Ever-Glory International Group, Inc. - Quarter Report: 2020 March (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 March 31, 2020

☐ 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)

86-25-5209-6831

 (Registrant’s telephone number, including area code)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒

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, 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided to Section 7(a)(2)(B) of the Securities Act.  ☐

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

Securities registered under Section 12(b) of the Act: 

Securities registered under Section 12(g) of the Act:  None. 

As of May 8, 2020, 14,804,832 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

CONDENSED CONSOLIDATED BALANCE SHEETS

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

AS OF MARCH 31, 2020 AND DECEMBER 31, 2019 (UNAUDITED)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED

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

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019 (UNAUDITED)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(In thousands of U.S. Dollars, except share and per share data or otherwise stated)

FOR THE THREE MONTHS ENDED March 31, 2020 AND 2019 (Unaudited)

See the accompanying notes to the condensed consolidated financial statements.

EVER-GLORY INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

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

FOR THE THREE MONTHS ENDED MARCH 31, 2020 AND 2019 (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 THREE MONTHS ENDED MARCH 31, 2020 AND 2019

(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 located in China 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”), Haian Tai Xin Garments Trading Company Limited (“Haian Tai Xin”), Ever-Glory International Group Apparel Inc.(“Ever-Glory Apparel”), Chuzhou Huirui 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”) and Ever-Glory Supply Chain Service Co., Limited (“Ever-Glory Supply Chain”).  The Company’s retail operations are provided through its wholly- owned subsidiaries, Shanghai LA GO Fashion Company Limited (“Shanghai LA GO GO”), Jiangsu LA GO Fashion Company Limited (“Jiangsu LA GO GO”), Tianjin LA GO Fashion Company Limited (“Tianjin LA GO GO”), Shanghai Ya Lan Fashion Company Limited (“Ya Lan”), Shanghai Yiduo Fashion Company Limited (“Shanghai Yiduo”) and Xizang He Meida Trading Company Limited (“He Meida”).

In March 2020, the Company incorporated Nanjing Rui Lian Technology Company Limited (“Nanjing Rui Lian”) and it is the Company’s wholly-owned PRC subsidiaries. Nanjing Rui Lian is engaged in the business of garments trading.

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 March 31, 2020 the condensed consolidated statements of income (loss) and comprehensive income(loss), condensed consolidated statements of equity, and cash flows for the three months ended March 31, 2020 and 2019. 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 8-03 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 months ended March 31, 2020 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, 2019. 

NOTE 2 SIGNIFICANT ACCOUNTING POLICIES

Revenue Recognition 

The company recognizes 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. 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. 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.

Our revenue recognition policy is in compliance with ASC 606, Revenue from Contracts with Customers that revenue is recognized when a customer obtains control of promised goods and is recognized in an amount that reflects the consideration that we expect to receive in exchange for those goods. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amount of revenue that is recorded reflects the consideration that we expect to receive in exchange for those goods. We apply the following five-step model in order to determine this amount:

We only apply the five-step model to contracts when it is probable that we will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. Once a contract is determined to be within the scope of ASC 606 at contract inception, we review the contract to determine which performance obligations we must deliver and which of these performance obligations are distinct. We recognize as revenues the amount of the transaction price that is allocated to the respective performance obligation when the performance obligation is satisfied or as it is satisfied. Generally, our performance obligations are transferred to customers at a point in time, typically upon delivery for local sales and upon shipment of the products for export sale.

For all reporting periods, we have not disclosed the value of unsatisfied performance obligations for all product revenue contracts with an original expected length of one year or less, which is an optional exemption that is permitted under the adopted rules.

Accounts Receivable, net

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.

For the three months ended March 31, 2020 and 2019, $0.26 million and $0 million of bad debt expenses have been provided in the consolidated financial statements, respectively. The allowance for doubtful account balances as of March 31, 2020 and December 31, 2019 are $5.6 million and $5.3 million, respectively. 

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:

The fair value of forward exchange contracts is based on broker quotes, if available. If broker quotes are not available, then fair value is estimated by discounting the difference between the contractual forward price and the current forward price at the reporting date for the residual maturity of the contract using a risk-free interest rate based on government bonds.

At March 31, 2020 and December 31, 2019, the Company’s financial assets (all Level 1) consist of cash placed with financial institutions that management considers to be of a high quality.

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.

The Company has adopted ASC 825-10 “Financial Instruments”, which allows an entity to choose to measure certain financial instruments and liabilities at fair value on a contract-by-contract basis. Subsequent fair value measurement for the financial instruments and liabilities an entity chooses to measure will be recognized in earnings.

Foreign Currency Translation and Other Comprehensive Income (Loss)

The reporting currency of the Company is the U.S. dollar. The functional currency of Ever-Glory, Perfect Dream, Ever-Glory HK and Ever-Glory Supply Chain 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, Ya Lan, He Meida, Huirui, Taixin, Haian Taixin and Nanjing Rui Lian 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. 

Income Taxes

ASC 740 states “Deferred tax assets are recognized in full and then reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be recognized.” A deferred tax asset is a tax reduction whose recognition is delayed due to deductible temporary differences and loss carryforwards. This can result in a change in taxes payable or refundable in future periods. A business should create a valuation allowance for a deferred tax asset if there is a more than 50% probability that the company will not realize some portion of the asset. Any changes to this allowance are to be recorded within income from continuing operations on the income statement. The need for a valuation allowance is especially likely if a business has a history of letting various loss carryforwards expire unused, or it expects to incur losses in the next few years.

Lease

The Company adopted ASC No. 842, Leases effective January 1, 2019 to account for all Company’s leases. All leases are recorded in the balance sheets. The lease liability is measured at present value of outstanding lease payments, both at commencement date and subsequently. The discount rate is generally the Company’s incremental borrowing rate as the lessor’s rate implicit in the lease is not readily determinable. The right-of-use (ROU) asset costs at commencement date consist of initial lease liability, any initial direct costs, and any lease payments made to the lessor at or before the commencement date, minus any lease incentives received. Subsequently, the carrying amount of ROU asset is derived from the carrying amount of the lease liability, plus unamortized direct costs and prepaid lease payments, and minus unamortized balance of lease incentives received. The annual amortization expenses will be recorded in consolidated statement of operations and allocating between cost of sales and operating expenses.

Recently Issued Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13 “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”; In November 2019, the FASB issued ASU No. 2019-10 “Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates” In March 2020, the FASB issued ASU No. 2020-03 “Codification Improvements to 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, 2022. 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 March 31, 2020 and December 31, 2019 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 March 31, 2020 and December 31, 2019.

In December 2019, Goldenway entered into a line of credit agreement with Industrial and Commercial Bank of China, which allows the Company to borrow up to approximately $5.6 million (RMB40.0 million). These loans are collateralized by the Company’s property and equipment. As of March 31, 2020, Goldenway had borrowed $5.6 million (RMB40.0 million) from Industrial and Commercial Bank of China with an annual interest rate 4.57% and due on August 2020.

In November 2018, Ever-Glory Apparel entered into a line of credit agreement for approximately $14.1 million (RMB100.0 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 March 31, 2020, Ever-Glory Apparel had borrowed $14.1 million (RMB 100.0 million) under this line of credit with annual interest rates ranging from 3.92% to 4.7% and due on from May 2020 to March 2021.

In August 2018, Goldenway entered into a line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $7.1 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 March 31, 2020, approximately $7.1 million was unused and available under this line of credit.

In August 2018, Ever-Glory Apparel entered into a line of credit agreement for approximately $8.5 million (RMB60.0 million) with Nanjing Bank and guaranteed by Jiangsu Ever-Glory, Mr. Kang and Goldenway. As of March 31, 2020, Ever-Glory Apparel had borrowed $1.4 million (RMB10.0 million) from Nanjing Bank with an annual interest rate 5.0% and due on June 2020. As of March 31, 2020, approximately $7.1 million was unused and available under this line of credit.

In June 2019, LA GO GO entered into a revolving line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $2.8 million (RMB20.0 million). The line of credit is guaranteed by Mr. Kang and Goldenway. As of March 31, 2020, LA GO GO had borrowed $2.1 million (RMB15.0 million) under this line of credit with an annual interest rate of 5.22% and due in June 2020. As of March 31, 2020, approximately $0.7 million was unused and available under this line of credit.

In June 2018, LA GO GO entered into a line of credit agreement for approximately $2.8 million (RMB20.0 million) with China Minsheng Bank and guaranteed by Ever-Glory Apparel and Mr. Kang. As of March 31, 2020, LA GO GO had borrowed $2.8 million (RMB20.0 million) from China Minsheng Bank with an annual interest rate of 5.0% and due in November 2020.  

In September 2019, LA GO GO entered into a line of credit agreement for approximately $2.8 million (RMB20.0 million) with the Bank of Communications and guaranteed by Jiangsu Ever-Glory, Ever-Glory Apparel and Jiangsu LAGOGO. As of March 31, 2020, approximately $2.8 million was unused and available under this line of credit.

In September 2019, Ever-Glory Apparel entered into a line of credit agreement for approximately $5.6 million (RMB40.0 million) with the Shanghai Pudong Development Bank and guaranteed by Goldenway. As of March 31, 2020, approximately $5.6 million was unused and available under this line of credit.

In August 2019, 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 $2.5 million with the Nanjing Branch of HSBC (China) Company Limited (“HSBC”). This agreement is guaranteed by the Company and Mr. Kang. As of March 31, 2020, approximately $2.5 million was unused and available under this line of credit.

All bank loans are used to fund our daily operations. All loans have been repaid before or at maturity date.

Total interest expense on bank loans amounted to $0.3 million and $0.4 million for the three months ended March 31, 2020 and 2019, respectively.

NOTE 5 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, 2020.

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.

Ever-Glory Supply Chain Service Co., Limited was incorporated in Hongkong, and under the current laws of Hongkong, its income tax rate is 8.25% when its profit is under HKD 2.0 million and its income tax rate is 16.5% when its profit is over HKD 2.0 million.

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 years ended March 31, 2020 and 2019 was taxable in the following jurisdictions: 

The following table reconciles the PRC statutory rates to the Company’s effective tax rate for the three months ended March 31, 2020 and 2019:

Income tax expense for the three months ended March 31, 2020 and 2019 is as follows:

The Company’s deferred tax liabilities arise from differences between US GAAP and PRC tax accounting for certain revenue and expense items, including timing of deduction of losses from allowances. 

The Company has not recorded U.S. deferred income taxes on approximately $103.6 million of its non-U.S. subsidiaries’ undistributed earnings because such amounts are intended to be reinvested outside the United States indefinitely. On December 22, 2017 the U.S. enacted the “Tax Cuts and Jobs Act” (“U.S. Tax Reform”) which made significant changes to corporate income tax law. One significant change was to decrease the general corporate income tax rate from 34% to 21%. This reduction had no effect on the Company’s income tax expense as the reduction in deferred tax assets was offset by an equivalent reduction in the valuation allowance. Another significant change resulting from U.S. Tax Reform is that any future remittances to the parent company from business income earned by its subsidiaries outside of the U.S. will no longer to taxable to the Company under U.S. tax law. The Company would be liable for payment of income tax, or reduction of the net operating loss carryover, at a reduced rate for any accumulated earnings and profits of its non-U.S. subsidiaries at December 31, 2017. U.S. Tax Reform includes provisions for Global Intangible Low-Taxed Income (“GILTI”) under which taxes on foreign income are imposed on the excess of a deemed return on tangible assets of certain foreign subsidiaries and for Base Erosion and Anti-Abuse Tax (“BEAT”) under which taxes are imposed on certain base eroding payments to affiliated foreign companies. Consistent with accounting guidance, we treat BEAT as a period tax charge in the period the tax is incurred and have made an accounting policy election to treat GILTI taxes in a similar manner. The Company measured the current and deferred taxes based on the provisions of the Tax legislation. After the Company’s measurement, no deferred tax expense (income) relating to the Tax Act changes for the three months ended March 31, 2020.

NOTE 6 EARNINGS PER SHARE

The following demonstrates the calculation for earnings per share for the three months ended March 31, 2020 and 2019:

NOTE 7 STOCKHOLDERS’ EQUITY

On January 31, 2019, the Company issued 1,942 shares of the Company’s common stock to two of the Company’s independent directors as compensation for their services rendered during the third and fourth quarter of 2018. The shares issued in 2019 were valued at $3.8 per share, which was the average market price of the common stock for the five days before the grant date.

On January 15, 2020, the Company issued 3,062 shares of Company’s common stock to two of the Company’s independent directors as compensation for their services rendered during the third and fourth quarter of 2019. The shares issued in 2020 were valued at $1.41 per share, which was the average market price of the common stock for the five days before the grant date. 

NOTE 8 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-term 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 months ended March 31, 2020 and 2019, the Company received $2,517 and $31,479 from the customers and paid $2,517 and $25,838 to Wubijia through the consignment, respectively. The net profit of $0 and $5,641 was recorded as other income during the three months ended March 31, 2020 and 2019, respectively.

Other expenses due to Related Parties

Included in other expenses for the three months ended March 31, 2020 and 2019 are rent due to entities controlled by Mr. Kang under operating lease agreements as follows:

The Company leases Chuzhou Huarui and Kunshan Enjin’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 totaled $0 million and $0.20 million during the three months ended March 31, 2020 and 2019, respectively.

In addition, the Company sub-contracted certain manufacturing work to related companies totaled $3.1 million and $5.1 million for the three months ended March 31, 2020 and 2019, respectively. The Company provided raw materials to the sub-contractors and charged a fixed fee for labor provided by the sub-contractors.

Sub-contracts with related parties included in cost of sales for the three months ended March 31, 2020 and 2019 are as follows:

Accounts Payable – Related Parties

The accounts payable to related parties at March 31, 2020 and December 31, 2019 are as follows:

Amounts Due From Related Parties-current assets

The amounts due from related parties at March 31, 2020 and December 31, 2019 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 months ended March 31, 2020 and 2019, 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 $0.2 million and $0 during the three month period ended March 31, 2020 and 2019, respectively. Jiangsu Ever-Glory purchased raw materials on the Company’s behalf and sold to the Company at cost for $0.7 million and $0.4 million during the three months ended March 31, 2020 and 2019, 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 March 31, 2020 and December 31, 2019, Jiangsu Ever-Glory has provided guarantees for approximately $33.0 million (RMB 230 million) and $33 million (RMB 230.0 million) of lines of credit obtained by the Company, respectively. 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 $29.4 million (RMB 205.5 million) and $29.4 million (RMB 205.5 million) as of March 31, 2020 and December 31, 2019 respectively. Mr. Kang has also provided a personal guarantee for $14.3 million (RMB 100.0 million) and $14.5 million (RMB 100.0 million) as of March 31, 2020 and December 31, 2019, respectively.

At December 31, 2019, $4.7 million (RMB 32.8 million) was outstanding due from Jiangsu Ever-Glory under the counter guarantee agreement. During the three months ended March 31, 2020, no advance was provided to and repayment of $0.7 million (RMB5.2 million) was received from Jiangsu Ever-Glory under the counter-guarantee. As of March 31, 2020, the amount of the counter-guarantee was $3.9 million (RMB 27.5 million) (the difference represents currency exchange adjustment of $0.07 million), which was 11.97% of the aggregate amount of lines of credit. This amount plus accrued interest of $0.3 million have been classified as a reduction of equity, consistent with the guidance of SEC Staff Accounting Bulletins 4E and 4G. At March 31, 2020 and December 31, 2019, the amount classified as a reduction of equity was $4.1 million and $5 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. Since January 1, 2019, interest rate has changed to 0.3625% as the bank benchmark interest rate decreased. Interest income for the three months ended March 31, 2020 and 2019 was approximately $0.02 million and $0.1 million, respectively.

NOTE 9 COMMITMENTS AND CONTINGENCIES

Operating Lease Commitment

The Company recognized operating lease liabilities and operating lease right-of-use assets on its balance sheets. ROU assets represent the right to use an underlying asset for the lease term, and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at the lease commencement date based on the estimated present value of lease payments over the lease term. The company has leases with fixed payments for land-use-rights, warehouses and logistics centers, flagship stores, and leases with variable payments for stores within shopping malls (“shopping mall stores”) in the PRC, which are classified as operating leases. Options to extend or renew are recognized as part of the lease liabilities and recognized as right of use assets. There are no residual value guarantees and no restrictions or covenants imposed by the leases.

The weighted average remaining lease term excluding stores in the shopping malls is 31 years and the weighted average discount rate is 4.35%. The lease term for shopping mall stores is commonly one year with options to extend or renew, and the rent is predetermined with a percentage of sales. The Company estimates the next 12 months rent for the shopping mall stores by annualizing current period rent calculated with the percentage of sales. Thus, the ROU assets and lease liabilities may vary significantly at different period ends. 

In the three months ended March 31, 2020, the costs of the leases recognized in cost of revenues and general administrative expenses are $6.0 and $0.2 million, respectively. Cash paid for the operating leases including in the operating cash flows was $6.2 million. 

Future minimum lease payments for leases with initial or remaining noncancelable lease terms in excess of one year are as follows:

Legal Proceedings

On March 2019, Shanghai La Go Go Fashion Company Limited (“LA GO GO”) filed a complaint against Shanghai Chijing Investment Management Co., Ltd. (“Shanghai Chijing”) for unpaid rent of RMB2.45 million ($0.36 million) in the Shanghai People’s Court (the “Court”). On July 2019, Shanghai Chijing filed a counterclaim against LA GO GO for RMB15.38 million ($2.17 million), alleging that LA GO GO had not fulfilled its corresponding obligations as a landlord. As a result, the Court has frozen the bank accounts of both Shanghai Chijing and LA GO GO. As of December 31, 2019, a total balance of RMB15.38 million ($2.2 million) was frozen in the bank accounts of LA GO GO. LA GO GO believes that Shanghai Chijing’s counterclaim is frivolous and without merit, and is rigorously defending against the counterclaim. As of December 31, 2019, the company had booked this restricted cash in other receivables. On March 10, 2020, the Court entered a judgment in favor of LA GO GO and dismissed Shanghai Chijing’s counterclaim. LA GO GO believes that the damages awarded by the Court in favor of LA GO GO were insufficient. As of the date of this report, both LA GO GO and Shanghai Chijing have appealed the decision of the Court entered on March 10, 2020 and the date of the appeal hearing has not been determined yet. 

In addition to the foregoing, we may become subject to other legal proceedings that arise in the ordinary course of business and have not been finally adjudicated. Adverse decisions in any of the foregoing may have a material adverse effect on our results of operations, cash flows or our financial condition. 

NOTE 10 RISKS AND UNCERTAINTIES

Economic and Political Risks

The Company’s results of operations could be adversely affected by general conditions in the global economy, including conditions that are outside of its control, such as the impact of health and safety concerns from the outbreak of COVID-19. The outbreak in China has resulted in the reduction of customer traffic and temporary closures of shopping malls as mandated by the provincial governments in various provinces of China from late January to March, which has adversely affected the company is the retail business with a decline in sales since February 2020. The Company’s wholesale business is also significantly affected as the Company is facing a sharp decline in its order quantities. Some of the Company’s wholesale clients have also cancelled or postponed existing orders.  Due to the Chinese factories’ shutdowns and traffic restrictions during the outbreak in China and potential shutdowns and traffic restrictions in the countries where the Company’s suppliers are located, The Company’s supply chain and business operations of its suppliers may be affected. Disruptions from the closure of supplier and manufacturer facilities, interruptions in the supply of raw materials and components, personnel absences, or restrictions on the shipment of the Company’s or its suppliers’ or customers’ products, could have adverse ripple effects on the Company’s manufacturing output and delivery schedule. The Company could also face difficulties in collecting its accounts receivables due to the effects of COVID-19 on its customers and risk gaining a large amount of bad debt. Global health concerns, such as COVID-19, could also result in social, economic, and labor instability in the countries and localities in which the Company, its suppliers and customers operate.

Although China has already begun to recover from the outbreak of COVID-19, the epidemic continues to spread on a global scale and there is the risk of the epidemic returning to China in the future, thereby causing further business interruption. While the potential economic impact brought by and the duration of COVID-19 may be difficult to assess or predict, a widespread pandemic could result in significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect the Company’s liquidity. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect the Company’s business and the value of its common stock. If the Company’s future sales continue to decline significantly, it may risk facing financial difficulties due to its recurring fixed expenses. The extent to which COVID-19 impacts the Company’s operating is uncertain and cannot be predicted at this time, and it will depend on many factors and future developments, including new information about COVID-19 and any new government regulations which may emerge to contain the virus, among others. 

The majority of the Company’s operations are conducted in the PRC. Accordingly, the Company’s business, financial condition and results of operations may be influenced by the political, economic and legal environment in the PRC, and by the general state of the PRC economy. The Company’s operations in the PRC are subject to special considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic and legal environment and foreign currency exchange. The Company’s results may be adversely affected by changes in the political and social conditions in the PRC, and by changes in governmental policies with respect to laws and regulations, anti-inflationary measures, currency conversion, remittances abroad, and rates and methods of taxation.  

Credit risk

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. 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 of 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.  

Concentration risk 

For the three-month period ended March 31, 2020, the Company had four wholesale customers that represented approximately 20%, 10%, 10% and 10% of the Company’s revenues. For the three-month period ended March 31, 2019, the Company had two wholesale customers that represented approximately 26% and 11% of the Company’s revenues.

For the wholesale business, the Company relied on one raw material supplier that represented 11% of the total raw material purchases during the three months ended March 31, 2020. The Company did not rely on any raw material supplier that represented more than 10% of the total raw material purchases during the three months ended March 31, 2019.

For the retail business, the Company relied on two raw material suppliers that represented approximately 60% and 34% of raw material purchases during the three months ended March 31, 2020. For the retail business, the Company relied on three raw material suppliers that represented approximately 36%, 35% and 23% of raw material purchases during the three months ended March 31, 2019.

For the wholesale business, during the three months ended March 31, 2020, the Company relied on one manufacturer that represented 11% of finished goods purchases, and during the three months ended March 31, 2019, the Company relied on two manufacturers that represented 11% and 10% of finished goods purchases.

The Company’s revenues for the three months ended March 31, 2020 and 2019 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

NOTE 12 SUBSEQUENT EVENTS

As of May 14, 2020, there is no material subsequent event to be disclosed.

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 months ended March 31, 2020 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 slow 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 requirement.

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”), Chuzhou Huirui Garments Co., Ltd. (“Huirui), Nanjing Tai Xin Garments Trading Company Limited (“Tai Xin”), Haian Tai Xin Garments Trading Company Limited (“Haian Tai Xin”), Nanjing Rui Lian Technology Company Limited (“Nanjing Rui Lian”), Ever-Glory Supply Chain Service Co., Limited (“Ever-Glory Supply Chain”) 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 Ya Lan Fashion Company Limited (“Ya Lan”), 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 March 31, 2020, we had 1,038 stores (including store-in-stores), which includes 4 stores that were opened and 67 stores that were closed in the first quarter of 2020. We expect to open an additional 100 to 150 stores in 2020.

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 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 2020.

In addition, economic conditions in the United States 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.

Our results of operations could be adversely affected by general conditions in the global economy, including conditions that are outside of our control, such as the impact of health and safety concerns from the outbreak of COVID-19. The outbreak in China has resulted in the reduction of customer traffic and temporary closures of shopping malls as mandated by the provincial governments in various provinces of China from late January to March, which has adversely affected our retail business with a decline in sales since February 2020. Our wholesale business is also significantly affected as we are facing a sharp decline in our order quantities. Some of our wholesale clients have also cancelled or postponed existing orders.  Due to the Chinese factories’ shutdowns and traffic restrictions during the outbreak in China and potential shutdowns and traffic restrictions in the countries where our suppliers are located, our supply chain and business operations of our suppliers may be affected. Disruptions from the closure of supplier and manufacturer facilities, interruptions in the supply of raw materials and components, personnel absences, or restrictions on the shipment of our or our suppliers’ or customers’ products, could have adverse ripple effects on our manufacturing output and delivery schedule. We also face difficulties in collecting our accounts receivables due to the effects of COVID-19 on our customers and risk gaining a large amount of bad debt. Global health concerns, such as COVID-19, could also result in social, economic, and labor instability in the countries and localities in which we or our suppliers and customers operate.

Although China has already begun to recover from the outbreak of COVID-19, the epidemic continues to spread on a global scale and there is the risk of the epidemic returning to China in the future, thereby causing further business interruption. While the potential economic impact brought by and the duration of COVID-19 may be difficult to assess or predict, a widespread pandemic could result in significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect our liquidity. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect our business and the value of our common stock. If our future sales continue to decline significantly, we may risk facing bankruptcy due to our recurring fixed expenses. The extent to which COVID-19 impacts our results will depend on many factors and future developments, including new information about COVID-19 and any new government regulations which may emerge to contain the virus, among others.

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. 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. 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.

Our revenue recognition policy is in compliance with ASC 606, Revenue from Contracts with Customers that revenue is recognized when a customer obtains control of promised goods and is recognized in an amount that reflects the consideration that we expect to receive in exchange for those goods. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The amount of revenue that is recorded reflects the consideration that we expect to receive in exchange for those goods. We apply the following five-step model in order to determine this amount:

We only apply the five-step model to contracts when it is probable that we will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer. Once a contract is determined to be within the scope of ASC 606 at contract inception, we review the contract to determine which performance obligations we must deliver and which of these performance obligations are distinct. We recognize as revenues the amount of the transaction price that is allocated to the respective performance obligation when the performance obligation is satisfied or as it is satisfied. Generally, our performance obligations are transferred to customers at a point in time, typically upon delivery for local sales and upon shipment of the products for export sale.

For all reporting periods, we have not disclosed the value of unsatisfied performance obligations for all product revenue contracts with an original expected length of one year or less, which is an optional exemption that is permitted under the adopted rules.

Estimates and Assumptions

In preparing our condensed 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 include the assumptions used to value tax liabilities, derivative financial instruments, the estimates of the allowance for deferred tax assets, and the accounts receivable allowance, and impairment of long-lived assets and inventory write-downs and write-offs.

Recently Issued Accounting Pronouncements

In June 2016, the FASB issued ASU No. 2016-13 ”Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”; In November 2019, the FASB issued ASU No. 2019-10 “Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates” In March 2020, the FASB issued ASU No. 2020-03 “Codification Improvements to 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, 2022. The Company is currently assessing the impact of this ASU on its consolidated financial statements.

Results of Operations

The following table summarizes our results of operations for the three months ended March 31, 2020 and 2019. The table and the discussion below should be read in conjunction with the 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 March 31, 2020 and 2019.

Total sales for the three months ended March 31, 2020 were $58.4 million, a decrease of 33.7% from the three months ended March 31, 2019. This decrease was primarily attributable to a 20.7% decrease in our wholesale business and a 39.7% decrease in our retail business.

Sales generated from our wholesale business contributed 38.2% or $22.3 million of our total sales for the three months ended March 31, 2020, a decrease of 20.7% compared to $28.1 million in the three months ended March 31, 2019. This decrease was primarily attributable to decreased sales in Mainland China, Germany, other European markets and Japan partially offset for increased sales in Hong Kong, the United States and the United Kingdom.

Sales generated from our retail business contributed 61.8% or $36.1 million of our total sales for the three months ended March 31, 2020, a decrease of 39.7% compared to 68.0% or $59.9 million in the three months ended March 31, 2019. This decrease was primarily due to the decrease in same-store sales. 

Total retail store square footage and sales per square foot for the three months ended March 31, 2020 and 2019 are as follows:

Same-store sales and newly opened store sales for the three months ended March 31, 2020 and 2019 are as follows:

We remodeled or relocated 117 stores in year 2019, and 2 stores during the three months ended March 31, 2020. We plan to relocate or remodel 50-100 stores in 2020. 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 2020.  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 three months ended March 31, 2020 and 2019.

Raw material costs for our wholesale business were 45.3% of our total wholesale business sales in the three months ended March 31, 2020, a decrease of 10.8% compared to 40.2% in the three months ended March 31, 2019.  The cost percentage to total sale increase was mainly due to the higher raw material prices.

Labor costs for our wholesale business were 1.1% of our total wholesale business sales in the three months ended March 31, 2020, a decrease of 20.2% compared to 1.1% in the three months ended March 31, 2019. The marginal decrease was mainly due to the fact that we outsourced most of the new orders in 2020.  

Outsourced production costs for our wholesale business decreased by 15.2% to $8.4 million in the three months ended March 31, 2020 from $9.9 million in the three months ended March 31, 2019. As a percentage of total wholesale sales, outsourced production costs were 37.6% of our total wholesale sales in the three months ended March 31, 2020, a decrease of 15.2% from the three months ended March 31, 2019. This decrease was primarily attributable to increased outsourced orders to our related entities in Vietnam, which have lower labor costs compared to orders outsourced to Chinese factories.

Overhead and other expenses for our wholesale business accounted for 0.4% and 0.3% of our total wholesale business sales for the three months ended March 31, 2020 and 2019, respectively.

Gross profit for our wholesale business for the three months ended March 31, 2020 was $3.5 million, a decrease of 46.7% compared to the three months ended March 31, 2019. Gross margin was 15.7% for the three months ended March 31, 2020, a decrease of 46.7% compared to 23.3% for the three months ended March 31, 2019. The decrease in gross margin was mainly due to the higher raw material prices.

Production costs for our retail business were $15.8 million during the three months ended March 31, 2020 compared to $24.2 million during the three months ended March 31, 2019. As a percentage of retail sales, retail production costs accounted for 43.9% of our total retail sales in the three months ended March 31, 2020, compared to 40.4% of total retail sales in the three months ended March 31, 2019. The decrease was due to higher discounts on our out-of-season products ended March 31, 2020 compared with the same period of the prior year.

Rent costs for our retail business were $7.7 million for the three months ended March 31, 2020 compared to $12.9 million for the three months ended March 31, 2019. As a percentage of retail sales, rent costs accounted for 21.3% of our total retail sales for the three months ended March 31, 2020, compared to 21.5% of total retail sales for the three months ended March 31, 2019. The decrease was primarily attributable to lower rent at certain locations.

Gross profit in our retail business for the three months ended March 31, 2020 was $12.5 million and gross margin was 34.8%. Gross profit in our retail business for the three months ended March 31, 2018 was $22.8 million and gross margin was 38.1%. The decrease in gross margin was attributable to decreased rent costs and decrease in production costs.

Total cost of sales for the three months ended March 31, 2020 was $42.3 million, compared to $58.6 million for the three months ended March 31, 2019, a decrease of 27.8%. As a percentage of total sales, cost of sales increased to 72.5% of total sales for the three months ended March 31, 2020, compared to 66.6% of total sales for the three months ended March 31, 2019. Consequently, gross margin decreased to 27.5% for the three months ended March 31, 2020 from 33.4% for the three months ended March 31, 2019.

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 decreased 35.8% to $13.5 million for the three months ended March 31, 2020 from $21.0 million for the three months ended March 31, 2019. The decrease was attributable to the decreased sales.

General and administrative expenses decreased 23.2% to $5.8 million for the three months ended March 31, 2020 from $7.5 million for the three months ended March 31, 2019. As a percentage of total sales, general and administrative expenses increased to 9.9% of total sales for the three months ended March 31, 2020, compared to 8.6% of total sales for the three months ended March 31, 2019. The decrease was mainly attributable to the decreased office expenses.

(Loss) Income from Operations

Loss from operations was $3.2 million for the three months ended March 31, 2020, compared to $0.8 million of income from operations for the three months ended March 31, 2019. As a percentage of sales, loss from operations accounted for 5.5% of our total sales for the three months ended March 31, 2020, a decrease of 493.0% compared to 0.9% the three months ended March 31, 2019 as a result of decreased gross profit.

Interest Expense

Interest expense was $0.3 million for the three months ended March 31, 2020, a decrease of 6.1% compared to the same period in 2019. The decrease was due to the decreased bank loans borrowed.

Income Tax Expenses

Income tax expense was $0.2 million and $0.8 million for the three months ended March 31, 2020 and 2019, respectively.

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, 2020.

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.

Ever-Glory Supply Chain Service Co., Limited was incorporated in Hongkong, and under the current laws of Hongkong, its income tax rate is 8.25% when its profit is under HKD 2.0 million and its income tax rate is 16.5% when its profit is over HKD 2.0 million.

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.   

Net Income (Loss)

Net loss for the three months ended March 31, 2020 and 2019 was $2.7 million and $0.5 million, respectively. Our basic and diluted loss per share were $0.18 and $0.04 for the three months ended March 31, 2020 and 2019, respectively.

Summary of Cash Flows

Summary cash flows information for the three months ended March 31, 2020 and 2019 is as follows:

Net cash provided by operating activities was $24.6 million and $11.1 million for the three months ended March 31, 2020 and 2019, respectively. This increase was mainly due to decreased accounts receivable and inventories, offset by decreased accounts payable.

Net cash provided by (used in) investing activities was $0.3 million and ($2.1) million for the three months ended March 31, 2020 and 2019. This change was mainly due to we purchased property and equipment in the three months ended March 31, 2020 less than the same period of 2019.

Net cash used in financing activities were $2.7 million and $0.05 million for the three months ended March 31, 2020 and 2019, respectively. During the three months ended March 31, 2020, we received new bank loans of $11.5 million and repaid the bank loans of $14.9 million.

Liquidity and Capital Resources

As of March 31, 2020, we had cash and cash equivalents $70.0 million, current assets other than cash $109.5 million and current liabilities $130.3 million. We presently finance our operations primarily from cash flows from operations and borrowings from banks, and we anticipate that these will continue to be our primary source of funds to finance our short-term cash needs.

Bank Loans

In December 2019, Goldenway entered into a line of credit agreement with Industrial and Commercial Bank of China, which allows the Company to borrow up to approximately $5.6 million (RMB40.0 million). These loans are collateralized by the Company’s property and equipment. As of March 31, 2020, Goldenway had borrowed $5.6 million (RMB40.0 million) from Industrial and Commercial Bank of China with an annual interest rate 4.57% and due on August 2020.

In November 2018, Ever-Glory Apparel entered into a line of credit agreement for approximately $14.1 million (RMB100.0 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 March 31, 2020, Ever-Glory Apparel had borrowed $14.1 million (RMB 100.0 million) under this line of credit with annual interest rates ranging from 3.92% to 4.7% and due on from May 2020 to March 2021.

In August 2018, Goldenway entered into a line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $7.1 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 March 31, 2020, approximately $7.1 million was unused and available under this line of credit.

In August 2018, Ever-Glory Apparel entered into a line of credit agreement for approximately $8.5 million (RMB60.0 million) with Nanjing Bank and guaranteed by Jiangsu Ever-Glory, Mr. Kang and Goldenway. As of March 31, 2020, Ever-Glory Apparel had borrowed $1.4 million (RMB10.0 million) from Nanjing Bank with an annual interest rate 5.0% and due on June 2020. As of March 31, 2020, approximately $7.1 million was unused and available under this line of credit.

In June 2019, LA GO GO entered into a revolving line of credit agreement with Nanjing Bank, which allows the Company to borrow up to approximately $2.8 million (RMB20.0 million). The line of credit is guaranteed by Mr. Kang and Goldenway. As of March 31, 2020, LA GO GO had borrowed $2.1 million (RMB15.0 million) under this line of credit with an annual interest rate of 5.22% and due in June 2020. As of March 31, 2020, approximately $0.7 million was unused and available under this line of credit.

In June 2018, LA GO GO entered into a line of credit agreement for approximately $2.8 million (RMB20.0 million) with China Minsheng Bank and guaranteed by Ever-Glory Apparel and Mr. Kang. As of March 31, 2020, LA GO GO had borrowed $2.8 million (RMB20.0 million) from China Minsheng Bank with an annual interest rate of 5.0% and due in November 2020.  

In September 2019, LA GO GO entered into a line of credit agreement for approximately $2.8 million (RMB20.0 million) with the Bank of Communications and guaranteed by Jiangsu Ever-Glory, Ever-Glory Apparel and Jiangsu LAGOGO. As of March 31, 2020, approximately $2.8 million was unused and available under this line of credit.

In September 2019, Ever-Glory Apparel entered into a line of credit agreement for approximately $5.6 million (RMB40.0 million) with the Shanghai Pudong Development Bank and guaranteed by Goldenway. As of March 31, 2020, approximately $5.6 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 $2.5 million with the Nanjing Branch of HSBC (China) Company Limited (“HSBC”). This agreement is guaranteed by the Company and Mr. Kang. As of March 31, 2020, approximately $2.5 million was unused and available under this line of credit.

All bank loans are used to fund our daily operations. All loans have been repaid before or at maturity date. 

DERIVATIVE LIABILITY

As of March 31, 2020 and December 31, 2019, there is no derivative liability.

Capital Commitments

We have a continuing program for the purpose of improving our manufacturing facilities and extending our retail 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 year 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 year. 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 March 31, 2020, we had access to approximately $49.3 million in lines of credit, of which approximately $23.2 million was unused and available. These credit facilities do not include any covenants. We have agreed to provide Jiangsu Ever-Glory a counter-guarantee of not less than 70% of the maximum aggregate lines of credit and borrowings guaranteed by Jiangsu Ever-Glory and collateralized by the assets of Jiangsu Ever-Glory and its equity investee, Nanjing Knitting, under agreements executed between the Company, Jiangsu Ever-Glory, Nanjing Knitting, and the banks. The maximum aggregate lines of credit and available borrowings was approximately $32.46 million (RMB 230.0 million) and approximately $3.9 million (RMB 27.5 million) was provided to Jiangsu Ever-Glory as the counter guarantee as of March 31, 2020.

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 in foreign exchange rates between the United States dollar and the Chinese RMB. Most of our sales are in dollars. During 2003 and 2004, the exchange rate of RMB to the dollar remained constant at RMB 8.26 to the dollar. On July 21, 2005, the Chinese government adjusted the exchange rate from RMB 8.26 to 8.09 to the dollar. From that time, the RMB continued to appreciate against the U.S. dollar. As of March 31, 2020, the market foreign exchange rate had increased to RMB 7.09 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 will pass some of the increased cost to our customers.

In addition, the financial statements of subsidiaries located in China (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 expenses items are translated at the average exchange rate for the period. All translation adjustments are included in accumulated other comprehensive income in the statement of equity. The foreign currency translation (loss) gain for the 3 months ended March 31, 2020 and 2019 was ($1.3) million and $4.0 million, 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

Not applicable.

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 its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Limitations on the Effectiveness of Disclosure Controls.  In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Evaluation of Disclosure Controls and Procedures.  Under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures for the period ended March 31, 2020. 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 operating effectively.

Changes in Internal Control Over Financial Reporting

Other than described above, during the first quarter of 2020, 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

From time to time, we may become involved in claims, suits, investigations and proceedings arising in the ordinary course of business.

On March 2019, Shanghai La Go Go Fashion Company Limited (“LA GO GO”) filed a complaint against Shanghai Chijing Investment Management Co., Ltd. (“Shanghai Chijing”) for unpaid rent of RMB2.45 million ($0.36 million) in the Shanghai People’s Court (the “Court”). On July 2019, Shanghai Chijing filed a counterclaim against LA GO GO for RMB15.38 million ($2.17 million), alleging that LA GO GO had not fulfilled its corresponding obligations as a landlord. As a result, the Court has frozen the bank accounts of both Shanghai Chijing and LA GO GO. As of December 31, 2019, a total balance of RMB15.38 million ($2.2 million) was frozen in the bank accounts of LA GO GO. LA GO GO believes that Shanghai Chijing’s counterclaim is frivolous and without merit, and is rigorously defending against the counterclaim. As of December 31, 2019, the company had booked this restricted cash in other receivables. On March 10, 2020, the Court entered a judgment in favor of LA GO GO and dismissed Shanghai Chijing’s counterclaim. LA GO GO believes that the damages awarded by the Court in favor of LA GO GO were insufficient. As of the date of this report, both LA GO GO and Shanghai Chijing have appealed the decision of the Court entered on March 10, 2020 and the date of the appeal hearing has not been determined yet.  

ITEM 1A. RISK FACTORS

As of the date of this report and except as set forth below, there have been no material changes to the risk factors disclosed in our annual report on Form 10-K filed with the SEC on March 30, 2020.

Unfavorable global economic conditions, including as a result of health and safety concerns, could adversely affect our business, financial condition or results of operations.

The Company’s results of operations could be adversely affected by general conditions in the global economy, including conditions that are outside of its control, such as the impact of health and safety concerns from the outbreak of COVID-19. The outbreak in China has resulted in the reduction of customer traffic and temporary closures of shopping malls as mandated by the provincial governments in various provinces of China from late January to March, which has adversely affected the company is the retail business with a decline in sales since February 2020. The Company’s wholesale business is also significantly affected as the Company is facing a sharp decline in its order quantities. Some of the Company’s wholesale clients have also cancelled or postponed existing orders.  Due to the Chinese factories’ shutdowns and traffic restrictions during the outbreak in China and potential shutdowns and traffic restrictions in the countries where the Company’s suppliers are located, The Company’s supply chain and business operations of its suppliers may be affected. Disruptions from the closure of supplier and manufacturer facilities, interruptions in the supply of raw materials and components, personnel absences, or restrictions on the shipment of the Company’s or its suppliers’ or customers’ products, could have adverse ripple effects on the Company’s manufacturing output and delivery schedule. The Company could also face difficulties in collecting its accounts receivables due to the effects of COVID-19 on its customers and risk gaining a large amount of bad debt. Global health concerns, such as COVID-19, could also result in social, economic, and labor instability in the countries and localities in which the Company, its suppliers and customers operate.

Although China has already begun to recover from the outbreak of COVID-19, the epidemic continues to spread on a global scale and there is the risk of the epidemic returning to China in the future, thereby causing further business interruption. While the potential economic impact brought by and the duration of COVID-19 may be difficult to assess or predict, a widespread pandemic could result in significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect the Company’s liquidity. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect the Company’s business and the value of its common stock. If the Company’s future sales continue to decline significantly, it may risk facing financial difficulties due to its recurring fixed expenses. The extent to which COVID-19 impacts the Company’s operating is uncertain and cannot be predicted at this time, and it will depend on many factors and future developments, including new information about COVID-19 and any new government regulations which may emerge to contain the virus, among others. 

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

Securities Authorized for Issuance under Equity Incentive Plans

The following table presents information regarding equity instruments outstanding under our 2014 Equity Incentive Plan as of March 31, 2020:

ITEM 6. EXHIBITS

The following exhibits are filed herewith:

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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