Ever-Glory International Group, Inc. - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2016

☐   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) 5209-6831

(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 ☒   No ☐

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).   ☒ Yes   ☐ 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.   ☐

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

As of November 11, 2016, 14,787,940 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

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(In thousands of U.S. Dollars, except share and per share data or otherwise stated)

AS OF SEPTEMBER 30, 2016 (UNAUDITED) AND DECEMBER 31, 2015

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)
(In thousands of U.S. Dollars, except share and per share data or otherwise stated)

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015 (UNAUDITED)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands of U.S. Dollars, except share and per share data or otherwise stated)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015 (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 NINE MONTHS ENDED SEPTEMBER 30, 2016 AND 2015

(UNAUDITED)

NOTE 1 BASIS OF PRESENTATION

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”), ChuzhouHuirui Garments Co. Ltd. (“Huirui”) 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 YaLan Fashion Company Limited (“YaLan”), Shanghai Yiduo Fashion Company Limited (“Shanghai Yiduo”) and Xizang He Meida Trading Company Limited (“He Meida”).

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 September 30, 2016, the condensed consolidated statements of income and comprehensive income (loss), and cash flows for the three and nine months ended September 30, 2016 and 2015. 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 nine months ended September 30, 2016 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, 2015. 

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.

Accounts Receivable

The Company extends unsecured credit to its customers in the ordinary course of business but mitigates the associated risks by performing credit checks and actively pursuing past due accounts.  An allowance for doubtful accounts is established and recorded based on management’s assessment of the credit history of its customers and current relationships with them. The Company writes off accounts receivable when amounts are deemed uncollectible.

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 September 30, 2016, the Company’s financial assets (all Level 1) consist of cash placed with financial institutions that management considers to be of a high quality.

As of September 30, 2016, the Company has a derivative liability 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 Ever-Glory, Perfect Dream and Ever-Glory HK is the U.S. dollar. The functional currency of Goldenway, New Tailun, Catch-luck, Ever-Glory Apparel, Shanghai LA GO GO, Jiangsu LA GO GO, Tianjin LA GO GO, Shanghai Yiduo, YaLan, He Meida, Huirui and Taixin 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 income and comprehensive income (loss) 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 (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition in Revenue Recognition (Topic 605), and requires entities to recognize revenue in a way that depicts the transfer of potential goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. This new standard is now effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and is to be applied retrospectively, with early adoption now permitted to the original effective date of December 15, 2016. The Company is currently evaluating this new standard and the potential impact this standard may have upon adoption. 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations. The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The effective date for this ASU is the same as the effective date for ASU 2014-09, Revenue from Contracts with Customers. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. ASU 2015-11 simplifies the measurement of certain inventories. Under the new guidance, inventories are required to be measured at the lower of cost and net realizable value, the latter representing the estimated selling price in the ordinary course of business, reduced by costs of completion, disposal, and transportation. Under current guidance, inventories are required to be measured at the lower of cost or market, but depending upon specific circumstances, market could refer to replacement cost, net realizable value, or net realizable value reduced by a normal profit margin. The guidance is to be applied prospectively, is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. Management is currently assessing the potential impact of this ASU on its consolidated financial statements.

In September 2015, FASB issued ASU No. 2015-16 Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments. The amendments in ASU 2015-16 require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. The Company assessed that there is no significant impact to the consolidated financial statements on this update.  

In February 2016, the FASB issued ASU No. 2016-02, Leases. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases (with the exception of short-term leases) at the commencement date. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2018. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" which modifies the measurement of expected credit losses of certain financial instruments. This ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2019. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

The Company reviews new accounting standards as issued. Management has not identified any other new standards that it believes will have a significant impact on the Company’s consolidated financial statements.

NOTE 3 INVENTORIES

Inventories at September 30, 2016 and December 31, 2015 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. Short-term bank loans consisted of the following as of September 30, 2016 and December 31, 2015.

In January 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 $9.0 million (RMB60.0 million). These loans are collateralized by the Company’s property and equipment. As of September 30, 2016, Goldenway had borrowed $6.0 million (RMB40.0 million) under this line of credit with annual interest rates ranging from 4.4% - 4.5% and due on various dates from November to December 2016. As of September 30, 2016, approximately $3.0 million was unused and available under this line of credit.

In September 2015, Ever-Glory Apparel entered into a line of credit agreement for approximately $18.0 million (RMB120.0 million) with Industrial and Commercial Bank of China and collateralized by assets of Jiangsu Ever-Glory’s equity investee, Nanjing Knitting, under a collateral agreement executed among Ever-Glory Apparel, Nanjing Knitting and the bank. As of September 30, 2016, Ever-Glory Apparel had borrowed $11.7 million (RMB 78.0 million) under this line of credit with annual interest rates ranging from 4.4% to 4.6% and due on various dates from October 2016 to September 2017. As of September 30, 2016, approximately $6.3 million was unused and available under this line of credit.

In June 2016, Goldenway entered into a line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $7.5 million (RMB50.0 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 September 30, 2016, Goldenway had borrowed $7.5 million (RMB50.0 million) under this line of credit with annual interest rates ranging from 3.3% to 3.8% and due on various dates from January to March 2017. 

In June 2016, Ever-Glory Apparel entered into a line of credit agreement for approximately $9.0 million (RMB60.0 million) with Nanjing Bank and guaranteed by Jiangsu Ever-Glory, Mr. Kang and Goldenway. As of September 30, 2016, Ever-Glory Apparel had borrowed $3.8 million from Nanjing Bank with an annual interest rates ranging from 3.7% to 4.0% and due on various dates from October to November 2016, and collateralized by approximately $4.5 million of accounts receivable from our wholesale customers. As of September 30, 2016, approximately $5.2 million was unused and available under this line of credit.

In October 2015, LA GO GO entered into a revolving line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $3.0 million (RMB20.0 million). The line of credit is guaranteed by Mr. Kang and Goldenway. As of September 30, 2016, LA GO GO had borrowed $2.2 million (RMB15.0 million) under this line of credit with an annual interest rate of 5.0% and due in January 2017. As of September 30, 2016, approximately $0.8 million (RMB5.0 million) was unused and available under this line of credit.

In January 2015, Ever-Glory Apparel and Goldenway 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 $12.6 million with the Nanjing Branch of HSBC (China) Company Limited (“HSBC”). This agreement is guaranteed by the Company and Mr. Kang. As of September 30, 2016, Ever-Glory Apparel had borrowed $7.4 million from HSBC with an annual interest rates ranging from 1.1% to 3.3% and due in October 2016, and collateralized by approximately $8.3 million of accounts receivable from our wholesale customers. These bank loans are to be repaid upon receipt of payments from customers. As of September 30, 2016, approximately $5.2 million was unused and available under this line of credit.

In June 2014, LA GO GO entered into a line of credit agreement for approximately $5.0 million (RMB33.0 million) with the Bank of Communications and guaranteed by Jiangsu Ever-Glory, Ever-Glory Apparel and Mr. Kang. As of September 30, 2016, LA GO GO had borrowed $3.0 million (RMB20.0 million) from the Bank of Communications with annual interest rates ranging from 4.6% to 5.0% and due on various dates from November 2016 to August 2017. As of September 30, 2016, approximately $2.0 million was unused and available under this line of credit.

In December 2015, LA GO GO entered into a line of credit agreement for approximately $3.0 million (RMB20.0 million) with China Minsheng Banking and guaranteed by Ever-Glory Apparel and Mr. Kang. As of September 30, 2016, LA GO GO had borrowed $3.0 million (RMB20.0 million) from China Minsheng Banking with an annual interest rate of 4.6% and due in December 2016.

In March 2016, Ever-Glory Apparel entered into a line of credit agreement for approximately $3.8 million (RMB25.0 million) with Bank of China and guaranteed by Jiangsu Ever-Glory. These loans are also collateralized by assets of Jiangsu Ever-Glory’s equity investee, ChuzhouHuarui, under a collateral agreement executed by Ever-Glory Apparel, ChuzhouHuarui and Bank of China. As of September 30, 2016, Ever-Glory Apparel had borrowed $1.5 million (RMB10.0 million) under this line of credit with annual interest rate at 4.8% and due in October 2016, and $1.1 million with an annual interest rate at 2.5% due in November 2016, collateralized by approximately $1.4 million of accounts receivable from our wholesale customers. These bank loans are to be repaid upon receipt of payments from customers. As of September 30, 2016, approximately $1.2 million was unused and available under this line of credit.

In December 2014, LA GO GO entered into a line of credit agreement for approximately $5.4 million (RMB36.0 million) with the China Citic Bank and guaranteed by Jiangsu Ever-Glory, Ever-Glory Apparel and Mr. Kang. As of September 30, 2016, LA GO GO had borrowed $1.3 million (RMB9.0 million) from the Bank of Communications with annual interest rate at 4.6% and due on December 2016. As of September 30, 2016, approximately $4.1 million was unused and available under this line of credit.

In July 2016, Ever-Glory Apparel entered into a line of credit agreement for approximately $6.0 million (RMB40.0 million) with China Everbright Bank and guaranteed by Goldenway and Mr. Kang. These loans are also collateralized by Jiangsu Ever-Glory’s property. As of September 30, 2016, Ever-Glory Apparel had borrowed $1.3 million under this line of credit with annual interest rate at 2.8% and due on November 2016, and collateralized by approximately $1.5 million of accounts receivable from wholesale customers. As of September 30, 2016, approximately $4.7 million was unused and available under this line of credit.

All loans have been repaid before or at maturity date.

Total interest expense on bank loans amounted to $0.6 million, $1.5 million, $0.6 million and $2.1 million for the three and nine months ended September 30, 2016 and 2015, respectively. 

NOTE 5 DERIVATIVE LIABILITY

As of September 30, 2016, the Company had one outstanding forward foreign exchange contracts (sell EUR dollars for RMB) with total notional amount of EUR0.65 million. As of December 31, 2015, the Company had four outstanding forward foreign exchange contracts (sell US dollars for RMB), with total notional amount of $11.1 million. The fair value of these contracts as of September 30, 2016 and December 31, 2015, as well as realized gains and losses on these foreign currency derivative activities during 2015 and the nine months ended September 30, 2016 were not significant.

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, except for He Meida, are subject to income tax at the 25% statutory rate.

He Meida incorporated in Xizang (Tibet) Autonomous Region is subject to income tax at 15% statutory rate. The local government has implemented an income tax reduction from 15% to 9% valid through December 31, 2017.

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 U.S. entity, the Company’s primary operations are through subsidiaries located in China, certain apparel manufacturing is performed outside of China in Southeast Asia, and sales are made globally. 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 its 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 $3.2 million as of December 31, 2013 based on the probability for such outcomes.

The Company and the PRC Tax Bureau have agreed that payments on the tax liability of $3.2 million should be made by the Company prospectively over the next two to three years period. Approximately $2.3 million had been paid as of September 30, 2016. 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), pre-tax income for the three and nine months ended September 30, 2016 and 2015 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 nine months ended September 30, 2016 and 2015:

Income tax expense for the three and nine months ended September 30, 2016 and 2015 is as follows:

The Company has not recorded U.S. deferred income taxes on approximately $81.8 million of its non-U.S. subsidiaries’ undistributed earnings because such amounts are intended to be reinvested outside the United States indefinitely. If these earnings were repatriated to the United States, the Company would be required to accrue and pay U.S. federal income taxes and foreign withholding taxes, as adjusted for foreign tax credits. Determination of the amount of any unrecognized deferred income tax liability on these earnings is not practicable.

NOTE 7 EARNINGS PER SHARE

The following demonstrates the calculation for earnings per share for the three and nine months ended September 30, 2016 and 2015: 

NOTE 8 STOCKHOLDERS’ EQUITY

On July 29, 2015, the Company issued an aggregate of 854 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 2014. The shares were valued at $5.91 per share, which was the average market price of the common stock for the five days before the grant date.

On July 29, 2015, the Company issued an aggregate of 920 shares of its common stock to two of the Company’s independent directors as compensation for their services in the first and second quarters of 2015. The shares were valued at $5.39 per share, which was the average market price of the common stock for the five days before the grant date.

On April 29, 2016, the Company issued an aggregate of 2,072 shares of its common stock to two of the Company’s independent directors as compensation for their services in the third and fourth quarters of 2015. The shares were valued at $2.43 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. Ever-Glory Enterprises (HK) Ltd. (Ever-Glory Enterprises) is the Company’s major shareholder. Mr. Xiaodong Yan was Ever-Glory Enterprises’ sole shareholder and sole director. Mr. Huake Kang, Mr. Kang’s son, acquired 83% interest of Ever-Glory Enterprises and became its sole director in 2014. All transactions associated with the following companies controlled by Mr. Kang or his son 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

Jiangsu Wubijia Trading Company Limited (“Wubijia”) is an entity engaged in high-grade home goods sales and is controlled by Mr. Kang. Wubijia has sold their home goods on consignment in certain Company’s retail stores since the third quarter of 2014. During the three and nine months ended September 30, 2016 and 2015, the Company received $9,747, $21,002, $14,065 and $23,851 from the customers and paid $6,483, $16,768, $11,283 and $20,383 to Wubijia through the consignment, respectively. The net (loss) profit of $3,264, $4,234, $2,782 and $3,468 was recorded as other income (expenses) during the three and nine months ended September 30, 2016 and 2015, respectively. 

Nanjing Knitting Company Limited (“Nanjing Knitting”) is an entity engaged in knitted fabric products and knitting underwear sales and is controlled by Mr. Kang. Nanjing Knitting has sold their knitting underwear on consignment in some Company’s retail stores since the third quarter of 2015. During the three and nine months ended September 30, 2016, the Company received $21,944 and $122,783 from the customers and paid $16,085 and $101,531 to Nanjing Knitting through the consignment, respectively. The net profit of $5,859 and $21,252 was recorded as other income during the three and nine months ended September 30, 2016. During the nine months ended September 30, 2015, the Company received other income $52,945 from customers and paid $42,770 to Nanjing Knitting through the Consignment, respectively. The net profit of $10,175 was recorded as other income during nine months ended September 30, 2015.

Included in other income for the three and nine months ended September 30, 2016 and 2015 is rent income from EsC’Lav, the entity controlled by Mr. Kang under operating lease agreement with term though 2016. The rent income is $16,022, $48,455, $15,613 and $50,718 for the three and nine months ended September 30, 2016 and 2015, respectively.

Other expenses due to Related Parties

Included in other expenses for the three and nine months ended September30, 2016 and 2015 are rent costs due to entities controlled by Mr. Kang under operating lease agreements as follows:

The Company leases Jiangsu Ever-Glory's factory as the factory is in a location where there is a good supply of experienced workers. The Company leases ChuzhouHuarui and KunshanEnjin's warehouse spaces because the locations are convenient for transportation and distribution.

Purchases from and Sub-contracts with Related Parties

The Company purchased raw materials from Nanjing Knitting totaling $0.11 million, $0.45 million, $0.07 million and $0.76 million during the three and nine months ended September 30, 2016 and 2015, respectively.

In addition, Sub-contracts with related parties included in cost of sales for the three and nine months ended September 30, 2016 and 2015 are as follows:

Accounts Payable – Related Parties

The accounts payable to related parties at September 30, 2016 and December 31, 2015 are as follows:

Amounts Due From Related Parties-current assets

The amounts due from related parties as of September 30, 2016 and December 31, 2015 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. During three and nine months ended September 30, 2016 and 2015, 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 a cost of $2.1 million and $3.9 million during the nine-month period ended September 30, 2016 and 2015, respectively. Jiangsu Ever-Glory purchased raw materials on the Company’s behalf and sold to the Company at a cost of $0.5 million and $0.1 million during the nine months ended September 30, 2016 and 2015, 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 more 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 September 30, 2016 and December 31, 2015, Jiangsu Ever-Glory has provided guarantees for approximately $54.6 million (RMB364 million) (2016) and $52.2 million (RMB339 million) (2015) of lines of credit obtained by the Company. Jiangsu Ever-Glory, ChuzhouHuarui 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 $31.0 million (RMB206 million) (2016) and $22.8 million (RMB148 million) (2015) as of September 30, 2016 and December 31, 2015, respectively.  Mr. Kang has also provided a personal guarantee for $31.3 million (RMB209 million).

As of December 31, 2015, $18.8 million (RMB122 million) was outstanding due from Jiangsu Ever-Glory under the counter guarantee agreement. During the nine months ended September 30, 2016, repayment of $1.8 million (RMB12 million) was received from and $1.2 million (RMB8 million) paid to Jiangsu Ever-Glory under the counter-guarantee. As of September 30, 2016, the amount of the counter-guarantee was $17.7 million (RMB118 million) (the difference represents currency exchange adjustment of $0.5 million), which was 32.5% of the aggregate amount of lines of credit. This amount plus accrued interest of $3.6 million have been classified as a reduction of equity, consistent with the guidance of SEC Staff Accounting Bulletins 4E and 4G. At September 30, 2016 and 2015, the amount classified as a reduction of equity was $21.3 million and $21.8 million, respectively. Interest of 0.5% is charged on net amounts due from Jiangsu Ever-Glory at each month end. Since April 1, 2015, interest rate has changed to 0.41% as the bank benchmark interest rate decreased. Interest income for the three and nine months ended September 30, 2016 and 2015 was approximately $0.2 million, $0.6 million, $0.2 million and $0.7 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. The allowance for doubtful accounts at September 30, 2016 and December 31, 2015 was $3.1 million and $2.2 million, respectively. 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 nine-month period ended September 30, 2016, the Company had no wholesale customer that represented more than 10% of the Company’s revenues. For the three-month period ended September 30, 2016, the Company had one wholesale customer that represented approximately 12% of the Company’s revenues. For the nine-month period ended September 30, 2015, the Company had one wholesale customer that represented approximately 11% of the Company’s revenues. For the three-month period ended September 30, 2015, the Company had one wholesale customer that represented approximately 16% of the Company’s revenues.

For the Company’s wholesale business during the three and nine months ended September 30, 2016 and 2015, no supplier represented more than 10% of the total raw materials purchased.

For the Company’s retail business, the Company had one supplier that represented approximately 23% of raw materials purchases during the three months ended September 30, 2016. The Company had no supplier that represented more than 10% of raw materials purchases during the three months ended September 30, 2015. The Company had no supplier that represented more than 10% of raw materials purchases during the nine months ended September 30, 2016 and 2015.

For the wholesale business, during the nine months ended September 30, 2016, the Company relied on two manufacturers for 26.6% and 11.6% of purchased finished goods. For the wholesale business, during the nine months ended September 30, 2015, the Company relied on one manufacturer for 19.5% of purchased finished goods. During the three months ended September 30, 2016, the Company relied on one manufacturer for 29.2% of purchased finished goods. During the three months ended September 30, 2015, the Company relied on one manufacturer for 15% of purchased finished goods. 

For the retail business, the Company had no supplier that represented more than 10% of finished goods purchases during the three and nine months ended September 30, 2016 and 2015.

The Company’s revenues for the three and nine months ended September 30, 2016 and 2015 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

The Company also provides general corporate services to its segments and these costs are reported as “corporate and others”:

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

The following discussion and analysis of our financial condition and results of operations for the three and nine months ended September 30, 2016 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 retailer of branded fashion apparel and leading global apparel supply chain solution provider based in China. We are listed on the NASDAQ Global Market 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 domestically and international recognized 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 end casual wear, sportswear, and outerwear brands. Our retail business consists of retail-channel sales directly to consumers through retail stores located throughout the PRC as well as sales via online stores at Tmall, Dangdang mall, JD.com, VIP.com and etc.

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 seven 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, Jiangsu province, China, Chuzhou, Anhui province, China and Samoa: 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”), ChuzhouHuirui Garments Co., Ltd. (“Huirui), Nanjing Tai Xin Garments Trading Company Limited (“Tai Xin”) and Ever-Glory International Group (HK) Ltd. (“Ever-Glory HK”).

Retail Business

We conduct our retail operations through Shanghai LA GO GO Fashion Company Limited (“LA GO GO”), Jiangsu LA GO GO Fashion Company Limited (“Jiangsu LA GO GO”), Tianjin LA GO GO Fashion Company Limited (“Tianjin LA GO GO”), Shanghai YaLan Fashion Company Limited (“YaLan”), 78% owned subsidiary Shanghai Yiduo Fashion Company Limited (“Shanghai Yiduo”) 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 and 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 objectives for our retail segment are to establish leading brands of women’s apparel and to build a nationwide retail network in China. As of September 30, 2016, we had 1,345 stores (including store-in-stores), including 273 stores were opened and 87 stores were closed during the nine months ended September 30, 2016.

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 good payment track records, we generally provide payment terms between 30 to 180 days following the 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 on the same day of the register receipt. For sales from e-commerce platforms such as Tmall, Dangdang mall, JD.com, VIP.com and etc., we generally receive payments 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 the slowdown of economies in China, the United States and Europe 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 2016.

In addition, economic conditions in China and other foreign markets in which we operate could substantially affect our sales profitability, 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 net of promotional discounts, rebates, and return allowances. Retail store sales are recognized at the time of the register receipt. Retail online sales are recognized when products are shipped and customers receive the products because we retain a portion of the risk of loss on these sales during transit.

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 2016 and 2015 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 (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which supersedes the revenue recognition in Revenue Recognition (Topic 605), and requires entities to recognize revenue in a way that depicts the transfer of potential goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to in exchange for those goods or services. This new standard is now effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and is to be applied retrospectively, with early adoption now permitted to the original effective date of December 15, 2016. The Company is currently evaluating this new standard and the potential impact this standard may have upon adoption. 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations. The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The effective date for this ASU is the same as the effective date for ASU 2014-09, Revenue from Contracts with Customers. The Company is currently assessing the potential impact of this ASU on its consolidated financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory: Simplifying the Measurement of Inventory. ASU 2015-11 simplifies the measurement of certain inventories. Under the new guidance, inventories are required to be measured at the lower of cost and net realizable value, the latter representing the estimated selling price in the ordinary course of business, reduced by costs of completion, disposal, and transportation. Under current guidance, inventories are required to be measured at the lower of cost or market, but depending upon specific circumstances, market could refer to replacement cost, net realizable value, or net realizable value reduced by a normal profit margin. The guidance is to be applied prospectively, is effective for fiscal years beginning after December 15, 2016, with early adoption permitted. Management is currently assessing the potential impact of this ASU on its consolidated financial statements.

In September 2015, FASB issued ASU No. 2015-16 Business Combinations: Simplifying the Accounting for Measurement-Period Adjustments. The amendments in ASU 2015-16 require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments are effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this update with earlier application permitted for financial statements that have not been issued. The Company assessed that there is no significant impact to the consolidated financial statements on this update.

In February 2016, the FASB issued ASU No. 2016-02, Leases. Under the new guidance, lessees will be required to recognize a lease liability and a right-of-use asset for all leases (with the exception of short-term leases) at the commencement date. The ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2018. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" which modifies the measurement of expected credit losses of certain financial instruments. This ASU is effective for fiscal years and interim periods within those years beginning after December 15, 2019. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

Results of Operations for the three months ended September 30, 2016 and 2015

The following table summarizes our results of operations for the three months ended September 30, 2016 and 2015. 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 September 30, 2016 and 2015. 

Sales for the three months ended September 30, 2016 were $109.9 million, a 7.3% decrease compared with the three months ended September 30, 2015. This decrease was primarily attributable to a 3.4% decrease in sales in our wholesale business and a 13.2% decrease in our retail business.

Sales generated from our wholesale business contributed 62.7% or $68.9 million of our total sales for the three months ended September 30, 2016, a 3.4% decrease compared with $71.3 million in the three months ended September 30, 2015. This decrease was primarily attributable to a decrease in sales in Mainland China, the United Kingdom and Japan, partially offset by anincrease in sales in Hong Kong, China, Germany, Europe-Other and the United States. 

Sales generated from our retail business contributed 37.3% or $41.1 million of our total sales for the three months ended September 30, 2016, a 13.2% decrease compared with 39.9% or $47.3 million in the three months ended September 30, 2015. This decrease was primarily due to a decrease in same store sales.

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 September 30, 2016 and 2015.

Raw material costs for our wholesale business were 45.7% of our total wholesale business sales in the three months ended September 30, 2016, compared with 46.6% in the three months ended September 30, 2015. The decrease was mainly due to lower raw material prices.

Labor costs for our wholesale business were 1.9% of our total wholesale business sales in the three months ended September 30, 2016, compared with 2.2% in the three months ended September 30, 2015. The marginal decrease was mainly due to a higher number of outsourced orders in 2016.

Outsourced production costs for our wholesale business for the three months ended September 30, 2016 decreased 2.1% to $25.9 million from $26.5 million for the three months ended September 30, 2015. Outsourced production costs accounted for 37.6% of our total wholesale business sales in the three months ended September 30, 2016, a 0.5% increase from the three months ended September 30, 2015. This increase was primarily attributable to higher average employee salaries at our outsourced manufacturing factories.

Overhead and other expenses for our wholesale business accounted for 0.2% of our total wholesale business sales for the three months ended September 30, 2016, compared with 0.2% of total wholesale business sales for the three months ended September 30, 2015.

Wholesale business gross profit for the three months ended September 30, 2016 was $10.1 million compared with $9.9 million for the three months ended September 30, 2015. Gross profit accounted for 14.6% of our total wholesale sales for the three months ended September 30, 2016, compared with 13.9% for the three months ended September 30, 2015. The increase was mainly due to a decrease in raw material costs.

Production costs for our retail business were $11.1 million for the three months ended September 30, 2016 compared with $12.6 million during the three months ended September 30, 2015. Retail production costs accounted for 27.1% of our total retail sales in the three months ended September 30, 2016, compared with 26.6% for the three months ended September 30, 2015. The increase was due to higher discounts on our out-of-season products in the three months ended September 30, 2016 compared with the same period of the prior year.

Rent costs for our retail business for the three months ended September 30, 2016 were $10.4 million compared with $12.3 million for the three months ended September 30, 2015. Rent costs for our retail business accounted for 25.2% of our total retail sales for the three months ended September 30, 2016, compared with 25.9% for the three months ended September 30, 2015. The decrease was primarily attributable to lower variable rent charged at certain locations.

Gross profit in our retail business for the three months ended September 30, 2016 was $19.6 million and gross margin was 47.6%. Gross profit in our retail business for the three months ended September 30, 2015 was $22.4 million and gross margin was 47.5%.

Total cost of sales for the three months ended September 30, 2016 was $80.3 million, a 6.9% decrease from $86.3 million for the three months ended September 30, 2015. Total cost of sales as a percentage of total sales for the three months ended September 30, 2016 was 73.1%, compared with 72.7% for the three months ended September 30, 2015. Gross margin for the three months ended September 30, 2016 was 26.9% compared with 27.3% for the three months ended September 30, 2015.

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 for the three months ended September 30, 2016 decreased 3.5% to $18.5 million from $19.2 million for the three months ended September 30, 2015. The decrease was attributable to lower retail sales and decreased store management expense. 

General and administrative expenses for the three months ended September 30, 2016 increased 5.7% to $9.8 million from $9.3 million for the three months ended September 30, 2015. The increase was mainly attributable to an increase of $1.9 million for bad-debt expense for the three months ended September 30, 2016 compared with the three months ended September 30, 2015. 

Income from Operations

Income from operations for the three months ended September 30, 2016 decreased 67.7% to $1.2 million from $3.8 million for the three months ended September 30, 2015. Income from operations for the three months ended September 30, 2016 accounted for 1.1% of our total sales, a 2.1% decrease compared with the three months ended September 30, 2015 as a result of decreased gross profit.

Interest Expense

Interest expense for the three months ended September 30, 2016 was $0.6 million, a 1.4% increase compared with the same period in 2015.

Income Tax Expenses

Income tax expense for the three months ended September 30, 2016 was $0.7 million, a decrease of 32% compared to the same period of 2015. The decrease was primarily due to decreased profits of our business.

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, except for He Meida, are subject to the 25% income tax rate.

He Meida incorporated in Xizang (Tibet) Autonomous Region is subject to income tax at the 15% statutory rate. The local government has implemented an income tax reduction from 15% to 9% valid through December 31, 2017.

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

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

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 Hong Kong, 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 $3.2 million as of December 31, 2013 based on the probability for such outcomes.

The Company and the PRC Tax Bureau have agreed that payments on the tax liability of $3.2 million should be made by the Company prospectively over the next two to three years period. Approximately $2.3 million has been paid as of September 30, 2016. 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 September 30, 2016. The net operating loss carry forwards for the United States income taxes may be available to reduce future years’ taxable income. These carry forwards will expire, if not utilized, through 2035. Management believes that the realization of the benefits from these losses is uncertain due to our limited operating history and continuing losses for the United States income tax purposes. Accordingly, we provided a 100% valuation allowance on the deferred tax asset to reduce the asset to zero.

Net Income

Net income for the three months ended September 30, 2016 was $0.4 million, an 84.9% decrease compared with the same period in 2015. Our basic and diluted earnings per share were $0.04 and $0.19 for the three months ended September 30, 2016 and 2015, respectively.

Results of Operations for the nine months ended September 30, 2016 and 2015

The following table summarizes our results of operations for the nine months ended September 30, 2016 and 2015. 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 nine months ended September 30, 2016 and 2015.

Sales for the nine months ended September 30, 2016 were $282.3 million, a decrease of 3.4% from the nine months ended September 30, 2015. This decrease was primarily attributable to a 9.4% decrease in sales in our retail business partially offset bya 3.6% sales increase in our wholesale business.

Sales generated from our wholesale business contributed 49.3% or $139.2 million of our total sales for the nine months ended September 30, 2016, an increase of 3.6% compared with $134.4 million in the nine months ended September 30, 2015. This increase was primarily attributable to increased sales in Hong Kong, China, Europe-Other and the United States partially offset by decreased sales in Mainland China, Germany, the United Kingdom and Japan. 

Sales generated from our retail business contributed 50.7% or $143.1 million of our total sales for the nine months ended September 30, 2016, a decrease of 9.4% compared with $157.8 million in the nine months ended September 30, 2015. This decrease was primarily due to a decrease in same store sales.

Total retail store square footage and sales per square foot for the nine months ended September 30, 2016 and 2015 are as follows:

Same-store sales and newly opened store sales for the nine months ended September 30, 2016 and 2015 are as follows:

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

We remodeled or relocated 216 stores in 2015, and 168 stores during the nine months ended September 30, 2016.We plan to relocate or remodel an aggregate of 150-200 stores in 2016. 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 2016.  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 nine months ended September 30, 2016 and 2015.

Raw material costs for our wholesale business were 44.5% of our total wholesale business sales in the nine months ended September 30, 2016, compared with 45.2% in the nine months ended September 30, 2015. The decrease was mainly due to lower raw materials prices.

Labor costs for our wholesale business were 2.8% of our total wholesale business sales in the nine months ended September 30, 2016, compared with 3.3% in the nine months ended September 30, 2015. The marginal decrease was mainly due to a higher number of outsourced orders in the nine months ended September 30, 2016.

Outsourced manufacturing costs for our wholesale business were 36.3% of our total wholesale sales in the nine months ended September 30, 2016, compared with 33.8% in the nine months ended September 30, 2015. This increase was primarily attributable to increased average salaries of the employees at our outsourced manufacturing factories.

Overhead and other expenses for our wholesale business accounted for 0.3% and 0.3% of our total wholesale sales for the nine months ended September 30, 2016 and 2015, respectively.

Gross profit for our wholesale business for the nine months ended September 30, 2016 was $22.4 million, a 3.9% decrease compared with the nine months ended September 30, 2015. As a percentage of total wholesale business sales, gross profit was 16.1% of our total wholesale business sales for the nine months ended September 30, 2016, compared with 17.3% for the nine months ended September 30, 2015. The decrease was mainly due to increased outsourced manufacturing costs.

Production costs for our retail business for the nine months ended September 30, 2016 were $45.2 million compared with $43.1 million for the nine months ended September 30, 2015. As a percentage of our total retail sales, production costs were 31.6% of our total retail sales for the nine months ended September 30, 2016, compared with 27.3% for the nine months ended September 30, 2015. The increase was due to higher discounts on our out-of-season products in the nine months ended September 30, 2016 compared with the same period of the prior year.

Rent costs for our retail business for the nine months ended September 30, 2016 were $35.6 million compared with $45.0 million for the nine months ended September 30, 2015. As a percentage of total retail sales, rent costs were 24.9% of our total retail sales for the nine month ended September 30, 2016 compared with 28.5% for the nine months ended September 30, 2015. The decrease was primarily attributable to lower rent at certain locations.

Gross profit for our retail business for the nine months ended September 30, 2016 was $62.3 million compared with $69.7 million for the nine months ended September 30, 2015. Gross margin for our retail business for the nine months ended September 30, 2016 was 43.5% compared with 44.2% for the nine months ended September 30, 2015

Total cost of sales for the nine months ended September 30, 2016 was $197.6 million, a 0.8% decrease compared with the nine months ended September 30, 2015. As a percentage of total sales, total costs were 70.0% of total sales for the nine months ended September 30, 2016, compared with 68.2% for the nine months ended September 30, 2015. Total gross margin for the nine months ended September 30, 2016 was 30.0% compared with 31.8% for the nine months ended September 30, 2015.

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 14.8% and 13.9% of raw material purchases for the nine months ended September 30, 2016 and 2015, respectively. No one supplier provided more than 10% of our raw material purchases for the nine months ended September 30, 2016 and 2015. For our retail business, purchases from our five largest suppliers represented approximately 33.0% and 21.7% of raw material purchases for the nine months ended September 30, 2016 and 2015, respectively. No one supplier provided more than 10% of our raw material purchases for the nine months ended September 30, 2016 and 2015. 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 54.4% and 43.8% of finished goods purchases for the nine months ended September 30, 2016 and 2015, respectively. One contract manufacturer provided approximately 26.6% and 11.6% of our finished goods purchases for the nine months ended September 30, 2016. One contract manufacturer provided approximately 19.5% of our finished goods purchases for the nine months ended September 30, 2015. For our retail business, our five largest contract manufacturers represented approximately 14.8% and 11.5% of finished goods purchases for the nine months ended September 30, 2016 and 2015, respectively. No contract manufacturer provided more than 10% of our retail finished goods purchases for the nine months ended September 30, 2016 and 2015. 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.