts payable and
accrued liabilities $ - $ - $ 33,275 $ 33,275
Due to related party - - 449 449
----------------------------------------------------------------------------
$ - $ - $ 33,724 $ 33,724
----------------------------------------------------------------------------
----------------------------------------------------------------------------
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June 30, 2010 Other Total
Held for Loans and Financial Carrying
Trading Receivables Liabilities Value
----------------------------------------------------------------------------
Financial assets
Cash $ 85,876 $ - $ - $ 85,876
Accounts receivable - 34,128 - 34,128
Other receivables - 1,331 - 1,331
----------------------------------------------------------------------------
$ 85,876 $ 35,459 $ - $ 121,335
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Financial liabilities
Accounts payable and
accrued liabilities $ - $ - $ 30,288 $ 30,288
Due to related party - - 440 440
----------------------------------------------------------------------------
$ - $ - $ 30,728 $ 30,728
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Financial risk management
Financial risk is the risk to the Company's earnings that arises from
fluctuations in market risk (including interest rate risk, foreign currency
risk), credit risk and liquidity risk and the degree of volatility of these
rates. The Company's business practices seek to minimize any potential adverse
effects on the Company's financial performance.
The Company's financial instruments that are included in the consolidated
balance sheets are comprised of cash, accounts receivable, other receivables,
accounts payable and accrued liabilities and due to related party. As at the
balance sheet date, there are no significant differences between the carrying
value of these items and their estimated fair values because they are short-term
in nature.
Market risk
Interest risk
Interest rate risk is the risk that the fair value of future cash flows of a
financial instrument will fluctuate because of changes in market interest rates.
The Company repaid its bank loan on June 25, 2010 and no longer has exposure to
interest rate fluctuations. The Company does not use any derivative financial
instruments to reduce its exposure to interest rate risk.
Foreign Currency risk
Foreign currency risk is the risk that the fair value of future cash flows of a
financial instrument will fluctuate because of changes in foreign currency
exchange rates. The Company has financial assets and liabilities in foreign
currencies that expose the Company to foreign exchange risks. The Company has
not hedged its exposure to currency fluctuations. The translation of foreign
operations to the reporting currency is not taken into account.
Credit risk
Credit risk is the risk that a counterparty to a financial instrument will
default on its obligations. The Company's maximum exposure to credit risk
consists of the carrying value of its cash, accounts receivable and other
receivables. The Company places the majority of its cash with a PRC regulated
financial institution.
Credit risk with respect to accounts receivable is mitigated through the sales
to numerous different customers. No customer accounted for more than 10% of
total sales. In addition, the Company evaluates the financial position of its
customers and regularly reviews their credit limit. Allowances are established
with regards to potential losses. The Company was not exposed to any particular
credit risk concentration for the three months ended September 30, 2010 and
2009, respectively.
Liquidity risk
Liquidity risk is the risk that the Company is not able to meet its financial
obligations as they become due. The Company finances its operations through cash
flows from operating activities. The Company's goal is to maintain an optimal
level of liquidity through the active management of the assets and liabilities
as well as the cash flows. As at September 30, 2010, the Company had $33,275 in
accounts payable and accrued liabilities and due to related party $449. All
financial liabilities have contractual maturities of less than one month as of
September 30, 2010.
15. CAPITAL DISCLOSURE
The Company's objectives when managing capital is to safeguard the entity's
ability to continue as a going concern and continue to provide returns and
benefits for its shareholders. The Company's capital is defined as shareholders'
equity as presented on the consolidated balance sheet excluding accumulated
other comprehensive income (loss). The Company's capital is as follows:
----------------------------------------------------------------------------
September 30, 2010 June 30, 2010
----------------------------------------------------------------------------
Shareholders' equity excluding
accumulated other comprehensive income
(loss) $ 104,840 $ 97,668
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The Company does not establish quantitative return on capital criteria for
management or internally imposed restrictions, but rather promotes
year-over-year sustainable profitable growth. The Company may adjust its capital
mix in order to manage its capital structure. There has been no change with
respect to the overall capital risk management strategy during the three months
ended September 30, 2010.
16. SUBSEQUENT EVENT
(a) On September 17, 2010, the Company announced its intention to proceed with a
normal course issuer bid as approved by the TSX Venture Exchange. The Company
can purchase for cancellation, at market prices, up to 3,112,975 of its issued
and outstanding common shares during the period October 4, 2010 to October 3,
2011.
As of November 23, 2010, the Company repurchased 70,800 shares at an average
price of $2.88 for total proceeds of $206. All of the repurchased shares will be
cancelled.
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