Ever-Glory International Group, Inc. - Quarter Report: 2014 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2014

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________

Commission file number: 0-28806

Ever-Glory International Group Inc.

(Exact name of registrant as specified in its charter)

Ever-Glory Commercial Center,

509 Chengxin Road, Jiangning Development Zone,

Nanjing, Jiangsu Province,

People’s Republic of China

(Address of principal executive offices)

(8625) 5209-6875

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of August 8, 2014, 14,781,241 shares of the Company’s common stock, $0.001 par value, were issued and outstanding.

EVER-GLORY INTERNATIONAL GROUP, INC.

FORM 10-Q

INDEX

Cautionary Note Regarding Forward-Looking Statements

Statements contained in this Quarterly Report on Form 10-Q, which are not historical facts, are forward-looking statements, as the term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, whether expressed or implied, are subject to risks and uncertainties which can cause actual results to differ materially from those currently anticipated, due to a number of factors, which include, but are not limited to:

Forward-looking statements also include the assumptions underlying or relating to any of the foregoing or other such statements. When used in this report, the words “may,”“will,”“should,”“could,”“expect,”“plan,”“anticipate,”“believe,”“estimate,”“predict,”“continue,” and similar expressions are generally intended to identify forward-looking statements.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Readers should carefully review the factors described in the Section entitled “Risk Factors” on Form 10-K and other documents we file from time to time with the Securities and Exchange Commission (‘SEC’).

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

AS OF JUNE 30, 2014 (UNAUDITED) AND DECEMBER 31, 2013

ASSETS

See the accompanying notes to the consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND 2013 (UNAUDITED)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2014 AND 2013

(UNAUDITED)

NOTE 1 SUMMARY OF BUSINESS AND BASIS OF PRESENTATION

Organization and business

Ever-Glory International Group, Inc. (the “Company”), together with its subsidiaries, is an apparel manufacturer, supplier and retailer in The People's Republic of China ("China” or "PRC"), with a wholesale segment and a retail segment. The Company’s wholesale business consists of recognized brands for department and specialty stores located in China, Europe, Japan and the United States. The Company’s retail business consists of flagship stores and store-in-stores for the Company’s own-brand products.

The Company’s wholesale operations are provided primarily through the Company’s wholly-owned PRC subsidiaries, Goldenway Nanjing Garments Co. Ltd. (“Goldenway”), Nanjing Catch-Luck Garments Co. Ltd. (“Catch-Luck”), Nanjing New-Tailun Garments Co. Ltd (“New-Tailun”), Ever-Glory International Group Apparel Inc.(“Ever-Glory Apparel”) and Nanjing Tai Xin Garments Trading Company Limited (“Tai Xin”), and the Company’s wholly-owned Samoa subsidiary, Ever-Glory International Group (HK) Ltd. (“Ever-Glory HK”). The Company’s retail operations are provided through its wholly- owned subsidiaries, Shanghai LA GO GO Fashion Company Limited (“Shanghai LA GO GO”), Jiangsu LA GO GO Fashion Company Limited (“Jiangsu LA GO GO”), Tianjin LA GO GO Fashion Company Limited (“Tianjin LA GO GO”), Shanghai Ya Lan Fashion Company Limited (“Ya Lan”) and Xizang He Meida Trading Company Limited (“He Meida”).

On June 26, 2014, Shanghai LA GO GO entered into a contract with Shanghai Yiduo Fashion Company Limited (“Shanghai Yiduo”) to acquire 78% of the shares of Shanghai Yiduo for $0.75 million (RMB4.6 million).  Shanghai Yiduo is currently owned by unrelated third parties and operates design and development of women’s apparel for Mecox Lane, one of China’s leading online platforms for apparel and apparel accessories. The acquisition price is to be paid as follows. 

The first $0.45 million installment was paid by the Company to Shanghai Yiduo in July 2014 and was financed by working capital. The completion of the acquisition is subject to the company’s final due dilligence and Shanghai Yiduo’s ability to collect certain account receivables. In the event Shanghai Yiduo is not able to collect the account receivables in accordance to the contract, the Company may reduce the purchase price or terminate the contract and get back the first install payment.   Management of the Company believes that the acquisition will improve the Company’s design and product development ability.

Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of the Company and its subsidiaries contain all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the condensed consolidated balance sheet as of June 30, 2014, the condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2014 and 2013, and the condensed consolidated statements of cash flows for the six months ended June 30, 2014 and 2013. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to Rule 10-01 of Regulation S-X of the Securities and Exchange Commission (the “SEC”). Accordingly, they have been condensed and do not include all of the information and footnotes required by GAAP for complete financial statements. Wholesale revenues are generally higher in the third and fourth fiscal quarters, while retail revenues are generally higher in the first and fourth fiscal quarters. The results of operations for the three and six months ended June 30, 2014 are not necessarily indicative of the results of operations to be expected for the full fiscal year. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, and Form 10-Q for the three and six months ended June 30, 2013.

NOTE 2 SIGNIFICANT ACCOUNTING POLICIES

Financial Instruments

Management has estimated that the carrying amounts of non-related party financial instruments approximate their fair values due to their short-term maturities. The fair value of amounts due from (to) related parties is not practicable to estimate due to the related party nature of the underlying transactions.

Fair Value Accounting

Accounting Standards Codification (“ASC”) 820 “Fair Value Measurements and Disclosures”, establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under ASC 820 are described below:

At June 30, 2014, the Company’s financial assets (all Level 1) consist of cash placed with financial institutions that management considers to be of a high quality.

At June 30, 2014 and December 31, 2013, the Company had an outstanding forward foreign exchange option contract subject to recurring fair value measurement (Level 3) with the change in fair value recognized in earnings (Note 5).

Foreign Currency Translation and Other Comprehensive Income

The reporting currency of the Company is the U.S. dollar. The functional currency of the Company, Ever-Glory HK and Perfect Dream Limited, British Virgin Islands incorporated subsidiary of the Company (“Perfect Dream”) is the U.S. dollar. The functional currency of Goldenway, New Tailun, Catch-luck, Ever-Glory Apparel, Tai Xin, Shanghai LA GO GO, Jiangsu LA GO GO, Tianjin LA GO GO, Ya Lan and He Meida is the Chinese RMB.

For subsidiaries whose functional currency is the RMB, all assets and liabilities were translated at the exchange rate at the balance sheet date; equity was translated at historical rates and items in the statement of comprehensive income were translated at the average rate for the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income. The resulting translation gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Items in the cash flow statement are translated at the average exchange rate for the period.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 will eliminate the transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principle-based approach for determining revenue recognition. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and must be applied retrospectively. Management is currently evaluating the potential impact of this ASU on the Company’s financial statements. 

NOTE 3 INVENTORIES

Inventories at June 30, 2014 and December 31, 2013 consisted of the following:

NOTE 4 BANK LOANS

Bank loans represent amounts due to various banks and are generally due on demand or within one year. These loans can be renewed with the banks. Bank loans consisted of the following at June 30, 2014 and December 31, 2013:

On January 1, 2014, Goldenway entered into a line of credit agreement with Industrial and Commercial Bank of China, which allows the Company to borrow up to approximately $6.50 million (RMB40 million). These loans are collateralized by the Company’s property and equipment. As of June 30, 2014, Goldenway had borrowed $6.50 million (RMB40 million) under this line of credit with an annual interest rate of 6.24% and due on various dates from March to April 2015.

On January 1, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $6.50 million (RMB40 million) with Industrial and Commercial Bank of China and guaranteed by Goldenway. As of June 30, 2014, Ever-Glory Apparel had borrowed $4.79 million (RMB 29.5 million) under this line of credit with an annual interest rate of 5.6% and due on various dates from November to December 2014. Ever-Glory Apparel had also borrowed $1.67 million from Industrial and Commercial Bank of China with annual interest rates ranging from 1.02% to 1.04% and due on various dates from July to October 2014, and collateralized by approximately $2.24 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $0.04 million was unused and available under this line of credit.  Approximately $0.44 million was repaid subsequent to June 30, 2014.

On June 14, 2013, Goldenway entered into a line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $8.12 million (RMB50 million). These loans are guaranteed by Jiangsu Ever-Glory International Group Corp. (“Jiangsu Ever-Glory”), an entity controlled by Mr. Kang, the Company’s Chairman and Chief Executive Officer. These loans are also collateralized by the Company’s property and equipment. As of June 30, 2014, Goldenway had borrowed $4.06 (RMB25 million) under this line of credit from Nanjing Bank with an annual interest rate of 6.16% due on August 2014. At June 30, 2014, approximately $4.06 million was unused and available under this line of credit. Approximately $4.06 million was repaid subsequent to June 30, 2014.

On June 14, 2013 and renewed on July 6, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $9.74 million (RMB60 million) with Nanjing Bank and guaranteed by Jiangsu Ever-Glory, Mr. Kang and Goldenway. As of June 30, 2014, Ever-Glory Apparel had borrowed $1.62 million (RMB 10 million) under this line of credit with an annual interest rate of 6.6% and due on September 2014. Ever-Glory Apparel had also borrowed $2.30 million from Nanjing Bank with annual interest rate of 3.1% and due on various dates from July to September 2014, and collateralized by approximately $3.16 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $5.82 million was unused and available under this line of credit.  Approximately $0.68 million was repaid subsequent to June 30, 2014.

On April 10, 2013, LA GO GO entered into a revolving line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $3.25 million (RMB20 million). The line of credit is guaranteed by Mr. Kang. As of June 30, 2014, LA GO GO had borrowed $2.44 million (RMB15 million) under this line of credit with an annual interest rate of 6.16% and due on various dates from July to October 2014. At June 30, 2014, approximately $0.81 million (RMB5 million) was unused and available under this line of credit. Approximately $0.81 million was repaid subsequent to June 30, 2014.

On January 29, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $8.44 million (RMB52 million) with the Bank of Communications and collateralized by assets of Jiangsu Ever-Glory’s equity investee, Nanjing Knitting, under a collateral agreement executed among the Company, Jiangsu Ever-Glory, Nanjing Knitting and the bank. As of June 30, 2014, Ever-Glory Apparel had borrowed $4.06 million (RMB25 million) with an annual interest rate of 6.9% and due on various dates from February to March 2015. Ever-Glory Apparel had also borrowed $1.87 million from the Bank of Communications with an annual interest rates ranging from 3.82% to 5.75% and due in February 2015, and collateralized by approximately $2.51 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $2.51 million was unused and available under this line of credit.

On July 16, 2013, LA GO GO entered into a line of credit agreement for approximately $3.57 million (RMB22 million) with the Bank of Communications and guaranteed by Jiangsu Ever-Glory and Mr. Kang. As of June 30, 2014, LA GO GO had borrowed $3.25 million (RMB20 million) from the Bank of Communications with an annual interest rate of 6.3% and due in June 2015. At June 30, 2014, approximately $0.32 million was unused and available under this line of credit.

On September 1, 2013, Ever-Glory Apparel entered into a line of credit agreement for approximately $11.37 million (RMB70 million) with Everbright Bank, and collateralized by assets of Jiangsu Ever-Glory, This loan is also guaranteed by Goldenway and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $3.25 million (RMB20.0 million) from Everbright Bank, with an annual interest rate of 6.3% and due in October 2014. Ever-Glory Apparel had also borrowed $2.98 million from Everbright Bank with annual interest rate of 2.98% and due in August 2014, and collateralized by approximately $3.98 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $5.14 million was unused and available under this line of credit. Approximately $3.98 million was repaid subsequent to June 30, 2014.

On July 29, 2011, Ever-Glory Apparel and Perfect Dream collectively entered into a secured banking facility agreement for a combined revolving import facility, letter of credit, invoice financing facilities and a credit line for treasury products of up to $7.0 million with the Nanjing Branch of HSBC (China) Company Limited (“HSBC”). This agreement is guaranteed by the Company and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $5.55 million from HSBC with an annual interest rates ranging from 2.78% to 5.88%, due on various dates from July to September 2014, and collateralized by approximately $7.9 million of accounts receivable from wholesale customers. These bank loans are to be repaid upon receipt of payments from customers. As of June 30, 2014, approximately $1.45 million was unused and available.

On November 11, 2013, Ever-Glory Apparel entered into a line of credit agreement for approximately $5.68 million (RMB35 million) with the Bank of China and guaranteed by Jiangsu Ever-Glory and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $1.62 million (RMB10 million) with an annual interest rate of 6.05% and due in October 2014 under this line of credit. Ever-Glory Apparel had also borrowed $3.49 million ($1.6 million and RMB 11.6 million) from the Bank of China with annual interest rates ranging from 3.62% to 3.9% and due on various dates from July to August 2014, and collateralized by approximately $4.99 million of accounts receivable from wholesale customers. Approximately $1.60 million was repaid subsequent to June 30, 2014.  As of June 30, 2014, approximately $0.57 million was unused and available.

As of June 30, 2014, LA GO GO had borrowed $3.25 million (RMB 20 million) from China Minsheng Bank, with annual interest rate of 6.3% and due in August 2014. This loan is guaranteed by Ever-Glory Apparel and Mr. Kang.

As of June 30, 2014, Ever-Glory Apparel had borrowed $2.68 million from Ping An Bank, with annual interest rate of 3.9% and due on various dates from July to September 2014, and collateralized by approximately $3.83 million of accounts receivable from wholesale customers. Approximately $1.0 million was repaid subsequent to June 30, 2014.

Total interest expense on bank loans amounted to $774,693, $1,481,808, $736,695, and $1,528,224 for the three and six months ended June 30, 2014 and 2013, respectively.

NOTE 5 DERIVATIVES LIABILITY

At June 30, 2014, the Company had one outstanding forward foreign exchange option contract (sell US dollars for RMB), with a notional amount of US$3,000,000, that expires in September 2014. The fair value of this contract at June 30, 2014, as well as gains and losses realized on other foreign currency derivative activity during 2014 and 2013 were not significant.

Subsequent to June 30, 2014, we entered into another forward foreign exchange option contract (sell US dollars for RMB), with a notional amount of US $700,000, that expires in September 2015.

At December 31, 2012, the Company had warrants outstanding to purchase an aggregate of 840,454 shares of the Company’s common stock, which warrants required liability classification because of certain provisions that may have resulted in an adjustment to their exercise price. The warrants expired in June 2013. At the expiration date, the remaining value of the warrants not exercised ($2,000) was reduced to $0. The increase in other income resulting from the decrease in derivative warrant liability was $2,000 and $294,000 for the three and six months ended June 30, 2013, respectively.

NOTE 6 INCOME TAX

The Company’s operating subsidiaries are governed by the Income Tax Law of the PRC concerning Foreign Investment Enterprises and Foreign Enterprises and various local income tax laws (“the Income Tax Laws”).

All PRC subsidiaries are subject to income tax at the 25% statutory rate.

Perfect Dream was incorporated in the British Virgin Islands (BVI), and under the current laws of the BVI dividends and capital gains arising from the Company’s investments in the BVI are not subject to income taxes.

Ever-Glory HK was incorporated in Samoa, and under the current laws of Samoa has no liabilities for income taxes.

Although the Company’s parent entity is a US entity, the Company’s primary operations are through subsidiaries located in China, certain apparel manufacturing is performed outside of China in Southeast Asia, sales are made globally, and the Company has other subsidiary operations in Hong Kong and Samoa. Therefore, the Company uses significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which it operates. In the ordinary course of the Company’s business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of transfer pricing for transactions with the Company’s subsidiaries, potential challenges to nexus, value added estimates, and similar matters. In September 2009, the Company formed its subsidiary, Ever-Glory HK, domiciled in Samoa, in order to engage in certain limited import and export of apparel, fabric and accessories, as well as to efficiently address currency exchange matters with international transactions. Over the past few years, the operational matters handled by this subsidiary have expanded with respect to sub-contracting of certain manufacturing work outside of China, as well as to other operational matters with non-PRC customers and vendors. Additionally, over this time period, tax guidance, rules and positions taken by the PRC with respect to transfer pricing issues have evolved, and in certain cases, become more standardized. As part of the Company’s on-going process of evaluating our tax positions, the Company considered various factors as they relate to its Samoan subsidiary and as related to intercompany transactions This evaluation resulted in a change in the Company’s estimate of exposure to potential unfavorable outcomes related to these uncertainties, and the Company recorded a tax liability of approximately $3,186,000 as of December 31, 2013 based on the probability for such outcomes.

As of June 30, 2014, the local PRC Tax Bureau is in discussions with the Company to finalize the process of payment for the approximate tax liability of $ 3,186,000. The Company and the PRC Tax Bureau have tentatively agreed that payments on the tax liability will be made by the Company prospectively over the next two to three year period. Beginning January 1, 2014, all net income generated from Ever-Glory HK has been reported as a taxable income at 25% tax rate in PRC.  

The PRC’s Enterprise Income Tax Law imposes a 10% withholding income tax for dividends distributed by a foreign invested enterprise in PRC to its immediate holding company outside China, such distributions were exempted under the previous income tax law and regulations. A lower withholding tax rate will be applied if there is a tax treaty arrangement between mainland China and the jurisdiction of the foreign holding company. The foreign invested enterprise became subject to the withholding tax starting from January 1, 2008. Given that the undistributed profits of the Company's subsidiaries in China are intended to be retained in China for business development and expansion purposes, no withholding tax accrual has been made.

After the tax liability adjustment resulted from the reevaluation of the Company’s tax position (resulting in the company allocating substantially all of the earnings of the Samoan subsidiary to the PRC and reporting such earnings as taxable in the PRC). PRC pre-tax income for the three and six months ended June 30, 2014 and 2013 was taxable in the following jurisdictions.

The following table reconciles the PRC statutory rates to the Company’s effective tax rate for the three and six months ended June 30, 2014 and 2013, respectively:

Income tax expense for the three and six months ended June 30, 2014 and 2013 is as follows:

NOTE 7 EARNINGS PER SHARE

The following demonstrates the calculation for earnings per share for the three and six months ended June 30, 2014 and 2013:

NOTE 8 STOCKHOLDERS’ EQUITY

On February 28, 2013, the Company issued an aggregate of 5,340 shares of its common stock to three of the Company’s independent directors as compensation for their services in the third and fourth quarters of 2012. The shares were valued at $1.89 per share, which was the average market price of the common stock for the five days before the grant date.

On August 19, 2013, the Company issued an aggregate of 3,631 shares of its common stock to three of the Company’s independent directors as compensation for their services in the first and second quarters of 2013. The shares were valued at $2.73 per share, which was the average market price of the common stock for the five days before the grant date.

NOTE 9 RELATED PARTY TRANSACTIONS

Mr. Kang is the Company’s Chairman and Chief Executive Officer. All transactions associated with the following companies controlled by Mr. Kang are considered to be related party transactions, and it is possible that the terms of these transactions may not be the same as those that would result from transactions between unrelated parties. All related party outstanding balances are short-tem in nature and are expected to be settled in cash.

Other income from Related Parties

Included in other income for the three and six months ended June 30, 2013 is rent revenue from entities controlled by Mr. Kang under operating lease agreements as follows.  There were no such income in 2014.

Other expenses due to Related Parties

Included in other expenses for the three and six months ended June 30, 2014 and 2013 are rent costs due to entities controlled by Mr. Kang under operating lease agreements as follows:

Purchases from, and Sub-contracts with Related Parties

Shanghai Weiwen Fashion Company Ltd. (Shanghai Weiwen) was incorporated in the PRC in 2012. This company designs and sells women’s apparel utilizing the “Velwin” brand. Shanghai Weiwen is owned by Mr. Kang. Shanghai Ya Lan entered an agreement with Shanghai Weiwen in April 2014 to purchase the “Velwin” brand along with existing inventory of Shanghai Weiwen. No customer relationships, production facilities, or other operating assets were acquired. Management of the Company believes that this asset purchase will provide the Company with additional multi-brand advantages. The purchase price of the inventory and brand was approximately $2.44 million. The purchase price was based primarily on the estimated fair market value of the inventory.

Shanghai Sea to Sky Fashion Company Ltd. (Shanghai Sea to Sky) was incorporated in the PRC in 2012. This company designs and sells women’s apparel utilizing the “Sea to Sky” brand. Shanghai Sea to Sky is owned by Mr. Kang. Shanghai LA GO GO entered an agreement with Shanghai Sea to Sky in April 2014 to purchase the “Sea to Sky” brand along with existing inventory of Shanghai Sea to Sky. No customer relationships, production facilities, or other operating assets were acquired. Management of the Company believes that this asset purchase will provide the Company with additional multi-brand advantages. The purchase price of the inventory and brand was approximately $0.39 million. The purchase price was based primarily on the estimated fair market value of the inventory. 

For the three and six months ended June 30, 2014 and 2013, the Company purchased raw materials of $450,620, $884,070, $101,370, and $184,608, respectively, from Nanjing Knitting.

In addition, the Company sub-contracted certain manufacturing work to related parties totaling $4,401,992, $10,312,113, $5,102,919, and $9,088,426 for the three and six months ended June 30, 2014 and 2013, respectively. The Company provided raw materials to the sub-contractors and was charged a fixed fee for labor provided by the sub-contractors. Sub-contracts with related parties included in cost of sales for the three and six months ended June 30, 2014 and 2013 are as follows:

Accounts Payable – Related Parties

The Company purchases raw materials from and subcontracts some of its production to related parties. Accounts payable to related parties at June 30, 2014 and December 31, 2013 are as follows:

Amounts Due From Related Parties

The amounts due from related parties at June 30, 2014 and December 31, 2013 are as follows:

Jiangsu Ever-Glory is an entity engaged in importing/exporting, apparel-manufacture, real-estate development, car sales and other activities. Jiangsu Ever-Glory is controlled by Mr. Kang. Because of restrictions on its ability to directly import and export products, the Company had utilized Jiangsu Ever-Glory as its agent to assist the Company with its import and export transactions and its international transportation projects from 2005 through 2011. Import transactions primarily consisted of purchases of raw materials and accessories designated by the Company’s customers for use in garment manufacture. Export transactions consisted of the Company’s sales to foreign markets such as Japan, Europe and the United States. These transactions ceased at end of 2011. During six months ended June 30, 2014 and 2013, the Company and Jiangsu Ever-Glory purchased raw materials on behalf of each other in order to obtain cheaper purchase prices. The Company purchased raw materials on Jiangsu Ever-Glory’s behalf and sold to Jiangsu Ever-Glory at cost for $0 and $72,548 during the six month period ended June 30, 2014 and 2013, respectively. Jiangsu Ever-Glory purchased raw materials on the Company’s behalf and sold to the Company at cost for $19,221 and $0 during the six months ended June 30, 2014 and 2013, respectively.

Amounts Due From Related Party under Counter Guarantee Agreement

In March 2012, in consideration of the guarantees and collateral provided by Jiangsu Ever-Glory and Nanjing Knitting, the Company agreed to provide Jiangsu Ever-Glory a counter guarantee in the form of cash of not less than 70% of the maximum aggregate lines of credit obtained by the Company. Jiangsu Ever-Glory is obligated to return the full amount of the counter-guarantee funds provided upon expiration or termination of the underlying lines of credit and is to pay annual interest at the rate of 6.0% of amounts provided. As of June 30, 2014 and December 31, 2013, Jiangsu Ever-Glory has provided guarantees for approximately $48.72 million (RMB 300 million) and $43.69 million (RMB 269 million) of lines of credit obtained by the Company. Jiangsu Ever-Glory and Nanjing Knitting have also provided their assets as collateral for certain of these lines of credit. The value of the collateral, as per appraisals obtained by the banks in connection with these lines of credit is approximately $16.72 million (RMB 103 million) as of June 30, 2014 and December 31, 2013. Mr. Kang has also provided a personal guarantee for $30.5 million (RMB 188 million).

During the six months ended June 30, 2013, US$4.82 million (RMB30.25 million) was provided to Jiangsu Ever-Glory under the counter-guarantee. US$16.79 million (RMB103 million) was outstanding at December 31, 2013. During six months ended June 30, 2014, an additional $5.03 million (RMB 31 million) was provided and approximately $1.30 million (RMB 8 million) of interest income was received under the counter-guarantee agreement. As of June 30, 2014, the amount of the counter-guarantee was $21.7 million (RMB 134 million) (the difference represents currency exchange adjustment of $0.12 million), which was 44.54% of the aggregate amount of lines of credit. This amount plus accrued interest of $1.50 million have been classified as a reduction of equity, consistent with the guidance of SEC Staff Accounting Bulletins 4E and 4G. At June 30, 2014 and 2013, the amount classified as a reduction of equity was $23.19 million and $19.08 million, respectively. Interest of 0.5% is charged on net amounts due from Jiangsu Ever-Glory at each month end. Interest income for the three and six months ended June 30, 2014 and 2013 was approximately $0.29 million, $0.5 million, $0.34 million and $0.64 million, respectively.

NOTE 10 CONCENTRATIONS AND RISKS

The Company extends unsecured credit to its customers in the normal course of business and generally does not require collateral. As a result, management performs ongoing credit evaluations, and the Company maintains an allowance for potential credit losses based upon its loss history and its aging analysis. Based on management’s assessment of the amount of probable credit losses, if any, in existing accounts receivable, management has concluded that no allowance for doubtful accounts is necessary at June 30, 2014 and December 31, 2013. Management reviews the allowance for doubtful accounts each reporting period based on a detailed analysis of accounts receivable. In the analysis, management primarily considers the age of the customer’s receivable and also considers the credit worthiness of the customer, the economic conditions in the customer’s industry, and general economic conditions and trends, among other factors. If any of these factors change, the Company may also change its original estimates, which could impact the level of the Company’s future allowance for doubtful accounts. If judgments regarding the collectability of accounts receivables are incorrect, adjustments to the allowance may be required, which would reduce profitability.

For the six-month period ended June 30, 2014, the Company had one wholesale customer that represented approximately 14% of the Company’s revenues. For the three-month period ended June 30, 2014, the Company had one wholesale customer that represented approximately 15% of the Company’s revenues. For the six-month period ended June 30, 2013, the Company had two wholesale customers that each represented approximately 11% of the Company’s revenues. For the three-month period ended June 30, 2013, the Company had two wholesale customers that represented approximately 14% and 10% of the Company’s revenues, respectively.

For the Company’s wholesale business during the three and six months ended June 30, 2014 and 2013, no supplier represented more than 10% of the total raw materials purchased.

For the Company’s retail business, the Company had no supplier that represented more than 10% of raw materials purchases during the three and six months ended June 30, 2014. For the Company’s retail business, the Company had no supplier that represented more than 10% of raw materials purchases during the six months ended June 30, 2013. The Company purchased 10% of its raw materials from one supplier during the three months ended June 30, 2013.

For the wholesale business, during the six months ended June 30, 2014, the Company relied on two manufacturers for 16% and 10% of purchased finished goods, respectively. During the six months ended June 30, 2013, the Company relied on two manufacturers for 15% and 13% of purchased finished goods, respectively. During the three months ended June 30, 2014, the Company relied on two manufacturers for 15% and 14% of purchased finished goods, respectively. During the three months ended June 30, 2013, the Company relied on two manufacturers for 17% and 16% of purchased finished goods, respectively.

For the retail business, the Company had no supplier that represented more than 10% of finished goods purchases during the six months ended June 30, 2014. The Company purchased 11% of its finished goods from one supplier during the three months ended June 30, 2014. The Company had no supplier that represented more than 10% of finished goods purchases during the three and six months ended June 30, 2013.

The Company’s revenues for the three and six months ended June 30, 2014 and 2013 were earned in the following geographic areas:

NOTE 11 SEGMENTS

The Company reports financial and operating information in the following two segments:

(a) Wholesale segment

(b) Retail segment

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED JUNE 30, 2014 AND 2013

(UNAUDITED)

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 six months ended June 30, 2014 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 MKT 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 six 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”), Ever-Glory International Group (HK) Ltd. (“Ever-Glory HK”), and Nanjing Tai Xin Garments Trading Company Limited (“Tai Xin”).

Retail Business

We conduct our retail operations through Shanghai LA GO GO Fashion Company Limited (“LA GO GO”), Jiangsu LA GO GO Fashion Company Limited (“Jiangsu LA GO GO”), Tianjin LA GO GO Fashion Company Limited (“Tianjin LA GO GO”), Shanghai Ya Lan Fashion Company Limited (“Ya Lan”) and Xizang He Meida Trading Company Limited (“He Meida”).

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. We maintain long-term, satisfactory relationships with a portfolio of well-known, mid-class global brands.

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:

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 June 30, 2014, we have 1055 stores (including store-in-stores) which included 125 stores that were opened and 30 stores that were closed in first half of 2014.

On June 26, 2014, Shanghai LA GO GO entered into a contract with Shanghai Yiduo Fashion Company Limited (“Shanghai Yiduo”) to acquire 78% of the shares of Shanghai Yiduo for $0.75 million (RMB4.6 million).  Shanghai Yiduo is currently owned by unrelated third parties and operates design and development of women’s apparel for Mecox Lane, one of China’s leading online platforms for apparel accessories. The acquisition price is to be paid as follows. 

The first $0.45 million installment was paid by the Company to Shanghai Yiduo in July 2014 and was financed by working capital. The completion of the acquisition is subject to the company’s final due diligence and Shanghai Yiduo’s ability to collect certain account receivables. In the event Shanghai Yiduo is not able to collect the account receivables in accordance with the contract, the Company may reduce the purchase price or terminate the contract and get back the first installment payment.  Management of the Company believes that the acquisition will improve the Company’s design and product development ability.

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

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 to 180 days following delivery of finished goods.

Retail business

For store-in-store shops, we generally receive payments from the stores between 60 to 90 days following the date of the register receipt. For our own flagship stores, we receive payments at the same time as the register receipt. For the sales in e-commerce platform such as Tmall, Dangdang mall, and Jingdong mall, we generally receive payments from these e-commerce companies between 5 to 15 days following the date 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 European 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 2014.

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 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. Retail sales through e-commerce companies are recognized when products are delivered and payments from customers are received.

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 2014 and 2013 include the assumptions used to value warrants and the estimates of the allowance for deferred tax assets.

Recently Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standard Update (ASU) No. 2014-09, Revenue from Contracts with Customers. ASU 2014-09 will eliminate the transaction- and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principle-based approach for determining revenue recognition. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and must be applied retrospectively. Management is currently evaluating the potential impact of this ASU on the Company’s financial statements. 

Results of Operations for the three months ended June 30, 2014 and 2013

The following table summarizes our results of operations for the three months ended June 30, 2014 and 2013. 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.

Revenue

The following table sets forth a breakdown of our total sales, by region, for the three months ended June 30, 2014 and 2013.

Sales for the three months ended June 30, 2014 were $85.7 million, an increase of 44.9% from the three months ended June 30, 2013. This increase was primarily attributable to a 53.6% increased sales in our retail business as well as a 34.5% increased sales in wholesales business.

Sales generated from our wholesale business contributed 42.5% or $36.4 million of our total sales for the three months ended June 30, 2014, an increase of 34.5% compared to $27.1 million in the three months ended June 30, 2013. This increase was primarily attributable to increased sales in P.R.C, Germany, the United Kingdom and the United States.

Sales generated from our retail business contributed 57.5% or $49.3 million of our total sales for the three months ended June 30, 2014, an increase of 53.6% compared to 54.3% or $32.1 million in the three months ended June 30, 2013. This increase was primarily due to the increase in same store sales and new stores opened. We had 1055 retail stores as of June 30, 2014, compared to 831 retail stores at June 30, 2013.

Costs and Expenses

Cost of Sales and Gross Margin

Cost of goods sold 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 goods sold 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 June 30, 2014 and 2013.

Raw material costs for our wholesale business were 45.2% of our total wholesale business sales in the three months ended June 30, 2014, compared to 44.5% in the three months ended June 30, 2013. The increase was mainly due to increased raw materials prices.

Labor costs for our wholesale business were 3.3% of our total wholesale business sales in the three months ended June 30, 2014, compared to 4.6% in the three months ended June 30, 2013. The decrease was mainly due to the fact that we outsourced most of the new orders in 2014.

Outsourced manufacturing costs for our wholesale business were 27.6% of our total wholesale business sales in the three months ended June 30, 2014, compared to 25.7% in the three months ended June 30, 2013. This increase was primarily attributable to increased average salaries of the employees in our outsourced manufacturing factories.

Overhead and other expenses for our wholesale business accounted for 0.4% of our total wholesale business sales for the three months ended June 30, 2014, compared to 0.5% of total sales for the three months ended June 30, 2013.

Wholesale business gross profit for the three months ended June 30, 2014 and 2013 was $8.5 and $6.7 million, respectively. As a percentage of wholesale sales, gross profit accounted for 23.5% of our total wholesale sales for the three months ended June 30, 2014, a decrease of 1.3% compared to 24.8% for the three months ended June 30, 2013. The decrease was mainly due to increased raw material prices and outsourced manufacturing costs.

Production costs for our retail business were $13.2 million during the three months ended June 30, 2014 compared to $9.5 million during the three months ended June 30, 2013. As a percentage of retail sales, retail production costs accounted for 26.8% of our total retail sales in the three months ended June 30, 2014, compared to 29.5% of total retail sales in the three months ended June 30, 2013. The decrease was due to our procurement cost controlling in the three months ended June 30, 2014 being better than the same period of the prior year.

Rent costs for our retail business were $15.3 million for the three months ended June 30, 2014 compared to $9.8 million for the three months ended June 30, 2013. As a percentage of sales, rent costs accounted for 31.0% of our total retail sales for the three months ended June 30, 2014, compared to 30.7% of total retail sales for the three months ended June 30, 2013.

Gross profit in our retail business for the three months ended June 30, 2014 was $20.8 million and gross margin was 42.2%. Gross profit in our retail business for the three months ended June 30, 2013 was $12.8 million and gross margin was 39.8%.

Total cost of sales for the three months ended June 30, 2014 was $56.3 million, compared to $39.7 million for the three months ended June 30, 2013, an increase of 42.0%. As a percentage of total sales, cost of sales decreased to 65.7% of total sales for the three months ended June 30, 2014, compared to 67.1% of total sales for the three months ended June 30, 2013. Consequently, gross margin increased to 34.3% for the three months ended June 30, 2014 from 32.9% for the three months ended June 30, 2013.

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.

Selling expenses increased 45.5% to $14.4 million for the three months ended June 30, 2014 from $9.9 million for the three months ended June 30, 2013. The increase was attributable to the increased average salaries, and increased number of stores, leading to increased number of retail employees, as well as increased store decoration and marketing expenses associated with the promotion of the LA GO GO brand.

General and administrative expenses increased 36.8% to $7.5 million for the three months ended June 30, 2014 from $5.5 million for the three months ended June 30, 2013. The increase was attributable to an increase in payroll for additional management and design and marketing staff as a result of our business expansion. As a percentage of total sales, general and administrative expenses decreased to 8.8% of total sales for the three months ended June 30, 2014, compared to 9.3% of total sales for the three months ended June 30, 2013.  The percentage decrease was attributable to the increase in our sales.

Income from Operations

Income from operations increased 82.1% to $7.4 million for the three months ended June 30, 2014 from $4.1 million for the three months ended June 30, 2013. As a percentage of sales, income from operations accounted for 8.6% of our total sales for the three months ended June 30, 2014, an increase of 1.7% compared to the three months ended June 30, 2013 as a result of increasing gross profit.

Interest Expense

Interest expense was $0.7 million for the three months ended June 30, 2014, an increase of 2.3% compared to the same period in 2013.

Change in fair value of derivative liability

Change in fair value of derivative liability was a gain of $0.002 million and $0.2 million, based on the Binnomial Lattice model, for the three months ended June 30, 2013.

Income Tax Expenses

Income tax expense for the three months ended June 30, 2014 was $1.9 million, an increase of 145% compared to the same period of 2013. The increase was primarily due to increased profits of LA GO GO.

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.

All PRC subsidiaries are subject to the 25% income tax rate.

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.

Although our parent entity is a US entity, our primary operations are through subsidiaries located in China, certain apparel manufacturing is performed outside of China in Southeast Asia, sales are made globally, and we have other subsidiary operations in Hong Kong and Samoa. Therefore, the Company uses significant judgment to calculate and provide for income taxes in each of the tax jurisdictions in which it operates. In the ordinary course of the Company’s business, there are transactions and calculations undertaken whose ultimate tax outcome cannot be certain. Some of these uncertainties arise as a consequence of transfer pricing for transactions our subsidiaries, potential challenges to nexus, value added estimates, and similar matters. In September 2009, we formed its subsidiary, Ever-Glory HK, domiciled in Samoa, in order to engage in certain limited import and export of apparel, fabric and accessories, as well as to efficiently address currency exchange matters with international transactions. Over the past few years, the operational matters handled by this subsidiary have expanded with respect to sub-contracting of certain manufacturing work outside of China, as well as to other operational matters with non-PRC customers and vendors. Additionally, over this time period, tax guidance, rules and positions taken by the PRC with respect to transfer pricing issues have evolved, and in certain cases, become more standardized. As part of the Company’s on-going process of evaluating our tax positions, we considered various factors as they relate to its Samoan subsidiary and as related to intercompany transactions. This evaluation resulted in a change in our estimate of exposure to potential unfavorable outcomes related to these uncertainties, and we recorded a tax liability of approximately $3,186,000 as of December 31, 2013 based on the probability for such outcomes.

As of June 30, 2014, the local PRC Tax Bureau is in discussions with the Company to finalize the process of payment for the approximate tax liability of $ 3,186,000. The Company and the PRC Tax Bureau have tentatively agreed that payments on the tax liability will be made by the Company prospectively over the next two to three year period. Beginning January 1, 2014, all net income generated from Ever-Glory HK has been reported as a taxable income at 25% tax rate in PRC.

Ever-Glory International Group Inc. was incorporated in the United States and has incurred net operating losses for income tax purposes through June 30, 2014. 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 June 30, 2014 was $5.5 million, an increase of 103% compared to the same period in 2013. Our basic and diluted earnings per share were $0.37 and $0.18 for the three months ended June 30, 2014 and 2013, respectively.

Results of Operations for the six months ended June 30, 2014 and 2013

The following table summarizes our results of operations for the six months ended June 30, 2014 and 2013. The table and the discussion below should be read in conjunction with the consolidated financial statements and the notes thereto appearing elsewhere in this report.

Revenue

The following table sets forth a breakdown of our total sales, by region, for the six months ended June 30, 2014 and 2013.

Sales for the six months ended June 30, 2014 were $191.7 million, an increase of 39.5% from the six months ended June 30, 2013. This increase was primarily attributable to a 47.1% increased sales in our retail business as well as a 29.2% increased sales in wholesale business.

Sales generated from our wholesale business contributed 39.6% or $75.8 million of our total sales for the six months ended June 30, 2014, an increase of 29.2% compared to $58.7 million in the six months ended June 30, 2013. This increase was primarily attributable to increased sales in PRC, Germany, the United Kingdom and the United States.

Sales generated from our retail business contributed 60.4% or $115.8 million of our total sales for the six months ended June 30, 2014, an increase of 47.1% compared to $78.7 million in the six months ended June 30, 2013. This increase was primarily due to the increase in same store sales and new stores opened. We had 1055 retail stores as of June 30, 2014, compared to 831 retail stores at June 30, 2013.

Total retail store square footage and sales per square foot for the six months ended June 30, 2014 and 2013 are as follows:

Same store sales and newly opened store sales for the six months ended June 30, 2014 and 2013 are as follows:

*Primarily sales from stores that were closed in the current reporting period.

We remodeled or relocated 123 stores in 2014, and we plan to relocate or remodel 150 stores in 2014. Remodels and relocations typically drive incremental same-store sales growth. A relocation typically results in an improved, more visible and accessible location, and usually includes increased square footage. We believe we will continue to have opportunities for additional remodels and relocations beyond 2014. Same-store sales are calculated based upon stores that were open at least 12 full fiscal months in each reporting period and remain open at the end of each reporting period.

Costs and Expenses

Cost of Sales and Gross Margin

Cost of goods sold 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 goods sold 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 six months ended June 30, 2014 and 2013.

Raw material costs for our wholesale business were 47.5% of our total wholesale business sales in the six months ended June 30, 2014, compared to 44.4% in the six months ended June 30, 2013. The increase was mainly due to increased raw materials prices.

Labor costs for our wholesale business were 3.2% of our total wholesale business sales in the six months ended June 30, 2014, compared to 3.9% in the six months ended June 30, 2013. The decrease was mainly due to the fact that we outsourced most of the new orders in 2014.

Outsourced manufacturing costs for our wholesale business were 29.6% of our total sales in the six months ended June 30, 2014, compared to 28.8% in the six months ended June 30, 2013. This increase was primarily attributable to increased average salaries of the employees in our outsourced manufacturing factories.

Overhead and other expenses for our wholesale business accounted for 0.4% and 0.5% of our total sales for the six months ended June 30, 2014 and 2013 respectively.

Gross profit in our wholesale business for the six months ended June 30, 2014 was $14.7 million, an increase of 11.1% compared to the six months ended June 30, 2013. As a percentage of wholesale sales, gross profit accounted for 19.4% of our total wholesale sales for the six months ended June 30, 2014, a decrease of 3.1% compared to 22.5% for the six months ended June 30, 2013. The decrease was mainly due to increased raw materials prices and outsourced manufacturing costs.

Production costs for our retail business were $33.8 million during the six months ended June 30, 2014 versus $24.5 million during the six months ended June 30, 2013. As a percentage of total retail sales, Production costs for our retail business were 29.2% of our total retail sales during the six months ended June 30, 2014, a decreased of 1.9% compared to 31.1% during the six months ended June 30, 2013. The decrease was due to our procurement cost controlling in the six months ended June 30, 2014 being better than the same period of the prior year.

Rent costs for our retail business were $41.6 million or 35.9% of our total retail sales during the six months ended June 30, 2014 versus $27.7 million or 35.1% during the six months ended June 30, 2013.

Gross profit in our retail business for the six months ended June 30, 2014 was $40.5 million and gross margin was 34.9%. Gross profit in our retail business for the six months ended June 30, 2013 was $26.6 million and gross margin was 33.7%.

Total cost of sales for the six months ended June 30, 2014 was $136.6 million, an increase of 39.8% compared to the six months ended June 30, 2013. As a percentage of total sales, cost of sales increased to 71.2% for the six months ended June 30, 2014, compared to 71.1% for the six months ended June 30, 2013. Consequently, gross margin decreased to 28.8% for the six months ended June 30, 2014 from 28.9% for the six months ended June 30, 2013.

We purchase the majority of our raw materials directly from numerous local fabric and accessories suppliers. For our wholesale business, purchases from our five largest suppliers represented approximately 20.9% and 22.9% of raw material purchases for the six months ended June 30, 2014 and 2013, respectively. No one supplier provided more than 10.0% of our raw material purchases for the six months ended June 30, 2014 and 2013. For our retail business, purchases from our five largest suppliers represented approximately 29.8% and 31.0% of raw material purchases for the six months ended June 30, 2014 and 2013 respectively. No one supplier provided more than 10% of our total purchases for the six months ended June 30, 2014 and 2013. We have not experienced difficulty in obtaining raw materials essential to our business, and we believe we maintain good relationships with our suppliers.

We also purchase finished goods from contract manufacturers. For our wholesale business, purchases from our five largest contract manufacturers represented approximately 46.8 and 46.6% of finished goods purchases for the six months ended June 30, 2014 and 2013 respectively. Two contract manufacturers provided approximately 16.0% and 10.3% of our finished goods purchases for the six months ended June 30, 2014. Two contract manufacturers provided approximately 15.4% and 13.1% of our finished goods purchases for the six months ended June 30, 2013. For our retail business, our five largest contract manufacturers represented approximately 20% and 16.0% of finished goods purchases for the six months ended June 30, 2014 and 2013, respectively. One manufacturer provided approximately 11.0% of our finished goods purchases for the six months ended June 30, 2014. No manufacturer provided more than 10% of our finished goods purchases for the six months ended June 30, 2013. We have not experienced difficulty in obtaining finished products from our contract manufacturers and we believe we maintain good relationships with our contract manufacturers.

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 costs of sales.

Selling expenses were $30.5 million in the six months ended June 30, 2014, an increase of 40.4% or $8.8 million compared to the six months ended June 30, 2013. The increase was attributable to increased average salaries, and increased number of stores, leading to increased number of retail employees, as well as increased store decoration and marketing expenses associated with the promotion of LA GO GO brand.

General and administrative expenses were $13.9 million in the six months ended June 30, 2014, an increase of 39.5% compared to the six months ended June 30, 2013. As a percentage of total sales, general and administrative expenses were 7.3% of total sales for the six months ended June 30, 2014 and 2013.

Income from Operations

Income from operations increased 32.8% to $10.7 million for the six months ended June 30, 2014 from $8.0 million for the six months ended June 30, 2013. This increase was due to our increased gross profit.

Interest Expense

Interest expense was $1.5 million for the six months ended June 30, 2014 and 2013 respectively.

Change in fair value of derivative liability

Change in fair value of derivative liability was a gain of $0.29 million, based on the Binnomial Lattice model, for the six months ended June 30, 2013. This related to outstanding warrants, which expired in June 2013 (described in Note 5 to the financial statements).

Income Tax Expenses

Income tax expense for the six months ended June 30, 2014 was $2.8 million, an increase of 87.0% compared to the same period of 2013. This increase was primarily due to increased profits of LA GO GO.

Net Income

Net income for the six months ended June 30, 2014 was $7.9 million, an increase of 36.5% compared to the same period in 2013. Our diluted earnings per share were $0.54 and $0.39 for the six months ended June 30, 2014 and 2013, respectively.

Summary of Cash Flows

Net cash provided by operating activities was $2.80 million for the six months ended June 30, 2014, compared with $5.12 million during the six months ended June 30, 2013. The decrease was primarily due to a decrease in Accounts payable.

Net cash used in investing activities was $4.2 million for the six months ended June 30, 2014, compared with $4.6 million during the six months ended June 30, 2013. The decrease was mainly due to decreased equipment purchases.

Net cash used in financing activities was $1.3 million for the six months ended June 30, 2014, compared with net cash provided by financing activities of $6.1 million during the six months ended June 30, 2013. During the six months ended June 30, 2014, we repaid $71.3 million of bank loans and received bank loan proceeds of $73.7 million. Also, under the counter-guarantee agreement, we advanced $5.1 million to the related party and received $1.3 million Interest income from the related party during the six months ended June 30, 2014.

Liquidity and Capital Resources

As of June 30, 2014, we had cash and cash equivalents of $25.0 million, other current assets of $151.1 million and current liabilities of $137.3 million. We presently finance our operations primarily from cash flows from operations and bank loans and we anticipate that these will continue to be our primary sources of funds to finance our short-term cash needs.

Bank Loans

On January 1, 2014, Goldenway entered into a line of credit agreement with Industrial and Commercial Bank of China, which allows the Company to borrow up to approximately $6.50 million (RMB40 million). These loans are collateralized by the Company’s property and equipment. As of June 30, 2014, Goldenway had borrowed $6.50 million (RMB40 million) under this line of credit with an annual interest rate of 6.24% and due on various dates from March to April 2015.

On January 1, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $6.50 million (RMB40 million) with Industrial and Commercial Bank of China and guaranteed by Goldenway. As of June 30, 2014, Ever-Glory Apparel had borrowed $4.79 million (RMB 29.5 million) under this line of credit with an annual interest rate of 5.6% and due on various dates from November to December 2014. Ever-Glory Apparel had also borrowed $1.67 million from Industrial and Commercial Bank of China with annual interest rates ranging from 1.02% to 1.04% and due on various dates from July to October 2014, and collateralized by approximately $2.24 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $0.04 million was unused and available under this line of credit.  Approximately $0.44 million was repaid subsequent to June 30, 2014.

On June 14, 2013, Goldenway entered into a line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $8.12 million (RMB50 million). These loans are guaranteed by Jiangsu Ever-Glory International Group Corp. (“Jiangsu Ever-Glory”), an entity controlled by Mr. Kang, the Company’s Chairman and Chief Executive Officer. These loans are also collateralized by the Company’s property and equipment. As of June 30, 2014, Goldenway had borrowed $4.06 (RMB25 million) under this line of credit from Nanjing Bank with an annual interest rate of 6.16% due on August 2014. At June 30, 2014, approximately $4.06 million was unused and available under this line of credit. Approximately $4.06 million was repaid subsequent to June 30, 2014.

On June 14, 2013 and renewed on July 6, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $9.74 million (RMB60 million) with Nanjing Bank and guaranteed by Jiangsu Ever-Glory, Mr. Kang and Goldenway. As of June 30, 2014, Ever-Glory Apparel had borrowed $1.62 million (RMB 10 million) under this line of credit with an annual interest rate of 6.6% and due on September 2014. Ever-Glory Apparel had also borrowed $2.30 million from Nanjing Bank with annual interest rate of 3.1% and due on various dates from July to September 2014, and collateralized by approximately $3.16 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $5.82 million was unused and available under this line of credit.  Approximately $0.68 million was repaid subsequent to June 30, 2014.

On April 10, 2013, LA GO GO entered into a revolving line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $3.25 million (RMB20 million). The line of credit is guaranteed by Mr. Kang. As of June 30, 2014, LA GO GO had borrowed $2.44 million (RMB15 million) under this line of credit with an annual interest rate of 6.16% and due on various dates from July to October 2014. At June 30, 2014, approximately $0.81 million (RMB5 million) was unused and available under this line of credit. Approximately $0.81 million was repaid subsequent to June 30, 2014.

On January 29, 2014, Ever-Glory Apparel entered into a line of credit agreement for approximately $8.44 million (RMB52 million) with the Bank of Communications and collateralized by assets of Jiangsu Ever-Glory’s equity investee, Nanjing Knitting, under a collateral agreement executed among the Company, Jiangsu Ever-Glory, Nanjing Knitting and the bank. As of June 30, 2014, Ever-Glory Apparel had borrowed $4.06 million (RMB25 million) with an annual interest rate of 6.9% and due on various dates from February to March 2015. Ever-Glory Apparel had also borrowed $1.87 million from the Bank of Communications with an annual interest rates ranging from 3.82% to 5.75% and due in February 2015, and collateralized by approximately $2.51 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $2.51 million was unused and available under this line of credit.

On July 16, 2013, LA GO GO entered into a line of credit agreement for approximately $3.57 million (RMB22 million) with the Bank of Communications and guaranteed by Jiangsu Ever-Glory and Mr. Kang. As of June 30, 2014, LA GO GO had borrowed $3.25 million (RMB20 million) from the Bank of Communications with an annual interest rate of 6.3% and due in June 2015. At June 30, 2014, approximately $0.32 million was unused and available under this line of credit.

On September 1, 2013, Ever-Glory Apparel entered into a line of credit agreement for approximately $11.37 million (RMB70 million) with Everbright Bank, and collateralized by assets of Jiangsu Ever-Glory, This loan is also guaranteed by Goldenway and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $3.25 million (RMB20.0 million) from Everbright Bank, with an annual interest rate of 6.3% and due in October 2014. Ever-Glory Apparel had also borrowed $2.98 million from Everbright Bank with annual interest rate of 2.98% and due in August 2014, and collateralized by approximately $3.98 million of accounts receivable from wholesale customers. At June 30, 2014, approximately $5.14 million was unused and available under this line of credit. Approximately $3.98 million was repaid subsequent to June 30, 2014.

On July 29, 2011, Ever-Glory Apparel and Perfect Dream collectively entered into a secured banking facility agreement for a combined revolving import facility, letter of credit, invoice financing facilities and a credit line for treasury products of up to $7.0 million with the Nanjing Branch of HSBC (China) Company Limited (“HSBC”). This agreement is guaranteed by the Company and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $5.55 million from HSBC with an annual interest rates ranging from 2.78% to 5.88%, due on various dates from July to September 2014, and collateralized by approximately $7.9 million of accounts receivable from wholesale customers. These bank loans are to be repaid upon receipt of payments from customers. As of June 30, 2014, approximately $1.45 million was unused and available.

On November 11, 2013, Ever-Glory Apparel entered into a line of credit agreement for approximately $5.68 million (RMB35 million) with the Bank of China and guaranteed by Jiangsu Ever-Glory and Mr. Kang. As of June 30, 2014, Ever-Glory Apparel had borrowed $1.62 million (RMB10 million) with an annual interest rate of 6.05% and due in October 2014 under this line of credit. Ever-Glory Apparel had also borrowed $3.49 million ($1.6 million and RMB 11.6 million) from the Bank of China with annual interest rates ranging from 3.62% to 3.9% and due on various dates from July to August 2014, and collateralized by approximately $4.99 million of accounts receivable from wholesale customers. Approximately $1.60 million was repaid subsequent to June 30, 2014.  As of June 30, 2014, approximately $0.57 million was unused and available.

As of June 30, 2014, LA GO GO had borrowed $3.25 million (RMB 20 million) from China Minsheng Bank, with annual interest rate of 6.3% and due in August 2014. This loan is guaranteed by Ever-Glory Apparel and Mr. Kang.

As of June 30, 2014, Ever-Glory Apparel had borrowed $2.68 million from Ping An Bank, with annual interest rate of 3.9% and due on various dates from July to September 2014, and collateralized by approximately $3.83 million of accounts receivable from wholesale customers. Approximately $1.0 million was repaid subsequent to June 30, 2014.

All bank loans are used to fund our daily operations.

Amounts due from related party

In March 2012, in consideration of the guarantees and collateral provided by Jiangsu Ever-Glory and Nanjing Knitting, the Company agreed to provide Jiangsu Ever-Glory a counter guarantee in the form of cash of not less than 70% of the maximum aggregate lines of credit obtained by the Company. Jiangsu Ever-Glory is obligated to return the full amount of the counter-guarantee funds provided upon expiration or termination of the underlying lines of credit and is to pay annual interest at the rate of 6.0% of amounts provided. As of June 30, 2014 and December 31, 2013, Jiangsu Ever-Glory has provided guarantees for approximately $48.72 million (RMB 300 million) and $43.69 million (RMB 269 million) of lines of credit obtained by the Company. Jiangsu Ever-Glory and Nanjing Knitting have also provided their assets as collateral for certain of these lines of credit. The value of the collateral, as per appraisals obtained by the banks in connection with these lines of credit is approximately $16.72 million (RMB 103 million) as of June 30, 2014 and December 31, 2013. Mr. Kang has also provided a personal guarantee for $30.5 million (RMB 188 million). During six months ended June 30, 2014, an additional $5.03 million (RMB 31 million) was provided and approximately $1.30 million (RMB 8 million) of interest income was received under the counter-guarantee agreement. As of June 30, 2014, the amount of the counter-guarantee was $21.7 million (RMB 134 million) (the difference represents currency exchange adjustment of $0.12 million), which was 44.54% of the aggregate amount of lines of credit. This amount plus accrued interest of $1.50 million have been classified as a reduction of equity, consistent with the guidance of SEC Staff Accounting Bulletins 4E and 4G.

Shanghai Weiwen Fashion Company Ltd. (Shanghai Weiwen) was incorporated in the PRC in 2012. This company designs and sells women’s apparel utilizing the “Velwin” brand. Shanghai Weiwen is owned by Mr. Kang. Shanghai Ya Lan entered an agreement with Shanghai Weiwen in April 2014 to purchase the “Velwin” brand along with existing inventory of Shanghai Weiwen. No customer relationships, production facilities or other operating assets were acquired. Management of the Company believes that this asset purchase will provide the Company with additional multi-brand advantages. The purchase price of the inventory and brand was approximately $2.44 million. The purchase price was based primarily on the estimated fair market value of the inventory.

Shanghai Sea to Sky Fashion Company Ltd. (Shanghai Sea to Sky) was incorporated in the PRC in 2012. This company designs and sells women’s apparel utilizing the “Sea to Sky” brand. Shanghai Sea to Sky is owned by Mr. Kang. Shanghai LA GO GO entered an agreement with Shanghai Sea to Sky in April 2014 to purchase the “Sea to Sky” brand along with existing inventory of Shanghai Sea to Sky. No customer relationships, production facilities or other operating assets were acquired. Management of the Company believes that this asset purchase will provide the Company with additional multi-brand advantage. The purchase price of the inventory and brand was approximately $0.39 million. The purchase price was based primarily on the estimated fair market value of the inventory. 

Capital Commitments

We have a continuing program for the purpose of improving our manufacturing facilities and extending our LA GO GO stores. We anticipate that cash flows from operations and borrowings from banks will be used to pay for these capital commitments.

Uses of Liquidity

Our cash requirements for the next twelve months will be primarily to fund daily operations and the growth of our business, some of this being used to fund new stores.

Sources of Liquidity

Our primary sources of liquidity for our short-term cash needs are expected to be from cash flows generated from operations, and cash equivalents currently on hand. We believe that we will be able to borrow additional funds if necessary.

We believe our cash flows from operations together with our cash and cash equivalents currently on hand will be sufficient to meet our needs for working capital, capital expenditure and other commitments for the next twelve months. No assurance can be made that additional financing will be available to us if required, and adequate funds may not be available on terms acceptable to us. If funding is insufficient at any time in the future, we will develop or enhance our products or services and expand our business through our own cash flows from operations.

As of June 30, 2014, we had access to $70.2 million in lines of credit, of which $20.7 million was unused and is currently available. These credit facilities do not include any covenants.

Foreign Currency Translation Risk

Our operations are, for the most part, located in the PRC, which may give rise to significant foreign currency risks from fluctuations and the degree of volatility of foreign exchange rates between the United States dollar and the Chinese RMB. Most of our sales are in United States (U.S.) dollars. During 2003 and 2004 the exchange rate of RMB to the U.S. dollar remained constant at 8.26 RMB to the dollar. On July 21, 2005, the Chinese government adjusted the exchange rate from 8.26 to 8.09 RMB to the U.S. dollar. From that time, the RMB continued to appreciate against the U.S. dollar. As of June 30, 2014, the foreign exchange rate had increased to 6.16 RMB to one U.S. dollar. We are continuously negotiating price adjustments with most of our customers based on the daily market foreign exchange rates, which we believe will reduce our exposure to exchange rate fluctuations in the future, and we will pass some of the increased cost to our customers.

In addition, the financial statements of Goldenway, New-Tailun, Catch-Luck, Ever-Glory Apparel, Taixin, Shanghai LA GO GO, Tianjin LA GO GO, Shanghai Yalan, He meida and Jiangsu LA GO GO (whose functional currency is RMB) are translated into US dollars using the closing rate method. The balance sheet items are translated into US dollars using the exchange rates at the respective balance sheet dates. The capital and various reserves are translated at historical exchange rates prevailing at the time of the transactions while income and expense items are translated at the average exchange rate for the period. All exchange differences are recorded within equity. The foreign currency translation gain (loss) for the three and six months ended June 30, 2014 and 2013 was $356,057, $(343,382), $850,555, $1,158,392, respectively.

OFF-BALANCE SHEET ARRANGEMENTS

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our financial instruments consist of cash and cash equivalents, trade accounts receivable, accounts payable, bank loans and long-term obligations. We consider investments in highly-liquid instruments purchased with a remaining maturity of 90 days or less from the date of purchase to be cash equivalents.

Interest Rates: Our exposure to market risk for changes in interest rates relates primarily to our short-term investments and short-term obligations; thus, fluctuations in interest rates would not have a material impact on the fair value of these securities. On June 30, 2014, we had $25.0 million in cash and cash equivalents. A hypothetical 5% increase or decrease in either the short term or long term interest rates would not have any material impact on our earnings or loss, or the fair market value or cash flows of these instruments.

Foreign Exchange Rates: We pay our suppliers and employees in Chinese RMB, however, most of our wholesales customers are located in the U.S., Japan and Europe and we generate sales from them in U.S. Dollars, Euros and British Pounds. Accordingly, our business has substantial exposure to changes in exchange rates between and among the Chinese RMB, the U.S. Dollar, the Euro and the British Pound. In the last decade, the RMB has been pegged at 8.26 RMB to one U.S. Dollar. On July 21, 2005 it was revalued to 8.09 per U.S. Dollar. Following the removal of the peg to the U.S. Dollar and pressure from the United States, the People’s Bank of China also announced that the RMB would be pegged to a basket of foreign currencies, rather than being strictly tied to the U.S. Dollar, and would be allowed to float trade within a narrow 0.3% daily band against this basket of currencies. The PRC government has stated that the basket is dominated by the U.S. Dollar, Euro, Japanese Yen and South Korean Won, with a smaller proportion made up of the British Pound, Thai Baht, Russian Ruble, Australian Dollar, Canadian Dollar and Singapore Dollar. There can be no assurance that the relationship between the RMB and these currencies will remain stable over time, especially in light of the significant political pressure on the Chinese government to permit the free flotation of the RMB, which could result in greater and more frequent fluctuations in the exchange rate between the RMB, the U.S. Dollar and the Euro. On June 30, 2014, the exchange rate between the RMB and U.S. Dollar was 6.16 RMB to one U.S. Dollar. For additional discussion regarding our foreign currency risk, see the section titled Risk Factors in the Annual Report on Form 10-K for fiscal year ended on December 31, 2013. Fluctuation in the value of Chinese RMB relative to other currencies may have a material adverse effect on our business and/or an investment in our shares.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended ( the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Evaluation of Disclosure Controls and Procedures. As of June 30, 2014, the end of the fiscal quarter covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not operating effectively as of June 30, 2014. Our disclosure controls and procedures were not effective because of certain “material weaknesses” described in the “Management’s Annual Report on Internal Control over Financial Reporting” section in Item 9 of our annual report for fiscal year ended December 31, 2013. As of June 30, 2014, we had not completed the remediation of these material weaknesses.

Limitations on the Effectiveness of Disclosure Controls. Readers are cautioned that our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will necessarily prevent all fraud and material error. An internal control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any control design will succeed in achieving its stated goals under all potential future conditions.

Changes in Internal Control over Financial Reporting

Our management has worked, and will continue to work to improve our internal controls over financial reporting. During the three months ended June 30, 2014, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

We know of no pending legal proceedings to which we are a party which are material or potentially material, either individually or in the aggregate. We are from time to time, during the normal course of our business operations, subject to various litigation claims and legal disputes. We do not believe that the ultimate disposition of any of these matters will have a material adverse effect on our financial position, results of operations or liquidity.

ITEM 1A. RISK FACTORS

There has been no material change in the information provided in Item 1A of Form 10-K Annual Report for the year ended December 31, 2013 filed with the SEC on April 14, 2014.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

The following exhibits are filed herewith: