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

Add: 2007   Update: 2009/03/21

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.

Overview

Ever-Glory and its subsidiaries (the "Company") manufacture apparel for men, women and children for primarily middle to high-grade well-known casual wear, sportswear and outerwear brands and for a variety of companies. All of its products are exported to Japan, Europe and the United States. The Company's customers include large retailers and well-known brands. The Company is the result of a merger of Andean Development Corporation, a corporation organized under the laws of the State of Florida ("Andean"); and Perfect Dream Limited, a corporation organized under the laws of British Virgin Islands "Perfect Dream"). Andean was formed on October 19, 1994 and engaged in the business of providing engineering and project management services and electrical and mechanical equipment for energy and private works projects. As of June 30, 2005, Andean had zero assets and liabilities of $57,000. Perfect Dream was incorporated on July 1, 2004 in the British Virgin Islands. In January of 2005, Perfect Dream acquired 100% of Goldenway Nanjing Garments Co., Ltd ("Goldenway").

Goldenway is a limited liability company, which was incorporated in the People's Republic of China (the "PRC") on December 31, 1993. Until December 2004, Goldenway was a subsidiary of Jiangsu Ever-Glory International Group Corporation ("Jiangsu Ever-Glory"). After its acquisition by Perfect Dream, Goldenway changed its status to that of a wholly foreign owned enterprise and increased its registered capital from $2,512,106 to $20,000,000. The increased registered capital will be paid-in in installments within three years of the issuance of Goldenway's updated business license. As of December 31, 2006, the Company has paid $2.63 million of its registered capital requirements. The remaining $14.86 million is due on February 1, 2008.

On December 30, 2006, the Company through its wholly owned subsidiary, Perfect Dream Ltd, a British Virgin Islands corporation, consummated the acquisition of 100% of the capital stock of Nanjing New-Tailun Garments Co, Ltd, a Chinese limited liability company ("New-Tailun") from Ever-Glory Enterprises (HK) Ltd, a British Virgin Islands corporation. The purchase price consisted of a combination of 20,833,333 shares of EGLY's common stock and $2,000,000 in cash. New Tailun is a 100% foreign-owned enterprise incorporated in People's Republic of China and is engaged in the manufacturing and sale of garments. New-Tailun has a staff of over 800 people with the annual production capacity of about 2.5million pieces. New Tailun's financial statements are included in the Company's consolidated financial statements. Management believes that the acquisition of New Tailun will enables Company to facilitate its increased production, strengthen the Company's outsourcing bases and supplement the Company's product lines.

In the fiscal year ended December 31, 2006, approximately 68.83 % of the Company's revenues came from customers in the Europe, 5.79 % from customers in Japan, 17.89 % from customers in the United States and 5.31 % from customers in China. In the fiscal year ended December 31, 2006, four customers represented approximately 72 % of the Company's sales. Management believes that the relationship with these customers is good.

The Company purchases the majority of its raw materials directly from numerous local fabric and accessories suppliers. The Company may also purchase finished goods from other contract manufacturers. One supplier represented approximately 15 % of the Company's raw materials purchases in the fiscal year ended December 31, 2006. The Company has not experienced difficulty in obtaining raw materials essential to its business and management believes that the relationship with its suppliers is good.

In 2006, the Company operated a factory in the Nanjing Jiangning Economic and Technological Development Zone in Nanjing, China.

The Company made a deposit to purchase a fifty-year land use right on 112,442 square meters of land in Nanjing Jiangning Economic and Technological Development Zone. The land contains an existing facility of 26,629 square meters, which includes manufacturing and office space. On April 7, 2006, the Company closed the transaction with the local government of Nanjing City. On June 24, 2006, the Company obtained the title to the land for the land use rights for 50 years. By the end of 2006, the Company completed the construction of the new office buildings and the new factory. The Company has been consolidating its operation into its new headquarters and manufacturing facility since January 2007. The new manufacturing facility occupies an area of 10,000 square meters and is equipped with state-of-the art equipment.

The factory employs a staff of over 600 people with an annual production capacity of over 700,000 pieces. All of the Company's work force is non-union, and the Company considers its relations with its employees to be satisfactory.

In 2006, all Chinese manufacturers of certain garments were subject to aggregate export quotas, or limitations, to the United States and Europe. Although certain of the Company's apparel products fall within the categories subject to the quotas with respect to exports to the United States and Europe, the Chinese government allocated a portion of the aggregate export quota to the Company based upon the amount of product that the Company exported in the prior year. The imposition of such quotas did not have a material affect on the Company's net sales and its net margin. See Results of Operations below. As a result of the Company's prior export performance, it was awarded a sufficient portion of the export quotas to enable it to increase its sales to customers in Europe and the U.S. despite the reinstitution of export quotas. The Company believes that its customer mix and its ability to adjust the types of apparel it manufactures will mitigate its exposure to such trade restrictions in the future.

Under the laws of the PRC, as a wholly foreign owned enterprise, in the fiscal year ended December 31, 2004, Goldenway was entitled to a 50% reduction in its income tax rate, from 24% to 12%. In the fiscal year ended December 31, 2005, Goldenway as a wholly foreign owned enterprise that exported over 70% of its products outside the PRC, is eligible for a 50% reduction in its tax rate from 24% to 12%. From 2006, Goldenway has an income tax rate of 12%.

The Company markets and sells its products through a combination of international distributors and direct sales to brands and retail chain stores primarily in Europe, the United States and in Japan.

Our cost of net revenues consists of the appropriate materials purchasing, receiving and inspection costs, inbound freight where applicable, garment finishing fees, direct labor, and manufacturing overhead, including the Company's contributions to a government mandated multi-employer defined contribution plan, packing materials and others. In addition, from time to time we subcontract manufacturing, which costs are included in our cost of net revenues.

Selling expenses consist primarily of transportation and unloading charges and product inspection charges.

General and administrative expenses consist primarily of related expenses for executive, finance, accounting, facilities and human resources personnel, office expenses and professional fees.

Results of Operations

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005The following table summarizes the Company's results of operations. The tableand the discussion below should be read in conjunction with the auditedfinancial statements and the notes thereto appearing elsewhere in this report.Results of OperationsYear Ended December 31, 2006 2005 $ % $ %Sales 22,332,386 100.00 % 10,813,961 100.00 %Gross Profit 4,088,991 18.31 % 2,101,396 19.43 %Operating Expense 2,027,831 9.08 % 969,663 8.97 %Income From Operations 2,061,160 9.23 % 1,131,733 10.47 %Other Income (Expenses) (255,725) (1.15 )% 73,487 0.68 %Net Income 1,493,425 6.69 % 1,043,540 9.65 %

Revenues, Cost of Revenues and Gross Margin

Revenues

Revenues for the year ended December 31, 2006 were $22,332,368, an increase of 106.51% from $10,813,961 for 2005. Our increase in revenues was primarily attributable to an increase in sales to customers in Europe, the US and in PRC. In 2006, sales to customers in Europe increased by $9,980,946 or 185.14 %, sales to customers in the U.S. increased by approximately $2,627,360 or 192.2 % and sales to customers in PRC increased by approximately $484,535 or 69% as compared to 2005.

Cost of Sales and Gross Margin

Cost of sales for the year ended December 31, 2006 was $18,243,377, an increase of 109.39% from $8,712,565 in 2005. As a percentage of revenues, cost of sales increased to approximately 81.69% for 2006 from approximately 80.57 % for 2005. Consequently, gross margin as a percentage of revenues decreased to approximately 18.31% for 2006 from approximately 19.43 % for 2005. Of the 1.12% decrease in gross margins, approximately 0.83% is attributable to an increase in the material purchasing price and approximately 0.26 % was attributable to increases in labor costs, which could not entirely be passed on to the Company's customers.

Export Quota Charges

Export quota charges in 2006 was $153,997 compared with Nil in 2005. The charges were mainly attributable to the bidding expenses for export quotas of certain categories of apparel products paid to the Chinese government.

Selling, and General and Administrative Expenses

Selling expenses in 2006 increased by 429.72% from $85,108 in 2005 to $450,832 in 2006. The increase in selling expenses was mainly attributable to an increase in transportation and logistic costs.

General and Administrative expenses in 2006 increased by 48.64 % to $888,447 from $597,727 in 2005. The increase of general and administrative expenses was mainly attributable to the increase of the expenses related to the investor relations activities.

Salaries and Allowances

Salaries and Allowances of the management in 2006 increased by 122.65% from $213,825 in 2005 to $476,071. The increase was mainly due to the increase in salaries for our management. We believe that such increase was necessary for us to support our business expansion and to implement our strategic plan of future growth.

Interest Expenses

Interest expense was $285,876 in 2006 compared to $74,284 in 2005. The primary reasons for the increase in interest expense were increase in our short term bank loans associated with our construction. In August, 2006, we entered into credit agreements with Nanjing City Commercial Bank to borrow an aggregate principal amount of up to $6.41 million that mature within twenty-four (24) months. As of December 31, 2006, our loan balance was $4,482,180 compared to $611,247 in 2005. This loan bears interest at monthly rates at 0.4875%

In addition, as of December 31, 2006, the Company has borrowed $4,859,656 from a related party primarily to fund the increase registered capital of Goldenway. Interest paid to this related party totaled $235,859 as of December 31, 2006. The Company did not enter any written agreement with this related party.

Income Tax Expenses

Income tax expenses in 2006 were $312,010, an increase of $150,330 from $ 161,680 in 2005. The increase was primarily due to the increase of our operating income.

Net Income

Net Income in 2006 was $1,493,425, an increase of $ 449,885 or 43.11% from $1,043,540. The increase was mainly attributable to the increase of our net sales.

LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2006, the Company had cash and cash equivalents of $660,096, other current assets of $9,573,443 and current liabilities of $12,978,980. To date, the Company has financed its operations primarily from operations and cash flow from operations is expected to continue to be the Company's primary source of funds to finance its short-term cash needs.

Net cash used in operating activities for 2006 was $1,333,799, compared with net cash provided by operating activities of $3,209,669 in 2005. The Company's primary source of operating cash flow was net income of $1,493,425. The decrease in our net cash was attributable to the increase of our accounts receivable of $3,284,045 as the result of the increase of net sales, as compared to the year of 2005.

Net cash used in investing activities was approximately $8,448,971 in 2006, compared with $2,519,904 in 2005. The increase was primarily attributable to construction costs of approximately $5,953,033 associated with our new office building and factory, and the purchase of new manufacturing equipment of approximately $2,535,218.

Net cash provided by financing activities was $8,730,589 in 2006, compared with $611,247 in 2005. On August 23, 2005, we entered into a short-term loan agreement with a bank pursuant to which we borrowed approximately $610,000 at an interest rate of 6.138% per annum for the purchase of raw materials. The loan matured and was paid off on August 23, 2006. The funds were used for the purchase of raw materials. The borrowings were guaranteed by Jiangsu Ever-Glory International Group Corporation, a related company.

On August 15, 2006, the Company, through Goldenway entered into a credit agreement with Nanjing City Commercial Bank to borrow an aggregate principal amount of up to $6.41 million that matures within 24

months. The loan is secured by our new facilities and is used to fund the construction costs as well as our daily operation. As of December 31, 2006, we have borrowed $4,482,180 with the interest rate of 0.4875% per month. The borrowings can be extended upon maturities on demands within the 24 months. We plan to repay the loans with the cash flows from our operation. In the event we do not have available cash flows from our operation to repay these loans, we will consolidate and refinance the loans upon maturities.

In addition, as of December 31, 2006, the Company has borrowed $4,859,656 from a related party primarily to fund the increased registered capital of Goldenway. Interest paid to this related party totaled $235,859 as of December 31, 2006.

Capital Commitments

The Company has a continuing program for the purpose of improving its manufacturing facilities. The Company anticipates that cash flows from operations and borrowings from banks will be used to pay for these capital commitments. Pursuant to the Articles of Association of Goldenway, registered capital of approximately $17.5 million must be paid into Goldenway by February 1, 2008. The increased registered capital will be paid-in in installments within three years of the issuance of Goldenway's updated business license. As of December 31, 2006, the Company has paid $2.6 million of its registered capital requirements. The remaining $14.9 million is due on February 1, 2008.

Upon closing of "Catch-Luck" transaction, the company will pay Ever-Glory Hong Kong an amount of $600,000 representing cash consideration.

Uses of Liquidity

The Company's cash requirements through the end of fiscal 2006 are primarily to fund operations and to complete the new manufacturing facility in Nanjing. The Company plans to acquire additional manufacturing capacity in the future to strengthen and stabilize its manufacturing base. The Company is also looking to establish its own distribution and logistics channels in overseas markets and to launch its own brand directly to the Chinese market. In addition, the Company will need to make the required capital contributions to its subsidiary, Goldenway.

Sources of Liquidity

The Company's primary source of liquidity for its short-term cash needs is expected to be cash flow generated from operations, and cash and cash equivalents currently on hand. The Company believes that will be able to borrow additional funds if needed.

The Company believes its cash flow from operations together with its cash and cash equivalents currently on hand will be sufficient to meet its working capital, capital expenditure and other commitments through December 2006. For its long-term cash needs, the Company is currently considering a number of different financing opportunities including debt and equity financing. Adequate funds may not be available on terms acceptable to it. If additional funds are raised through the issuance of equity securities, dilution to existing stockholders may result. If funding is insufficient at any time in the future, the Company will develop or enhance its products or services and expand its business funded by its own operation cash flows.

As of December 31, 2006 the Company had outstanding borrowings under a credit facility with a bank of approximately $ 4,482,180. As of December 31, 2006, the Company did not have any standby letters of credit or standby repurchase obligations.

Foreign Currency Translation Risk.

The Company's major operations are in the PRC, which may give rise to significant foreign currency risks from fluctuations and the degree of volatility of foreign exchange rates between the United States dollar and the

Chinese Renminbi. Sales of the Company's products are in dollars. During 2003 and 2004 the exchange rate of RMB to the dollar remained constant at 8.26 RMB to the dollar. On July 21, 2005, the Chinese government adjusted the exchange rate from 8.26 to 8.09 RMB to the dollar. In 2006, the RMB kept on appreciating to the dollar. By the end of 2006, the market foreign exchanges rate was increased to 7.8087 RMB to one dollar. As a result, the ongoing appreciation of RMB to dollar negatively impacted our gross margins for the year ended December 31, 2006. We are always negotiating order 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 pass some increase of the cost to our customers.

In addition, the financial statements of Goldenway (whose functional currency is the 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 year. All exchange differences are recorded within equity. The foreign currency translation gain for the years ended December 31, 2006 and 2005 were $ 532,746 and $5,621, respectively.

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. The most critical accounting policies and estimates are:

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates in 2006 and 2005 include the allowance for the useful life of property and equipment.

Inventories, consisting of raw materials and finished goods related to the Company's products are stated at the lower of cost or market utilizing the specific identification method.

Fair value of financial instruments, our financial instruments consist of accounts receivable, accounts payable and accrued liabilities are reflected in the financial instruments. The fair value of financial instruments approximate their recorded values.

We recognize revenue upon delivery to our customers for local sales and upon shipment of the products for export sales, at which time title passes to the customer.

Details regarding our use of these policies and the related estimates are described in the accompanying financial statements as of December 31, 2006 and for the years ended December 31, 2006 and 2005. During the year ended December 31, 2006, there have been no material changes to our critical accounting policies that impacted our consolidated financial condition or results of operations.

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.

RECENT ACCOUNTING PRONOUNCEMENTS

In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments" (SFAS 155"), which amends SFAS No. 133, "Accounting for Derivatives Instruments and

Hedging Activities" ("SFAS 133") and SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities" (SFAS 140"). SFAS 155 amends SFAS 133 to narrow the scope exception for interest-only and principal-only strips on debt instruments to include only such strips representing rights to receive a specified portion of the contractual interest or principle cash flows. SFAS 155 also amends SFAS 140 to allow qualifying special-purpose entities to hold a passive derivative financial instrument pertaining to beneficial interests that itself is a derivative instruments. The Company is currently evaluating the impact this new Standard, but believes that it will not have a material impact on the Company's financial position.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets-an amendment to FASB Statement No. 140 ("SFAS 156"). SFAS 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. We do not expect the adoption of SFAS 156 to have a material impact on our results of operations or financial condition.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109 ("FIN 48"), which clarifies the accounting for uncertainty in tax positions. This Interpretation provides that the tax effects from an uncertain tax position can be recognized in the Company's financial statements, only if the position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of fiscal 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact this new Standard, but believes that it will not have a material impact on the Company's financial position.

In September 2006, FASB issued Statement 157, Fair Value Measurements. This statement defines fair value and establishes a framework for measuring fair value in generally accepted accounting principles (GAAP). More precisely, this statement sets forth a standard definition of fair value as it applies to assets or liabilities, the principal market (or most advantageous market) for determining fair value (price), the market participants, inputs and the application of the derived fair value to those assets and liabilities. The effective date of this pronouncement is for all full fiscal and interim periods beginning after November 15, 2007. The Company is currently evaluating the impact this new Standard, but believes that it will not have a material impact on the Company's financial position.

In September 2006, FASB issued Statement 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, which amend FASB Statements No. 87, 88, 106 and 132(R). This statement requires employers to recognize the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability in its financial statements and to recognize changes in that funded status in the year in which the changes occur. The effective date for the Company would be for any full fiscal years ending after December 15, 2006. The Company is currently evaluating the impact this new Standard, but believes that it will not have a material impact on the Company's financial position.