Zungui Haixi Corporation (TSX VENTURE:ZUN), a China-based manufacturer of
sportswear and casual footwear, today announced its financial results for the
three and six months ended December 31, 2010. All amounts in this release are in
Canadian dollars unless otherwise indicated.
"We are pleased to report strong revenue growth of 30% for the quarter based on
increased retail outlets and consumer demand as well as our success in growing
the Zungui brand in our key markets," indicated Mr. Yanda Cai, Chief Executive
Officer. "We are on track for continuing the pace of our store network growth
with the planned addition of 140 new retail outlets over the next two quarters
and the expansion of our manufacturing capacity to meet current demand. We are
pleased to report that we have received building permit approval for our new ten
storey building and plan to commence construction in April, 2011."
Highlights for the Second Quarter and Year-To-Date:
-- Revenue increased 30% to $47.9 million in the second quarter and
increased 23% to $98.3 million for the year-to-date;
-- In RMB, revenue increased 32% to RMB 314.7 million for the second
quarter and increased 27% to RMB 643.2 million for the year-to-date;
-- Revenue before subsidies increased 33% to $50.0 million for the second
quarter and increased 27% to $102.7 million for the year-to-date;
-- Gross margin improved to 26.3% for the quarter compared to 25.7% same
quarter last year;
-- Opened 53 net new distributor owned retail outlets compared to 37 retail
outlets same quarter last year;
-- Opened 56 net new corporate-owned retail outlets in the second quarter;
-- Corporate-owned retail outlets reported second quarter revenue of $1.6
million ($2.3 million year-to-date) compared to $0.1 million ($0.2
million year-to-date) for the same quarter last year reflecting a start
up phase of development;
-- Selling expenses increased $3.7 million in the quarter compared to the
same quarter last year primarily due to increased advertising
expenditures of $2.7 million;
-- Net income decreased 10% to $5.0 million for the second quarter and
decreased 9% to $12.1 million for the year-to-date reflecting increased
subsidy provisions to distributors and increased selling expenses;
-- Diluted earnings per share of 8 cents compared to 11 cents for the same
quarter last year based on a 21% increase in the weighted average number
of shares outstanding in the period and a 3 cent impact for increased
advertising expenses; and,
-- Diluted earnings per share of 19 cents for the six months ended December
31, 2010 compared to 26 cents for the same period last year on a 22%
increase in the weighted average number of shares outstanding in the
period.
On a trailing 12 month basis, the Company's revenue is $182.2 million, net
income is $25.8 million and diluted earnings per share is 41 cents.
Conference Call
Zungui will host a conference call to discuss the first quarter results at 9am
(EST) February 28, 2011. The details are as follows:
Dial-in number: 1-877-440-9795 or 416-340-8527
Taped rebroadcast (until midnight on March 14, 2011): 1-800-408-3053
Taped replay access passcode: 2366382
About Zungui Haixi
Zungui Haixi Corporation, through its wholly owned subsidiaries, is engaged in
the manufacture and sale of athletic footwear, apparel and accessories, and also
casual footwear, in the People's Republic of China. Both product lines are
marketed under the ZUNGUI brand. Zungui Haixi distributes its products to
consumers throughout China through an extensive network of retail outlets which
exclusively carry ZUNGUI branded products. There are 62,080,400 common shares
issued and outstanding. The corporate website is www.zunguihaixi.com.
Caution Regarding Forward-Looking Statements
Certain statements in this press release contain forward-looking information
that involve risk and uncertainties. Statements other than statements of
historical fact contained in this press release may be forward-looking
statements within the meaning of certain securities laws, including, without
limitation, statements involving management's expectations, intentions and
beliefs concerning the domestic PRC sportswear industry, the competitive
landscape in this industry and the general economy, statements regarding the
future financial position or results of the Company, business strategies,
proposed acquisitions, growth opportunities, budgets, litigation, projected
costs and plans and objectives of or involving the Company. Such statements
should be considered forward-looking statements, Wherever possible, words such
as "may", "would", "could", "will", "anticipate", "believe", "plan", "expect",
"intend", "estimate", "aim", "endeavour", "project", "continue" and similar
expressions have been used to identify forward-looking statements.
These forward-looking statements reflect management's current beliefs and
business judgement with respect to future events and are based on information
currently available to management. Forward-looking statements involve
significant known and unknown risks, uncertainties and assumptions, and you
should not place undue reliance on these forward-looking statements. Although
management believes its current beliefs and assumptions are reasonable, many
factors could cause Zungui's actual results, performance or achievements to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements, including,
without limitation, those listed in the "Risk Factors" section of the Company's
other filings with Canadian securities regulatory authorities at www.sedar.com.
Should one or more of these risks or uncertainties materialize, or should
assumptions underlying the forward-looking statements prove incorrect, actual
results, performance or achievements could vary materially from those expressed
or implied by the forward-looking statements contained in this press release.
The forward-looking statements contained in this press release are expressly
qualified in their entirety by this cautionary statement. These forward-looking
statements are made as of and speak as of the date of this press release and the
Company does not intend to, or assume any obligation to, update or revise these
forward-looking statements to reflect new information, events, results or
circumstances or otherwise after the date on which such statement is made as to
reflect the occurrence of unanticipated events, except as required by law,
including securities laws.
Zungui Haixi Corporation
Management's Discussion and Analysis of Financial Condition and Results of Operation
For the three and six months ended December 31, 2010
All amounts in thousands of Canadian dollars unless otherwise stated
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
The following management's discussion and analysis of financial condition and
results of operation (the "MD&A") of Zungui Haixi Corporation ("Zungui" or
"Company") is prepared for the three month and six months ended December 31,
2010 with comparative figures for the three and six months ended December 31,
2009. Zungui became the parent company of Southern Trends International Holding
Company Limited ("Southern"), through a share exchange agreement completed in
conjunction with the completion of the Company's initial public offering on
December 21, 2009. All figures presented for periods prior to December 21, 2009
refer to Southern financial statements. The MD&A should be read in conjunction
with the audited consolidated financial statements for the year ended June 30,
2010, and the notes contained therein, and the unaudited consolidated financial
statements for the three and six months ended December 31, 2010 and the notes
contained therein. The unaudited interim consolidated financial statements were
prepared in accordance with Canadian generally accepted accounting principles
("GAAP") and are presented in thousands of Canadian dollars unless otherwise
noted. Additional information relating to the Company can be found at
www.sedar.com.
Disclosure contained in this MD&A is current to February 25, 2011 the date of
approval of the MD&A and financial statements by the Board of Directors.
Caution Regarding Forward-Looking Statements
Certain statements in this MD&A contain forward-looking information that involve
risk and uncertainties. Statements other than statements of historical fact
contained in this MD&A may be forward-looking statements within the meaning of
certain securities laws, including, without limitation, statements involving
management's expectations, intentions and beliefs concerning the domestic
People's Republic of China (PRC) sportswear industry, the competitive landscape
in this industry and the general economy, statements regarding the future
financial position or results of the Company, business strategies, proposed
acquisitions, growth opportunities, budgets, litigation, projected costs and
plans and objectives of or involving the Company. Such statements should be
considered forward-looking statements, Wherever possible, words such as "may",
"would", "could", "will", "anticipate", "believe", "plan", "expect", "intend",
"estimate", "aim", "endeavour", "project", "continue" and similar expressions
have been used to identify forward-looking statements.
These forward-looking statements reflect management's current beliefs and
business judgement with respect to future events and are based on information
currently available to management. Forward-looking statements involve
significant known and unknown risks, uncertainties and assumptions, and you
should not place undue reliance on these forward-looking statements. Although
management believes its current beliefs and assumptions are reasonable, many
factors could cause Zungui's actual results, performance or achievements to be
materially different from any future results, performance or achievements that
may be expressed or implied by such forward-looking statements, including,
without limitation, risks related to: failure to maintain or promote the ZUNGUI
brand; dependency on distributors and retailers for product sales and brand
promotion; difficulty in continuing to grow Zungui's distribution network;
dependency on certain of its key executives, design, technical and other
personnel; failure to effectively integrate additional corporate-owned and
managed retail outlets; strong competition; the loss, or decrease in, sales to
Zungui's major distributors; failure to successfully implement plans to expand
production capacity and improve production efficiency; failure to execute growth
strategy; reliance on subcontractors; fluctuations in the price, availability
and quality of raw materials; exposure to credit risks of distributors; selling
prices; failure to accurately track inventory levels or sales figures; failure
to maintain and cultivate key relationships; failure to optimize and adjust
product mix;
failure to anticipate and respond in a timely manner to fashion trends and
changes in consumer tastes in the PRC; liability for unpaid contributions to the
social security insurance program; increases in labour costs and labour
disputes; protection of trademarks and other proprietary rights; damage to
administrative or production facilities, fire or other calamities; proof of
title; exposure to environmental liability; exposure to product liability,
property damage or personal injury claims; closure of retail outlets; failure to
obtain additional financing; risks relating to holding companies; risks
associated with dividends; conflict of interests of directors and officers;
limited recourse against principal securityholder and existing shareholders;
disclosure controls and procedures and internal controls over financial
reporting; language barriers between certain directors and officers of the
Company; influence by the majority shareholder; future sales of common shares;
risks associated with state ownership; exposure to fluctuations in the economic
conditions in the PRC; fluctuations in foreign exchange rates; changes in
Zungui's tax treatment; limitations in the ability to repatriate profits or
convert currency; limited shareholders' rights in China; risks relating to a
developing legal system; intellectual property rights protection and
enforcement; requirements for permits and business licenses; risks relating to
the appropriation of land used in Zungui's operations; natural disasters;
reliance on third-party sources and industry publications; volatile market
price; return on an investment in common shares. Should one or more of these
risks or uncertainties materialize, or should assumptions underlying the
forward-looking statements prove incorrect, actual results, performance or
achievements could vary materially from those expressed or implied by the
forward-looking statements contained in this MD&A. The forward-looking
statements contained in this MD&A are expressly qualified in their entirety by
this cautionary statement. These forward-looking statements are made as of and
speak as of the date of this MD&A and the Company does not intend to, or assume
any obligation to, update or revise these forward-looking statements to reflect
new information, events, results or circumstances or otherwise after the date on
which such statement is made as to reflect the occurrence of unanticipated
events, except as required by law, including securities laws.
Contents of MD&A
Overview
Selected Financial Information
Factors Affecting the Results of Operations
Results of Operations
Summary of Quarterly Results
Liquidity and Capital Resources
Capital Structure
Off-Balance Sheet Arrangements
Use of Proceeds
Related Party Transactions
Financial Instruments and Other Instruments
Recent Accounting Changes
Outlook
Overview
Zungui is principally engaged in the manufacture and sale of athletic footwear,
apparel and accessories ("Sportswear Product Line") and casual leather footwear
("Casual Product Line") in the PRC. Both product lines are marketed under the
well-recognized ZUNGUI brand. As of December 31, 2010, Zungui distributes its
products to consumers through 100 corporate-owned retail outlets and through 47
distributors, who in turn sell products via an extensive network of 1,935 retail
outlets, 1,540 of which offer the Sportswear Product Line and 395 of which offer
the Casual Product Line. All retail outlets exclusively sell products which
carry the ZUNGUI brand.
Net new store openings
Q1 Q2 Total
------------------------------------------------------------
Corporate 13 56 69
Distributor 120 53 173
During the three and six months ended December 31, 2010, the Company focused on
revenue growth and increased profitability through the expansion of its retail
network. It provided services and training and accrued subsidies to distributors
to help meet customer needs and network expansion. As well the Company increased
its advertising expenditures to build brand recognition. For the three months
ended December 31, 2010, revenue grew 30% to $47.9 million from $37.0 million
compared to same period last year. In Renminbi ("RMB"), revenue grew 32% to RMB
314.7 million from RMB 238.9 million last year. The lower growth rate in
Canadian dollars is attributable to the fluctuations in the Chinese currency
relative to the Canadian dollar reporting currency in 2009 and 2010.
Selected Financial Information
The following table sets forth selected financial information for the periods
indicated. The selected financial information has been derived from the
Company's unaudited interim consolidated financial statements for the three and
six months ended December 31, 2010.
For the three months For the six months
ended ended
Earnings Data December 31 December 31
----------------------------------------------------------------------------
2010 2009 2010 2009
-------------------------------------------------
Revenue $ 47,877 $ 36,960 $ 98,302 $ 79,990
Cost of sales 35,304 27,455 73,035 58,744
-------------------------------------------------
Gross profit 12,573 9,505 25,267 21,246
Selling expenses 4,258 511 6,035 1,104
Research and development
expenses 202 149 403 287
General and administrative
expenses 1,265 840 2,320 1,404
Other expenses (income),
net (34) (24) 82 (31)
Income tax expense 1,883 2,479 4,372 5,275
Net income $ 4,999 $ 5,550 $ 12,055 $ 13,207
Earnings per share - basic
and diluted $ 0.08 $ 0.11 $ 0.19 $ 0.26
As at December 31, As at June 30,
Balance Sheet Data 2010 2010
----------------------------------------------------------------------------
Cash $ 81,684 $ 85,876
Inventories 3,511 3,498
Property, plant and equipment 8,827 6,470
Total assets 129,498 131,705
Working capital 95,687 89,532
Retained earnings 66,648 56,161
Total shareholders' equity 104,514 96,003
Factors Affecting Results of Operations
Foreign Currency
All of the Company's revenues and expenses, other than the corporate expenses,
are generated in the PRC. Accordingly, the results of operations are impacted by
the fluctuation of the RMB against the Canadian dollar when converted for
financial reporting purposes. The weighted average exchange rate for one RMB,
expressed in Canadian dollars, for the three months ended December 31, 2010 and
2009 was 0.1521 and 0.1547 and for the six months ended December 31, 2010 and
2009 was 0.1528 and 0.1576. The movement of the Chinese currency relative to the
Canadian dollar in the three and six months ended December 31, 2010 resulted in
the statement of operations in Canadian dollars being 2% and 4% less than would
have been reported if the Company had used the average exchange rate for the
same period of 2009, respectively.
Financial Highlights in RMB
The following table sets forth selected financial information for the Company
for the periods indicated in RMB which is the Company's functional currency for
its wholly owned subsidiary in China. The Company's head office's functional
currency is Canadian dollars. The Company uses Canadian dollars as its reporting
currency. This information has been derived from the Company's records
supporting the unaudited interim consolidated financial statements for the three
and six months ended December 31, 2010 and 2009, immediately prior to their
conversion to Canadian dollars.
For the three months ended For the six months ended
In RMB December 31 December 31
------------------------------------------------------------
2010 2009 2010 2009
------------------------------------------------------------
Revenue RMB 314,691 RMB 238,899 RMB 643,151 RMB 506,816
Cost of sales 232,052 177,459 477,828 372,272
------------------------------------------------------------
Gross profit 82,639 61,440 165,323 134,544
Net income 32,858 35,878 78,820 83,553
Weighted average
exchange rate
for one RMB,
expressed in
Canadian
dollars 0.1521 0.1547 0.1528 0.1576
Revenues
The Company's revenues consist of sales from footwear, apparel and accessories
sold within the PRC. The Company provides sales rebates, advertising
contributions and accrues subsidies payable to its distributors that are
deducted from its gross revenue to derive its net revenue.
Cost of Sales
The Company's cost of sales consists of internal and external production costs.
Internal production costs include raw materials, labour and manufacturing costs.
Outsourced production costs refer to the cost of procuring finished footwear,
apparel and accessories, which represents amounts paid to subcontracted
manufacturers in the PRC.
Seasonality
The results of the Company are generally not subject to seasonality although the
Company is modestly affected by the Chinese New Year typically held in the third
quarter of the fiscal year.
Results of Operations Three and Six Months Ended December 31, 2010 compared to
December 31, 2009
(Amounts in thousands of dollars, unless specified otherwise)
Revenue
The Company derives its revenue from two distribution channels: distributors and
corporate-owned retail outlets. Total revenue increased 30% to $47.9 million for
the three months ended December 31, 2010 compared to the second quarter of last
year. In RMB, revenue increased 32% to RMB 314.7 million for the three months
ended December 31, 2010 compared to RMB 238.9 million for the same period last
year. The strengthening of the Canadian dollar during the year relative to the
RMB reduced the percentage increase in revenue by 2% when reported in Canadian
dollars.
Total revenue increased 23% to $98.3 million for the six months ended December
31, 2010 compared to the same period last year. In RMB, revenue increased 27% to
RMB 643.2 million compared to the first six months of last year. The
strengthening of the Canadian dollar for the six months ended December 31, 2010
relative to the RMB reduced the percentage increase in revenue by 4% when
reported in Canadian dollars.
Revenue by Product Line
For the three months ended December 31
--------------------------------------------------
2010 % of Total 2009 % of Total
--------------------------------------------------
Footwear $ 42,502 85.1 $ 31,767 84.3
Apparel and accessories 7,462 14.9 5,910 15.7
--------------------------------------------------
49,964 100.0 37,677 100.0
--------------------------------------------------
Subsidy provision 2,087 717
Total $ 47,877 $ 36,960
------------- -------------
For the six months ended December 31
--------------------------------------------------
2010 % of Total 2009 % of Total
--------------------------------------------------
Footwear $ 89,260 86.9 $ 69,156 85.3
Apparel and accessories 13,433 13.1 11,907 14.7
--------------------------------------------------
102,693 100.0 81,064 100.0
--------------------------------------------------
Subsidy provision 4,391 1,074
Total $ 98,302 $ 79,990
------------- -------------
Total revenue before subsidy provision increased 33% to $50.0 million for the
three months ended December 31, 2010 compared to the second quarter of last
year.
Footwear revenue increased 34% to $42.5 million for the three months ended
December 31, 2010 compared to the same period last year, and was comprised of
$37.1 million (Q2 2010 - $27.7 million) in revenue from athletic footwear and
$5.4 million (Q2 2010 - $4.0 million) from casual footwear. Footwear units sold
during the quarter increased to 3.0 million compared to 2.3 million for the same
quarter last year. The growth in revenue was the result of increased number of
retail outlets (2,035 retail outlets in total compared to 1,719 at December 31,
2009) and increased consumer demand.
Total revenue before subsidies increased 27% to $102.7 million for the six
months ended December 31, 2010 compared to the same period last year. Footwear
units sold during the six months ended December 31, 2010 increased to 6.3
million compared to 5.1 million for the same period last year.
In RMB, the Company's revenue per average number of retail outlets increased 14%
to RMB 0.2 million during the three months ended December 31, 2010 compared to
the same period last year. For each of the three months ended December 31, 2010
and 2009, 96.8% and 99.7% of the Company's revenue was derived from its
wholesale distribution channel, respectively. The corporate stores contributed
$1.6 million of revenue for the three months ended December 31, 2010 and $2.3
million for the six months ended December 31, 2010.
Cost of Sales
For the three months ended December 31
--------------------------------------------------
2010 % of Total 2009 % of Total
--------------------------------------------------
Footwear (internal
production)
Raw materials $ 13,389 37.9 $ 10,039 36.5
Labour 1,880 5.3 1,088 4.0
Manufacturing costs 1,004 2.9 496 1.8
--------------------------------------------------
Subtotal 16,273 46.1 11,623 42.3
Footwear (outsourced
production) 13,660 38.7 11,426 41.6
Apparel and accessories
(outsourced production) 5,371 15.2 4,406 16.1
--------------------------------------------------
Total $ 35,304 100.0 $ 27,455 100.0
--------------------------------------------------
--------------------------------------------------
For the six months ended December 31
--------------------------------------------------
2010 % of Total 2009 % of Total
--------------------------------------------------
Footwear (internal
production)
Raw materials $ 24,714 33.8 $ 20,187 34.4
Labour 3,278 4.5 2,211 3.8
Manufacturing costs 1,818 2.5 1,015 1.7
--------------------------------------------------
Subtotal 29,810 40.9 23,413 39.9
Footwear (outsourced
production) 33,577 46.0 26,552 45.2
Apparel and accessories
(outsourced production) 9,648 13.2 8,779 14.9
--------------------------------------------------
Total $ 73,035 100.0 $ 58,744 100.0
--------------------------------------------------
--------------------------------------------------
During the three months ended December 31, 2010, cost of sales increased 29% to
$35.3 million compared to last year. In RMB, cost of sales increased 31% to RMB
232.1 million for the three months ended December 31, 2010. The price of raw
material inputs did not change materially this quarter. Outsourced production
accounted for 47% of the footwear units sold compared to 55% for the same
quarter last year.
During the six months ended December 31, 2010, cost of sales increased 24% to
$73.0 million compared to the first six months of fiscal 2010. In RMB, cost of
sales increased 28% to RMB 477.8 million. Outsourced production accounted for
54% of the footwear units sold during the six months ended December 31, 2010
compared to 57% for the same period last year.
The Company expects to have additional increased production capacity by April
2011 when the existing five production lines will be fully upgraded and/or
replaced with new equipment.
Gross Profit
For the three months ended December 31
--------------------------------------------------
Gross Gross
Margin Margin
2010 % 2009 %
--------------------------------------------------
Footwear $ 10,794 26.5 $ 8,114 26.0
Apparel and accessories 1,779 24.9 1,391 24.0
------------- -------------
Total $ 12,573 26.3 $ 9,505 25.7
------------- -------------
------------- -------------
For the six months ended December 31
--------------------------------------------------
Gross Gross
Margin Margin
2010 % 2009 %
--------------------------------------------------
Footwear $ 22,049 25.8 $ 18,274 26.8
Apparel and accessories 3,218 25.0 2,972 25.3
------------- -------------
Total $ 25,267 25.7 $ 21,246 26.6
------------- -------------
------------- -------------
The gross margin improved for the three months ended December 31, 2010 compared
to the same quarter last year on a positive impact of 1.1 percentage points from
the corporate stores which have a higher gross margin. Excluding the corporate
stores, the gross margin declined to 25.2% based on increased cost of goods sold
and a subsidy provision of $2.1 million.
For the six months ended December 31, 2010, the gross margin declined compared
to the prior year as a result of increased subsidy provision of $4.4 million
made to distributors to support additional new store growth.
Selling Expenses
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Increase 2010 2009 Increase
------------------------------------------------------------
Selling Expenses $ 4,258 $ 511 734% $ 6,035 $ 1,104 447%
The Company spent $3.2 million ($4.5 million for the year to date) on
advertising during the three months ended December 31, 2010 compared to $0.4
million ($1.0 million for the year to date) for the same quarter last year as
the Company continued with its advertising campaign to increase brand
recognition predominantly through television commercials on five television
stations this quarter. Selling expenses were increased by $0.9 million on the
opening of new corporate owned retail outlets which are currently in the start
up phase of operations. Selling expenses represented 8.9% and 1.4% of total
revenue for the three months ended December 31, 2010 and 2009, respectively, and
were 6.1% and 1.4% of total revenue for the six months ended December 31, 2010
and 2009, respectively.
Research and Development Expenses
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Increase 2010 2009 Increase
------------------------------------------------------------
Research and
Development
Expenses $ 202 $ 149 35% $ 403 $ 287 41%
Research and development expenses increased during the three and six months
ended December 31, 2010 as the Company invested additional funds on expanding
its research and development centre and the number of new products being
developed.
General and Administrative Expenses
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Increase 2010 2009 Increase
------------------------------------------------------------
General and
Administrative
Expenses $ 1,265 $ 840 51% $ 2,320 $ 1,404 65%
Corporate expenses related to being a public company, including salaries,
directors fees, audit fees and stock compensation expenses totalled $0.5 million
and $0.9 million during the three and six months ended December 31, 2010.
General and administrative expenses represented 2.6% and 2.3% of total revenue
for the three months ended December 31, 2010 and 2009, respectively and 2.4% and
1.8% of total revenue for the six months ended December 31, 2010.
Other Expenses (Income), net
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Increase 2010 2009 Decrease
------------------------------------------------------------
Other expense
(income), net $ (34) $ (24) 42% $ 82 $ (31) 365%
Other expenses, net includes a loss of $0.2 million on the disposition of
several buildings that were demolished during the first quarter as part of
preparation of the new building construction.
Income Tax Expense
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Decrease 2010 2009 Decrease
------------------------------------------------------------
Income tax
expense $ 1,883 $ 2,479 24% $ 4,372 $ 5,275 17%
The statutory income tax rate in the PRC is 25% and in Canada is 33%. During the
first quarter, the Company implemented procedures to reduce the level of
non-deductible expenses in the PRC which lowered the effective tax rate in the
quarter to 26% compared to 31% for the same quarter last year. Tax losses in
Canada for which no accounting benefit has been recognized further increased the
effective tax rate tax to 27% for the three months ended December 31, 2010
compared to 30% last year.
Net Income
For the three months ended For the six months ended
December 31 December 31
------------------------------------------------------------
2010 2009 Decrease 2010 2009 Decrease
------------------------------------------------------------
Net income $ 4,999 $ 5,550 10% $ 12,055 $ 13,207 9%
Net income decreased 10% to $5.0 million for the three months ended December 31,
2010 compared to the same period last year. In RMB, net income decreased 8% to
RMB 32.9 million for the three months ended December 31, 2010 compared to RMB
35.9 million in the second quarter of last year. Revenue growth of 30% generated
an additional $3.1 million of gross profit which was more than offset by
increases in selling expenses of $3.7 million, general and administrative
expenses of $0.4 million, and research and development expenses of $0.1 million
resulting in lower net income of $1.1 million, which was reduced by lower income
taxes of $0.6 million resulted in a decrease in net income of 10% or $0.5
million. Net income decreased 9% to $12.1 million for the six months ended
December 31, 2010 for the same combination of reasons.
Basic and Diluted Earnings Per Share
Basic and diluted earnings per share was 8 cents for the three months ended
December 31, 2010 compared to 11 cents for the same quarter last year and was 19
cents for the six months ended December 31, 2010 compared to 26 cents for the
first six months of fiscal 2010. There were 62,128,100 shares issued and
outstanding as at December 31, 2010. The weighted average number shares
outstanding during the three months ended December 31, 2010 and 2009 was
62,208,740 and 51,375,000, respectively and for the six months ended December
31, 2010 and 2009 was 62,234,256 and 50,687,500, respectively. As a result of
the application of continuity of interest accounting, all periods prior to the
initial public offering completed on December 21, 2009 are deemed to have
50,000,000 shares issued and outstanding for the purpose of determining earnings
per share.
Summary of Quarterly Results
The following table is a summary of the selected quarterly financial information
for each of the eight quarters ended December 31, 2010. The results over the
last eight quarters are impacted by the fluctuation of the RMB against the
Canadian dollar. Revenue has increased over the past eight quarters as a result
of the expansion of the number of distributor and corporate owned retail outlets
by 32% from 1,544 retail outlets at January 1, 2009 to 2,035 retail outlets as
at December 31, 2010.
Dec 31 Sept 30 June 30 Mar 31
Quarter Ended 2010 2010 2010 2010
--------------------------------------------------------
Revenue $ 47,877 $ 50,425 $ 50,553 $ 33,342
Net income 4,999 7,056 8,575 5,194
Earnings per share -
basic and diluted $ 0.08 $ 0.11 $ 0.14 $ 0.08
Dec 31 Sept 30 June 30 Mar 31
Quarter Ended 2009 2009 2009 2009
--------------------------------------------------------
Revenue $ 36,960 $ 43,030 $ 44,349 $ 31,104
Net income 5,550 7,657 7,597 5,144
Earnings per share -
basic and diluted $ 0.11 $ 0.15 $ 0.15 $ 0.10
Liquidity and Capital Resources
Liquidity
The purpose of liquidity management is to ensure there is sufficient cash to
meet all of the Company's financial commitments and obligations as they fall
due. The Company believes that it has the flexibility to obtain, from current
cash holdings and ongoing operations, the funds needed to fulfill its cash
requirements during the current financial year. The Company's main source of
funds is from the sales of its products to distributors and cash on hand. The
Company's use of funds is primarily for its operating expenses including the
payment for its production of footwear and outsourced production to third party
suppliers.
The Company has been expanding and utilizing cash to increase its brand
recognition and support its' growth in retail outlets. As a result, the cash on
hand has decreased from $85.9 million as at June 30, 2010 to $81.7 million as at
December 31, 2010. The cash on hand is expected to decrease next quarter as the
Company anticipates beginning construction of its new building.
The Company commences its manufacturing or outsourcing of most products at the
time that it enters into a binding production contract with the distributor to
limit its inventory levels. Finished goods inventory increased to $2.7 million
as at December 31, 2010 from $1.6 million as at June 30, 2010 but was lower than
the level at December 31, 2009 of $9.9 million. The other components of
inventory decreased 55% to $0.9 million.
Accounts receivable decreased to $30.5 million as at December 31, 2010 compared
to $34.1 million as at June 30, 2010 and $28.7 million as at December 31, 2009
as sales continued to increase and extended payment terms continued to be
offered to certain distributors to provide support to them to open more retail
stores. The days sales outstanding is 62 days for the three months ended
December 31, 2010 compared to 60 days for the year ended June 30, 2010 and 58
days for the three months ended December 31, 2009. The Company has not
experienced any increase in bad debts or increased provision for allowance for
doubtful accounts.
At present, there are no known demands, commitments, events or uncertainties
that would adversely affect the trends and expected fluctuations in the
Company's liquidity. The Company believes it has the funds required to meet its
business objectives and working capital and other cash requirements for at least
twelve months. However, there can be no assurances that these funds will be
sufficient and the Company may have to evaluate additional means of financing,
including additional debt or equity financing.
Net cash used by operating activities for the three months ended December 31,
2010 was $4.9 million compared to $4.6 million for the same quarter last year.
During the six months ended December 31, 2010 and 2009, net cash provided by
operating activities was $2.6 million and $2.8 million, respectively. During the
three months ended December 31, 2010, the increased accounts payable on subsidy
payments expected to be made in future quarters increased the use of cash in the
quarter. No dividends were paid out during the three or six months ended
December 31, 2010 or 2009. Net cash provided/(used) during the three months
ended December 31, 2010 and 2009 was ($9.8) million and $28.7 million,
respectively. During the three months ended December 31, 2009, the Company's
initial public offering raised cash of $34.0 million.
Working capital increased from $89.5 million (RMB 572.5 million) as at June 30,
2010 to $95.7 million (RMB 634.1 million) as at December 31, 2010 as a result of
the growth in revenue and profitability.
Capital Expenditures
The Company's capital expenditures primarily relate to its investment in
equipment to upgrade its production lines and leasehold improvements for the
corporate-owned retail outlets. The Company expects to complete the upgrade
and/or replacement of its existing equipment by April, 2011. The Company has
received building permits for its planned construction of a new ten storey
building. The Company has been delayed on its construction as the City of Shishi
has been constructing an eight lane highway in front of the planned building
site. Once the highway construction has been completed, the Company will be in a
position to begin construction which we anticipate will be in April, 2011. The
Company expects to complete construction of the building and installation of two
new production lines by the second quarter of fiscal 2012 at a cost of
approximately $7 million. Additional research and development and quality
control equipment will also be installed at a cost of approximately $3 million.
Capital Structure
Shares Outstanding
As of December, 2010, the Company has 62,128,100 common shares issued and
outstanding. As of February 25, 2011, the date of this MD&A, the Company has
62,080,400 common shares issued and outstanding.
Normal Course Issuer Bid
On September 17, 2010 the Company announced approval from the TSX Venture
Exchange to proceed with a normal course issuer bid. The Company can purchase
for cancellation, at market prices, up to 3,112,975 of its issued and
outstanding common shares, representing 5% of the 62,259,500 common shares
outstanding as at September 29, 2010. The Bid commenced on October 4, 2010 and
will terminate on October 3, 2011, or on such earlier date as the Bid is
completed or otherwise terminated by Zungui.
During the three months ended December 31, 2010, the Company repurchased 131,400
shares at an average price of $2.79 for total proceeds of $0.4 million. All of
the repurchased shares have been cancelled. Subsequent to December 31, 2010, the
Company repurchased under its normal course issuer bid 47,700 shares at an
average price of $2.67 for total proceeds of $0.1 million. All of the
repurchased shares will be cancelled.
Reorganization and Share Capital
On December 21, 2009, the Company completed a share exchange agreement with
Southern whereby the 10,000 issued and outstanding common shares of Southern
were exchanged for 50,000,000 common shares of the Company. On June 25, 2009,
Southern, an investment holding company, acquired 100% ownership interest in
Honorable Int'l Investment Co., Limited ("Honorable") which is an investment
holding company based in Hong Kong. Honorable acquired 100% interest in
Mengshida Shoes Co., Ltd Shishi City ("Mengshida") on July 25, 2008. Mengshida
manufactures and sells athletic footwear and related apparel and accessories as
well as leisure leather shoes in the PRC.
These reorganization transactions were accounted for on a continuity of interest
basis of accounting whereby the various assets and liabilities are accounted for
at the carrying value in the combining companies' records. Current and
comparative consolidated financial results are presented as if the companies
have always been combined. The number of common shares outstanding has been
restated for the purpose of determining earnings per share to reflect the
reorganization.
Initial Public Offering
On December 21, 2009, the Company completed its initial public offering ("IPO")
by issuing 11,500,000 common shares at a price of $3.25 per common share,
resulting in net proceeds of $33,040 after deducting the underwriters' fees and
other related expenses of the offering of $4,355.
The Company granted the underwriters an over-allotment option exercisable for a
period of 30 days from closing of the IPO to purchase up to an additional
1,725,000 common shares at the issue price. No stock based compensation was
recorded for this option. On January 12, 2010, the underwriters exercised the
over-allotment option and purchased 759,500 common shares at $3.25. Net proceeds
of $2,278 were received after deducting the underwriters' fees and related
expenses of $190.
In addition, the underwriters received compensation options entitling them to
acquire up to 7% of the number of common shares issued under the IPO including
any shares exercised under the over-allotment option. On December 21, 2009, the
underwriters received an option to purchase 805,000 common shares ("compensation
options") at $3.25 for a period of 24 months. On January 12, 2010, the
underwriters received a further 53,165 compensation options in conjunction with
the exercise of the over-allotment that will be exercisable for common shares at
$3.25 per share until January 12, 2012.
Stock Options
On December 13, 2010, the Company granted 150,000 stock options to employee and
non-employee directors at an exercise price of $2.65 and an expiry date of
December 13, 2015.
In addition, there are 700,000 stock options outstanding granted to consultants
and 950,000 stock options outstanding previously granted to employees and
non-employee directors. The stock options have the same terms and conditions and
were granted on December 21, 2009 at an exercise price of $3.25 and an expiry
date of December 21, 2014.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Use of Proceeds
The Company completed its initial public offering on December 21, 2009 and
received net cash proceeds of $34,759 after deducting the underwriter fees but
prior to the issue costs of $1,719. On January 12, 2010, the Company received a
further $2,278 of net cash proceeds from the exercise of the over-allotment
option.
Balance to be
Intended Use of Disbursed as of disbursed as of
Proceeds As disclosed December 31, 2010 December 31, 2010
---------------------------------------------------------
Retail and
Distribution
Network Expansion $ 16,000 $ 5,459 $ 4,860
Increase Production
Capacity -
Building and
Equipment 7,000 1,553 5,447
Brand Recognition,
Awareness and
Image 9,000 5,088 3,912
Working Capital 2,800
-------------------
Net Proceeds $ 34,800
-------------------
The disbursement of the network expansion proceeds is expected to continue to
increase during the next two quarters of fiscal 2011 as distributors achieve the
criteria for payment of the subsidies. The Company does not expect to utilize
approximately $5.7 million of the expansion proceeds for the original 350 new
retail outlets opened in calendar 2010. This will not affect the Company's
ability to achieve its business objectives and milestones. The Company will use
the remaining funds to construct a larger building and implement growth plans in
fiscal 2011 and beyond. While the Company intends to use the net proceeds as
stated above, circumstances may arise where, for sound business reasons and in
order to account for currency fluctuations, a reallocation of monies may be
necessary or advisable.
Related Party Transactions
Directors of Mengshida have jointly provided personal guarantees to indemnify
Mengshida on certain potential tax exposures including related interest and
penalties for periods prior to 2006. As a result, the Company has recorded an
other receivables from the directors of $1.4 million as at December 31, 2010 and
June 30, 2010.
A loan was received from a director of Honorable for $0.4 million as at December
31, 2010 and June 30, 2010. The loan is not secured, is interest free and
payable on demand.
Directors of Mengshida have jointly made personal guarantees to indemnify the
Company for any premiums for social insurance in arrears in excess of RMB
4,465,000 relating to periods prior to December 31, 2009. One of the Directors
has pledged 2,000,000 common shares of the Company owned by him for any
potential liability that may become payable under this undertaking.
A corporation owned 50% by one of Zungui's Directors received $400,000 in cash
and 700,000 stock options of the Company in trust for various parties as
consideration for services rendered in connection with the initial public
offering. The stock options were granted at $3.25 and vest in equal amounts over
three years. A company controlled by the same Director received 440,000 of the
700,000 stock options granted by the Company. The above transactions were
conducted in the normal course of business and are measured at the exchange
amount, which is the amount of consideration established and agreed to by the
parties.
On January 5, 2011, the Company entered into a consulting contract with a China
based firm to provide management training, over a two year period, to the 50
most senior executives at Mengshida. The consideration for these services will
be an option on 800,000 common shares of the Company at an exercise price of
$2.60 per share. The options have been granted and is settled upon exercise
through the transfer of shares of the Company from the holdings of the Chairman
and controlling shareholder. The options have an expiry date of January 5, 2013.
The Company has the right to terminate this agreement by July 1, 2011 and
require the consultant to return the option on 800,000 common shares of the
Company if it is not satisfied with the services provided.
Financial Instruments and Other Instruments
The Company held cash of $81.7 million on its balance sheet as at December 31,
2010. The Company does not have any cash equivalents or invested assets. The
Company does not currently utilize any other instruments such as derivative
financial instruments to reduce its exposure to interest rate risk. The
Company's location in the Fujian Province is in close proximity to a large
number of suppliers of raw materials required in the manufacturing of the
Company's products creating procurement efficiency and, as a result, the Company
does not need to enter into any forward future contracts to purchase raw
materials. All of the Company's financial assets and financial liabilities are
short term in nature and are measured on an ongoing basis at fair value or
amortized cost.
Adoption of New Accounting Policies
The Company has a stock based compensation plan. The Company estimates the fair
value of options granted to employees, non-employees directors and consultants
using the Black-Scholes option pricing model. The Company recognizes the fair
value as a compensation expense over the period that the stock options vest,
with a corresponding increase to contributed surplus. When these stock options
are exercised, the amount of the proceeds together with the amount recorded in
contributed surplus, is recorded in share capital.
The CICA has amended Handbook Section 3862 to require enhanced disclosure on the
fair value of certain financial instruments. The Company adopted these
recommendations effective June 30, 2010 and the required disclosures are
included in the note 16 to the unaudited interim consolidated financial
statements. The Company does not have any financial instruments measured at fair
value that require disclosure of the hierarchy levels. These amendments did not
impact the company's results of operations or financial position.
Future Accounting Changes
Transition to IFRS
Canada's Accounting Standards Board ratified a strategic plan that will result
in Canadian GAAP, as used by public companies, being evolved and converged with
International Financial Reporting Standards ("IFRS") over a transitional period
to be complete by 2011. The Company will be required to report using IFRS
effective for interim and annual financial statements relating to the fiscal
year ended June 30, 2012. The Company will issue its financial statement in the
first quarter of 2012 in accordance with IFRS including comparative data for
2011.
The Company expects the transition to IFRS to have an impact on financial
reporting, business processes and information systems. The Company began a
preliminary assessment during the year ended June 30, 2010. During the second
quarter of 2011, the Company engaged an external advisor to assist with the
initial assessment phase of the process and develop a conversion plan for the
detailed assessment, design and implementation phase of the project. The Company
has completed its initial analysis of key areas for which changes to accounting
policies may be required and is currently in the detailed analysis phase of the
project reviewing all relevant IFRS requirements and identification of areas
requiring accounting policies changes or those with accounting policy
alternatives. The Company will continue to assess the first-time adoption
requirements and alternatives (IFRS 1) throughout the next two quarters and
finalize the first-time adoption alternatives prior to June 30, 2010. The
Company will review the impact on information technology, internal controls and
contractual arrangements during the next two quarters. The Company will invest
in training and resources through the transition process to facilitate a timely
conversion.
Business Combinations, Consolidations and Non-Controlling Interests
In January 2009, the CICA issued Handbook Section 1582, Business Combinations
replacing Section 1581, Business Combinations. Section 1582 will apply to a
transaction in which the acquirer obtains control of one or more businesses (as
defined in the Section). Most assets acquired and liabilities assumed, including
contingent liabilities that are considered to be probable, will be measured at
fair value. A bargain purchase will result in the recognition of a gain.
Acquisition costs will be expensed. These standards are applicable to interim
and annual financial statements of the Company beginning on July 1, 2011. The
Company does not anticipate any significant impact upon the adoption of these
standards.
In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial
Statements and 1602, Non-Controlling Interests replacing Section 1600,
Consolidated Financial Statements. Section 1601 establishes standards for the
preparation of consolidated financial statements and Section 1602 establishes
standards for accounting for a non-controlling interest. These standards are
applicable to interim and annual financial statements of the Company beginning
on July 1, 2011. The Company does not anticipate any significant impact upon the
adoption of these standards.
Outlook
The PRC domestic footwear market remains a high growth industry consistent with
the growth of the PRC's economy. Zungui's focus is on the domestic market and
the Company allocates its resources and efforts to meet the demands of China's
growing local markets. Zungui is currently working to increase its presence in
Tier 2 and 3 Cities, with populations ranging up to 5 million people, throughout
the PRC, where both population and disposable income are growing. This increased
presence will be achieved by opening additional corporate-owned retail outlets
and by assisting distributors in expanding their retail presence.
Corporate-owned retail outlets typically offer higher margins than sales through
distributors as well as greater operating flexibility. By increasing the number
of corporate-owned retail outlets, Zungui believes it can focus its growth
strategy in certain regions while complementing its current distribution
network. Through to June 30, 2011, the Company expects to open an additional 40
corporate-owned retail outlets and 100 distributor retail outlets.
Zungui Haixi Corporation
Consolidated Balance Sheets
(Unaudited)
(Expressed in thousands of Canadian Dollars)
December 31, 2010 June 30, 2010
Current assets
Cash $ 81,684 $ 85,876
Accounts receivable, net 30,497 34,128
Prepaid expenses 2,826 343
Inventories (Note 4) 3,511 3,498
Other receivables (Note 13) 1,350 1,331
Future income taxes 803 58
--------------------------------------
Total current assets 120,671 125,234
Property, plant and equipment (Note
5) 8,827 6,470
--------------------------------------
Total assets $ 129,498 $ 131,705
--------------------------------------
--------------------------------------
Current liabilities
Accounts payable and accrued
liabilities $ 20,269 $ 30,288
Taxes payable 4,282 4,974
Due to related party (Note 13) 433 440
--------------------------------------
Total current liabilities 24,984 35,702
Shareholders' equity
Share capital (Note 7) 33,380 33,451
Contributed surplus (Note 7) 3,512 3,282
Surplus reserve funds (Note 9) 6,043 4,774
Retained earnings 66,648 56,161
Accumulated other comprehensive
income (loss) (5,069) (1,665)
--------------------------------------
Total shareholders' equity 104,514 96,003
--------------------------------------
Total liabilities and shareholders'
equity $ 129,498 $ 131,705
--------------------------------------
--------------------------------------
Subsequent Event (Note 17)
The accompanying notes are an integral part of these consolidated financial
statements.
Approved By the Board
(Signed) "Michael W. Manley"
Director
(Signed) "Patrick A. Ryan"
Director
Zungui Haixi Corporation
Consolidated Statements of Income and Comprehensive Income
(Unaudited)
(Expressed in thousands of Canadian Dollars, except per share data)
Three Months Ended Six Months Ended
December 31, December 31,
2010 2009 2010 2009
----------------------------------------------------
Revenue (Note 11) $ 47,877 $ 36,960 $ 98,302 $ 79,990
Cost of sales 35,304 27,455 73,035 58,744
----------------------------------------------------
Gross profit 12,573 9,505 25,267 21,246
----------------------------------------------------
----------------------------------------------------
Selling expenses 4,258 511 6,035 1,104
Research and development
expenses 202 149 403 287
General and
administrative expenses 1,265 840 2,320 1,404
Foreign exchange loss 23 - 32 -
Other expenses (income),
net (57) (24) 50 (31)
----------------------------------------------------
5,691 1,476 8,840 2,764
----------------------------------------------------
Income before income
taxes 6,882 8,029 16,427 18,482
Income tax expense (Note
12) 1,883 2,479 4,372 5,275
----------------------------------------------------
Net income 4,999 5,550 12,055 13,207
----------------------------------------------------
----------------------------------------------------
Other comprehensive
income (loss):
Unrealized gain(loss)
on foreign currency
translation of self-
sustaining operations (1,984) (1,055) (3,404) (3,950)
----------------------------------------------------
Comprehensive income $ 3,015 $ 4,495 $ 8,651 $ 9,257
----------------------------------------------------
----------------------------------------------------
Basic and diluted
earnings per share
(Note 7(b)) $ 0.08 $ 0.11 $ 0.19 $ 0.26
----------------------------------------------------
Weighted average number
of shares outstanding 62,208,740 51,375,000 62,234,256 50,687,500
----------------------------------------------------
----------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
Zungui Haixi Corporation
Consolidated Statements of Shareholders' Equity
(Unaudited)
(Expressed in thousands of Canadian Dollars)
Three Months Ended Six Months Ended
December 31, December 31,
2010 2009 2010 2009
----------------------------------------------------
Share Capital
Balance, beginning of
period $ 33,451 $ - $ 33,451 $ -
Issuance of share
capital, net - 33,040 - 33,040
Repurchased for
cancellation (71) - (71) -
Stock based compensation
expense - (1,816) - (1,816)
----------------------------------------------------
Balance, end of period $ 33,380 $ 31,224 $ 33,380 $ 31,224
Contributed Surplus
Balance, beginning of
period $ 3,398 $ 1,174 $ 3,282 $ 1,174
Stock based compensation
expense 114 1,829 230 1,829
----------------------------------------------------
Balance, end of period $ 3,512 $ 3,003 $ 3,512 $ 3,003
Surplus Reserve Funds
Balance, beginning of
period $ 4,774 $ 1,938 $ 4,774 $ 1,938
Transfer from retained
earnings 1,269 - 1,269 -
----------------------------------------------------
Balance, end of period $ 6,043 $ 1,938 $ 6,043 $ 1,938
Retained Earnings
Balance, beginning of
period $ 63,217 $ 39,678 $ 56,161 $ 32,021
Net income 4,999 5,550 12,055 13,207
Repurchase of shares for
cancellation (299) - (299) -
Transfer to surplus
reserve funds (1,269) - (1,269) -
----------------------------------------------------
Balance, end of period $ 66,648 $ 45,228 $ 66,648 $ 45,228
Accumulated Other
Comprehensive Income
(Loss)
Balance, beginning of
period $ (3,085) $ (2,853) $ (1,665) $ 42
Unrealized foreign
currency translation
gains (losses) (1,984) (1,055) (3,404) (3,950)
----------------------------------------------------
Balance, end of period $ (5,069) $ (3,908) $ (5,069) $ (3,908)
Total Shareholders'
Equity $ 104,514 $ 77,485 $ 104,514 $ 77,485
----------------------------------------------------
----------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
Zungui Haixi Corporation
Consolidated Statements of Cash Flows
(Unaudited)
(Expressed in thousands of Canadian Dollars unless otherwise noted)
Three Months Ended Six Months Ended
December 31, December 31,
2010 2009 2010 2009
--------------------------------------------------------
Cash flows from
operating
activities
Net income $ 4,999 $ 5,550 $ 12,055 $ 13,207
Items not affecting
cash:
Depreciation 467 109 778 223
Future income
taxes (209) - (756) (10)
Provision for
doubtful accounts (46) 164 (32) 167
Stock based
compensation 114 13 230 13
Loss on disposal
of property,
plant and
equipment 20 - 202 -
Changes in non-cash
working capital
Accounts
receivable 4,598 (5,400) 2,494 (9,071)
Prepaid expenses (1,421) 6 (2,525) -
Inventories (246) (3,780) (137) (8,029)
Other receivables (40) (44) (66) (71)
Accounts payable
and accrued
liabilities (12,464) (1,080) (9,076) 6,252
Taxes payable (691) (106) (524) 144
--------------------------------------------------------
Net cash provided
(used) by operating
activities (4,919) (4,568) 2,643 2,825
Cash flows from
investing
activities
Property, plant and
equipment (2,152) (16) (2,922) (16)
Proceeds from sale
of equipment - - 20 -
Construction in
progress (685) - (695) -
--------------------------------------------------------
Net cash used in
investing
activities (2,837) (16) (3,597) (16)
Cash flows from
financing
activities
Due to related
party (16) - (7) -
Increase in share
capital - 33,965 - 33,965
Repurchase of
shares for
cancellation (369) - (369) -
--------------------------------------------------------
Net cash provided
(used) by financing
activities (385) 33,965 (376) 33,965
Effect of exchange
rate changes on
cash (1,669) (685) (2,862) (2,508)
--------------------------------------------------------
Net increase
(decrease) in cash (9,810) 28,696 (4,192) 34,266
Cash, beginning of
period 91,494 29,327 85,876 23,757
--------------------------------------------------------
Cash, end of period $ 81,684 $ 58,023 $ 81,684 $ 58,023
--------------------------------------------------------
--------------------------------------------------------
Supplemental
disclosure of cash
information
Interest paid in
cash $ - $ 20 $ - $ 54
Income taxes paid in
cash 2,832 2,611 5,716 5,189
The accompanying notes are an integral part of these consolidated financial
statements
Zungui Haixi Corporation
Notes to Consolidated Financial Statements
For the three and six month periods ended December 31, 2010 and 2009
(Unaudited)
(Expressed in thousands of Canadian Dollars except
per share and share amounts)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
Zungui Haixi Corporation ("Zungui" or "Company") was incorporated under the
Ontario Business Corporation Act on August 11, 2009. Zungui is a holding company
listed on TSX Venture Exchange. Through its subsidiaries, Zungui manufactures
and sells sports footwear and related apparel and accessories as well as leisure
leather shoes in the People's Republic of China ( the "PRC" or "China").
Zungui's wholly owned subsidiaries include Southern Trends International Holding
Company Ltd. ("Southern"), Honorable Int'l Investment Co., Limited ("Honorable")
and Mengshida Shoes Co., Ltd. Shishi City ("Mengshida").
On December 21, 2009, the Company completed a share exchange agreement with
Southern whereby the 10,000 issued and outstanding common shares of Southern
were exchanged for 50,000,000 common shares of the Company. On June 25, 2009,
Southern, an investment holding company, acquired 100% ownership interest in
Honorable which is an investment holding company based in Hong Kong. Honorable
acquired 100% interest in Mengshida on July 25, 2008.
These reorganization transactions were accounted for on a continuity of interest
basis of accounting whereby the various assets and liabilities are accounted for
at the carrying value in the combining companies' records. Current and
comparative consolidated financial results are presented as if the companies
have always been combined. The number of common shares outstanding has been
restated for the purpose of determining earnings per share to reflect the
reorganization.
2. INITIAL PUBLIC OFFERING
On December 21, 2009, the Company completed its initial public offering ("IPO")
by issuing 11,500,000 common shares at a price of $3.25 per common share,
resulting in net proceeds of $33,040 after deducting the underwriters' fees and
other related expenses of the offering of $4,335.
The Company granted the underwriters an over-allotment option exercisable for a
period of 30 days from closing of the IPO to purchase up to an additional
1,725,000 common shares at the issue price. No stock based compensation was
recorded for this option. On January 12, 2010, the underwriters exercised the
over-allotment option and purchased 759,500 common shares at $3.25, resulting in
net proceeds of $2,278 after deducting the underwriters' fees and other related
expenses of $190.
In addition, the underwriters received compensation options entitling them to
acquire up to 7% of the number of common shares issued under the IPO including
any shares exercised under the over-allotment option. Refer to Note 7(d).
3. SIGNIFICANT ACCOUNTING POLICIES
These interim consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles ("GAAP") for interim
financial statements and are consistent with the accounting policies and methods
of computation as were used in the preparation of the audited consolidated
financial statements for the year ended June 30, 2010. The interim consolidated
financial statements do not contain all the information and disclosures required
by GAAP applicable for annual consolidated financial statements and accordingly
should be read in conjunction with the audited consolidated financial statements
for the year ended June 30, 2010. The results of the operations for the interim
periods are not necessarily indicative of the full-year results.
(a) Foreign currency translation
The Company's primary economic activities are in China and the functional
currency is Chinese Renminbi ("RMB") for its wholly owned subsidiary, Mengshida,
located in China. The Company's head office, Honorable and Southern's functional
currency is Canadian dollars. The Company uses Canadian dollars as its reporting
currency. Mengshida is considered to be a self-sustaining foreign operation and
its' financial statements are translated into the reporting currency using the
current rate method. Under this method, revenue and expenses are translated into
the reporting currency using the weighted average exchange rates for the period
and assets and liabilities are translated using the exchange rate at the end of
the period. Capital transactions are translated using historical rates. All
resulting exchange differences are reported as accumulated other comprehensive
income (loss), which is presented as a separate component of shareholders'
equity.
(b) Changes in accounting policies
(i) Stock-based compensation plan
The Company has a stock based compensation plan which is described in Note 8.
The Company measures and recognizes compensation expense using the fair value
method. Under this method, the Company estimates the fair value of options
granted to employees, non-employee directors and consultants at the grant date
using the Black-Scholes option pricing model. The Company recognizes the fair
value as a compensation expense over the period that the stock options vest on a
straight line basis, with a corresponding increase to contributed surplus. When
these stock options are exercised, the amount of the proceeds together with the
amount recorded in contributed surplus, is recorded in share capital.
(ii) Financial Instruments
The CICA has amended Handbook Section 3862 to require enhanced disclosure on the
fair value of certain financial instruments. The Company adopted these
recommendations effective June 30, 2010 and the required disclosures are
included in Note 15. The Company does not have any financial instruments
measured at fair value that require disclosure of the hierarchy levels. These
amendments did not impact the Company's results of operations or financial
position.
(c) Future accounting changes
(i) Transition to IFRS
Canada's Accounting Standards Board ratified a strategic plan that will result
in Canadian GAAP, as used by public companies, being evolved and converged with
International Financial Reporting Standards ("IFRS") over a transitional period
to be complete by 2011. The Company will be required to report using IFRS for
interim and annual financial statements relating to the fiscal year ended June
30, 2012. The Company will issue its financial statement in the first quarter of
2012 in accordance with IFRS including comparative data for 2011.
The Company expects the transition to IFRS to have an impact on financial
reporting, business processes and information systems. The Company began a
preliminary assessment during the year ended June 30, 2010. During the second
quarter of 2011, the Company engaged an external advisor to assist with the
initial assessment phase of the process and develop a conversion plan for the
detailed assessment, design and implementation phase of the project. The Company
will invest in training and resources through the transition process to
facilitate a timely conversion.
(ii) Business Combinations, Consolidations and Non-Controlling Interests
In January 2009, the CICA issued Handbook Section 1582, Business Combinations
replacing Section 1581, Business Combinations. Section 1582 will apply to a
transaction in which the acquirer obtains control of one or more businesses (as
defined in the Section). Most assets acquired and liabilities assumed, including
contingent liabilities that are considered to be probable, will be measured at
fair value. A bargain purchase will result in the recognition of a gain.
Acquisition costs will be expensed. These standards are applicable to interim
and annual financial statements of the Company beginning on July 1, 2011. The
Company does not anticipate any significant impact upon the adoption of these
new standards.
In January 2009, the CICA issued Handbook Section 1601, Consolidated Financial
Statements and 1602, Non-Controlling Interests replacing Section 1600,
Consolidated Financial Statements. Section 1601 establishes standards for the
preparation of consolidated financial statements and Section 1602 establishes
standards for accounting for a non-controlling interest. These standards are
applicable to interim and annual financial statements of the Company beginning
on July 1, 2011. The Company does not anticipate any significant impact upon the
adoption of these new standards.
4. INVENTORIES
Inventories consist of:
----------------------------------------------------------------------------
December 31, June 30,
2010 2010
----------------------------------------------------------------------------
Raw materials $ 384 $ 1,433
Work in progress 466 466
Finished goods 2,661 1,599
----------------------------------------------------------------------------
Total inventory $ 3,511 $ 3,498
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Inventories expensed as cost of sales were $35,217 and $72,919 for the three and
six months ended December 31, 2010, respectively and were $27,441 and $58,714
for the three and six months ended December 31, 2009, respectively.
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consist of:
----------------------------------------------------------------------------
December 31, 2010
----------------------------------------------------------------------------
Accumulated
Cost Depreciation Net Book Value
----------------------------------------------------------------------------
Plant and building $ 5,331 $ 1,935 $ 3,396
Machinery and production
equipment 1,871 773 1,098
Automobiles and trucks 647 211 436
Leasehold improvements 3,832 683 3,149
Construction in progress 687 - 687
Office equipment 154 93 61
----------------------------------------------------------------------------
Total $ 12,522 $ 3,695 $ 8,827
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
June 30, 2010
----------------------------------------------------------------------------
Accumulated
Cost Depreciation Net Book 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
Construction in progress - - -
Office equipment 148 92 56
----------------------------------------------------------------------------
Total $ 9,895 $ 3,425 $ 6,470
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Depreciation expense was $467 and $778 for the three and six months ended
December 31, 2010, respectively, and $109 and $223 for the three and six months
ended December 31, 2009.
6. BANK LOAN
On July 17, 2009, the Company signed a one year term loan agreement with Bank of
Agriculture Shishi branch to borrow $511 (RMB 3,000,000). The interest rate is
the higher of 5.31% per annum or the lending rate per Bank of China, reset every
3 months. Interest is payable on a quarterly basis. The loan was fully repaid on
June 25, 2010.
Interest expense was $nil for the three and six months ended December 31, 2010
and $20 and $70 for the three and six months ended December 31, 2009,
respectively.
7. SHARE CAPITAL, PAID IN CAPITAL AND CONTRIBUTED SURPLUS
(a) Share Capital:
As at December 31, 2010 the authorized share capital of Zungui was unlimited
common shares with no par value.
----------------------------------------------------------------------------
Weighted
Number of Number of Number of Average
Shares Stock Compensation Exercise
Issued Options Options Price Amount
----------------------------------------------------------------------------
Balance as at
August 11, 2009 1 - - $ - $ -
Share exchange
transaction
(Note 1) 50,000,000 - - - -
Initial public
offering (Note
2) 11,500,000 - - - 33,040
Cancellation of
share (1) - - - -
Stock options
(Note 7(d)):
Granted - 700,000 - 3.25 (1,005)
Underwriter
options (Note
7(d)) - - 805,000 3.25 (811)
----------------------------------------------------------------------------
Balance as at
December 31,
2009 61,500,000 700,000 805,000 $ 3.25 $ 31,224
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Balance as at:
June 30, 2010
and September
30, 2010 62,259,500 700,000 858,165 $ 3.25 $ 33,451
Normal course
issuer bid (131,400) - - - (71)
----------------------------------------------------------------------------
Balance as at
December 31,
2010 62,128,100 700,000 858,165 $ 3.25 $ 33,380
----------------------------------------------------------------------------
----------------------------------------------------------------------------
On September 17, 2010, the Company announced its intention to proceed with a
normal course issuer bid as approved by the TSX Venture Exchange. The Company
can purchase for cancellation, at market prices, up to 3,112,975 of its issued
and outstanding common shares during the period October 4, 2010 to October 3,
2011. During the three and six months ended December 31, 2010, the Company
repurchased 131,400 shares at an average price of $2.79 for total proceeds of
$370. Of the total cost, $71 is charged to share capital and $299 is charged to
retained earnings. All of the repurchased shares were cancelled.
(b) Earnings Per Share:
As a result of the reorganization as described in Note 1 and the application of
the continuity of interest accounting, all periods prior to the initial public
offering completed on December 21, 2009 are deemed to have 50,000,000 shares
issued and outstanding for the purposes of calculating earnings per share.
(c) Stock Options Outstanding:
A summary of the stock options outstanding as at December 31, 2010 are as follows:
----------------------------------------------------------------------------
Remaining
Contract- Number Number
Exercise Date of Expiry ual Outstand- Exercis-
Price Grant Date Life (Years) ing able
----------------------------------------------------------------------------
Employee and
Non-Employee December December
Directors $3.25 21, 2009 21, 2014 4.0 950,000 316,666
----------------------------------------------------------------------------
December December
Consultants $3.25 21, 2009 21, 2014 4.0 700,000 233,333
----------------------------------------------------------------------------
December December
Underwriters $3.25 21, 2009 21, 2011 1.0 805,000 805,000
----------------------------------------------------------------------------
January January
Underwriters $3.25 12, 2010 12, 2012 1.0 53,165 53,165
----------------------------------------------------------------------------
Employee and
Non-Employee December December
Directors $2.65 13, 2010 13, 2015 5.0 150,000 -
----------------------------------------------------------------------------
----------------------------------------------------------------------------
(d) Consultant and Underwriters Options:
In conjunction with the initial public offering, on December 21, 2009 the
Company granted 700,000 stock options at an exercise price of $3.25 to
consultants (see Note 13(d)). The consultant's stock options vest equally over a
three year period. The per share fair value of these grants was $1.44. Stock
based compensation in the amount of $1,005 was deducted from share capital as
part of the expenses of the offering.
On December 21, 2009, the Company also granted the underwriters an option to
purchase 805,000 common shares ("compensation options") at $3.25 for a period of
24 months. The per share fair value of these grants was $1.01. Stock based
compensation in the amount of $811 was deducted from share capital as part of
the expenses of the offering.
The fair value of the option grants above were estimated at the date of the
grant using a Black-Scholes option pricing model with the following weighted
average assumptions:
----------------------------------------------------------------------------
Six Months Ended
December 31, 2009
----------------------------------------------------------------------------
Risk-free interest rate 1.59-2.46
Expected dividend yield 0.0%
Expected volatility 54.3%
Expected option life (in years) 2 - 4
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Expected volatility is based on the historical volatility of companies in
comparable industries. The risk-free interest rate is based on yields of
Government of Canada T-bills with similar maturities. The expected option life
was estimated based on vesting schedule and the expiry date for the compensation
options.
(e) Paid in Capital:
As part of the reorganization referred to in Note 1, the paid in capital of
Mengshida of $1,174 became the contributed surplus of the Company.
On January 29, 2010, the Company applied to change the registered capital of
Mengshida to $33.9 million (RMB 220.0 million). As of December 31, 2010,
Mengshida's registered and paid in capital was $33.8 million (RMB 220.3
million).
8. STOCK BASED COMPENSATION
The Company introduced a stock option plan on December 21, 2009 to incent
directors, officers, consultants and employees. In accordance with the stock
option plan, the term of any stock option grant cannot exceed five years and no
more than 10% of Company's common shares are reserved for stock option grants.
On December 13, 2010, the Company granted 150,000 stock options at an exercise
price of $2.65 to Company employee and non-employee directors with an expiry
date of December 13, 2015. The stock options vest equally over a three year
period and as at December 31, 2010, none were vested nor exercisable. The per
share fair value of these grants was $1.23.
On December 21, 2009, the Company granted 950,000 stock options at an exercise
price of $3.25 to Company employees and non-employee directors with an expiry
date of December 21, 2014. The stock options vest equally over a three year
period and as at December 31, 2010, 316,666 were vested and exercisable. The per
share fair value of these grants was $1.44.
The fair value of the options grants was estimated at the date of the grant
using a Black-Scholes option pricing model with the following weighted average
assumptions:
----------------------------------------------------------------------------
Three and Six Months Three and Six Months
Ended Ended
December 31, 2010 December 31, 2009
----------------------------------------------------------------------------
Risk-free interest rate 2.558 2.46
Dividend yield 0.0% 0.0%
Expected volatility 57.8% 54.3%
Expected option life (in years) 4 4
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Expected volatility is based on the historical volatility of companies in
comparable industries. The risk-free interest rate is based on yields of
Government of Canada T-bills with similar maturities.
During the three and six months ended December 31, 2010, stock based
compensation expense was $114 and $230, respectively, and during the three and
six months ended December 31, 2009, stock based compensation was $13.
9. SURPLUS RESERVE FUNDS
In accordance with applicable regulations for foreign funded enterprises in the
PRC, Mengshida, the Company's operating subsidiary, is required to retain a
certain amount from net income as reserve funds. The amount retained shall not
be less than 10% of net income as determined under PRC GAAP annually for
statutory reserves. When the balance of the statutory reserves reaches 50% of
the registered capital of Mengshida, no further appropriations are required.
During the three months ended December 31, 2010, Mengshida transferred $1.3
million to its' surplus reserve funds. As of December 31, 2010 Mengshida's
surplus reserve funds aggregated $6,043 (June 30, 2010 - $4,774) which
represents 17% (15% as of June 30, 2010) of Mengshida's registered capital.
10. MAJOR CUSTOMERS AND SUPPLIERS
The Company sells products to various customers. There were no customers that
purchased more than 10% of the Company's products for the three and six month
periods ended December 31, 2010 and 2009.
During the three month period ended December 31, 2010, purchases from three
suppliers, each represented 16% ($5,446), 15% ($5,073) and 15% ($4,868) of total
purchases. During the three month period ended December 31, 2009, purchases from
three suppliers represented 18% ($5,208), 17% ($5,070) and 17% ($5,070) of total
purchases. During the six month period ended December 31, 2010, purchases from
three suppliers, each represented 18% ($12,212), 17% ($11,637) and 17% ($11,633)
of total purchases. During the six month period ended December 31, 2009,
purchases from three suppliers represented 18% ($11,569), 18% ($11,500) and 18%
($11,330) of total purchases.
11. REVENUE
----------------------------------------------------------------------------
Three Months Ended December 31, Six Months Ended December 31,
2010 2009 2010 2009
----------------------------------------------------------------------------
Footwear $ 42,502 $ 31,767 $ 89,261 $ 69,157
Apparel and
accessories 7,462 5,910 13,432 11,907
----------------------------------------------------------------
49,964 37,677 102,693 81,064
Subsidy
provision 2,087 717 4,391 1,074
----------------------------------------------------------------------------
Revenue $ 47,877 $ 36,960 $ 98,302 $ 79,990
----------------------------------------------------------------------------
----------------------------------------------------------------------------
12. INCOME TAXES
The Company is subject to income taxes in Canada while its operating subsidiary,
Mengshida is subject to the Corporate Income Tax Law of the PRC enacted on
January 1, 2008 which resulted in a unified tax rate of 25% for all enterprises.
The Company is not subject to any taxation in the British Virgin Islands and the
Company is subject to 16.5% income tax rate in Hong Kong.
The Company established a valuation allowance of $1,591 as at December 31, 2010
($1,515 as at June 30, 2010) due to the uncertainty of future realization of
future income tax assets that originated from tax losses recognized in Canada
and Hong Kong. As at December 31, 2010, the Company has income tax losses of
$2,913 ($1,820 as at June 30, 2010) for which no accounting benefit has been
recognized and which can be applied against future years' taxable income in
Canada. These losses expire in the year 2020 ($1,820) and 2021 ($1,093). The
Company has income tax losses of $175 in Hong Kong which do not expire.
13. RELATED PARTY TRANSACTIONS
(a) Directors of Mengshida have jointly made personal guarantees to indemnify
Mengshida on certain potential tax exposures including the related interest and
penalties arising in periods prior to 2006. Accordingly, the Company has
recorded an other receivables of $1.4 million from Directors.
(b) Due to related party consists of a loan from a Director of Honorable
totalling $433 (Hong Kong $3,200,000 and RMB 100,000) as at December 31, 2010
and $440 (Hong Kong $3,200,000 and RMB 100,000) as at June 30, 2010. This loan
is unsecured, is interest free and is payable on demand.
(c) The Directors of Mengshida have jointly made personal guarantees to
indemnify Mengshida for any premiums for social insurance in arrears in excess
of RMB 4,465,000 as discussed in Note 14. One of the Directors has pledged
2,000,000 common shares of the Company owned by him for any potential liability
that may become payable under this undertaking.
(d) A corporation 50% owned by one of Zungui's Directors received $400,000 in
cash and 700,000 stock options of the Company in trust for various parties as
consideration for services rendered in connection with the initial public
offering. The stock options were granted at $3.25 and vest in equal amounts over
three years. A company controlled by the same Director received 440,000 of the
700,000 stock options granted by the Company. The above transactions were
conducted in the normal course of business and are measured at the exchange
amount, which is the amount of consideration established and agreed to by the
parties.
(e) See Note 17.
14. CONTINGENCY
Pursuant to the relevant laws and regulations of the PRC, the Company makes
contributions to the local Labour and Social Security Bureaus based on a rate
determined by the local bureaus. The process of determining this rate involves
uncertainties and judgments on the part of the Bureaus. Significant estimates
and judgement are applied by management to determine the appropriate amount of
social insurance to be paid. The Directors of Mengshida have jointly made
personal guarantees to indemnify the Company for any premiums for social
insurance in arrears and all related fines, penalties, interest and other
payments in excess of RMB 4,465,000 ($674) that the Company may be required to
make relating to periods prior to December 31, 2009 in the event of a dispute or
settlement with the applicable government authorities. See Note 13(c).
15. FINANCIAL INSTRUMENTS
Financial assets and financial liabilities are measured on an ongoing basis at
fair value or amortized cost. Fair value estimates are made at a specific point
in time, using available information about the financial instrument. These
estimates are subjective in nature and involve uncertainties and the exercise of
significant judgement. The fair value of financial assets and financial
liabilities approximates their carrying value due to their short term maturity.
The classification of the financial instruments as well as their carrying values
is shown in the table below:
----------------------------------------------------------------------------
Held for Loans and Other Financial Total Carrying
December 31, 2010 Trading Receivables Liabilities Value
----------------------------------------------------------------------------
Financial assets
Cash $ 81,684 $ - $ - $ 81,684
Accounts
receivable - 30,497 - 30,497
Other receivables - 1,350 - 1,350
----------------------------------------------------------------------------
$ 81,684 $ 31,847 $ - $ 113,531
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Financial
liabilities
Accounts payable
and accrued
liabilities $ - $ - $ 20,269 $ 20,269
Due to related
party - - 433 433
----------------------------------------------------------------------------
$ - $ - $ 20,702 $ 20,702
----------------------------------------------------------------------------
----------------------------------------------------------------------------
----------------------------------------------------------------------------
Held for Loans and Other Financial Total Carrying
June 30, 2010 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 or six months ended December 31, 2010
and 2009, respectively.
Liquidity risk
Liquidity risk is the risk that the Company is not able to meet its financial
obligations as they become due. The Company finances its operations through cash
flows from operating activities. The Company's goal is to maintain an optimal
level of liquidity through the active management of the assets and liabilities
as well as the cash flows. As at December 31, 2010, the Company had $20,269 in
accounts payable and accrued liabilities and due to related party $433. All
financial liabilities have contractual maturities of less than one year as of
December 31, 2010.
16. CAPITAL DISCLOSURE
The Company's objectives when managing capital is to safeguard the entity's
ability to continue as a going concern and continue to provide returns and
benefits for its shareholders. The Company's capital is defined as shareholders'
equity as presented on the consolidated balance sheet excluding accumulated
other comprehensive income (loss). The Company's capital is as follows:
----------------------------------------------------------------------------
December 31, June 30,
2010 2010
----------------------------------------------------------------------------
Shareholders' equity excluding accumulated
other comprehensive income (loss) $ 109,583 $ 97,668
----------------------------------------------------------------------------
----------------------------------------------------------------------------
The Company does not establish quantitative return on capital criteria for
management or internally imposed restrictions, but rather promotes
year-over-year sustainable profitable growth. The Company may adjust its capital
mix in order to manage its capital structure. There has been no change with
respect to the overall capital risk management strategy during the three months
ended December 31, 2010.
17. SUBSEQUENT EVENT
On January 5, 2011, the Company entered into a consulting contract with a China
based firm to provide management training, over a two year period, to the 50
most senior executives at Mengshida. The consideration for these services is an
option on 800,000 common shares of the Company at an exercise price of $2.60 per
share. The options have been granted and will be settled upon exercise through
the transfer of shares of the Company from the holdings of the Chairman and
controlling shareholder. The options have an expiry date of January 5, 2013. The
Company has the right to terminate this agreement by July 1, 2011 and require
the consultant to return the option on 800,000 common shares of the Company if
it is not satisfied with the services provided.
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