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EVK > SEC Filings for EVK > Form 10-Q on 10-Nov-2011All Recent SEC Filings

Show all filings for EVER-GLORY INTERNATIONAL GROUP, INC.

Form 10-Q for EVER-GLORY INTERNATIONAL GROUP, INC.


10-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations for the three and nine months ended September 30, 2011 should be read in conjunction with the Financial Statements and corresponding notes included in this Quarterly Report on Form 10-Q. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations, and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors and Special Note Regarding Forward-Looking Statements in this report. We use words such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing," "expect," "believe," "intend," "may," "will," "should," "could," "target", "forecast" and similar expressions to identify forward-looking statements.

Overview

Our Business

We are a leading apparel supply-chain manager and retailer in China. We are listed on the NYSE Amex under the symbol of "EVK".

We classify our businesses into two segments: Wholesale and Retail. Our wholesale business consists of wholesale-channel sales made principally to famous brands, and department stores located throughout Europe, the U.S., Japan and the People's Republic of China ("PRC"). We focus on well-known, middle-to-high grade casual wear, sportswear, and outerwear brands. Our retail business consists of retail-channel sales directly to consumers through retail stores located throughout the PRC.

Although we have our own manufacturing facilities, we currently outsource most of the manufacturing to our long-term contractors as part of our overall business strategy. We believe outsourcing allows us to maximize our production capacity and maintain flexibility while reducing capital expenditures and the costs of keeping skilled workers on production lines during low seasons. We oversee our long-term contractors with our advanced management solutions and inspect products manufactured by them to ensure that they meet our high quality control standards and timely delivery.

Wholesale Business

We conduct our original design manufacturing ("ODM") operations through four wholly-owned subsidiaries which are located in the Nanjing Jiangning Economic and Technological Development Zone and Shang Fang Town in the Jiangning District in Nanjing, China: Ever-Glory International Group Apparel Inc. ("Ever-Glory Apparel"), Goldenway Nanjing Garments Company Limited ("Goldenway"), Nanjing New-Tailun Garments Company Limited ("New Tailun"), Nanjing Catch-Luck Garments Co., Ltd. ("Catch-Luck"), and one wholly-owned subsidiary incorporated in Samoa, Ever-Glory International Group (HK) Ltd. ("Ever-Glory HK").

Retail Business

We conduct our retail operations through Shanghai LA GO GO Fashion Company Limited ("LA GO GO"), a wholly-owned subsidiary of Ever-Glory Apparel.

Business Objectives

Wholesale Business

We believe the enduring strength of our wholesale business is mainly due to our consistent emphasis on innovative and distinctive product designs that stand for exceptional styling and quality.

The primary business objective for our wholesale segment is to expand our portfolio into higher-class brands, expand our customer base and improve our profit. We believe that our growth opportunities and continued investment initiatives include:

Expand our global sourcing network

Expand our overseas low-cost manufacturing base (outside of mainland China);

Focus on high value-added products and continue our strategy to produce mid to high end apparel

Continue to emphasize product design and technology utilization.

Seek strategic acquisitions of international distributors that could enhance global sales and our distribution network; and

Maintain stable revenue increases in the markets while shifting focus to higher margin wholesale markets such as mainland China.

Retail Business

The business objective for our retail segment is to establish a leading brand of women's apparel and to build a nationwide retail network in China. As of September 30, 2011, we have 421 stores (including store-in-stores) which includes 154 stores that were opened and 26 stores that were closed in 2011.

We believe that our growth opportunities and continued investment initiatives include:

Build the LA GO GO brand to be recognized as a major player in the mid-end women's apparel market in China;

Expand the LA GO GO retail network throughout China;

Improve the LA GO GO retail stores' efficiency and increase same-store sales


Continue to launch LA GO GO flagship stores in Tier-1 Cities and increase penetration and coverage in Tier-2 and Tier-3 Cities

Become a multi-brand operator by seeking opportunities for long-term cooperation with reputable international brands and by facilitating international brands entry into the Chinese market.

Seasonality of Business

Our business is affected by seasonal trends, with higher levels of wholesale sales in our third and fourth quarters and higher retail sales in our first and fourth quarters. These trends primarily result from the timing of seasonal wholesale shipments and holiday periods in the retail segment.

Collection Policy

Wholesale business

For our new customers, we generally require orders placed to be backed by letters of credit. For our long-term and established customers with a good payment track record, we generally provide payment terms between 30 and 120 days following delivery of finished goods.

Retail business

For store-in-store shops, we generally receive payments from the stores between 60 and 90 days following the date of the register receipt. For our own flagship stores, we receive payments at the same time of the register receipt.

Global Economic Uncertainty

Our business is dependent on consumer demand for our products. We believe that the significant uncertainty in the global economy and a slowdown in the United States and Europe economies have increased our clients' sensitivity to the cost of our products. We have experienced continued pricing pressure. If the global economic environment continues to be weak, these worsening economic conditions could have a negative impact on our sales growth and operating margins in our wholesale segment in 2011.

In addition, economic conditions in the United States and in foreign markets in which we operate could substantially affect our sales and profitability and our cash position and collection of accounts receivable. Global credit and capital markets have experienced unprecedented volatility and disruption. Business credit and liquidity have tightened in much of the world. Some of our suppliers and customers may face credit issues and could experience cash flow problems and other financial hardships. These factors currently have not had an impact on the timeliness of receivable collections from our customers. We cannot predict at this time how this situation will develop and whether accounts receivable may need to be allowed for or written off in the coming quarters.

Despite the various risks and uncertainties associated with the current global economy, we believe our core strengths will continue to allow us to execute our strategy for long-term sustainable growth in revenue, net income and operating cash flow.

Summary of Critical Accounting Policies

We have identified critical accounting policies that, as a result of judgments, uncertainties, uniqueness and complexities of the underlying accounting standards and operation involved could result in material changes to our financial position or results of operations under different conditions or using different assumptions.

Revenue Recognition

We recognize wholesale revenue from product sales, net of value-added taxes, upon delivery for local sales and upon shipment of the products for export sales, at such time title passes to the customer provided however that (i) there are no uncertainties regarding customer acceptance (ii) persuasive evidence of an arrangement exists (iii) the sales price is fixed and determinable, and (iv) collectability is deemed probable. We recognize wholesale revenue from manufacturing fees charged to buyers for the assembly of garments from materials provided by the buyers upon completion of the manufacturing process and upon delivery to the buyer for local sales and upon shipment of the products for export sales, provided that (i)there are no uncertainties regarding customer acceptance (ii) persuasive evidence of an arrangement exists (iii) the sales price is fixed and determinable, and (iv) collectability is deemed probable. Retail sales are recorded at the time of register receipt.

Estimates and Assumptions

In preparing our consolidated financial statements, we use estimates and assumptions that affect the reported amounts and disclosures. Our estimates are often based on complex judgments, probabilities and assumptions that we believe to be reasonable, but that are inherently uncertain and unpredictable. We are also subject to other risks and uncertainties that may cause actual results to differ from estimated amounts. Significant estimates in 2011 and 2010 include the assumptions used to value warrants and the estimates of the allowance for deferred tax assets.


Results of Operations for the three months ended September 30, 2011 and 2010

The following table summarizes our results of operations for the three months ended September 30, 2011 and 2010. The table and the discussion below should be read in conjunction with our condensed consolidated financial statements and the notes thereto appearing elsewhere in this report.

                                                   Three Months Ended September 30,
                                                   2011                          2010
                                               (in U.S. Dollars, except for percentages)
             Sales                     $  53,673,933        100.0 %   $ 31,935,974       100.0 %
             Gross Profit              $  11,195,724         20.9 %   $  6,352,142        19.9 %
             Operating Expense         $   7,701,114         14.3 %   $  4,785,171        15.0 %
             Income From Operations    $   3,494,610          6.5 %   $  1,566,971         4.9 %
             Other Expenses (Income)   $     144,834          0.3 %   $  (544,008)       (1.7) %
             Income tax expense        $     646,793          1.2 %   $    284,914         0.9 %
             Net Income                $   2,702,983          5.0 %   $  1,826,065         5.7 %

Revenue

The following table sets forth a breakdown of our total sales, by region, for
the three months ended September 30, 2011 and 2010.

                                                                                                       Growth in 2011
                                                    % of total                        % of total       Compared with
                                      2011            sales             2010            sal es              2010
Wholesale business
The People's Republic of China    $ 14,055,869             26.2 %   $  3,064,451              9.6 %              358.7 %
Germany                              5,480,075             10.2        4,931,175             15.4                 11.1
United States                        8,143,230             15.2        4,257,550             13.3                 91.3
United Kingdom                       6,785,148             12.6        3,387,371             10.6                100.3
Japan                                3,655,819              6.8        3,531,122             11.1                  3.5
Europe-Other                         3,922,109              7.3        6,435,129             20.2                (39.1 )
Total wholesale business            42,042,250             78.3       25,606,798             80.2                 64.2
Retail business                     11,631,683             21.7        6,329,176             19.8                 83.8
Total                             $ 53,673,933            100.0 %   $ 31,935,974            100.0 %               68.1 %

Sales for the three months ended September 30, 2011 were $53.7 million, an increase of 68.1% from the three months ended September 30, 2010. This increase was primarily attributable to increased sales in our retail business as well as our wholesale business expand.

Sales generated from our wholesale business contributed 78.3% or $42.0 million of our total sales for the three months ended September 30, 2011, an increase of 64.2% compared to $25.6 million in the three months ended September 30, 2010. This increase was primarily attributable to increased sales in the PRC, the United Kingdom and the United States. The increased sales in the wholesale segment was primarily due to that following factors:(i) the progressive adjustment of our wholesale client and product portfolio which resulted in an increase of orders in the wholesale segment; (ii) in response to the global economic uncertainty, in mid 2010 we adjusted our sales strategy to develop more wholesale customers in China. (iii) expansion of our outsourcing base to Vietnam and Cambodia starting from the third quarter of 2010, which significantly increased our production capacity to process more orders;

Sales generated from our retail business contributed 21.7% or $11.6 million of our total sales for the three months ended September 30, 2011, an increase of 83.8% compared to 19.8% or $6.3 million in the three months ended September 30, 2010. This increase was primarily due to new stores opened and the increase in same store sales. We had 421 LA GO GO stores as of September 30, 2011, compared to 214 LA GO GO stores at September 30, 2010.

Costs and Expenses

Cost of Sales and Gross Margin

Cost of sales includes the direct raw material cost, direct labor cost, and manufacturing overhead including depreciation of production equipment and rent, consistent with the revenue earned. Cost of sales excludes warehousing costs, which historically have not been significant.

The following table sets forth the components of our cost of sales and gross profit both in amounts and as a percentage of total sales for the three months ended September 30, 2011 and 2010.


                                                 Three months ended September 30,                Growth
                                               2011                            2010              In 2011
                                            (in U.S. dollars, except for percentages)
Net Sales for Wholesale Sales       $  42,042,250         100.0 %   $ 25,606,798         100.0 %    64.2 %
Raw Materials                          21,183,921          50.4       12,541,213          49.0      68.9
Labor                                   1,097,522           2.6          931,186           3.6      17.9
Outsourced Production Costs            12,491,707          29.7        8,006,409          31.3      56.0
Other and Overhead                        149,404           0.4          107,689           0.4      38.7
Total Cost of Sales for Wholesale      34,922,554          83.1       21,586,497          84.3      61.8
Gross Profit for Wholesale              7,119,696          16.9        4,020,301          15.7      77.1
Net Sales for Retail                   11,631,683         100.0        6,329,176         100.0      83.8
Production Costs                        3,920,469          33.7        1,860,082          29.4     110.8
Rent                                    3,635,186          31.3        2,137,253          33.8      70.1
Total Cost of Sales for Retail          7,555,655          65.0        3,997,335          63.2      89.0
Gross Profit for Retail                 4,076,028          35.0        2,331,841          36.8      74.8
Total Cost of Sales                    42,478,209          79.1       25,583,832          80.1      66.0
Gross Profit                        $  11,195,724          20.9 %   $  6,352,142          19.9 %    76.3 %

Raw material costs for our wholesale business were 50.4% of our total wholesale business sales in the three months ended September 30, 2011, compared to 49.0% in the three months ended September 30, 2010. The percentage increase was mainly due to increased raw materials prices.

Labor costs for our wholesale business were 2.6% of our total wholesale business sales in the three months ended September 30, 2011, compared to 3.6% in the three months ended September 30, 2010. The marginal decrease was mainly due to the fact that we outsourced most of the new orders in 2011.

Outsourced manufacturing costs for our wholesale business were 29.7% of our total wholesale business sales in the three months ended September 30, 2011, compared to 31.3% in the three months ended September 30, 2010. This decrease was primarily attributable to: (i) the outsourced manufacturing costs in the PRC decreased because we had available domestic capacity in the three months ended September 30, 2011, compared with limited capacity in the three months ended September 30, 2010, and our Chinese suppliers were willing to lower their prices due to their excess production capacity(ii) outsourced orders of approximately $5.8 million to our related entities in Vietnam and Cambodia, which have lower labor costs compared to orders outsourced to Chinese factories.

Overhead and other expenses for our wholesale business accounted for 0.4% of our total wholesale business sales for the three months ended September 30, 2011, compared to 0.4% of total sales for the three months ended September 30, 2010.

For our wholesale business gross profit for the three months ended September 30, 2011 was $7.1 million, an increase of 77.1% compared to the three months ended September 30, 2010. As a percentage of wholesale sales, gross profit accounted for 16.9% of our total wholesale sales for the three months ended September 30, 2011, an increase of 1.2% compared to 15.7% for the three months ended September 30, 2010. The increase was mainly due to the lower outsourced manufacturing costs .

Production costs for our retail business were $3.9 million during the three months ended September 30, 2011 compared to $1.9 million during the three months ended September 30, 2010. As a percentage of retail sales, retail production costs accounted for 33.7% of our total retail sales in the three months ended September 30, 2011, compared to 29.4% of total retail sales in the three months ended September 30, 2010. This increase was primarily due to reduced retail prices in various promotions in exchange for increased sales volume during the three months ended September 30, 2011.

Rent costs for our retail business were $3.6 million for the three months ended September 30, 2011 compared to $2.1 million for the three months ended September 30, 2010. As a percentage of sales, rent costs accounted for 31.3% of our total retail sales for the three months ended September 30, 2011, compared to 33.8% of total retail sales for the three months ended September 30, 2010. Total rent costs increased as a result of the increase in the number of our stores. The decrease in rent costs as a percentage of total retail sales was due to increase of same store sales during the third quarter of 2011.

Gross profit in our retail business for the three months ended September 30, 2011 was $4.1 million and gross margin was 35.0%. Gross profit in our retail business for the three months ended September 30, 2010 was $2.3 million and gross margin was 36.8%.

Total cost of sales for the three months ended September 30, 2011 was $42.5 million, compared to $25.6 million for the three months ended September 30, 2010, an increase of 66%. As a percentage of total sales, cost of sales decreased to 79.1% of total sales for the three months ended September 30, 2011, compared to 80.1% of total sales for the three months ended September 30, 2010. Consequently, gross margin increased to 20.9% for the three months ended September 30, 2011 from 19.9% for the three months ended September 30, 2010.

Selling, General and Administrative Expenses

Our selling expenses consist primarily of local transportation, unloading charges, product inspection charges, salaries for retail staff and decoration and marketing expenses associated with our retail business.


Our general and administrative expenses include administrative salaries, office expense, certain depreciation and amortization charges, repairs and maintenance, legal and professional fees, warehousing costs and other expenses that are not directly attributable to our revenues.

Costs of our distribution network that are excluded from cost of sales consist of local transportation and unloading charges, and product inspection charges. Accordingly our gross profit amounts may not be comparable to those of other companies who include these amounts in cost of sales.

                                                    Three Months Ended September 30,
                                                  2011                             2010              Increase
                                               (in U.S. Dollars, except for percentages)
Gross Profit                          $    11,195,724          20.9 %   $  6,352,142          19.9 %     76.3 %
Operating Expenses:
Selling Expenses                            4,257,401           7.9 %      2,283,606           7.2       86.4
General and Administrative Expenses         3,443,713           6.4 %      2,501,565           7.8       37.7
Total                                       7,701,114          14.3 %      4,785,171          15.0       60.9
Income from Operations                $     3,494,610           6.5 %   $  1,566,971           4.9 %    123.0 %

Selling expenses increased 86.4% to $4.3 million for the three months ended September 30, 2011 from $2.3 million for the three months ended September 30, 2010. The increase was attributable to the increased number of retail employees and increased average salaries, as well as increased store decoration and marketing expenses associated with the promotion of the LA GO GO brand.

General and administrative expenses increased 37.7% to $3.4 million the three months ended September 30, 2011 from $2.5 million for the three months ended September 30, 2010. As a percentage of total sales, general and administrative expenses decreased to 6.4% of total sales for the three months ended September 30, 2011, compared to 7.8% of total sales for the three months ended September 30, 2010. This decrease was due to the increase of our sales.

Income from Operations

Income from operations increased 123% to $3.5 million for the three months ended September 30, 2011 from $1.6 million for the three months ended September 30, 2010. As a percentage of sales, income from operations accounted for 6.5% of our total sales for the three months ended September 30, 2011, an increase of 1.6% compared to the three months ended September 30, 2010 as a result of decreasing outsourced manufacturing costs for our wholesale business.

Income from operations from our retail business decreased to $ (0.26) million for the three months ended September 30, 2011 from $0.52 million for the three months ended September 30, 2010. The decrease was attributable to the increased number of retail employees and increased average salaries, as well as increased store decoration and marketing expenses associated with the promotion of the LA GO GO brand. We had 61 new stores opened for the three months ended September 30, 2011, compared to 21 new stores opened for the three months ended September 30, 2010.

Interest Expense

Interest expense was $0.4 million for the three months ended September 30, 2011, an increase of 339.9% compared to the same period in 2010. The increase was due to the increased bank loans as a result of our business expansion.

Change in fair value of derivative liability

Change in fair value of derivative liability resulted in a gain of $15,500 for the three months ended September 30, 2011, based on the Binomial Lattice model, and a gain of $621,600 for the three months ended September 30, 2010, based on the Black-Scholes option pricing model.

Through September 30, 2010, the Company used the Black-Scholes option pricing model to calculate the fair value of its warrant liabilities. Since October 1, 2010, the Company has used the Binomial Lattice model to calculate the fair value of its warrant liabilities, as management believes that the Binomial Lattice model results in a valuation that is more representative of the fair value of the warrants.

Income Tax Expenses

Income tax expense for the three months ended September 30, 2011 was $0.6 million, an increase of 127.0% compared to the same period of 2010. The increase was primarily due to increased profits of Goldenway and Ever-Glory Apparel.

Our PRC subsidiaries are governed by the Income Tax Law of the PRC concerning Foreign Investment Enterprises and Foreign Enterprises and various local income tax laws. Each of our consolidated entities files its own separate income tax return.

Below is a summary of the income tax rate for each of our PRC subsidiaries in 2010 and 2011:


                Goldenway      New-Tailun      Catch-Luck       LA GO GO       Ever-Glory Apparel
        2010          25.0 %          12.5 %          12.5 %         25.0 %                   25.0 %
        2011          25.0 %          25.0 %          25.0 %         25.0 %                   25.0 %

Perfect Dream Limited was incorporated in the British Virgin Islands on July 1, 2004, and has no income tax.

Ever-Glory International Group (HK) Ltd was incorporated in Samoa on September 15, 2009, and has no liabilities for income tax.

Ever-Glory International Group Inc. was incorporated in the United States and has incurred net operating losses for income tax purposes through 2010. The net operating loss carry forwards for United States income taxes may be available to reduce future years' taxable income. These carry forwards will expire, if not utilized, through 2031. Management believes that the realization of the benefits from these losses is uncertain due to our limited operating history and continuing losses for United States income tax purposes. Accordingly, we provided a 100% valuation allowance on the deferred tax asset to reduce the asset to zero.

Net Income

Net income for the three months ended September 30, 2011 was $2.7 million, an increase of 48.0% compared to the same period in 2010. Our basic and diluted earnings per share were $0.18 and $0.12 for the three months ended September 30, 2011 and 2010, respectively. This increase was primarily due to the increase in our sales.

Results of Operations for the nine months ended September 30, 2011 and 2010

The following table summarizes our results of operations for the nine months ended September 30, 2011 and 2010. The table and the discussion below should be read in conjunction with the consolidated financial statements and the notes . . .

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